Bankers' Insight & Issues

Bhutanese Economy and Banking Sector; Category: Business article December 2015 Author : P.B. Moktan The economic environment of Bhutan is in challenging phase with increasing macroeconomic imbalances, inappropriate macroeconomic policies, and deep uncertainty fueled by trade deficit with India and acute rupee shortage in the country. Annual credit growth rate decreased from average 33% in 2012, to below 10 percent in 2014 due to credit restriction imposed by RMA in import driven sectors. Since then, and following the re- introduction of housing and vehicle loans in September 2014  (suspended in 2012), annual credit growth rate has slightly increased to 13.5 % as of March 2015 from 9.4 % as of December 2014. However, real activity in the economy is sharply contracting, with GDP growth of only 2.1% as of Dec 2014 and inflation rate hovering around 6-7% during the year. Unsustainable fiscal imbalances, loose monetary conditions and trade deficit with India were key to the deteriorating situation in Bhutanese economy. The government deficit is increasing every year without proper fiscal deficit management policy in place and a sharp increase in central bank financing of the government deficit by way of special WMA with RMA and Bank of Bhutan and 91-day Govt. treasury bills. The policy response to the deteriorating situation has been inappropriate. Expansionary monetary policy measures; e.g., a lowering of reserve requirements from 17% to 10% in 2012 and further from 10% to 5% in 2013 and Govt. ESP of around nu. 2.1 bn injection in banks have further worsened the excess liquidity conditions in banking sectors coupled with restriction imposed in lending side creating further mist-match in the balance sheet. For e.g; BoBL alone had excess liquidity of nu. 6.3 bn as on December, 2013 further increased to 13.3 bn as of Dec 2014. The ensuing excess liquidity induced a drop in treasury bill rates from 2.3 percent to below 0.14 percent in 2015. Recently RMA has increased the CRR from 5% to 10 % basically to mob-up the excess liquidity from the banking system, which did not give any respite to the banks in reality. Contrary to this situation other banks’ base rate dropped by 45 basis point in an average whereas BOBL increased by 17 basis point in 2015.  The base rate decreased in other banks were primarily attributed to their prudent liquidity management practices; since many banks were cautious when it came to accepting large deposits. Banks were not interested to accept deposits since they were already flooded with excess deposit. This ultimately resulted in lower cost of fund, resulting in decreased their base rates. On the other hand, BoBL has contradicting goal; to be as competitive as private bank but with social mandate precluding from partaking in free market competition. Consequences of this contradictory goal forced bank to accept deposits resulting in increased in base rate of the bank. The reduction in nominal interest rate means that together with an inflation rate of 6.2 percent, real interest rates are sharply negative. The deteriorating macroeconomic environment has put considerable strain on the financial condition of the banking system. Even though the system has proved so far to be remarkably resilient, some banks have been weakened considerably, and are prone to further deterioration in light of the significant risks. Reported high capital adequacy ratios found to be overstated due to insufficient provisioning. In addition, asset quality has deteriorated. The ratio of gross nonperforming loans (NPAs) to total loans has increased from 3 percent as of 2012 to 9.8 percent at the end of 2014 on an average in the economy. The banking sector of Bhutan consists of 5 banks. Two of them are state-owned, two are domestic privately owned and one foreign privately owned bank. The banking system, have been plagued by a large stock of NPAs and weak provisioning practices. The Banking sector in Bhutan is not yet in compliance with the Basel Core Principles for Banking Supervision (BCP), it suggests that even though existing loan classification and provisioning rules are broadly adequate, they are not well implemented in practice and banks are under provisioned in terms of operation risk and credit risk management. Disclaimer : The views expressed in this working paper are those of the author(s) and do not necessarily represent any banks or institutes.

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Prem Moktan, Bank of Bhutan,
Thimphu - 2014 

Topic : Venture into global Market- why firms choose different entry modes for different markets at different times

By Prem Moktan, Bank of Bhutan, 2012

In this essay we will examine various factors that determine the entry modes of multinational companies in the foreign markets. We will explore and analyse with various case studies as why firms choose different entry modes for different markets at different times. In order to study the various factors that determine the entry modes of the firms in international market, use of various journals of international business studies, articles, websites, newspapers and books are made as work of references, and no field research or survey is conducted in preparing the assignment.

