Economic Risks of International Trade Assignment Help
Economic risk
Economic risk means the risk resulting from the macroeconomic conditions of the country that have an immediate effect on the cross-border business. It includes risks of exchange rates, political instability and off-shore regulations etc (Investing Answers).
Foreign Exchange Risk
Engaging in international trade exposes a country to foreign currencies. Prices received for the sales, and prices to be paid for the purchases may change due to fluctuations in the currency’s exchange rates. When the home currency (say Australian Dollars) appreciates in relation to the foreign currency (say US Dollar), the revenue gained from the sale in foreign country would diminish after being converted into the domestic currency at a lower rate; whereas purchases from the foreign country would now be cheaper as the Australian buyer will have to pay less in terms of US Dollars. Exchange rates are highly volatile and unpredictable in nature, due to which it is very difficult to control this type of risk when doing international trade. Consequently the trader may end up paying more or receiving less (Sargeant, 2009).
Geographical and Economic Conditions of the Country
The geographical and economic conditions of the dealing country have an impact on the international trade. Home industries have to think in terms of the geographical conditions of the foreign countries. Whether their product is suited to the living conditions and environment in the foreign country? Moreover, when the country is flourishing economically, it’s industries are also expanding and prospering which brings good foreign business without the risk of solvency of the foreign businesses. Inability to judge the prevailing circumstances in the foreign country may result in greater risks and uncertainties.
Business Environment in the Foreign Country
Besides economic and geographical conditions, businesses in the trading countries also have to consider the presence of sound business environment in the target countries. Whether there are any governance laws and regulations relating to a particular trade activity? Whether that law or regulation is sufficiently strong, or is it weak?
Risk of Increased Imports
International trade always comes with an underlying drawback of increase in imports of a country. While exports are highly beneficial for the economic prosperity of any nation, imports may further deteriorate the already worse conditions of an unsound economy.Domestic industries may fail to improve the quality of their output in relation to foreign country imports, resulting in consumer preference for imports. This results in high rise in imports, while there is no corresponding increase in the exports. When this situation arises, only the countries with well setup modern industries and good economic conditions get the true benefit of the international trade.
Burden on Balance of Trade
Rising Imports directly results in a great burden on a country’s balance of trade. Adverse Balance of trade is one of the key reasons behind Balance of Payments deficit. This risk can only be controlled through establishing checks and controls over the exports and imports in order to keep them in balance.
Risk of Transportation
This is another big risk when trade takes place internationally. Goods are exposed to risk while being in transit from their point of production to the ultimate destination. Businesses have to essentially incur air or ocean insurance charges. These extra costs increases the price of the final product for the consumer and also results in inflation.
Risk of Globalization
Globalization refers to the convergence of global markets. This phenomenon has brought closer the national markets of all nations and given rise to a single international market where countries and consumers can exchange goods and services. Global market is highly competitive and demands great efforts from the manufacturers and producers in order for their product to be globally acceptable and competitive. So if a country is unable to improve the quality of its product and offer it at a highly competitive price, it cannot establish its stronghold in the international market. Moreover, restrictions on import embargoes and trade tariffs can further make it difficult for the country to improve the domestic situations. General Agreement on Trade and Tariff (GATT) and the compliance rules and regulation of World Trade Organization also challenge the countries. For example, the payment system around the globe has been considerably improved during the last decades; so the manner in which the banking system operates and payments are accepted in the economy play a great role, since it has an effect on the speed, efficiency and reliability of international transactions (Johnson, 2002).
Risk of Credit Control for the Businesses
Businesses dealing internationally have an added risk of protracted defaults. The buyer may fail to pay, the seller may fail to keep his promise, or the carrier may fail to deliver the goods. Filing of lawsuits is expensive and the outcome is usually dependent on the laws and practice in the foreign country.
Interest Rate Risk
This risk is borne by interest-bearing assets or securities, such as floating-rate loan. When the interest rate in the country increases, the buyer or the seller will have to make additional interest payments (United Overseas Bank, 2010). The rate of interest in turn is governed by the monetary policy of the country and there are other factors as well including inflation, demand and supply of credit money, and the rate of growth of economy (Davies, 1920). When a company is one country obtains floating rate loan from the bank operating in other country, the amount paid in respect of finance charges against the loan will increase or decrease depending on the economic conditions and the level of interest rate in that country.
