How Does Globalization Affect Financial Market - Research Paper Example

? How does Globalization Affect Financial Market? of the of the Summary Globalization and liberalization in the global economic system has helped to improve the level of economic well being of the developing countries and have successfully facilitated the growth of the developed ones. However, the integration of different marketplaces has made the state of economic and monetary affairs highly complex. Analysts find debatable issues of concern in many economic affairs. For instance, the relationship between the real exchange rate and the external foreign asset of a country has become a controversial issue. This is because globalization has created a wide-ranging affects in the financial markets of various economies. This essay will focus on the quantitative and qualitative analysis of globalization of the financial sector. The essay will use descriptive statistics to conduct the quantitative analysis. The paper will explain the impact of globalization in the capital, investment and the exchange rate market. The studies of the essay will help the researcher analyze the advantages and disadvantages of globalization in the global financial market. It will show how a single change in the financial market of one nation in the current world can affect the market conditions of all the other economies. Contents Contents 3 Introduction 4 Situation Analysis 5 Conclusion 17 References 18 Introduction The report will throw a light on the impact of globalization in the financial market. In order to implicitly analyze this statement, the paper will utilize both theoretical and technical tools of research analysis. After completing the analysis, the researcher will conclude with the empirical analysis. This is the era of globalization and liberalization. Globalization is the process that involves the international integration between the nations that takes place from the interchange of ideas, products, world views and culture between nations. In the contemporary world, the economic development of any economy is not possible without the effective contribution of globalization. Any development in the transportation, communication or internet segment of the market is only feasible with the contribution of globalization. This process has helped countries augment the living standard of individuals and substantially helped them to experience the usage of new goods and services. The growth of business activities in the modern economies has shown the requirement for contribution of financial sectors. The financial segment of any country includes the commercial banks, non-banking financial institutions and the central banks of the countries (Kang & Paper, 2007). The globalization process has largely influenced the performance of the financial sectors of different countries. The exchange rates now are flexible in order to compete and cope up with the machineries of globalization. Globalization in the world economy has facilitated large capital flows between countries. The monetary authorities between nations are largely entangled with each other due to the globalized state of affairs in the contemporary market system. Capital rising, globalization of the equity markets, domination of the financial sectors in different economies and maximization of the investment returns are all the functions that have enveloped the current world market due to the emergence of globalization. The integration of the financial system between countries has only taken place due to globalization (Baldwin, 1999). Situation Analysis Financial Market in the Modern Economies: The financial market refers to the markets where the trade involves financial securities or commodities. The transactions are made at low cost and the prices at which the transactions are made reflect the demand and supply of such financial products. The banking and non-banking financial institutions that facilitate the trading of such financial products are also included in the financial markets. There are a lot of activities in the financial markets of any economy: Capital acquisition in the capital market Transfer of business in the derivative market Price Determination Transfer of money in the money market International trading in the currency marketplace Globalization, or the opening up of the major economies in the world, has largely affected the financial markets of almost of the economies. The real assets in an economy helped in augmenting the productive capacity of the nation. On the other hand, the financial assets like the bonds and the shares are simply sheets of paper that does not contribute to the growth of the economy on the whole. It rather helps to create means by which individuals in the economies can claim to acquire real assets. Quantitative and Qualitative Analysis of the impact of Globalization on the Financial Market Foreign Direct Investment Foreign direct investment is the key factor that helps to regulate the extent of competitiveness of an economy. It is empirically true that economic development in the global economy is not possible without equitable economic growth of all the nations. It is true that since 1990, after globalization, many multinational business firms belonging to the developed economies of the world have made many Greenfield (fresh) investments in the developing economies. Since these economies were developing in nature, the foreign direct investments have helped these economies to grow rapidly over time. The significant emergence of BRICS (Brazil, Russia, India, China and South Africa) economies in the modern world indicates this fact. Figure 1: FDI increasing in the Developing Economies Since 1990 (Source: Hens, 2010) Since 1990, it is evident from the above graph that there has been a substantial rise in the extent of Foreign Direct Investment in the financial markets of the developing economies. This has helped these economies to expand their core domestic and international competitiveness and has substantially helped them to achieve high growth rates. Figure 2: Global Foreign Direct Investment Trading Since 1980 (Source: Treasury, 2003) The above bar graph clearly shows that the amounts of global foreign direct investment have significantly increased after 1990. This had been triggered when most of the economies in the world had opened up and corporate firms analyzed that operating business beyond domestic borders would help them exploit their resources most efficiently and thereby achieve competitive advantage over their competitors. For instance, if a developing economy like, India at present, experiences a strong service sector contribution in its Gross Domestic Product, it is only possible due to the phenomenon of globalization that has facilitated high foreign direct investment