International Financial Management - Wall-Mart - Essay Example

?INTRODUCTION Business of Multi-National Corporations receives impact from wide range of factors. Success of multi-national corporations’ business model is not only leveraged from successfully investing in local markets but at the same time must have portion of asset deployed in other countries to generate revenues. Wall-Mart being Multinational Corporation has invested significantly in the international markets with core objective of growth. Recently closed fiscal year accounted around 39.2 percent of the Wall-Mart’s resources (in terms of capital expenditure) invested in international portfolio. Moreover, Wall-Mart also has projected plan to invest further 37% of its US $ 13.05 million and 38 percent of US $ 12.5 million of capital investment in the international market for the year 2013 and 2014 respectively. Significant portion of the above mentioned investment is aimed at adjustments and capturing e-commerce retail sales in US, Brazil and China (Wal-Mart, 2013). In light of the Wall-Marts decision to invest and since the conditions of the world are constantly changing; therefore, underlying report is aimed at exploring factors that affect the foreign direct investment in specific context to China. The report will provide comprehensive review of foreign direct investment arena of China that determines its attractiveness. Furthermore, assessment of the FDI scenario of China with reference to global financial crises and the current position will be highlighted. Finally the improvement recommendations will be made. IMPORTANCE OF INVESTMENT AVENUES ASSESSMENT Foreign Direct Investment, in accordance with the definition of World Bank, is investment leading to ten percent stake ownership by an organization that is not domestic by origin. MNC’s have been making investments in foreign investments since past 200 years but these investments centrally constituted portfolio investments than green field business purpose, wholly owned subsidiaries or joint ventures (Vardar, 2011). Liberalization of economies led to the relaxation of paths for the foreign investors by removing barrier (Vardar, 2011). Factors that drive multinational corporations towards investment in international arena are concretely dependent on either the objective of growth of diversification. Though increasingly important driver of the country’s economies; FDI also benefits extensively to the investing companies in response to taking risks and costs in international markets. Companies usually undertake foreign investment decisions when export and licensing such as tariffs and quotas etc are prone to increased costs and risks than benefits. Alike, Wall-Mart many other corporations such as Coca-Cola, Exxon Mobile, Tesco, Starbucks, Nokia etc all have invested their stakes in the foreign markets. Complimenting to growth and diversification, factors that influence international investment are highlighted as follows: Significant reduction in transportation cost is gained. Attractive markets may turn unprofitable on shipping or transporting of products in bulk from local market to long distance markets. Internationalization and FDI stake in market, according to internationalization strategy, gets attractive once the cost, difficulties and limited level of control in licensing mode restrains corporations from gaining actual benefits from international markets. Investment in international markets also forms an important dimension of strategic behavior of gaining dominant position in the international market. This factor adds significant value to the firm in comparison with competitors by gaining first mover’s advantage. Stages of the product’s life cycle where demand of the product increases to considerable extent in the international markets leads to firm’s investment in the international market. In most instances, the maturity stage of product’s life cycle leads to FDI in international market. Each country in the world offers some advantages that are not offered by many other markets or locations in the world. Other than market attraction, factors such as low cost manufacturing, raw material facilitation or processing are offered by different markets of the world. These location based advantages also attract companies for investment. Weigh of any single or more of these factors by the countries attract FDI. All these factors prove true in terms of Wall-Mart’s presence in China. Huge market with rising middle class in China, maturity of the retail grocery industry in local markets, international competitions among world grocery retailers etc have also made China an important destination for Wall-Mart for Greenfield investment. Moreover, rising e-commerce trend in China attracts Wall-Mart to gain the first mover advantage by investing the Wall-Mart’s e-commerce facilitation to its customers. FACTORS