Financial and Economic environment of South Africa - Term Paper Example

Lecturer Financial and Economic environment of South Africa relative to South African using an online US website Introduction The International monetary Fund and the World Bank have argued it to venture into globalization to increase its business operations so as to reduce its dependence on financial aids. For South Africa to expand its businesses to other nations it has learned of the environment of the global markets. There are also factors that will affect international business, they are, cultural, political and economic factors. Political events in are of great concern because they influence the cost of doing business, the social and economic stability of countries, the accessibility to the human and non human resources (Fung, et al, 32). They also have security and safety implications and have effects on the transfer payments. Most ideas, principles and legal concepts used in international transactions often find expression in the legislative acts and policies of nation states. Although many forces besides economic factors help shape world trade, it cannot be denied that the economic component of international relations is the most significant and that generally, a prosperous and stable international business environment. Aspects of returns and risks From the website www.cia.gov, it evident that there are a number of aspects that affect the countries return and risk on investment to a business, some of this include; Ratio analysis used to obtain the company’s financial performance in many key areas. The ratios include the liquidity ratios that point out the easiness of turning assets into cash and they include current ratio which measures the financial power, the quick ratio which concentrates mainly on liquid assets whose value is sure, and working capital which is more of cash flow measure than a ratio. The leverage ratio shows the degree to which the business is dependent on debt financing. The gross margin ratio is the proportion of sales dollar left following the subtraction from the net sales the cost of goods sold. The net profit margin ratio which is the proportion of sales dollars left after subtracting the cost of goods sold and every expense excluding income taxes. Inventory turnover ratio which discloses how well the inventory is being controlled. Accounts receivable turnover ratio which shows how well collection of accounts receivable is being done, if receivables are slow in being transferred to cash liquidity could be damaged (fxTrade, 6). The return on assets ratio which indicates how well profits are being created from the assets employed. The return on investment ratio which is the proportion of return on owner’s funds invested in the business, it also indicates whether the effort put into the business in worthwhile. Information technology is used to process and analyze accounting transaction. The input devices regularly linked with the accounting information systems comprise the typical personal computers or running applications workstations, running applications, devices for scanning, standardized data entry scanning devices, electronic data interchange for electronic communication devices and e-commerce. The basic processing is realized through computer systems variety from individual personal computers to large scale enterprise servers; however the fundamental processing model is the double entry accounting system (Pomeranz & Topik 82). The output content may include any type of financial reports from tax reports to budgets. The use of also management information system which offers human/machine interactive that supports decision making for users both out and in the organization boundaries. This system support daily operated activities of the organization, future and current tactical decisions, and on the complete strategic direction. The financial applications make up the management information system which commonly implemented modules include, the payables, general ledger, receivables, procumbent, inventory, projects, assets and budgeting. Accounting information system covers all business functions from complicated processing functions and financial management planning to account transaction processing system. Financial reporting begins at the operational levels of the organization where the transaction processing systems capture significant business events e.g. selling and purchasing activities, these events are categorized and summarized for external financial reporting and internal decision making(Pomeranz & Topik 106). The cost accounting systems are used in service and manufacturing environments, these help the organization to follow the costs linked with the production of goods. The accounting information system also provides complex analyses for improved resource distribution and performance tracking. Management accounting system is used to help an organization in the planning, monitoring and controlling of a wide range of activities. The systems can be used to assemble information, to develop a variety of scenarios and to decide on the optimal answer among different scenarios. The internal reports to different managers in helping them in improving their departmental performance include the performance reports which use budgets to compare budgeted amounts to actual expenditures, performance reports help managers to plan for future demand in production as well as cost increases. Budgets reports also help in departmental performance because the department should try to accomplish its goals and objectives while within the budgeted amounts, budgets list all revenues and expenses. And the cost reports helps managers to control and plan the profit margins, the report helps managers to see the cost prices of goods versus selling prices. Risk evaluation is used to determine the consequence of risks to the business. To evaluate risk it is advisable to rank these risks once