in the economy. Capital Market A capital market is a market where the individuals trade financial securities in the economy. Public as well as the private business enterprises trade in the capital market by selling securities in order to raise fund for their business. Thus it is said that the capital market of any economy is composed of both primary and secondary markets. It has been found that before globalization, the state of financial resources of the economies were tragic in the developing countries. Any productive business projects could not be financed in these countries over time. After globalization, the growth of foreign direct investments in these economies has helped in the growth of the capital markets of these nations. The equity market was rapidly progressing in these nations after globalization. It is also considered that the development of the stock markets in different economies then has largely helped in economic growth in these nations. The financial markets prospered and greater lending facilities were available in the developing economies. It was empirically stated that the rising amount of foreign direct investments in the economies had made the domestic banks expand their lending operations. Many failed projects in the economies were offered an implicit bail out by the commercial banks. Figure 3: Growing Banking Deposit and Lending Operations (Source: Roodman, 2011) From the above line diagram, it can easily be stated that the deposit and the lending activities have increased significantly since globalization in the early nineties. The rise in the investment opportunities has helped the nations to improve its employment facilities. This has helped to increase the gross amount of savings in the economies. However, it is interesting to note that the gross amount of lending operations were always more than the amount of deposits in the commercial banks. Figure 4: Rise in the Trading of the Foreign Assets (Source: Gjedrem, 2006) It was also found that the amounts of foreign assets inflow in the developing economies were significantly rising after the financial globalization. The above line diagram clearly portrays the rising amount of trade in exports and foreign assets in the global market from 1990 to 2004. It is true that the rise in the net foreign assets of the developing economies is responsible for the poor real exchange rates of the developing economies. Figure 5: Improving Capital Market in a Developing Economy after Globalization (Source: Goel & Gupta, 2011) The above bar diagram shows that the capital market (as measured in terms of the stock market valuation) in a developing nation like India have significantly improved after globalization. The bond market that is also known as the fixed income market is an integral part of the financial market in the global economy. Bond market is the market where the trading of the debt securities takes place in the economy. It includes securities issued by government as well as by corporate organizations. The bond market in any economy helps to expand or stimulate the economy and facilitates the growth of business firms. It has been empirically found that the modern corporate organizations have greater trust on bonds when it comes to financing their business development projects. This is the reason for which it has been found that the issues of bonds has been significantly more in the global market in almost all the economies than the gross trading of bank lendings. Figure 6: The Bond Trading being greater than the Bank Lending Operations (Source: Regional Outlook, n. d.) The above graph clearly shows that due to globalization, the extent of bond trading in the global economy has been significantly more than the bank lending operations. The high demand for bonds in the financial market has significantly augmented the amount price of bonds in the financial marketplaces in different economies. Since the price of bonds is inversely related to the rate of interest in the market, the soaring price levels of bonds post-globalization have considerably reduced the interest rates in the market. Figure 7: Rise in the Bond trading in Australia (Source: Ryan, 2007) The above graph shows the amount of rising bond trading activities in the economies in the developed countries like Australia. Exchange Rates An exchange rate between two nations identifies the rate at which the currency of one nation will be swapped over by the currency of another country. It can also be termed as the assessment of the currency of a homeland in terms of the value of currency of another nation. An exchange rate can be a real exchange rate or a nominal exchange rate. The change in the exchange rates of a nation largely manipulates the values of its foreign assets and liabilities. If the value of currency of a country appreciates, then the value of its liability to pay off its foreign assets falls. This helps to improve the nations NFA condition and vice versa. The nominal exchange rate (e) explains the amount of home currency (units) that can be procured with a given unit of a foreign exchange. Thus a rise in (e) refers to the depreciation or devaluation of the coinage of a nation. On the other hand, the fall in (e) refers to the appreciation or evaluation of the currency of a nation. Real exchange rate is defined as the ratio of the price level (Pd) of the home currency and the price value of the overseas currency (Pf ). The real exchange rate of a country (Q) = Pd/e*Pf. It refers to the amount of goods and services of a domestic nation that can be acquired by a unit of money of a foreign nation (CNB, 2013). Since the phenomenon, the prices of the goods and services in the global economy have been determined by the free forces of demand and supply. This has forced the exchange rates in the money market to be flexible in most of the economies. It has been found that due to the impact of globalization the exchange rates have tilted in favor of the developed economies and have devaluated or fallen badly in case of the developing economies. This is because the rise in the extent of foreign direct investments in the developing economies than the developed countries has not only induced growth in these nations but have also made this progress highly dependent on the developed countries in the global economic scenario. An abolition of such investments from these economies can often alter the growth of these countries (Bodie, Kane &Marcus, 2009). Figure 8: Improving Exchange Rate of U.S. since 1990 (Source: RBA, 1996) Trading of Gold Precious metals like gold and silver are vital factors in the financial market. The central banking authorities in almost all the economies in the world have reserves of gold. In the contemporary world, gold is often treated as an instrument of financial investment. If