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N39012 Finance and Investment : Market and its Efficacy

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You are a junior consultant working for an international investment organisation. The firm has some new prospective clients visiting the Head Office in London. Your manager, the head of emerging markets, is very keen to sign the clients but wants to improve their understanding of international trade, finance and investment matters. 
You are tasked with writing a comprehensive report on the following:
Finance is considered as the life blood or the engine of growth for international trade and development. 
a.Evaluate how the financial markets work to allocate capital within a domestic economy and internationally for trade, investment and development purposes.   
b.Using an emerging economy of your choice critically evaluate what are the key challenges that country faces due to industrialisation and trade policies?

Answer:


Introduction 

Importance of financial market in modern world of trade and business existence operation and expansion is immense. The charismatic impact or result of international trade and business is availability of any goods and service in any country from any country of the globe. International trade not only just a channel to ascertain cross border movement and transaction of goods but also a best way of making the world market accessible compressing its size.  The goods in the local market can come from various international sources through trade that makes the market process dynamic. Another important aspect of any national GDP is its industrial production.  The operation and expansion of both of them depends heavily on capital, which further shaped up by existence of financial market in any nation. Financial market is not only the source of capital but the very structure of it determines the mode of allocation and implementation to cause changes in infrastructure and proposed transformation in the economic structure (Frederic, Mishkin, tanley and Eakins 2012). The paper aims to discuss how the financial market as source and provision of capital that drives the growth of nations play important role. China as emerging economy has been incorporated in the discussion and the challenges of the nation in terms of trade and industrialization policies with shedding light on composition of financial market and its efficacy.

Background of financial markets:

The market place of finance allows trading of financial commodities like agricultural products and precious metals and securities like stock, bonds at lower cost of transaction reflecting forces of supply and demand. The financial market is the aggregation of buyers and sellers conducting stock and commodity exchange.

The market can be interpreted in two different ways. It can operate in form of organization facilitating trade of financial product or in form of buying and selling transaction taking place between buyers and sellers. The financial market posses the potential to exist both in form of domestic market as well as international or foreign market. The structure of the market aims bring all the sellers as well as buyers in close contact to make them interact and let the transaction take place in less cost. This actually allows the business to interact and expand. Looking at the concept of financial market in finance terminology, it depicts the mechanism through which the capital is raised, international trade is conducting while transferring the risk. The broader objective of such kind of processing is to make the people with demand of capital to interact with those who have source of it. The lender issues a script of the purchase of the products to the borrower in order to make them agree to pay back the credit within stipulated time. The scripts or receipts of purchase are called securities that are purchased and sold. The greater the extent of financial sector, higher is the concentration of investment in industries, trade and undeveloped national sectors (Paul, Maurice and Marc 2014). The financial market makes capital allocation efficiently when the market is operation is free of state intervention and ownership in the economy. However the efficiency of capital allocation is positively related to the legal protection provided to the minor investors, information on the stock and bond returns.

Capital allocation within domestic & international economy 

Capital allocation is the process that depicts the segregation of the different sources financial resources and their implementation in different project, process and people. The aim of the proper capital allocation is to let it generate more additional wealth for the shareholders. Decision of capital allocation comes with loads of complex ideas due to existence of unlimited virtual options available to management. The capital allocation depends upon the different sources of capital that is further ascertained by different types of financial market.

The domestic capital allocation has made its source from capital market, stock and bond market, commodity market, money market and insurance market Moreover derivative market, future market, hedge fund and foreign exchange based market also help in determining the domestic as well as international capital allocation (Zhang, Wang and Wang 2012). The domestic allocation of capital majorly dependent on the extent and operation of capital market, which is comprised of primary and secondary market. The mechanism of capital allocation is broadly dependent on the transaction-taking place in this market as it allows the business to acquire capital to expand or make purchase of equipments (Frederic, Mishkin, tanley and Eakins 2012). In all form of capital allocation, the larger amount of capital can be derived from stock market operations. This allows larger public corporations to sell share of its ownership to be invested and held by people who earn profit based on the increased earning of the company. Stocks are exchanged or transacted in world exchange market. Bond market is another source of capital that have much impact on the rate of interest. The commodity market as segment of financial market depends on the trading of primary products on regulated exchanges for commodities. Most important commodity to be traded is oil. Money market is another source of capital through the provisions of short-term debt and investment.  The money market is such platform that provides capital for allocation throughout the world in international market as well. The market is apt for temporary transaction taking place in terms of borrowing and lending. Short term financing in liquid form for the economic needs globally the money market plays pivotal role (Evans and Hnatkovska 2014)  . The people who borrow in money market are liable to replay the payment after a year making the financing to be short-term in terms of issued paper work. Be it international business expansion or transportation of goods and services through trade or industrial progression, any capitalistic investment has risk associated in it which is taken care of by derivative market (Brigham and Ehrhardt 2013). This type of transactions makes provision of administration of such risk owing much importance in the economic functions. capital can be allocated through future market that indulges in exchange of goods in future. This type of transaction is best for huge transactions involved in trade that further has many long term contingencies.