INFLUENCING THE GLOBAL FLOW OF FOREIGN DIRECT INVESTMENT OECD’s primary measures revealed that Global FDI in 2012 has been around US $1.4 trillion (OECD, 2013). This amount includes decrease of about 14 percent of FDI in 2011. FDI trend across years for inflow and outflow is presented below: (OECD, 2013) The trend above shows segregated FDI trend for EU, G-20 countries and OECD in addition to the world. There has been high consolidation of FDI in 2012 and five countries of all hosted 44 percent of the total FDI (OECD, 2013). Chart below reflects the lion share holder (China) along with other four major share holders: (OECD, 2013) FDI for the year 2012 being 1.405 trillion though constitutes significant amount; however, it is still 14 percent lesser than the movement of investments in 2011 (OECD, 2013). This situation calls for assessment of factors that affect the FDI movement to and from the country. GENERAL REVIEW As a matter of fact multinational corporations are constantly evaluating best destination for their resource deployment. Resource receiving countries, on the other hand, are also constantly striving to attract and become destination of MNC’s business branch. Countries by hosting investments gain benefits in wider aspects than financial support only to their balance sheet. For instance, investment provides job opportunity to human capital of the host country. In addition, this hosting also facilitates the increased interaction with developed countries to learn and adopt knowledge transfer, technological and managerial expertise etc. Turkey, currently target destination of MNCs, on turn of century attracted MNCs as production facilitator as well as business revenue generation location by providing goods and services to the Turkish markets. Change in Turkey’s preferences of FDI received great impact from structural reforms that resulted in growth of local economy by 6 percent annually from 2002 to 2008. For the mentioned growth factors at play included political stability, government policy liberalization and openness to attract the FDI etc (Vardar, 2011). Most important factor that attracted MNCs to invest in India remained the offering of production efficient destination with wage adjusted skilled labor location based advantage (IMF-CMCG, 2003). Countries in the Eastern Europe attract MNCs FDI with attractively developed infrastructure rather than cost effectiveness (IMF-CMCG, 2003). Study aimed at exploring the factors that affect FDI in developing countries produced distinct results for upper middle, lower middle and lower income countries. Players like per capita GDP, level of urbanization, living standard, inflation, wage level and current account of the country influence the MNCs decision to invest in lower income countries. In addition, similar study also revealed that countries with status of lower middle income are able to attract FDI from MNCs based on their conditions in terms of labor force, urbanization, standard of living, wages level, trade facilitation, current account and external debt. Countries that are accounted as upper middle income countries influence the MNCs decision to invest on the basis of their positions in terms of per capita GDP, urbanization, level of domestic investment, level of trade freedom and assistance and level of external debt (Yasmin, Hussain, and Chaudhary, 2003). For the developed countries, study concluded the determining factor of FDI for US is large market size or more appropriately stated as GDP only (Meier, n.d.). FACTORS AFFECTING FDI FLOW IN CHINA As noted earlier, China shared significant 18 percent of the total FDI receipts from the countries abroad. Core statistics of China’s FDI position is presented as follows: FDI POSITION OF CHINA FDI (INFLOW) FOR 2012 USD 253 BILLION COMPARISON WITH 2011 11% HIGHER INVESTMENTS BY CHINA IN 2012 IN OTHER COUNTRIES USD 62.4 BILLION FDI INFLOW AS PERCENTAGE OF GDP 2012 2011 2010 2009 2008 3.1% 3.1% 3.1% 2.3% 3.9% FDI FLOW AS PERCENTAGE OF GDP 2012 2011 2010 2009 2008 0.8% 0.6% 1.0% 0.9% 1.2% (OECD, 2013) This position of FDI has also received impact from wide number of factors. Furthermore, the most of the FDIs in China have been in form of green field investments. Study stated that China has attracted the FDI based on the location advantage it offers. Important to mention is the fact the referred location advantage is not spread across the entire China and carry differences in terms of short and long term investments. The paper developed evidence that role of location of province dominates the location advantage that China offers to MNC. Furthermore, FDI from all the sources are not aimed at single motivation such as New Industrialized Countries and countries under Association of Southeast Asian Nation direct FDI to China for its export orientation while developed countries direct FDI to China more with market orientation (Xinzhong, 2005). Another study assessed the FDI trend in China from 1983 to 2011 and ascertained that FDI in China is affected by factors is largely affected by specific period of investment. Furthermore, the factors including exchange rate, consumption level and consumer price index has also played significant role in determining the level of FDI in China (Wu and Fang, 2012). Most recently in the June 2013, China witnessed the intense rise in FDI with total amount of US $ 14.4 billion. Market analysts attribute this growth to the investors’ short term and long term confidence in China’s economic value chain and consumption trends (Reuters, 2013). FDI FLOW TREND IN CHINA IN SPECIFIC REFERENCE TO 2007 CRISES (World Bank, n.d.) Noticeable from the above graph is the fact that China didn’t notice decline immediately from the global financial crises. Instead FDI in the year 2008 increased from USD 156.24 billion to USD 171.53 billion. This trend is in contrast to global FDI that declined from USD two trillion of FDI inflow to USD 1.81 trillion as evident from the global FDI trends below: (UNCTAD, 2013) 2009 noted decline in the FDI position of China from USD 171.5 billion to USD 131.05 billion (UNCTAD, 2013). This decline was limited as China’s economy had constraint exposure to the sub-prime mortgage loans of US; the bubble of which burst and drowned the many economies. The revival of China’s economy in 2010 with increased amount than reported declined self reflects (notable) immunity of China from crises (UNCTAD, 2013). INVESTMENT DIFFICULTIES Investments in cross border countries are prone to various issues along with the benefits it offers. Among risks that needs to be accounted to successfully reap benefit from cross border investments include dealing with country risk, political risk, exchange rate risks etc. FDI in form of green field investment or mergers and acquisitions are also required to assess the cultural factors in detail to ensure the accomplishment of desired rate of return from the FDI cost incurred. Among various risk that impacts most to FDI are exchange rate risk and political risk. These two risks are assessed below: Exchange Rate Risk The exchange rate of the US Dollar against the Chinese Yuan as of July 29, 2013 has been 6.13. In the recent days, the parity of US dollars against the Chinese Yuan increased from 6.2408 Yuan to 6.24. Analyst recommendations on this increasing parity are increased pressure on the Chinese currency for appreciation (Stock Market Watch, 2013). Importantly, any investor with exposure to international market cannot escape the exchange rate risk. For Wall-Mart alike other companies for whom China was export oriented destination this rising parity increases cost, curtails profits and hence ultimately affects income. The challenge has increased for US companies where dollar has declined in value by 30 percent in past three years while contrastingly China is revaluing its Renminbi. Rising exchange rate risk also results in the other risks such as strategic risks of inability to the meet the demand in the international market etc. Exchange rate also negatively affects the operational efficiencies such as increased costs and other supply chain costs etc. Financial risk arising from exchange rate risks includes loss in the value of assets as well as trading losses etc. Hence, single factor of mismatch of cost and revenues if not managed with exchange rate risk affects the entire cash flows of the companies (Mahidhar, 2006). Political Risk The political risks also accounted as the country risk is on the higher end for China. In the earlier era the environment for the doing business for China had been unfavorable. The policy environment in China was regarded as one aimed to deter FDI to China (Graham, 2001). Political risks in international business arises from factors leading to the discontinuity of business, difficulty in forecasting business trends in future or change in political set up also results in political risk (Filipe, Ferreira, Coelho, and Moura, 2012). Presence of many multinational firms in China is reflective of measures that Chinese Government has taken measures to increase the political viability of China for business. For instance, China committed WTO to open up its avenues for foreign players in five years time in 2001 (Xinzhong, 2005). With respect to political risk, Kim (2010) states the FDI are attracted in countries with higher level of corruption in the government. Further, Kim (2010) revealed that politically stable countries are more prone to invest in countries with lower level of political stability. Assessing China on this scale, Corruption Perceptions Index 2012 ranked China on 80th position (with 39th or 3.9 score) among countries assessed. Corruption in China over year has increased as score of China was 3.6 in 2011. This is significantly higher