The Effect of Problems in the Euro Zone on International Business - Example

Report on The Effect of Problems in The Euro zone on International Business Student's Name Institution Table of contents Executive Summary 3 1.1 The context 3 1.2. Background 4 1.3. Purpose of the Report. 5 2.0. Method section 6 2.1. Design 6 2.2. Sampling Procedure 6 2.3. Reliability 6 3.1. Causes of the Euro zone Crisis 7 3.2. Emergency Measures taken to stem the Crisis 7 3.3. Impact on Local Businesses in the Region. 9 3.4. Global Impact on Businesses and Industries 9 3.5. Impact on Shareholders 11 3.6. Political Influences Which Might Affect Business. 11 4.0. Results/Findings section. 11 5.0. Interpretation of the results. 12 6.1. Recommendations 13 7.0. Reference List 14 Executive Summary This report aims at assessing the effect of problems in the Euro zone on international business. It introduces the client to the context and background of The Euro zone crisis. The report analyzes the impact of the crisis on local businesses; the impact of the crisis on local businesses; the impact of the crisis on shareholder value and the wealth of the most affected companies; and the short, medium and long term political influences which might affect business. The findings are summarized and the results of the findings are analyzed and interpreted comprehensively. Recommendations on the measures that companies should take to caution against actual and potential business risks are given so as to assist McKinsey & Co clients with strategy creation in the Euro zone and in regions affected by the Euro zone crisis. 1. Introduction 1.1 The context The Euro zone crisis refers to a sovereign debt crisis in The European Union. It’s a fiscal crisis that has made it impractical for some countries to refinance or repay their sovereign debit without being assisted by other countries or third parties. The problem can be traced to The Maastricht Treaty of 1992 which was signed by member states of The European Union whereby they agreed to limit their debt levels and deficit spending (Smith 2012, P. 25). Trouble struck in the early 2000s when some members of The European Union failed to abide by the provisions of The Maastricht criteria and had to turn future government revenues into securities in order to reduce deficits and debts. The sovereign states sold their rights to future revenues which made it possible for them to earn revenue without violating the deficits and debts targets set in The Maastricht Treaty (Smith 2012, P. 26). The countries masked their debt and deficit levels through combining backdoor techniques such as off-balance sheet transactions. 1.2. Background The decision by eleven European states to turn their national currencies into a single currency was made on 1st July 1999. The decision came ten years after The European Monetary Union had been conceived in 1989 by a team comprising of leaders of central banks in 1989. The conception of the European Monetary Union had led to signing of The Maastricht Treaty in 1991. The treaty had established the “convergence criteria” which was essentially a set of rules and guidelines for countries willing to join the monetary union (Pryce 2012, P. 121). Assenting to the criteria was a pre-condition for qualification to join the union and spelt out regulations relating to national debt, interest rates, inflation, exchange rates and budget deficits. The United Kingdom, Sweden and Denmark opted not to join the monetary union from the very date of inception (Smith 2012, P. 28). The Euro monetary system comprised of The European Central bank with the central banks of the participating member states being responsible for the monetary policy of the union. A large region of Europe came to share a common currency but with very stark differences due to the fact that the states were sovereign nations with autonomous and independent systems (Arestis 2011, P. 78). The Euro replaced domestic currencies in the member countries. The European monetary union grew from a membership of eleven countries in 1999 to a membership of seventeen countries in 2011(Pryce 2012, P, 120). Ever since the Euro came into existence there has been skepticism on its future and survival as some members had failed to meet the guidelines set under the treaty. However, the Euro performed very well in the initial years. The European Central bank established a target system that connected large value payments made across borders in The European Union (Pryce 2012, P. 122). Through the system similar products or instruments exchanged in distinct national markets were regarded as close substitutes. Since it was easy for financial institutions across the union to borrow abroad, financial innovations and positive competition increased (Arestis 2011, P. 79). The growth in credit was reflected in the housing sector as the financial and construction industry grew rapidly. The growth in those sectors spurred macroeconomic vulnerability as the boom in property prices translated the credit growth into a debt climax. The fast growth hid the faults in the fiscal system which got exposed with the worsening public debt and fiscal deficit (Redlich 2012, P. 154). The global financial meltdown of 2007-2008 triggered the debt crisis in the Euro-zone and growth levels declined rapidly. It became apparent that low interest rates had led to excessive lending which had left governments with large fiscal deficits and public debts; and banks with bad debts (Arestis 2011, P. 80). 