Presence of insurance is great assurer of risks involved in investment of capital in traded and business. A business or production involves ranges of stages and activities that require capital to incur greater costs. There are various risks in such long time based process. This would lead to various risks that is mitigated by insurance transaction. For example, the transportation of goods through ship involves risk of loss of goods in climatic contingencies. An insurance made on such transaction can make the company incur some support in case of such loss takes place. The insurance makes proper redistribution of risk. In financial system interbank and foreign exchange, market is important platform to make transaction involved in trading currencies. In the interbank market, currencies are traded among financial bodies, banks all over the world that do not include small traders or investors in retail. Foreign exchange market is one of the most liquid and highly volatile market capturing $1.9 trillion of transaction per day approximately. In terms of total cash value of trade made by person, firm or country in the world as participants in such market.

Importance of financial market in trade and industrialization:

The business and production in any sector and comprising of any size requires financing to make sure the availability of capital that plays inevitable role in operation of economic and business activities. The role of financial market in structuring the core of any industry or sector lays important role through executing few roles like-

Supporting investors of various institution in their investment decisions. Moreover in developing long term solutions regarding financing is also taken care by the strong existence of financial market. The system conducts flow of funds from the surplus source to deficit destination facing shortage in funds. The market based direct or bank based indirect operation make huge contribution in the need of capital and its accumulation over time. Through existence and operation of various financial market, institutions and instruments the system leads toward major economic growth of the nation through consolidating the base of trade and industrialization (Paul, Maurice and Marc 2014). In both the sectors the financial market plays big role through making provision of capita for both short term and long term needs. As per the analysis made by trade economists, the greater the strength and functioning of financial market of a nation, higher is the economic growth of any nation as the capital and its utilization propels the nation toward ultimate growth.

Financial System of China:

One of the emerging nations in the world in terms of economic operation and transaction is China. The nation is second largest in world in terms of gross domestic product and turning into world’s biggest economy possibly by next 10 years (Brigham and Ehrhardt 2013). The nation is biggest producer and exporter of manufacturing and complex industrial goods along with various services provided worldwide. Almost 94% of the export revolves around manufacturing indicating greater concentration of industrial sector with huge production for both domestic and international market. In terms of volume of international trade the country; also possess top position in the chart of top rankers globally. The nation makes transaction worth $2.09 trillion in export and $1.58 trillion in import indicating voluminous trade transaction made every year. The producer of $11.8 trillion worth gross domestic product makes the country depend hugely on availability of capital and its proper allocation (Zhang, Wang and Wang 2012). The role of financial market is pivotal in this sense in order to make the country acquire and consolidate the capital base it requires in order to continue the production to meet the expanding demand both by its ever growing internal market and international demand as well in terms of export.

The country experiences a well developed and integrated financial system existent from prior 1949. Post 1949 foundation of People’s Republic of china, maximum of the capitalist firms and institutions became nationalized and came under operation of government. From 1950 to 1978, the financial system of the nation mostly consisted of single bank operated by People’s Bank of China (PBOC) which was owned and controlled under the Ministry of Finance. This replaced the central bank in China and served the role of both central and commercial bank that captures 93% of the total financial assets (Allen, Qiah, Zhang and Zhao 2012).  The bank operates in currency controls and its circulation and disburses expenses made in budget. It also plays the role of currency issuance, administers the payments and receipts of the accounts in government bodies. The role of PBC in international trade and transactions made overseas are undeniably important.