 Firms face three interlocking questions with regard to international expansion, what market to enter (entry location), how to enter (mode of entry), and when to enter (timing of entry) (Vishal, Yang and Gerardo, 2002). The multinational company’s different entry modes in the international markets have been regarded as closely associated with varying degrees of resources commitment, risk exposure, control, and profit return. The primary factors that determine their entry modes depend on different types of factors, including firm- specific factors, industry specific and country specific factors (Erramilli and Roa, 1993, Kim and Hang, 1992, Kumar and Subramaniam, 1997: Madhok, 1997; cited in Yang Pan and David K, 2004). As suggested by Kumar and Subramanian (1997), a natural hierarchy exists among the various modes of entry.

 Modes of entry can be classified as equity based and non-equity based. Equity based modes are wholly owned operations and equity joint ventures(EJVS), while non-equity base entry modes are divided into contractual agreement and exports (Yang Pan and David, k., 2004).

Many researches were interested to know how multinational firms choose the entry mode to foreign market when they have choice though firms at times have to adopt the entry mode dictated by the host country government. According to Yang pan and David “three main schools of thought have been put forward to explain the choice of entry modes. The first school of thought views business operation in an overseas market as inherently risky because of the political, culture and market system that the firms must adapt to”. The second school of thought explains with respect to transactional cost perspective. Yang Pan and David (2000) stated that firms will internalize those activities that they can perform it at a relatively lower cost but subcontract those activities externally if other providers have a lower cost advantage. Third school of thought highlights the importance of location-specific factors (Hill, Hwang and Kim, 1990 cited in Yang and David, 2000). Dunning (1988) emphasis on three pillars; such as ownership-specific factors, location specific factors and internalization factors in his eclectic paradigm with regard to international business.

However, Hill, C.W.L., Cronk, T., Wickramasekera, R. (2010) suggest that there are six different modes to enter the foreign market. They are exporting, turnkey project, licensing, franchising , establishing joint venture or setting up a new wholly owned subsidiary in the host country. When setting up production abroad, they can start up new venture or take over existing ones by way of acquisition and merger (Caves and Mehra, 1986). There is indication that MNEs possessing strong R&D capabilities establish wholly-owned subsidiaries to exploit proprietary technology abroad, while those facing high technology barriers use joint ventures to enlist advanced technology from foreign partners ( Gatigono and Anderson, 1989;Kogut and Chang, 1991 cite in Chen, Shih-Fen, Hennart and Jean-Francois, 2002). Numerous studies indicate a firm's entry mode choice impacts a firm's overseas business performance and survival (Anderson & Gatignon, 1986; Kim & Hwang, 1992; Davidson, 1982 cited in Davis, 2000). The entry modes choice is influenced by transactional –cost, resource-based theory and eclectic theory (Anderson & Gatignon, 1986; Chang, 1995; Kim & Hwang, 1992 cited in Davis, 2000).

Explanations based on transaction-costs stress the preeminent role of control that each expansion type of mode affords an entrant.  Resource based explanations suggest that resource availability and utilization figure in choices among modes of entry if there are cost distinctions. Eclectic discussions posit a wide variety of factors, such as firm size, multinational experience and ability to differentiate products to influence entry mode (Gaves & Mehra, 1986). The investment behavior and entry mode of MNCs are primarily determined by firm-specific advantages, especially proprietary technologies and also location-specific factors (Haishun Sun, 1999).

 The timing of entry has received relatively little attention. However, earlier economic studies on the timing entry sought to explain how the monopolistic advantage of the firms determined the entry modes (Vibha, Yigang and Gerardo, 2002). There are supporting evidence that surviving first movers achieve higher market shares and profitability, largely as result of economic, preemptive, technological, and behavioral reasons (Kerin et al., 1992; Lilien and Yoon, 1990 cited in Vibha, Yigang and Gerardo, 2002).

