Assignment 1: Lasa 2 Risk Management Applications 275600

Assignment 1 Lasa 2risk Management Applicationswhile There Are Many

Use the publicly-traded company you chose in Module 1 and imagine it has made a strategic decision to start doing business in China. Using the discussion, Currency Exchange Rates: A Case in China with Country Risk, (Chapter 7, Global Finance , page 192 of your textbook) as a model for the report you will write, prepare a report in which you: Develop a brief country risk assessment. Determine the political, economic, social, and capital risks associated with doing business in China. What are the most important factors to consider? Why? After years of keeping the Yuan pegged to the US dollar, in 2015 the Chinese allowed it to float freely in international currency exchange rate markets. You may read more about the Yuan reforms here. Many economists believe that keeping the Yuan pegged to the US dollar has caused it to be undervalued by 30 to 50 percent. Discuss what impact a revaluation of the Yuan might have on US multinationals doing business there, on China’s exports, and on Chinese citizens’ standard of living. What impact would a revaluation have on Chinese inflation and on purchasing power parity? Explain. Your paper should be about 2,000 words.

Paper For Above instruction

The expansion of a multinational corporation (MNC) into new markets presents a complex array of risk considerations, particularly when entering a significant economy such as China. Conducting a thorough risk assessment is paramount to strategically navigate political, economic, social, and capital risks. This paper evaluates these risks based on the decision of a hypothetical publicly-traded company, originally chosen in prior coursework, to initiate business activities in China. Additionally, the implications of China's currency reforms, specifically the revaluation of the Yuan following its transition from a pegged to a floating exchange rate, are analyzed concerning US multinationals, Chinese exports, inflation, and citizens’ standard of living.

Country Risk Assessment

Engaging in business operations within China encompasses multifaceted risks. A brief assessment includes political instability and regulatory uncertainties, economic volatility, social dynamics, and capital flow challenges. These factors influence the strategic decisions of corporations seeking to establish or expand their presence.

Political Risks

China's political landscape, dominated by the Chinese Communist Party (CCP), entails risks related to government stability, policy unpredictability, and regulatory changes. Although the government maintains a stable authority structure, recent crackdowns on private enterprises and foreign firms highlight potential policy risks that could impact operational freedom or profitability (Tan-Mullins & Chen, 2018). Geopolitical tensions, especially concerning US-China relations, may also influence business conditions through tariffs or trade restrictions that policymakers could impose unexpectedly.

Economic Risks

The Chinese economy, characterized by rapid growth and transformation, faces risks from shifting economic policies, debt levels, and changing consumer markets. While the country has transitioned to a consumption-driven economy, concerns about corporate debt levels and local government financing pose risks to economic stability (Naughton, 2018). The revaluation of the Yuan adds volatility to trade balances, impacting import and export margins and overall economic health.

Social Risks

Social risks encompass demographic challenges, social stability, and cultural differences. An aging population, urban-rural disparities, and the desire for increased social freedoms could lead to unrest if economic benefits do not reach all sectors promptly (Cheng & Liu, 2020). Public sentiment and consumer confidence are vital factors influencing demand and business sustainability.

Capital Risks

Capital risks in China involve currency exchange fluctuation, capital control restrictions, and the potential for repatriation difficulties. The liberalization of the Yuan introduces exchange rate variability, affecting profit margins for foreign investors. Additionally, China's capital controls aim to prevent capital flight, which could restrict access to funds or complicate repatriation of profits (Cheng, 2019).

Key Factors to Consider & Rationale

The most critical considerations include the geopolitical environment, currency stability, regulatory landscape, and social cohesion. These factors directly influence operational costs, profitability, and long-term sustainability. For instance, currency fluctuations impact pricing strategies and profit repatriation, while political stability influences the legal environment and enforcement of contracts. Social stability affects workforce availability and consumer markets, reinforcing the need to understand and adapt to Chinese cultural and social nuances (Gao & Zheng, 2021).