Other sources of finance in the nation are range of banks like China Development Bank that make major contribution in funding the economic development and channelize foreign direct investment. The Agricultural Bank of China provides major funding for operation in the agricultural sector.  The China Construction Bank provides partial capitalization of overall investments while making provision of funds driven to construction and industrial enterprises.     Industrial and commercial bank of China conducts commercial transactions acting like saving bank of the nation. The economic reform of the nation in 1979 saw major breakthrough that consolidated the role of banking system even more. The aim was to make increase in the availability of capital that could cater to greater and expanding demand of capital requirement utilized in industrial as well as other economic sector operation. The nation has made the its international sources of capital stronger. The major sources in international market are International Monetary Fund and World Bank. Several programmes of United Nations are also major provider of capital sources that the nation has available. The advanced economic countries of the world like Japan, Hong Kong, Singapore are biggest medium of conducting the investment process.

Quite evidently the country makes financial allocation in internal and international market through extensive operation of stock market and Forex market operation after the major contribution made by the banking sector of the nation.  The existent two stock exchanges  Shanghai Stock Exchange and Shenzhen Stock Exchange make the nation have immense stock value in world worth $4.48 trillion leading it to become largest stock market globally.

Critical evaluation of Chinese trade policies: 

In order to provide stimulus to international trade and business, the role of policies related to trade taken by national government are of crucial importance, Most common policy here to be seen is to tamper the relative price of export or import in order to stimulate or contact the trade operation. China experienced a range of development strategy in trade that can be broadly divided into two major phases before and after accession made to World Trade Organization. In the phase prior to WTO accession, the major trade strategy driving economy of China was export promotion and import substitution and marginal trade liberalization in the span of 1980-2001(Financial Times 2017). The strategies reveal the inclination of central government planning focusing toward institutional reform, structural reform and open-economy policies. Radical trade liberalization took  place in 1992 that made the country sign trade agreements under GATT extensively making the nation more pro-international trade while making it more open. Over the passage of time and various economic conditions the trade policies went through series of change,. The global financial crisis of 2008 gave the economy massive hit leading to downfall of economic output. The entire world were plunged into a recessionary forces that made the countries trade and exchange less. Export of China fell subsequently with huge drop in import as well. The balance of trade moved into deficit from surplus situation. This made the country go for policies that brings stability to external demand and stimulates internal demand within the nation. Stabilization was brought by promotion of trade financing and facilitation loosing much of the control in export since trade allowances was enhanced by reducing export taxes on export.  Exchange rate regime was brought under pegging system. The nation implemented trade policies through mechanizing the tariff rates that was high when China joined WTO. The tariff hovered around 100% and advalorem tax ranged from 0-65% on the primary products (Evans and Hnatkovska 2014). This shows import substitutive policies discouraging import.  Over the time, China moved toward trade liberalization policy that relaxed the tariff rate. Moreover, the government adopted policies to provide tax benefit, no export and import tax or tariff rates within a specific national territory called special economic zone. From a restrictive and closed economy, China has moved toward a much lenient trade policies that encourage more investments in the nation and capital inflow o order to expand the business and production (Ballwieser et al. 2012). Yet the national policies fall short in maintaining complete stimulus to trade. The Chinese market is transiting one so liberalization combined with few stringent state directed policies of state often hinders the free flow of trade and investment. Stringent intellectual property rights, widespread cyber economic espionage, distorted and discriminate policies in innovation, shortfall in meeting WTO obligations are few of the challenges nation put forward to the international market that have impact on the transactions (Frederic, Mishkin, tanley and Eakins 2012).  The protective and influential changes made to value of currency often influence the trade values of other nations. However the policies of industrial sector and trade development have been able to make remarkable changes over the period of time even though they exerted negative impact partially on the economic condition of the nation.

Conclusion:

The discussion took us through the theory of financial market and nature of its role in an economy. The discussion rightly points at the fact how financial market acts as biggest source of capital and allocation and movement of it in helping the rapid industrialization as well increase in volume of trade and expansion in business. The greater the source of capital through a well-structured financial market operation greater is the possibility of economic growth enhancing the performance of the nation. The case study of China as emerging economy showed that the nation has embarked on various trade policies since its inception of economic development in 1979 but overtime made a shift toward more flexible, self-reliant and open economy adopting policies to encourage more capital inflow that meets the need of enhanced production backed by expanding domestic market. Even though few policies pull the trade opportunities backward, the nation overall has been able to mark its superiority in world through the largest trade transactions as well as greatest producer of manufacturing.

Reference:

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