 Figure 1. A hierarchical model of choice of Entry Modes

Source : Yigang Pan; Tse, David K., Journal of International Business Studies, 2000 4th Quarter, Vol. 31 Issue 4, p535-554, 20p, 2 Diagrams.

While the performance implications of entry-mode are widely acknowledged, little is known about the underlying institutional factors impinging on entry mode decisions. One reason is that prior investigations focused on identifying a comprehensive set of strategic variables and relationships that influence an entry- mode decision at its occurrence (Davidson, 1982; Anderson & Gatignon, 1986).

Core competencies and entry mode:

Firms enter into foreign market to earn greater returns from their core competencies, transfering the skills and product derived from thier core compentencies to foreign markets where indigenous competitors lack those skills (Hill, Cronk and Wickramasekera, 2010). According to them, it is the nature of core competencies of the firms that determines the optimal entry mode. Core competencies can be in technology know-how and management know-how. Where firm’s core competencies are in technology know-how, it should if possible avoid licensing and joint venture arrangement to protect the competencies. It is suggested that wholly owned subsidiary would be best form of the firms. In JCB case joint venture was limiting their expansion, because JCB was hesitant to transfer their core competency; leading technology know-how to joint venture with Escorts.  If the core competences of the firms are in management know-how, there is less risk of losing control over the management skill to joint venture or licensing model.

Pressure for cost reduction and entry mode:

Firms will choose to combine exporting and wholly owned subsidiaries if there is greater pressure for cost reduction. Firms may be able to realize substantial location and experience curve economies by manufacturing in those location where factors conditions are optimal and then exporting to rest of the world (Hill, Cronk and Wickramasekera, 2010). Then firms may export their finished products to marketing subsidiaries located in various countries. Setting up wholly owned marketing subsidiaries is preferable to joint- venture to controlling and coordinating dispersed value chain. It also gives firms the ability for cross-subsidization of weaker markets.

Figure 2: Decision Framework of entry modes:

Source : Hill, C.W.L., Cronk, T., Wickramasekera, R. (2010) Global Business Today: Asia- Pacific Edition, Ch.11 p. 449.

Figure 3:  Impact of micro-level factors on choice of entry modes

IMPACT OF MACRO-LEVEL FACTORS ON CHOICE OF ENTRY MODES
Determinants	Equity Vs. Non-equity	Within Non-equity	Within Equity modes
		Export Vs.Contrctual	EJV Vs.WOS
Host country factors:
Prioritized location	High	Low	Low
Host country risk	High	Low	Low
Home country Factors
Management orientation	High	Low	Low
Risk orientation	High	Low	Low
Host and Home country
Trade relationship	High	Low	Low
Political relationship	High	Low	Low
Industry factors
Marketing management	High	Low	Low
Asset management	High	Low	Low

Source : Yigang Pan; Tse, David K., Journal of International Business Studies, 2000 4th Quarter, Vol. 31 Issue 4, p535-554, 20p, 2 Diagrams.

 Case study:

A case study of an Italian fashion firm’s entry into the Chinese market:

 A leading Italian fashion company, which has a total of 15 brands, distributed internationally attempted two separate entry modes into Chinese market. In 2005 company started a JV with a local firm to distribute the company’s brand. In 2006 company started new Brand with an entry mode of WOS for distributing the Brand in the Chinese market. The firm’s entry modes choice and decision making processes were based on: Assets specificity gave company advantage of unique managerial capability which distinguishes them from local company. Brand equity was competitive advantage for entering into Chinese market and company has financial capability to establish wholly owned subsidiary. Company was already operating in Chinese market which gave them international experience. Country risk, market potential, cultural distance, Government restriction, and market competition were other important factors (Yao, Elena & Ann, 2011). The success of Company entry mode choice has been demonstrated by its performance in China. By now the company has opened 20 stores in several locations in China, all through WOS, and is planning more locations in the future. The company has emphasized the importance on special assets and brand equity to select higher control entry mode, which are fundamental considerations in a fashion brand’s foreign expansion decision (Moore and Burt, 2007 cited in Yao, Elena & Ann, 2011). High control over the foreign operation was preferred by Company to protect its brand equity from possible damage by inappropriate operations on the part of local partners. A high control entry mode was also beneficial to the company for gaining a higher profitability during long-term operation in the market.

