Economic Stability and Its Impact on International Business - Case Study Example

Economic Stability & its Impact on Intrnational Business Comparison of economic stability of India & China with respect to FDI 4/3/2013 Type your name here Introduction Fluctuations form a common part in an economy. An economy with fewer or lesser fluctuations is said to be economically stable. A stable economy is characterised by a constant or small changes in its output growth and also has a low and stable inflation rate prevailing in its economy whereas when an economy exhibits characteristics like high or variable inflation rates, frequent economic and financial crisis, pruned to larger recessions and unstable business cycles, that economy is often referred to as unstable economy. This paper evaluates the manner in economic stability is important and compares China and India to find out which is a preferable option for FDI. Economic Stability Countries all around the globe desires for a stable economy as it helps them to become a developed country. Monetary and financial policy helps in controlling inflation in an economy and lays down a path for stable economy. Financial stability is of prime importance to achieve economic stability since most transactions in real world are routed through the financial system of the economy. A sound financial stability ensures better development of the economy by deployment of funds in profitable businesses, price stability and proper balance of payments (Bologna, 2011). Further, a strong financial stability absorbs the shocks of adverse and unforeseeable situations and provides a corrective measure to prevent the same from damaging the financial condition of the economy. Inflation i.e. rising prices with low productivity and decrease in the purchasing power of currency is also considered as a key factor in achieving a stable economy. Inflation if not controlled may lead to large recessions and financial crisis. Framing of adequate monetary policies helps in controlling inflation to a considerable extent. Thus, to achieve economic stability, inflation and financial stability plays a major role besides other factors such as political, economical, social, technological and legal factors which contributes equally (Blinder, Ehrmann, Fratzscher, De Haan and Jansen, 2008). Economic Stability in International Business With globalisation reaching its zenith, there has been a sharp increase in international trade. Country all around the globe enter into different contracts and treaties with each other to promote international trade. Economic stability affects international businesses and international trade to a considerable extent which has been discussed as under. Whenever, doing a business in different country it is of prime importance to check the economic stability of that country. If inflation in the country in which business is to be transacted is on a higher front or varies constantly it may not be feasible to invest in such a country since it will be a situation where prices of raw materials or products will be higher without an equal rise in its productivity showing signs of considerable losses and economic instability. Another factor which needs to be considered primarily is the international exchange rates prevailing at the time of business being transacted. In cases of economic instability exchange rates due to unsound financial system keeps on fluctuating at an excessive rate which might incur profits or losses accordingly, bringing exchange rate risks in business apart from other business risks which prevail during a normal business transaction (Čihák, 2006). This could be well understood by means of the following example. Suppose, if the exchange rate of the currency in which transaction is to be enacted appreciates i.e. local currency devaluates in comparison to that currency then it would be profitable to produce goods in domestic country and then exporting it to the other country making international trade profitable. However, a vice versa of the same would prove to be unprofitable or may incur losses in entering into such an international trade. Thus, lack of economic stability has further added the risk of exchange rate fluctuations to further control these exchange rate fluctuations an International Monetary Fund was established to bring some stability in the economy globally (Garcia & Rio, 2005). International businesses or transactions is much easier and prune to lesser risks in countries which has achieved economic stability. Since, an economic stable country is often considered to be a developed country than a developing country and the financial system of such a developed country is strong and stable which makes balance of receipts and payments easier in an international transaction being transacted. It is to be further noted that is easier to achieve economies of scale in international businesses in countries which are economically stable (Goodhart and Rochet, 2011). A stable economy is further characterised by having a strong financial stability and better sociocultural environment, political environment, internal and external trade policies and higher productivity which all adds to boost up an international transaction or business profitability. On the other hand a country which is not economically stable is mostly a developing or an underdeveloped country which to some extent lacks in dominating the terms of contracts or treaties entered by them during international transactions with an economically stable country. Thus, economic stability plays an important role during international business as it has been highlighted and explained above that how inflation, financial stability and higher productivity impacts on such transactions (Nier, 2005). Comparison of China & India as a preferable destination for FDI Before making a comparison of two Asian countries in terms of economic stability as preferred location for FDI it is important to understand the meaning of economic stability (already discussed above) and FDI. FDI (Foreign Direct Investment) has played a major role in international trade and globalisation in the recent past decade as it provides external finance in those countries where FDI is made and further help in developing the economy of that country. FDI implies an international direct investment made by an organisation, entity or company from one country into another country by investing in the productive assets of the targeted company and having some influence and control over the targeted company (Haldane, Hall