Why does the country like Venezuela impose capital controls

Read case answer question

Name

Professor

Institution

Course

Date

The Venezuelan Bolivar Black Market

Why does the country like Venezuela impose capital controls?

Introduction

Governments generally impose capital controls to prevent or limit the movement of its capital out of the country. However, it is necessary to note that the government of Venezuela can impose capital controls to ban the movement of capital to the other countries. The capital control can take a number of forms; but the most common one is the Capital controls that are directed at the control of capital flows like bank loans or portfolio investments. According to David, (2009), government mainly imposes capital controls if the costs of allowing the free movement of capital across its border outweigh the benefits. The desirability of this form of control have attracted a lot of attention in the recent past, for example, the when the Venezuelan government under the leadership of Hugo Chavez imposed the capital control, there were debates on the legality and practicality of the capital control. However, the government may to impose capital controls because of the following reasons as in the case of the Venezuelan government:

i) Controls represent to the Venezuelan government a most favorable macro prudential policy that promises to reduce the extent of financial crises it is facing. In this way, the government will also have an opportunity to prevent the associated externalities. The government therefore, limits the systemic risks in the banking sector.

ii) The Venezuelan government feels that the country’s economic growth will be averagely higher if it imposes capital controls. Michael, & Barton, (1995) argues that there is a positive correlation between capital control and growth. For example, during the Breton wood periods, the overall global economic growth was relatively higher than now that there is free movement of capital. The Venezuelan government was at the brink official crisis, therefore, it had to control the amount of capital entering or leaving the country, thereby arresting any father capital outflows

iii) Foreign assets: the number of Venezuelan residents owning foreign assets was on the increase, probably due to the insecurity and uncertainties during those times. It was therefore, prudential to invest in oversea countries. The government had to impose control on this outflow, thereby ensuring that the domestic credit is relatively available and cheaper than the foreign credit. The government ensures that the domestic businesses have access to cheap loans while the wealthy residents provide the government with funds.

iv.) Capital controls and financial fragility. Uncontrolled capital flows in to the country results into negative economic developments. Michael, & Barton, (1995) attributes this to the erosive nature of the capital inflows on the value of the country’s currency. This cause makes the currency appreciate thereby leading to inflation. In times of inflation, the government experiences unsustainable monetary boom. From experiences, economic booms come before financial crisis as there will be a sharp reversal of the capital inflows and the domestic and foreign capital moved to other countries. Venezuela is a developing country; therefore, if the inbound loans are high, the debt increases and the currency value fall, causing the country to pay dearly as foreign currency will dominate the foreign loans. Any further fluctuation in the value of the currency makes foreign loans expensive.

in the Venezuelan case, what is the difference between grey market and black market

The republic of Venezuela has a number of economic markets in which goods are traded legally and illegally thorough different channels. The country has both black and grey market based on the mode of operation and the channels of distribution. In the case of Venezuela, Santiago’s case is the most relevant case study for this; he earns his money in the right way but cannot use it to distribute his pharmaceutical products. This is the grey market because they engage in illegal trade through the sale of legally accepted products. However, the pattern of distribution is unauthorized, as the original manufacturers do not accept such a mode of distribution. It is necessary to note that the grey market is composed of illegal distribution geared at evading paying taxes or contributing to any public service like social security. Additionally, there are two main forms of grey market in Venezuela, the one dealing with the imported manufactured products, which are relatively expensive in Bolivian and unissued in other countries. This is relatively related to the secretive and technically trade in various commodity futures.

Black market

On the other hand, a black market is an economy where traders engage in the buying and selling of capital is not regulated. It might involve the exchange of illegal gods and services. In the black economy, it is necessary to note that most of the regulatory rules such as taxation and equal measures act do not apply. In such parallel economy, the number of goods traded can vary on demand and supply and the prices of such gods are not commensurate to the value, it is a form of extortion. This trade in Venezuela is seen in the trade of hard currency, by depositing bolivars to the brokers account for exchange with US dollars.

Q#2)

a) Impact of foreign exchange rates on various countries

The fluctuation in the exchange rates of various currencies bring with it Various benefits and loses, however, the most profound is the loses especially for the XJP which operates internationally. Most of the market share of the products produced by JXI. Any loss in value is kroner lead to the financial gain in ZXI. However, the opposite is true if the economic value of the kroner falls. This is to say that, unless the company invests in futures to cushion itself from the financial ruin posed by the exchange risks. The people who own shares in the XJP will lose the value of the kroner falls, and the capital base of the company will not be stable anymore.