identified, which can be done by considering the consequence and likelihood of each risk. This can be done through comparison to business plan, e.g. determining which risks may affect the objectives, and assess in the light of legal requirements, costs and investor concerns. Tools to use in risk evaluation include a risk map which an organization can plot the significance and likelihood of the risk occurring and each risk is rated on a scale of one to ten. The map helps to visualize risks in relation to each other, determine their degree and plan what type of controls to implement to reduce the risks. To prioritize risks allows directing time and money to the most significant risk. Putting up controls and systems, could involve defining a decision process and escalation measures to follow should the event occur. Financial analysis is procedures and methods used to verify the past, present and future status and business performance with the intention of knowing how the business performed in the past, how it performs at the present, and use data for forecasting purposes, and making decisions about business performance. Techniques of financial analysis include horizontal and vertical analysis, horizontal analysis is the comparison of two or more year’s financial data, and vertical analysis is the process of preparing and presenting common sizes statements. another technique is the ratio analysis which is a benchmark by which means of which relationship among two or a variety figures can be compared .to evaluate a return is done by dividing the investment by the cost of the investment .efficiency is the measure of how well the organization is doing. Efficiency can be measured through evaluation of the performance by determining what the organization is supposed to achieve. Another way to measure efficiency is through budgeting. Another way is through control which ensures that managers and subordinates are doing the right thing. Balance of trade between US and South Africa As revealed from the website www.census.gov/foreign-trade/balance, recent statistics of studies carried out, it was revealed that South Africa exported an estimated US$288 billion worth of merchandise to the US in the year 2006 while it imported an estimated US$55 billion worth of merchandise in the same year. Even though the pace of integration between South Africa and US is on an increase making trade relations between the two countries more complex, the governments are currently formulating ways in which they can avoid any more complications and conflicts as a result. Additionally, the current United States and South Presidents are attempting to resolve the tension that has existed between South Africa and the United States regarding trade disputes as well as issues pertaining to human rights. As in this case with a number of international trades between nations, there are bound to be issues involving financing trade between the trading countries and South Africa and the US have not been spared from such issues. It is estimated that some 80% to 90% of international trade is dependent upon trade finance where by mid 2009 the trade finance market has been observed to be experiencing difficult times which may contribute to global economic malaise. Possible issues raised by the United States strategy of economic engagement with South Africa include response to South Africa’s unfair trade practices, the rise of an economically powerful South Africa that is rapidly developing more assertiveness in global affairs and adjustment in terms of economic competition in sectors where South Africa has a comparative advantage. Surveys conducted indicate that imports from South Africa by the United States may be subsidized, unfairly aided or dumped by government entities in South Africa which still greatly influence the economy. Imports from South Africa may also be penetrating the US in such great quantities that they are a substantial cause of threat or serious injury to competing US companies and industries. Economic relationship especially in respect to trade flows between a developed and developing country is said to cause some amount of political friction. Rising United States imports from South Africa have been on the debating table for the past 20 years where the country’s trade deficit with South Africa is often mentioned by major business and news press. Inflation and depreciation in South Africa South Africa experienced high fluctuation around 1990 that greatly affected the country’s economy negatively. Reports say that the inflation rate reached 95% at around March 1990. Consequently, the country’s economy went down and in turn putting the citizens in many problems of trying to cope with the situation. There was an increase in the prices of goods, the interest rates and difficulty in running other businesses. This was brought about by the change in the fiscal and monitory policies in the country that went further to affect the country’s GPD. Then, the GPD went down for a long time. South Africa’s attempted to stabilize its currency was through the Convertibility program. This involved the creation of the currency board that had a fixed exchange rate. Here, the board was expected to give complete support in the U.S. dollars whenever there was Rand (ZAR) given out. Also, the U.S. dollar was made as lawful tender in South Africa. However, the currency board laws were very strict in that they restricted the government from running fiscal deficits and fund them by making more money. It also restricts the Central Bank from going after a dynamic monitory strategy (Nobile, 33). This meant that the citizens could exchange their goods and assets for home currency at affixed rate. In addition, they were allowed to have more foreign currency at a fixed exchange rate. These rules were aimed at limiting the government’s economic strategy alternatives. More so, they were meant to give the citizens an assurance of no more risks in