Political Risks of International Trade
Political risks refer to the risk that buyer and seller countries are exposed to as a result of uncertain, unstable or unfavorable political conditions in the other country. These include the following:
Political Condition & Changes in Policies
Political conditions prevailing in the foreign country pose a risk to the international trade. A country would be more optimistic in dealing in trade with a country having favorable political conditions than the one with adverse conditions. Moreover, the political changes in the other country may adversely affect the expected outcome of an IT agreement. The political risk results from these political changes when a government unexpectedly changes its policies. Government policies that may affect the international trade include fiscal policy, trade barriers, imposition of heavy duties and taxes, import embargoes etc. All these policies are aimed at restricting imports and serving limits to the international trade and may result in loss of revenue by the foreign companies. Stable government and consistent trade policies are more preferable and favorable for healthy international trade.
The communion of UN which was chaired by the nobel-prize winning economist Joseph Stiglitz stated, “The framework for financial market liberalization under the Financial Services Agreement of the General Agreement on Trade in Services (GATS) under the WTO and, even more, similar provisions in bilateral trade agreements may restrict the ability of governments to change the regulatory structure in ways which support financial stability, economic growth,
and the welfare of vulnerable consumers and investors.” (TradeWatch.org, 2013)
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Policy of Protectionism
In order to normalize the domestic conditions, economies may resort to the imposition of the policy of protection in order to discourage the imports and encourage domestically produced products and services. The aim of protectionism is to inflate the prices of imported goods so that consumers shift their attention to the domestic produce. This is unfavorable for the exporting countries and a big risk to the international trade. Some governments even resort to obtaining foreign funds or tariffs to obtain the right for exports. Tariffs and quotas are the devices of protectionism that are used to protect the domestic consumers from international competition. This is a great risk for the selling countries as it either cuts own their revenues due to imposition of high taxes and duties, or restricts their right to trade in certain economies. It is recognized by the economists that substitutes to tariffs and quotas are at least as much harmful to the international trade as tariffs and quotas themselves (Colander, 1991).
Laws in the Trading Country
Even in the countries that have reduced the trade barriers with the agreements of free-trade, trading is usually influenced by the difference in the laws and regulations governing the particular countries. This affects the revenues and profit derived by the businesses trading internationally, and therefore represents a considerable risk for them.
Dependence on Other Country for Certain Needs
This risk transpires from certain needs of the country that cannot be fulfilled domestically or elsewhere in the world then some exporting countries. As a result the importing country develops dependence on these countries for the export of certain goods and raw material, such as petroleum and crude oil; consequently, leaving no room for the development or improvement of domestic industries.
Risk of Developing Political Dependence
This is one of a major political risk of engaging in international trade and has more severe consequences. Countries providing significant exports to the other countries at reasonably low prices may try to influence the political and economic policies of the other countries. This results in political dependence on the other countries which is very risky for any country’s sovereignty.
Inadequacy of Knowledge
Inadequacy of knowledge about the foreign policy or policies relating to international trade and underlying agreements may result in business failure. Knowledge of market and business risks while dealing in the foreign country has to be considered in order to conduct business successfully. Business risk is anything that may negatively affect the achievement of overall objectives of the business. For example, emergence of new competitors, failure for the new product to survive in the foreign market, change of political regimes, incompatibility between the company product/service and the culture of the foreign country.
War and Terrorism
War and terrorism both have an adverse effect on the international trade for both the buyer and seller countries and their industries.
Bibliography
Colander, D. (1991). Why Aren’t Economists as Important as Garbagemen?: Essays on the State of Economics (1st ed.). M.E. Sharpe.
Davies, G. R. (1920). Factors Determining the Interest Rate. The Quarterly Journal of Economics, 34(3), 445-461 .
Investing Answers. (n.d.). Economic Risk – Financial Dictionary. Retrieved October 23, 2013, from InvestingAnswers.com: http://www.investinganswers.com/financial-dictionary/economics/economic-risk-2918
Johnson, O. E. (2002). Financial Risks, Stability, and Globalization . International Monetary Fund.
Sargeant, N. (2009, February 26). What risks do organizations face when engaging in international finance activities? Retrieved Ovtober 18, 2013, from Investopedia: http://www.investopedia.com/ask/answers/06/internationalfinancerisks.asp
TradeWatch.org. (2013). Trade Agreements Cannot Be Allowed to Undermine Fin. Retrieved October 22, 2013, from http://www.citizenarchive.org: http://www.citizenarchive.org/documents/FinanceReregulationFactSheetFINAL.pdf
United Overseas Bank. (2010). Risks in International Trade & Mitigating Measures. Retrieved October 18, 2013, from uob.com.sg: http://www.uob.com.sg/assets/pdfs/corporate/corporate/TradeTutorials_RisksinInternationalTrade.pdf