1.3. Purpose of the Report. The purpose of the report is to assist clients with strategy creation in The Euro zone and in other regions affected by activities in The Euro zone. The report assesses the actual and potential business risks and advises clients on the impact of those risks on international businesses. 2.0. Method section The research was investigative, analytical and prescriptive. It relied mainly on secondary sources of information as well as primary sources. Secondary sources included books and articles. The internet was also a very useful source of information. Magazines and newspaper articles were also used. Primary documents included instruments such as the Maastricht treaty, The European Union Charter, and other legal and commercial instruments governing trade and international relations in The Euro zone. 2.1. Design The researcher used descriptive research to establish the effect of problems in The Euro zone on international business. The Ex Post Facto Research design was used in this study since the researcher did not develop new findings but examined and analyzed existing data. The design was chosen because it was the most effective way of obtaining valid data that was required for the study. 2.2. Sampling Procedure The research employed both probability and non-probability sampling. In countries worst hit by The Euro zone Crisis the researcher used purposive sampling technique in order to get the required data with minimized margin of error. 2.3. Reliability The procedure selected for collecting data was examined critically to assess the extent of its reliability. Pre-testing helped in enhancing the reliability of the instrument as being a consistent measure of the concept being studied. The diverse secondary sources of data used in preparing the report were reliable since they were written by different authors from different parts of the globe and hence avoided bias. 3.0. Analysis of the Euro zone Crisis 3.1. Causes of the Euro zone Crisis The introduction of The Euro as a common currency meant that the Euro zone was a monetary union without a fiscal union. This prevented national central banks or the European Central bank from financing or monetizing government deficits. Countries were following a similar fiscal path without a common treasury (IMF 2011, P. 12. Spending was regulated on a national level subject to the prevailing political circumstances in the member state. The deficit and debt ratios in the economies that suffered would have been controlled had there been a fiscal union as it would have been possible to regulate national financial institutions (Broeck & Guscina 2011, P. 35).The other cause was variation in productivity within the Euro zone. Unemployment rates are very different. The capacity of the member states to weather the global financial crisis was not similar as some super economies such as Germany were meant to outdo the rest. 3.2. Emergency Measures taken to stem the Crisis Greece was the first to admit that it had an understated fiscal deficit. The Greek government debt had been downgraded by rating agencies. In the final quarter of 2009, Greece’s public debt was over 113% of The GDP, higher than the Euro zone limit of 60 %( Smith 2012, P. 29). By the first quarter of 2010, there was a full blown sovereign debt crisis in The Euro Zone, with Greece being at the fore front. A bailout package was put together for Greece by the international monetary fund and The European union on 2nd May 2010 in order to restore investors’ confidence. The bailout was on the condition that Greece was to implement austerity measures (Pryce 2012, P. 124). On 9th May 2010, the member states of The European Union created The European Financial Stability Facility (EFSF) to maintain financial stability in Europe by offering financial aid to Euro zone members experiencing financial difficulties (IMF 2011, P. 15). The EFSF was instructed to sell bonds and use the proceeds to give loans of up to 440 billion Euros to Euro zone countries in trouble. The bonds were to be guaranteed by The European commission, the euro zone member countries and the international monetary fund. The EFSF combined funds from The European commission and the IMF to obtain a fiscal safety net of up to 750 billion dollars (Redlich 2012, P. 156). The European Central Bank then began buying government debts as a method of reducing bond yields. Greece was instructed to privatize state enterprises and mobilize 70 billion dollars. The Irish republic was bailed out with 85 billion Euros by the IMF and the European Union in November 2010 and passed the most frugal budget in its history that year (IMF 2011, P. 16). In 2011, Portugal admitted that it could not deal with its debts and had to be bailed out by The European Union. In July 2011, an extraordinary summit was held in Brussels where the leaders agreed on a further bail out for Greece through participation of the private sector and the IMF. The agreement included a reduction in interest rates and extension of loan repayment periods (IMF 2011, P. 10). The lending conditions proposed for Greece were also extended to Ireland and Portugal (Broeck & Guscina 2011, P. 39). Analysts say that the Cyprus crisis is the worst and could threaten the very existence of The European Union. 