level of corruption as ranking of United States is 19th on the index in 2012 (Kim, 2010). RECOMMENDATIONS TO REDUCE THE RISK EXPOSURE Exchange rate risk and political risk are now accepted factors for the MNC and are required to take measure to deal with their impact. For the exchange rate risk, MNCs cater it in dual ways. First, in terms of natural hedge and second mode refers to financial hedging. Natural hedging refers to integrating supply chain in a manner where costs are also incurred in markets from where revenues are generated. For instance, BMW sales in China were constantly rising; however, due to exchange rate factor from 2005-09 negative impact of €2.4bn was reported. Hence, BMW hedged the risk naturally and integrated supply chain in China. It expanded its supply chain and established production unit in many countries of consumption while leveraging proximity benefit to other countries close to existing of manufacturing units. Similarly, Joint venture with China’s Brilliance China Automotive was established in Shenyang, China and by 2009 Rmb6bn worth of cost’s supplies were bought from within China only (Bin and Ying, 2012). This strategy works for the long run hedging. The other form of financial hedge was conducted to control the exchange rate risk in short term. Financial derivates since charge premium gets costly in the long run and are used for hedging risk in the short run (Mahidhar, 2006). To mitigate the political risk, MNCs in general and Wall-Mart in specific are required to tighten measures of auditing the financial performance. Moreover, the whole decentralized units are also not feasible for the MNCs and must be kept under the regulatory check of headquarters. Finally, MNC shall assess the capital investments and budgeting at higher rate of required return to mitigate the impact of exchange rate political rate risk. CONCLUDING REMARK Government of China has already taken significant measures to attract the FDI as observable from the fact that China had been most attractive target for FDI from MNCs. In 2010, Chinese government has increased liberalization measures to attract increased FDI. For instance, in 2010 China raised ceiling level of the examination and approval authority on foreign projects provincially. Similarly, in 2011 in case if any specific requirement is not required, China also lifted the approval requirement for establishing a branch for MNCs. In order to facilitate the MNCs for exchange rate risk mitigation China shall provide benefits to MNC for expanding value chain set ups in China for the products and services that are consumed locally. Well structured mechanisms shall influence increased control over rising corruption. Though this will negatively affect the FDI in short run in line with proven relationship in the study of Kim (2010); however, would prove to be beneficial for China in long run. References Bin, X., and Ying, L. (2012). The case study: How BMW dealt with exchange rate risk. Available from http://www.ft.com/cms/s/0/f21b3a92-f907-11e1-8d92-00144feabdc0.html#axzz2aQBKwTQR [Accessed 25 July 2013] Filipe, J., Ferreira, M., Coelho, M., and Moura, D. (2012). FDI in political risks: the new international context. Int. J. Trends Fin. Eco. Sc., vol. 2, no. 2, pp. 117-124 Graham, E. (2001). Foreign Direct Investment in China: effects on growth and economic performance. 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Available from http://www.turkishweekly.net/article/343/factors-of-investment-decision-for-multinational-corporations-the-case-of-turkey.html [Accessed 25 July 2013] Wal-Mart. (2013). Walmart reinforces financial priorities: growth, leverage and returns; company lowers fiscal 2014 capital plan from current year. Available from http://news.walmart.com/news-archive/2012/10/10/walmart-reinforces-financial-priorities-growth-leverage-returns-company-lowers-fiscal-2014-capital-plan-from-current-year [Accessed 25 July 2013] World Bank. (n.d.). Foreign Direct Investment, net inflows (BoP, current US$). Available from http://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD [Accessed 25 July 2013] Wu, S-X., and Fang, H. (2012). Empirical Analysis of Factors Affecting China's FDI. Advances in Applied Economics and Finance (AAEF), vol. 3, no. 3, pp. 583-590 Xinzhong, L. (2005). Foreign direct investment inflows in China: determinants at location. Available from http://sdocumen.ish-lyon.cnrs.fr/cnrs_cass2/sites/www.i-conf.org.cnrs_cass2/files/16_Li_Xinzhong.pdf [Accessed 25 July 2013] Yasmin, B., Hussain, A., and Chaudhary, M. (2003). Analysis of factors affecting foreign direct investment in developing countries. Pakistan Economic and Social Review, vol. XLI, no. 1&2, pp. 59-75. Available from http://pu.edu.pk/images/journal/pesr/PDF-FILES/5%20YASMIN%20Analysis%20of%20Factors%20Affecting%20FDI%20in%20Developing-V41-2003.pdf [Accessed 25 July 2013] Read More