Management of the exchange risks

The company needs to consider various ways of managing it s exchange risks exposure. The transaction exposure that the company faces includes payable denominated in foreign currencies. The company should determine a better way of setting an optimal date for settling liabilities and receiving account payables. The company should determine how it could gain while discharging its debt obligation due to other companies as results of exchange rates. The company can achieve this optimally when the final date of its settlement is in the area of foreign currency weakness

As a regulatory requirement if the FASB Statement no. 52, the company should know how to translate the foreign currency by including the FC transaction gains and losses while determining its net income. A company might consider hedging the exposures. Managers can hedge their exposures by pricing and settlement. However, a company can also consider hedging through forward contracts, leading, netting, lagging, or rein voicing. The company can achieve this by negotiating its prices for receivable in its local reporting currency, thereby shifting the risk to the other arty involved in the transaction. If the company cannot realize the benefits of negotiating for reporting in the local currency, it can negotiate for early payment of the value of its local currency. This strategy involves negotiation of an early payment of the accounts payables before the foreign currency fluctuates bellow a certain level. The company can also use the time value of money by buying forward contract in foreign currency, thereby offsetting the company exposure related to foreign currency assets or liability situation (O’Sullivan, &, Sheffrin, 2003).

b) Divisionalisation in the XJP

The concept of divisionalisation or decentralization is a highly effective mode of operation for the company operating multinational. The companies have one head quarters in one country; however, the company operates as a division. Like the XJP case, the company has its Head office, but each division as its own branch. For example, if the company realizes the value of its currency in one country is extremely low, the company can use the weakening currency to hedge against the strong currency. For example, if the currency of a subsidiary company if the of the XJP is falling, they can use that currency to pay for the value goods and service in another country with a falling currency thereby maintaining their strong currency.

If the currency of a country in which one of their subsidiaries is operating in is strong, the company can use the strong to discharge its debt obligation for payables with strong currency.

Suffice to say, XJP can cushion itself from the fluctuation in the value of its currency by determining the currency of the subsidiary with a strong currency thereby mitigating the foreign exchange risks.

c) Relationship, between spot exchange rates, expected exchange rates and , budgeted exchange rate, forward rates and the expectation of the Chinese subsidiary results by the US parent company

Actual spot exchange rates: the actual spot exchange rates are the price that buyers of foreign currency pay for the currency. Traders usually set this for two days due the globally accepted settlement cycles of the foreign exchange contract. It is different from the budgeted spot exchange rates in that the budgeted exchange rates might not be effective due to constant fluctuation. It is just an estimate and might not be useful. On the other hand, the foreign exchange rate is the rate at which banks are willing to exchange currencies from one to another at a predetermined future date. This is like a forward price, which the bank and a client agree upon with a client to pay for the exchange of one currency to another.

The government determines this rate by considering the spot exchange rates and the difference in the exchange rates between different countries. These exchange rates are quite different, the parent company may set the performance goals for the Chinese subsidiary, and however, the company might not meet the expected exchanhangertaes because of the sharp change in the value of the foreign currency. For example, if the parent company budgeted the exchange rates Rmb10.50/Euros, then the spot exchange rates fall below that, the Chinese subsidiary may be seen as an underperforming branch. However, if the rate increased beyond a certain level, financial position of the Chinese subsidiary might appear bullish

3,) If I were Paul young I would easily hedge out the funds of the company against strong currency to cushion me from the loses associated with the exchange rates fluctuation. This fluctuation might have an impact on the reporting price of the company profits and assets. This means that the company uses its assets to cushion itself from the exchange risks (Michael, Arthur,. & Eiteman, 2008)

Q#3 A Small Country in a Global Capital Market

a) Do you think countries as small as New Zealand and Iceland are more or less sensitive to potentials impacts of the global capital movement?

All countries are sensitive to global capital movement. However, small countries are more sensitive and susceptible to this capital movement by virtue of their small economies. For example, if the level of economic activities between the resident of the country in foreign countries increase, the countries can experience a complete financial ruin. Any slight instability in the capital base of the country can destroy the country.

b) Use of interest rates to protect the currency of a country

If countries very their interest rates with the aim of protecting their currencies, for a long time, they are exposed a number of risks. The main risk is the instability of its currency in the end. No country can maintain a stable currency, therefore the country would have to very its exchange rates with the fluctuation in the exchange market,

The practice also exposes the country to credit risks, as the country currency would be easy to determine. This might attract foreign investors into the country, who might fly with their currency at the end of their trading period or during financial crisis. Movement of foreign currency in large quantity is called capital flight, which has a very negative impact on the currency of the country.

c) Disruptive current account deficit

Obstfeld, & Taylor (2004), states that while a country manage a stable current account deficit, there was no reason for panic as the country assumes that the current account deficit would be sustainable, however there comes a time when the country experiences a complete reversal of the trend and the deficit disrupts reversals. This trend occurs when the country start experiencing debt crisis and the ability to finance the current account deficit collapses. Taylor, (1996), discuses that the country’s growth falls by a large percentage making putting the count try at the mercy of extranet debtors. The implication of this includes fall in the value of the dollar, the inflation of the general price of imports. The government might react to this by increasing the interest rates. The government might also have to reduce consumptions and investment sharply and reduce assets valuation.

References

Taylor, A., (1996), “International Capital Mobility in History: The Saving-Investment

Relationship,” NBER Working Paper no.5743.

Michael L. & Barton A.,(1995).Retailing Management Second Edition. Irwin Mc Graw Hill

David S. (2009)., Gray Markets: Prevention, Detection & Litigation. Oxford University Press.

O’Sullivan, A. & M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey: Pearson Prentice Hall.

Michael H., Arthur I. & K. Eiteman, (2008). Fundamentals of multinational Finance. (3rd Edition): Addison Wesley;