Multinational financial management theory and practice

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Foreign exchange rate policies during a financial panic

In order to avoid further down-turn, the central bank should carry out the following payment mechanisms that will keep the economy intact. First and foremost, the central bank should prevent panic sparked off by bad companies from getting to good banks. This implies that the central bank must give sufficient reserves to good banks to meet the withdrawal of deposits but not enough for them to extend new loans to help speculation against currency. Another step is for the central bank to ensure that customers, especially exporters, for the banks which have failed continue to receive credit so as to keep the production going on. This means that the functions of failed banks must be kept alive by the central bank as it restructures the balance sheet for their final sale. The central bank should allow for currency depreciation by floating the currency so as to avoid capital inflow. If the amount of working credit remains unchanged, domestic firms will take an advantage of the depreciating currency and increase their exports CITATION Par01 l 1033 (Park, 2001). The resulting increase in exports will bring about a recovery from the economic down-turn. The growth will restore confidence in the economy, prompting domestic firms to repatriate their capital from abroad. The result will be an appreciation in the value of currency from its depreciated state, although not often to the pre-crisis state CITATION Lee11 l 1033 (Lee & Lee, 2011).

Asian financial crisis in Thailand

Thailand reduced its liquid foreign exchange reserve in a bid to protect its currency. When the Thai baht fell against the dollar in value, regional currencies increased in value, causing the cost of foreign debt to skyrocket. This triggered the financial crisis whereby most countries of the South East Asia were rendered bankrupt. Therefore, these countries could not be able to pay their financial debt and required a lot of financial aid from multination financial aid organizations such as the IMF. Thailand’s baht lost 52 percent of its pre-crisis value against the dollar CITATION Bat08 l 1033 (Batum Corporation, 2008). IMF provided financial support to these countries with the aim of restoring investor confidence and removing Thailand from the hook of the crisis. However, the funds seemed to exacerbate the flight instead of reducing its effects. This is because it served to emphasize domestic financial weakness hence diminishing investor confidence. The economies that suffered the economic crisis are now teaming up to self insure themselves against the consequences of balance of payments difficulties experience earlier. The country has managed to reserve foreign currency so as to avoid another financial turmoil. The regional policy makers and firms were avoiding unbridled financial liberalization and therefore issued few external bonds.

Thailand was praised by the World Bank for being receptive to foreign investment, having market friendly philosophy and being outward looking. Its reception of foreign investment made it a home for many Japanese manufacturing companies. However, this was the main contributor to its collapse when the financial crisis hit Asia. The bank of Thailand tried to maintain the baht-U.S dollar peg by buying currencies that were being traded. This was done by use of official foreign reserves. By the end of July, 1997 the remaining option for Thailand was to replace the fixed exchange rate with a managed float since it could tap no more reserves. A request for loan by Thai’s finance minister was turned down which led to his call for IMF’s assistance. This had been fifteen years since the last call on IMF for assistance. The government was forced to set as its economic objective a budget surplus of 1% of its GDP CITATION Man03 l 1033 (Manuer & Ayatolla, 2003). This was as a result of the restrictions imposed by IMF following their financial aid. The expected revenue was expected to fall to a certain value which forced the Thailand to cut its spending and increase taxes. This further brought down the economy. This saw a decrease in the decrease in employee salary and even laying off of workers. There was a nationwide decrease in retail sales by four percent in the first three-quarters of 1997. Import for consumer goods reduced by one percent during the same period. The investment by private institutions shrank considerably by during the year. The heavy depreciation of baht led to an increase in the amount of export by 26%. The increase in exports was seen as a possible turn from the downturn of the financial crises CITATION Lin10 l 1033 (Lindsay, 2010).

The stiffening of the monetary policy in order to raise interest rates to curtail further currency depreciation, the sudden closure of poorly performing financial institutions, a significant cut in budget outlays and the increase of prudential ratios created a huge credit crunch that deepened the financial crisis in Thailand. To honor its exchange rate commitment, Thailand depleted its foreign exchange rate reserve. The move was to defend its overvalued currency. With the fall in reserves, foreign creditor companies panic and demand an immediate repayment of their loans. It is evident that the Asian financial crisis brought the economy of Thailand to its knees CITATION The07 l 1033 (The Economist, 2007). Multinational companies in Thailand were not spared in its wake. The measures that the country took to control the crisis served to worsen it as its economy deteriorated further. The call for aid from the IMF to cushion their down-turn attracted stiffer restrictions from IMF. The limit by IMF was to see a cut in their financial budget by a certain percentage. This further depreciated baht hence leading to a further financial turmoil. Multination companies in Thailand suffered a big blow as most of them registered a loss. It is estimated that a single multinational company registered an abnormal (-1.43%) loss in its monthly income. Currency derivatives use and potential working hedging strategies did not protect firms from the Asian financial crisis. IMF ordered the closure of up to 58 companies in Thailand. Multinationals were not spared. This is probably due to the magnitude of the panic and the resultant lack of liquidity in the market of the derivatives during and after the crisis CITATION Mor12 l 1033 (Morodum Inc., 2012).