the currency fails in an economy or the government of a country has no cash reserves to pay off the national debt then the gold reserves can often be used as a substitute of money. It has been found that after globalization in the financial premises, lack of adequate capital flows in the economies have carved the path for trading with gold. In the modern world, gold which is kept as central banks reserves of a nation, is often used to pay off the national debts and henceforth helps to maintain the trade balance among the nations. Figure 9: Rising Gold Prices in the Global Economy since Globalization (Source: Eeden, 2011) The above graph shows the rising price level of gold in the financial market after the occurrence of globalization. The rise in the demand for gold in the global market for the purpose of international trade is largely responsible for the rise in the price level of the metal. Interpretation This section of the essay will implicitly explain the impact of globalization on the financial markets of the different economies in the world considering it qualitatively with the help of empirical relevance. Globalization has helped to increase the scale and scope of operations in the financial markets of the economies. However the benefits or drawbacks of globalization are different in different economies in the world. The third world countries in 1990 like, India and Australia were financially distressed. The gulf wars and the exchange rate crisis in these nations forced the countries to resort to loans from the International Monetary Fund and World Bank. This was the setting of the globalized era which had integrated the financial markets of the world economies. As stated above, the rise in the foreign direct investments in the financial markets of the developing economies like, China and Brazil had helped these nations to foster their economic growth (Kang & Paper, 2007). Globalization in the financial market was found to significantly improve the capital markets in the global economy. Securities trading were positioned at its zenith since that time. The association of liberalization and privatization can be accounted as the primary cause for such a situation and its impact along with the emergence of globalization. At this point of time, many socialistic economies in the world were transformed into capitalistic and mixed economies. The excessive rules and regulations that were imposed on the private companies in certain world economies like, India at this point of time were much relaxed. This had helped to expand the scale of business operations. A rise in the business operations had demanded for a greater amount of financial mobilization. Thus the level of securities trading in the economies had started to increase significantly. All the instruments of financial markets started to improve after globalization (Kang & Paper, 2007). However, globalization in the financial system has lead to various problems. It has been found that the financial markets of the developing economies have become further dependent on the financial markets of the foreign economies. There has been a rise in the level of speculative activities in different nations. Gold in India and real estate in Spain are the empirical examples of such unproductive business dealings in these nations. The European property bubble and the American mortgage crisis have created trickle-down effect in the economies of the other countries. These two reasons are the causes which are associated with the global financial crisis that had occurred in 2008. It has been found that the substantial fall in the extent of foreign direct investments in the developing and developed economies is responsible for the sudden recessionary trails in the global economy. The economic growth rates of most of the countries have significantly fallen and the velocity of money circulation of the global economy have shown substantial degradation. Financial crisis in the global market and the withdrawal of many foreign direct investments are responsible for the lack of implicit bail outs offered by the commercial banks in countries for the failed projects. The lending operations of the banks have fallen and these crises of credit have forced to increase the interest rates charged on loans. As the interest rates in the markets have increased, the bond prices have significantly fallen. This has taken place only because of globalization which has helped the financial global market to become highly integrated. A problem in the financial system of any economy gradually trickles down to the same of the other countries in the world (Amirkhanyan, 2012). Conclusion Though globalization has contributed significantly to the economic development of almost all the countries in the world, its impact shows a gradual decline over the time in the recent years. The integration of the financial markets of all the economies in the world has resulted in the creation of many advantages and disadvantages. It is true that the growth in the capital and investments of the developing economies of the world could not be attained without the benefit of financial globalization. But the integration of the financial marketplaces has made the state of monetary policies extremely complex. International policy coordination is a step undertaken by the several modern world economies where the monetary and fiscal authorities of these countries coordinate and decide over the policies to be adopted for different nations. In the recent times, the central banks in the American and European economy have adopted the policy of Quantitative Easing. These banks have demanded for worthy government bonds from the commercial banks. In return of the government bonds, the central banks have claimed to provide loans to the commercial banks at about 1% rate of interest. It has been analyzed that such a tool would augment the credit lending capability of the commercial banks and would lower the high interest rates prevailing in the market. As bond price is inversely proportional to the rate of interest, the fall in the interest rate in the economy would increase the bond prices in the economies. Thus the application of efficient policies in the modern trading world is of extreme importance. Since the economies are all coordinated, a disturbance in the economy of one nation would automatically be reflected in the other nations and therefore will be affected. As the collapse of the Lehman Brothers investment bank in U.S. had added fuel to the fire by resulting in global financial crisis in 2008, the global economies are yet to recover entirely from the negativities which that emerged then (Amirkhanyan, 2012). References Amirkhanyan. (2012). Globalization and International Relations. 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