Figure 4: Entry mode characteristic of fashion retailers.

As illustrated by the continuum in Figure 4, high control entry modes demand greater resource commitments in international market, and the foreign operation is exposed to a higher degree of uncertainties. However, low control modes require a more limited resource commitment, thus reducing investment risk, but the fashion retail firm has little power over foreign operations, which could result in reduced financial returns (Hill et al., 1990 cited in Yao, Elena & Ann, 2011).

Case study of JCB in India.

In case of JCB India, it was equity based joint-venture entry mode due to country specific factor (government regulations) with 40 per cent stake. Direct export to India was difficult due to high tariff and Indian government regulation required foreign investor to create joint venture with local companies. Indian construction market was ripe for growth and opportunity for expansion. Therefore, company decided to get a foothold in the nation on time to get advantage of time entry (Kerin et al., 1992; Lilien and Yoon, 1990 cited in Vibha, Yigang and Gerardo, 2002).

Since JCB core competency was in technology know-how, it should if possible avoid licensing and joint venture arrangement to protect the competencies (Hill, Cronk and Wickramasekera, 2010). So JCB decided to go for FDI by purchasing all of Escort’s equity, transforming the joint venture into wholly-owned subsidiary as shown in decision framework figure 2. Therefore, it very clear from JCB’s strategy to adopt different entry mode from joint-venture to wholly owned subsidiary was due to various factors, such as core competencies(technology and management know-how) and host country’s regulation (country specific factors).

 Source :  Hill, C.W.L., Cronk, T., Wickramasekera, R. (2010) Global Business Today: Asia- Pacific Edition, Ch.11 p. 436. Cited from P. Marsh, partnership feels the Indian heat, Financial Times, 22 June 2006, JCB targets Asia to spread production, Financial Times, 16 March, 2005. www.jcb.com/aboutjcb/jcbindia.aspx.

Conclusion:

The multinational companies’ entry modes in the international markets are determined by various factors such as varying degrees of resources commitment, risk exposure, control, and profit return. The primary factors that determine their entry modes include firm- specific factors, industry specific and country specific factors (Erramilli and Roa, 1993, Kim and Hang, 1992, Kumar and Subramaniam, 1997: Madhok, 1997; cited in Yang Pan and David K, 2004). Modes of entry can be classified as equity based and non-equity based. Equity based modes are wholly owned operations and equity joint ventures(EJVS), while non-equity base entry modes are divided into contractual agreement and exports (Yang Pan and David, k., 2004).

Multinational companies core competecies can be technology know –how and management know –how (Hill, Crank and Wickramasekera, 2010). It is the nature of core competencies of the firms, political risk, economic risk, transport cost, trade barriers and firms strtegy that determines the optimal entry mode. Where firm’s core competencies are in technology know-how, they avoid licensing and joint venture arrangement to protect the competencies as seen in JCB joint-venture case with Escorts in India. Wholly owned subsidiaries are preferred, since they best control technology know-how. If the core competences of the firms are in management know-how, there is less risk of losing control over the management skill to joint venture or licensing model. Acquisitions are easy modes of entry and may enable firms to preempt their global competitors with less time taken and involve buying known revenue and profit stream. However, acquisition may fail due to over paying for the target; culture clashes and failure integrate operations. In recent years, models of entry strategies have focused on structural and transactional disequilibrium between markets and suggested that the sustainability of entry depends on factors such as national characteristics, competitive rivalry, and demand conditions in host markets (Porter, 1990 cited in Davis, Desai and Francis, 2000 ). However, companies not sharing resources and competencies may lack essential economies to effect successful direct entry (Brown, Dev, CS & Zhou, 2003). The firms may gain efficiencies in acquiring and implementing market specific knowledge if they access local provider’s knowledge and technology base. In effect, such firms gain access to complementary resources and skills, such as reputation, distribution and access to customers that help eliminate or reduce cultural, technical and economic barriers.

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