Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

The governments of many less developed countries have experienced problems in recent years as their debt levels have risen leading to what has been called a “global debt crisis”.

Required:
a) Explain briefly why these problems amount to a “crisis.
b) Discuss the approaches that have been used to overcome the problems.
c) Outline the benefits to multinational business enterprises of resolving the current global debt problems.
answer
a) Debt crisis in less developed countries (LDCs)
The debt crisis in LDC has risen as governments have taken on levels of debt to fund their development programmes which are beyond their ability to finance. As the levels of debt increases, the ability to pay decreases thus increasing the amount of GDP absorbed in servicing the debt rather than in financing development. Other factors that have caused debt crisis in less development countries are:

Decline in oil prices and revenues to LDCs especially where the oil reserves were used to borrow loans when World Oil prices were high e.g in case of Nigeria and Venezuela.
Appreciation of currency value of lenders vis-à-vis that of LDCs
Misuse of debt some corrupt governments of LDCs thus no ability to pay when those debts matures.
Imposed quota system on exports LDCs thus imports exceed exports and there is always need for funds to finance the deficit.

b) If the debt crisis is temporary due to fall in commodity prices, the country could borrow short term debt to cover the temporary shortfall. Where the problem of debt crisis is long term, the following measures would be appropriate:

Restructuring and rescheduling of debt. This would allow the government more time in which to repay the loan.
Economic reforms e.g structural adjustment programmes improve balance of trade and stimulate growth.
Debt refinancing i.e borrow a lower interest loan, pay-off the high interest rate loan and continue paying lower interest charges on new loan.
Increase foreign direct investment, exports and reduce imports.
Debt cancellation i.e write-off of debt lending governments and banks thus reducing interest charges and increasing ability to pay the remaining debts.
Debt-equity swaps i.e. convert debt to equity giving foreign lenders a stake in local industries thus becoming shareholders. This reduces the burden of interest payment and increase the ability to pay.

c) The solutions to the debt crisis in LDC will benefit the MNC as follows:
Improved trading position e.g less debt burden leads to improved economic position, thus reduced controls on capital flows, exchange rates and imports.
Political and economic stability will result thus improved operational environment of MNC. Increased size of local market for MNC due to increased purchasing power from economic growth. Reduced foreign exchange exposure – They will be able to match local payments with local revenues thus reduce/simplify the foreign exchange exposure management.

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