having more domestic currency than the foreign currency. This program indeed helped the country economic point to enhance. It led to the fall of the inflation rate from the monthly rate of approximately 11% in 1991 to 8% in 1993. The exchange rate has increased because the rate of inflation did not decrease with the fixed exchange rate. This in turn led to the decline in the trade balance and the present account. Educations become expensive to in the United States and the number of students enrolling in US universities went down. Exchange rate South Africa has implemented a floating exchange rate system that is managed and regulated since July, 21 2005 (Matsubo & Karkomi, 20).This is based on the supply and demand in the market as well as reference to currency packages instead of pegging itself to the single USD. Rand exchange rate, reform’s general objective is to establish an exchange rate system which is sound as well as maintain the Rand exchange rate basic stability on a level which is rational and balanced (Matsubo & Karkomi, 22). When the Rand was calculated on July 21, 2005, to the US dollar on the basis of an exchange rate which is at a level that is balanced and rational, it was revaluated by 2 percent. The South Africa government allowed its currency to fluctuate against the currencies basket. The basket comprised the euro, the dollar, the Korean won and the yen. The factors that were put into account were direct investment, trade, capital transactions that are, external claims and debts (Matsubo & Karkomi, 36). Currently, South Africa has been able to gradually decontrol its foreign exchange management. They have adopted 0.3% narrow band on the central rate’s either side within which the Yuan can be able to fluctuate against the dollar. However, it’s hard to make a profit by hoping that the Rand will appreciate. It’s hard for the one-off appreciation and depreciation of Rand, as the country has kept a responsible attitude to promote actively and gradually, the Rand exchange rate reform. The shift that was made by South Africa’s exchange rate system drew substantial attention as the press and economists expressed doubts on how effective the RMB conducted its revaluation as its rate was too scant to be able to satisfy their expectations (Matsubo & Karkomi, 41). Apart from the RMB revaluation of 2.1% there has been a steady appreciation of the RMB. Nevertheless, the appreciation overall rate is about 3% as it was indicated on March 19, 2006. Though the South Africa monetary authority did not markedly appreciate their currency, its flexibility was increased relatively. Investing an imaginary US$10,000, my current position is 65,442.8 Rand (CNY) (OANDA, 2011). Factors that would trigger this outcome include; Interest rates: Central banks ‘benchmark’ interest rates influence the financial institutions retail rates that they charge to customers when they borrow money. In instances where the economy is underperforming they lower interest rates in order to make it cheaper for customers to borrow (fxTrade, 11). This activity boosts customer spending helping expand the economy. In order to slow inflation rate in an economy which is overheated, they raise the benchmark making borrowing expensive. Investors that seek a balance between safety of funds and yield returns find interest rates a concern. Appreciation in interest rates increases yields for assets that are denominated in that currency thus, increasing the value of the currency. Depreciation in interest rates, leads to change from that currency to another one (fxTrade, 13). Employment outlook: The economic growth is affected immediately by the level of employment. Increase in unemployment reduces customer spending slowing down the economy, devaluating a country’s currency because of lower demand and decline in confidence (fxTrade, 12). The employed ones tend to save more and reduce spending as they worry of the future. Continuation of decline in demand, builds the currency supply depreciating the exchange rate further (fxTrade, 12). Expectations in Economic Growth: An economy must expand, in order to meet a growing populations needs. Rapid growth, increases price outpacing wage advances decreasing the actual buying power (fxTrade, 13). An economic growth rate of 2% is what most countries targets every year. Higher growth leads to higher inflation while slower growths lead to deflation. Trade balance: Balance of trade in a country is attained by reducing the total value of imports from the total value of exports. A positive outcome indicates a favorable balance of trade while a negative outcome indicates trade gap or deficit (fxTrade, 2011). Trade balance affects a currency’s supply and demand. Trade surplus increases demand of a currency this is because foreign buyers have to exchange more of their home currency for them to buy its goods. On the other hand, a trade deficit increases a country’s currency supply leading to devaluation if the demand is exceeded by supply greatly (fxTrade, 14).. Actions of central bank: To influence economic growth and directly intervene in the market, central bank is taking some other measures like quantitative easing. This involves purchasing government bonds and other financial institutions assets in order to increase liquidity in the banking system (fxTrade, 29). It is put into effect when lowering interest rates fails to boost the economy. Its disadvantage is it increases the currency supply which could lead to currency devaluation. If am sent to South Africa and am paid in US$ then by the end of my second year, I think I would be relatively better in terms of spending power. This is because the value of the US dollar is relatively higher than that of South Africa’s Rand. South Africa does not publicly announce the currently denomination or composition of its foreign exchange reserves and United States information from the government’s Treasury department are considered potentially