3.3. Impact on Local Businesses in the Region. The Euro Zone crisis began by affecting the peripheral economies in The Euro zone, but it spread and began affecting the core economies in the zone. The Euro zone accounts for 19.4 % of the world’s economy while the entire European Union accounts for approximately 26 %( Arestis 2011, P. 81). The Euro zone crisis therefore not only threatens the European economy but also the global economy as the Euro zone is a significant world market. The crisis has had both economic and political consequences as its creation was integral to European integration. Thomas Reuter’s data revealed that energy, consumer goods and health care are the most exposed economic sectors in The Euro Zone (Redlich 2012, P. 157). The giant economies of German and France have been particularly affected. They face large exposures since they have been involved in the bail-out measures. The United Kingdom also faces negative repercussions because even though it is not a member of The Euro zone, British banks have played a substantial role in helping the troubled countries in The Euro Zone (Pryce 2012, P. 126). Local businesses have lost a lot of revenue due to austerity measures and the unwillingness of creditors to invest there. 3.4. Global Impact on Businesses and Industries The Grant Thornton international business report revealed that the euro zone crisis has had a negative impact on four in ten businesses in the globe creating losses of about 2 trillion US dollars(Redlich 2012, P. 158).Global businesses and industries which export products to the Euro zone are bound to suffer heavy losses due to the debt crisis. In the United States companies dealing with auto components, automobiles, food and tobacco firms suffered the most from the crisis. They include General Motors, General Electric and McDonald’s. United States banks were also exposed by the crisis with Citigroup’s exposure being $13.5 billion, with Bank of America at $16.7 billion and JPMorgan Chase at $14 billion. In South Africa, revenues declined by 15 billion US dollars as a result of the crisis (Arestis 2011, P. 83).In The United States, the crisis caused revenue to fall by 10% in 11% of the businesses. The Euro zone crisis has also had an impact in the emerging markets of India and China. The euro zone and indeed Europe as a region is a significant market for the countries. Due to the Euro Zone crisis, The HSBC China Manufacturing company dropped from a rating of 50.0 to 47.7 in a month’s time, its lowest level over a period of thirty two months (Arestis 2011, P. 84). The European Union is a major trading partner with India accounting for 13.3% of India’s imports and 20.2% of India’s exports. Bilateral trade beaten the two has been growing on an average of 9.6 %( Smith 2012, P. 30). The Euro zone crisis has therefore had adverse impacts on India’s exports. Young and Partners revealed that the number of mergers and acquisition in the chemicals industry fell from twenty seven in the first quarter of 2010, to eighteen in the second quarter, to sixteen in the last quarter (Redlich 2012, P. 161) 3.5. Impact on Shareholders American stock markets and European stock markets are strongly correlated. A study by the Deutsche bank revealed that from the onset of the global financial crisis and the subsequent Euro Zone crisis, American markets have been driving European markets. Global equity markets react highly to events in Europe (Arestis 2011, P. 85). The shareholder value and wealth of those holding shares in the most affected companies will reduce significantly. Shareholders and investors are moving assets and money-market funds elsewhere to reduce risk. 3.6. Political Influences Which Might Affect Business. Politics and political policies will influence business in the Euro zone. The Euro zone may have to embrace both a monetary union and a fiscal union to ensure similar fiscal policies and transfers between rich and poor countries (Pryce 2012, P. 127). The European central bank would also be capable of executing the role of a central banker and regulate the fiscal policies in the union. The other radical measure would be for the most affected economies to leave the Euro zone or to disband the European monetary union and to stop relying on a single currency (Redlich 2012, P. 170). Businesses should be testing their trading systems to handle the possibility of the euro zone collapsing and the consequences of countries reverting to using their national currencies. 