and Pezzini, 2007). It is different from indirect investments where an overseas company invests in the stock portfolio without having any influence or control over the invested company. Foreign Direct Investment is the latest buzz word in the economy and developed countries target developing countries which benefits both targeting and targeted country. An analysis of two Asian countries named India and China has been made as under in terms of economic stability as most preferred location for FDI. For making a Foreign Direct Investment certain factors play an important role like wage rates prevailing in the targeted country, intellectual property rights, taxation of the country, domestic market of the targeted country and scope of future expansions in the same and the environmental and political conditions. It is to be noted that China is much more economically stable than India. Inflation rates in India is on a rising trend which is around 8-9% in 2012 and is very near to touch double digits whereas the same is around 4.5% – 5.5 % in China and shows less variation in the recent past. Further financial stability and infrastructure facility is more stable and advanced in China than in India. Further in the recent past it has seen that Indian market is flooded with Chinese products and Chinese goods have been dominating the Indian market. India is a labour intensive country which is still in its developing phase and education system is still growing in the country due to which labour supply in India is in abundance and cost of hiring the same is much below in comparison to China which is more of an industrial intensive country in Asia. It is to be noted that India is highly dominated by unskilled labour than China which has more dominated by skilled labours. China has Intellectual Property protection acts but it is still facing major conflicts between its private sectors and government in the recent past which makes it a serious issue for other countries to make a Foreign Direct Investment decisions in the country (Born, Ehrmann and Fratzscher, 2011). On the other hand India has stronger Intellectual Property protections with more definite outcomes than China which attracts foreign investors in making investments in India. Both India and China has a taxation structure which is strict in its rules and regulations but it is to be noted that taxes are higher in India than China, thus Indian government demands a higher part of earned income than China thereby lowering the operating profits of investments made in India. Further, exemptions offered by Chinese government is better and higher than made by Indian government which is an area of concern for countries making an investment in India. However, Value Added Tax (VAT) in China is around 17% whereas it is much lower in India around 13% on an average. Both India and China has huge population but consumption is on the lower side. There is a scope in expansion of domestic markets in both the countries. However, China which is more economically stable has lower inflation rate and higher purchasing power in terms of India whose currency value is lower in comparison to China (Wang & Edwards, 2013). Licenses for operating different kinds of business, Permits for new businesses and government approvals take a shorter span of time to be issued and acted upon in China than in India which has a rigid system of operating on such issues. Thus, in times of urgency obtaining such government regulated licenses, permits and approvals may be difficult and hamper business in the shorter period. Environmental policy laws are mandatory in China and companies operating in China needs to follow the basic guidelines of Environment Protection Laws, however in reality these laws are a bit liberal for domestic countries operating in China than foreign companies establishing their units in the same region. Even India has its own Environment Laws but they are a bit liberal in comparison to China (Oosterloo, Haan and Jong-A-Pin, 2007). Requirement of local partner to conduct an international business in Asian countries is not of that prime importance. A wholly owned subsidiary by the foreign investor can manage its business in China without much of government restrictions and regulations whereas in India some businesses are restricted to be conducted by local nationals only thus promoting the requirement of local business partner which leads to distribution of profits earned by foreign investor in India to a certain percentage. However, it is to be noted that over 90% of businesses are open to be conducted wholly by foreign investors and requirement of a local business partner is not mandatory in such businesses. Recommendations & Conclusion In respect of the comparison of India and China conducted above, we find that Foreign Direct Investments had played an important role in developing the economy of China and still foreign investors tend to invest in China, however till first half of 2012, China was considered to be most preferred location of FDI but the flow has recently shifted to India. China has attained quite economic stability and cost of production has gone up due to lesser unskilled labours in China than in India. India on the other hand has lagged behind due to its cumbersome political instability, lower growth rate, frequent fluctuations in its exchange rate and higher inflation rate prevailing in the country which in the recent past has improved to a considerable extent even though the country is far behind in achieving economic stability (Neogi, 2013). Foreign investors will be lured by the heavy labour force that India pertains and the recent development and government policies to attract more Foreign Direct Investments in the country to make it economically stable. It would be more beneficial for India if it could make structural changes in its economy at a faster rate to attract a higher percentage of foreign investors in the country. Further, India in the recent past has allowed economic freedom and has opened global trade which has attracted more foreign investors (Kaminsky and Reinhart, 2009). It would be even greater if the country revises its labour laws and environment protection laws to make it a little more flexible in its rules and regulations for which the government of India has taken initiative. Framing of strict monetary policies will further add to the list as it will help the country to attract more foreign investments and attain economic stability at a quicker pace. 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