The measures taken by Thailand are not very attractive taking into consideration that it is still grappling with the then financial crisis. It has never returned to its initial state. The financial bailout from IMF was a good turn for them which saw them bend their knees further. This serves as a lesson to Thailand and other countries. The slow recovery of Thailand from the turmoil is reflected easily by the slow growth of the multinational companies still present CITATION Wes02 l 1033 (Weston & Allayannis, 2002).

Asian financial crisis in Malaysia

The Malaysian experience from the crisis shows that Asian countries have liberalized their financial sector and still contain their financial flows through selective capital regulations or control in order to prevent speculation. Malaysia resorted to a controversial capital control as a result of the crisis. Domestic coalitions between the private and the public sector in Malaysia have had a significant contribution to the economic growth of the country between 1998 and 2007. When financial crisis hit South East Asia, Malaysia responded promptly by embracing IMF-like measures (Gitman & McDaniel, 2009). Tight monetary and fiscal policies were implemented in order to defend the Ringgit, limit interest rate hikes and slow credit growth. The first policy, macroeconomic, implemented by the government under the guide of the then Deputy prime-minister Anwar Ibrahim failed to exude confidence in investors and hence exacerbated the crisis. Owing to the worsening crisis, the tight fiscal policies transformed to an expansionary one with higher capital spending and tax reductions in the month of August 2008. The shift was not enough and the country embarked on the controversial exchange and capital controls. The main aim of this was to remove speculations against Ringgit, limit capital flight and gain monetary independence for Malaysia (Hansen & Guan, 2009). The measures taken were: the Ringgit was pegged at RM 3.8 per US dollar, investors were refrained from withdrawing their financial investments in Malaysia for at least one year, Ringgit trading outside the country was prohibited so as to cut down on offshore Ringgit trading market, the transfer of funds outside the country was subject to approval, trade settlements in Ringgit, as well as international lending and borrowing were prohibited, and export and export of Ringgit banknotes were restricted CITATION Nau74 l 1033 (Nauman-Etienne, 1974).

This decision was contrary to international financial market’s expectations. In fact, rating agencies downgraded Malaysia, its sovereign bonds were increased relative to those of Korea and Thailand and Malaysia was gotten rid of from major investment indices. This was as a result of the measure it had taken which brought uncertainty on their influence on direct foreign investment. Initially, financial sector regulation was better established in Malaysia than most of its neighbors. This was because of the central financial reforms Malaysia had undertaken CITATION Sha02 l 1033 (Shapiro, 2002).

Capital controls in Malaysia was met with a lot of resentments as multinational companies and other foreign investors thought that Malaysia was going to experience extreme slowdown and hence would not be able to recover from the financial crisis. However, after its absorption in September 1998, Malaysia experienced a strong and fast recover y from the economic meltdown. The ban of offshore trading brought a stop to capital flight which allowed a decrease in interest rates and business expansions (Field, 2009).

The capital control policy by Malaysian government greatly impacted on the business of multinational companies. The uncertainty in the measures taken by the government led many multinational companies withdraw their investment in Malaysia. This was brought about by the fear for any further economic melt-down. The declines in exports, as well as consumer confidence were among the biggest setbacks for multinational companies as their product could not gain the wider market and hence registering huge losses. The financial crisis led to many workers being laid off. This negatively impacted on multinational companies because the government policy preferred the laying off of a foreign worker to a local worker (Moss, 2007). However, the reduced interest rates attracted other multinational companies. Investors were attracted by the cuts on their investment charges. The country did this in order to regain its image economically as investors would bring an economic through reduction of unemployment and payment of taxes to the government. Portfolio investors who had been denied the chance to withdraw their finances were worst hit because reinvestment on their part could not be realized. This meant that they had to wait for a year or more in order to make huge investments from their finances in the Malaysian banks CITATION Bha00 l 1033 (Bhalla, 2000). Multinational companies which also had their finances banked with Malaysian banks could not invest in other better performing economies as they were financially tied. In a general perspective, multinational companies were negatively affected by the financial crisis. The companies made huge losses, laid off most of its workforce and others opted out of Malaysia immediately CITATION Lip11 l 1033 (Lipson, 2011). It is of importance to note that Malaysia recovered fast from the turmoil and hence those multinational companies present then also experienced a strong economic growth too CITATION Zum08 l 1033 (Zumkehr & Edo, 2008).

Multinational companies in Eastern Asia generally faced negative and significant effects from the credit crunch. The response strategy by Malaysian government was the best choice in the case for it speeded up the recovery of the state from its state of bankruptcy. For multinationals in Malaysia, the experience was the same. The recovery of the country brought a simultaneous recovery in the multinational companies. The companies’ growth was significant, although they were not reinstated. Malaysia is one of the economies to emulate in South East Asia as it took a very different approach towards managing the crisis. Unlike other countries, it did not subscribe to borrowing from IMF. It adopted a capital policy which saw it rise faster than other countries like Korea and Thailand CITATION Ril12 l 1033 (Riley, 2012).

References

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