4.0. Results/Findings section. Despite the measures taken there are serious doubts on the capacity of the affected countries to service their debts. The combined efforts of the European Central Bank, economic and political communities has avoided the total collapse of the economic bloc but should not be taken as an indicator that all is well since they only serve to mask the underlying problem. The measures taken have failed to alleviate the fiscal problems and financial markets in the world remain skeptical about the debt crisis. The economies of all G7 countries are struggling and while the GDP of the US has recovered, the GDP of counties in the Euro-zone has not. The policies that have been put in place to get the Euro zone on track are therefore not politically and economically feasible. European banks will be short of capital for a considerably long period. 5.0. Interpretation of the results. Austerity will not help in addressing the crisis as it will only bring the economic growth to a standstill. Further bail outs will result in major losses for businesses. Banks may also exercise strict fiscal policies reading to an uncompetitive environment that is unhealthy for businesses. Since the Euro zone may collapse, another currency could redominate mismatching the liabilities and assets in the contracts of companies with suppliers and customers. It is highly likely that the liquidity of companies operating in the region will dry up. Companies must make measures to caution themselves against the worst possible situation. 6.0. Conclusion The response to the Euro zone crisis by the European Union, the European Central bank and the IMF has only served to worsen the crisis. The recession in the Euro zone is likely to continue. Projections of the International Monetary Fund and the World Bank show that throughout Europe, economies continue to slowdown. The growth projections of reducing budget deficits by France, Portugal and Spain are optimistic but very unrealistic. Managers and boards of multi-national companies must draft contingency plans preparing a “worst case scenario: where one or more countries may exit the Euro zone due to a sovereign debt default. 6.1. Recommendations Local and global companies operating in the Euro zone must plan and analyze a balanced assessments of opportunities, tax risks, legal risks, and commercial risks of continuing to operate in The Euro zone Companies with investments Iain Europe, especially in the worst hit countries, should move their assets elsewhere especially in the emerging markets such as China, India, Brazil and South Africa. Companies should avoid rigid management strategies as either a strong economy or a weak economy could exit from the Euro zone. Strategies should be flexible to accommodate any extreme outcome. Companies operating in the Euro zone should have the location of their bank deposits reviewed and specifically state the currency in which they want contractual payments to be made. For instance they should expressly state that even if a country was to exit from the Euro zone, they would still be paid in Euro so as to avert liquidation incase the Euro zone collapses and currencies are redominated. Companies should also be keen on clauses regarding the place of jurisdiction and the governing law to apply in case of disputes when entering into contractual arrangements. The choice of a struggling country’s law as the governing law and choosing the jurisdictions of its courts could have fatal economic consequences for a company. Companies should also put a currency indemnity clause in their contracts to have a cover against the consequences of redenomination. Companies should also see the opportunities in the crisis and take the chance to buy troubled assets in Europe at relatively low prices. The assets can be sold elsewhere or they become very lucrative when countries in the Euro zone recover and become stable once again. Companies should identify the most likely transfer pricing and tax risks so that they can understand the practical action they would take in case of a breakup of the Euro zone. Companies should accelerate collection of money owed to them by contracting parties in the Euro zone; they should also consider moving their assets and revenues from banks in the economically weak countries to banks in the strong countries. Reducing operation costs for entities in the Euro zone advisable. For example, General motors’ reduced its workforce in Europe by 5, 800 and closed one of its plants in Belgium. Companies should borrow before the credit dries up and hedge floating interests now before rates are pushed up by likely credit squeeze. 7.0. Reference List Arestis, P. et al. (2011). An assessment of the global impact of the financial crisis. Basingstoke, Palgrave Macmillan, pp 78-95. Broeck, M., & Guscina, A. (2011). Government debt issuance in the Euro area the impact of the financial crisis. [Washington, D.C.], International Monetary Fund. http://bibpurl.oclc.org/web/24285/2011/wp1121.pdf, pp35-50. IMF (2011) Euro Area Policies: Spillover Report 2011, Washington DC, Accessed on 12 August, 2011. http:// www.imf.org/external/pubs/ft/scr/2011/cr11185.pdf, pp 10-36. Pryce, V. (2012). The Euro crisis and why politicians don't get it. London, Biteback, pp 120- 130. Redlich, S. (2012). From the financial crisis to the European debt crisis research on Developments and Analysis of Potential Impacts and Consequences. MüNchen, AVM, pp 154-180. Smith, P., & Oreiro, J. (2012). The Financial Crisis Origins and Implications. Basingstoke, Palgrave Macmillan. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=729818, pp 25-35. Read More