misleading (Fung, et al .66). A lot has been said concerning trade deficit between the two countries where it is argued that the United States has been running a huge trade deficit against South Africa for the past few years and has led to problems (Pomeranz & Topik .166). From the website, http://www.cme.com/prices/daily_settlement.cfm, South Africa has experienced economic pressure and depreciation in the past effect of this hyperinflation in South Africa is that the government and the central bank lost their self confidence. The levels of investment were also affected in that they went down. There was a collapse in the real wages by half while the rate of poverty went up from 27% in 1980 to 47% in 1989. In addition, there was the reduction in the fixed investment in the industrial sector. There are various reasons that led to the depreciation’s in South Africa. One of them is the uncontrolled growth of money supply in the country. Research shows that the fiscal deficit rose in 1983 due to the increase in the amount of losses and the evasion of tax. As a result, the country could not effectively take part in the world market. The government then imposed inflation tax so as to pay off the fiscal deficits (retrieved from www.finance.yahoo.com, on 17/11/2011) The weakness of the country’s financial institutions was another cause of the unsteadiness of the Argentina’s currency. The country had a crisis at the banks and this caused the unsteadiness. Subsequently, the central bank decided to take away the commercial bank deposits in an attempt to beat the issue of liquidity in the country. Researchers reported that the there was an increased limitation on the country’s credit to the public sector. It further shows that the private sector was only allocated about 45% of the total home credit. Consequently, the money supply in Argentina dropped as some of its citizens owned more than US$50 billion in other countries. There are other external factors that also contributed to the currency crisis in South Africa. One of these factors is the change in the interest rate. Other countries raised their interest rates on the money borrowed by the Argentina’s government. One of these countries is the U.S. which tightened its financial conditions on its own financial institutions. This in turn made it very expensive to borrow money from its banks because of the increased reserve requirements. There was also a policy of the Central Bank Circular 1050 which was made in 1980. The policy fixed the payments in monthly installments to the U.S dollar’s value. This led to the rise in the charges hence bringing down the country’s financial confidence and increased the country’s economy pressure. . Exposure to foreign exchange risk Firms conducting international businesses and trading are the most vulnerable to foreign exchange rate risk exposure (Nobile, 33).Foreign investors investing in our country bring a lot of benefits to the local people especially developing countries like mine. They boost the national kitty trough tax payments and at the same time create job opportunities to the native people. As country, we might lose all these benefits because foreign exchange rate risk exposure(Soenen,21).In order to protect these investments it is prudent enough to allow them manage this risk through hedging. Foreign investors risk losing their investments in a number of ways and if they are not protected they may stop investing. Foreign companies from the US risk losing a lot of money because of the fluctuating nature of the US dollar value in South Africa country. Hedging should be allowed because it gives the foreign investors the confidence they need to invest. One way this companies might incur losses in the course of their investments is trough quoting of prices for contracts (Nobile, 35). Apart from quotation risk, there are other ways through which foreign investors can be exposed to foreign exchange rate risk. One such way is through the Interest rate risk exposure where an interest rate differential can occur between the two countries’ currencies involved in a foreign exchange contract (Nobile, 43).foreign investors investing in the stock market are exposed to a double risk. This is due to fluctuation in both the stock prices and the currency rates. According to Nobile (2044), hedging of speculative positions that arise due to adverse moves in foreign exchange rates is an important foreign currency exchange rate risk management method that is normally utilized by foreign traders to protect their investments. The same policy should be extended to the national currency regulation as this will be a vital step South Africa in stabilizing its currency against the dollar Work cited Cooperate Information. .Exchange rates. http://www.corporateinformation.com/Currency-Exchange-Rates.aspx?c=404.Retrived 2011-02-16. fxTrade . Top 5 Factors Affecting Exchange Rates. Retrieved from http ://fxtrade.oanda.com/learn/top-5-factors-that-affect-exchange-rates?banner_id=9461&zone_id=1551 on February 9th, 2011. Matsubo, Ken. & Karkomi, Simon. South Africa’s Reform on Exchange Rate System and International Trade between Japan and South Africa. Retrieved from http://docs.google.com/viewer?a=v&q=cache:Z6vBBrOnuHcJ:www.mof.go.jp/jouhou/soken/kenkyu/ron154.pdf+what+kind+of+currency+rate+system+does+South Africa+has&hl=en&gl=ke&pid=bl&srcid=ADGEESiYNBpYW0e_rdPa9BgKJwpawcrUi9CWVg-AIAsmHnenlTwTgW1hw6OFmVgiVwY7mtYjABJX0-0htBro2x6QrNGwMgu1fx0Ufb7nDUlvgwchSXDkggkvxvlEF5S-7yw4KY65D2bc&sig=AHIEtbTRyxO2OaR_QvomDyPSXl6wHnnasg&pli=1 on February 9, 2011. Nobile, John. Why hedge foreign currency risk?http:// ezinearticles.com/?Why-Hedge-Foreign-Currency-Risk?&id=33036.Retieved 2011-02-16. OANDA . Currency Converter. Retrieved from http://www.oanda.com/currency/converter/ on February, 09, 2011. Soenen, .Alex. Foreign exchange exposure management. http://alexandria.tue.nl/repository/freearticles/334449. pdf. Retrieved 2011-02-16. Read More