Impact of the Yuan Revaluation

The Chinese government maintained a pegged Yuan for decades, allowing it to remain undervalued by an estimated 30 to 50 percent to bolster export competitiveness. In 2015, China moved towards a more flexible exchange rate regime, allowing the Yuan to float within a controlled band. This move aimed to facilitate currency reforms and align the Yuan more closely with market fundamentals. Economists widely agree that the undervaluation has contributed to trade imbalances, capital flows, and inward migration of foreign investment (Subramanian, 2018). A revaluation of the Yuan—appreciation—has wide-ranging effects:

  • On US Multinational Corporations (MNCs): Appreciation of the Yuan would increase the cost of Chinese exports for US companies, reducing their price competitiveness in other markets. Conversely, it would lower the cost of importing goods from China, potentially improving profit margins for US firms sourcing from China. However, it could also lead to reshuffling supply chains, forcing companies to reconsider sourcing strategies, and potentially shifting manufacturing to other countries with lower labor costs (Barboza, 2018).
  • On China’s Exports: An appreciating Yuan would make Chinese goods more expensive internationally, likely reducing export volume. This could negatively impact China’s export-driven growth model, potentially slowing economic growth and forcing industries to innovate or shift toward domestic markets (Rogoff, 2018).
  • On Chinese Citizens’ Standard of Living: Revaluation could raise domestic prices for imported goods, affecting consumers’ purchasing power. While potentially curbing inflation driven by undervaluation, it could also lead to increased living costs, especially affecting lower-income households that rely heavily on imported products (Li & Wang, 2017).

Impact on Inflation and Purchasing Power Parity

The revaluation of the Yuan would tend to improve China’s inflation outlook by moderating imported inflation, given that many imported goods would become cheaper in Yuan terms. This shift aligns with the law of purchasing power parity (PPP), which suggests that exchange rates should adjust to equalize the price levels across countries over time (Krugman & Obstfeld, 2018). If the Yuan appreciates, the PPP would move closer to parity, increasing the real purchasing power of Chinese consumers. However, the speed and magnitude of revaluation will influence the extent to which these effects manifest.

Conclusion

Expanding operations into China requires a comprehensive understanding of country-specific risks and economic adjustments. While the country offers vast market potential, political, economic, social, and capital risks must be carefully managed. The transition of the Yuan to a floating exchange rate marks a critical juncture, with significant repercussions for multinational corporations, trade balances, inflation, and the standard of living. Strategic planning, risk mitigation, and adaptability will be essential for US multinationals to capitalize on opportunities while safeguarding against inherent risks.

References

  • Barboza, D. (2018). China’s Currency Reforms and Its Impact on Global Trade. The New York Times.
  • Cheng, P. (2019). Capital Controls and Foreign Investment in China. Journal of International Business, 30(2), 112-130.
  • Cheng, P., & Liu, Y. (2020). Social Stability and Economic Growth in China. Asian Development Review, 37(3), 45-68.
  • Gao, Q., & Zheng, H. (2021). Cultural Considerations for Foreign Businesses in China. Business Horizons, 64(1), 83-92.
  • Krugman, P., & Obstfeld, M. (2018). International Economics: Theory and Policy. Pearson.
  • Li, X., & Wang, Z. (2017). Inflation and Consumer Purchasing Power in China. Journal of Chinese Economic Studies, 23(4), 231-249.
  • Naughton, B. (2018). The Chinese Economy: Transitions and Growth. MIT Press.
  • Rogoff, K. (2018). The Chinese Currency: Policy and Impacts. Journal of International Economics, 118, 137-152.
  • Subramanian, A. (2018). Currency Undervaluation and Its Global Effects. Peterson Institute for International Economics.
  • Tan-Mullins, M., & Chen, L. (2018). Political Risks and Foreign Investment in China. International Journal of Business and Economics, 20(4), 59-75.

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