IF Module-1-Introduction
IF Module-1-Introduction
INTRODUCTION
The history of trading between countries can be traced back to human civilization. The goods were
exchanged in barter system or on purchase against gold. The concept of International Business got
momentum in 19th century. The first of globalization began around 1870 and ended with World War I (1919)
driven by the industrial revolution. During the period subsequent to the World War II, International business
grew manifold and spread to all corners of the globe.
Exchange of goods, services, financial resources, technology and manpower is the reality of today’s
economic system. The process of integration of the world economy has witnessed the creation of a very
dynamic international financial market thus paving way for the field of study of International finance. The
significance of international finance as a discipline has evolved in the last few decades making it
indispensable for financial managers to have a grasp on the subject in order to make intelligent corporate
decisions.
Definition
“The finance manager of the new century cannot afford to remain ignorant about international financial
markets & instruments and their relevance for the treasury function. The financial markets around the world
are fast integrating and evolving a whole new range of products & instruments. As national economies are
becoming closely knit through cross-border trade & investment, the global financial system must innovate
to cater to the ever changing needs of the real economy. The job of finance manager will become increasingly
more challenging, demanding & exciting.” -Apte
International business is a term used to collectively describe all commercial transactions that take place
between two or more regions, countries and nations beyond their political boundary.
Any firm contemplating foreign expansion must first struggle with the issue of which foreign market to
enter, the timing and mode of entry. The various modes for serving foreign markets are
● International Trade – Importing (Buying goods from another country) and Exporting (Selling
goods to another country).
● Licensing – It is an arrangement whereby the licensor grants the rights to intangible property to
another entity (the licensee) for a specified period, and in return, the licensor receives a royalty fee
from the licensee.
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● Franchising – It is a specialized form of licensing in which the franchiser not only sells intangible
property to the franchisee, but also insists that the franchisee agree to abide by strict rules as to how
it does business, often assisted by the franchiser.
● Joint Ventures – It entails establishing a firm that is jointly owned by two or more otherwise
independent firms. Example, Fuji Xerox was setup as a joint venture between Xerox and Fuji Photo.
Foreign Direct Investment by the way of Greenfield or Brownfield venture. If a firm can set up a
new operation in another country from scratch, it is known as Greenfield Venture. If it acquires an
established firm in that host nation and uses that firm to promote its products, it is known as
Brownfield venture. FDI can also happen by the way of other activities like Strategic alliances,
Turnkey projects, Joint Ventures, etc.,
A study of the institutions, policies and practices that govern the global financial management and financial
aspects of global business is called as international finance.
3. It deals with inflow and out flow of funds on current a/c, capital account and BOP
5. International finance relates to Global sourcing of fund such as American Deposit Receipt, Global
Deposit Receipt, Foreign Currency Convertible Bonds and Foreign Currency Exchangeable Bonds.
Domestic finance
In case of domestic finance, the companies raise fund by minimum cost of capital and try to maximize
the investors’ return.
International finance
The term international finance is similar to the domestic finance, but the most important difference is
foreign currency or foreign exchange
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Following are the some of the difference between Domestic Finance and International Finance:
A sizeable number of issues has involved in international business and finance. The players in international
business who are none other than MNCs are beset with many numbers of difficulties and roadblocks.
Some of the strategic issues involved in International business and finance are:
Economic System refers to the kind of governance of a country. It may be on the basis of the principles of
communism, capitalism, socialism and mixed economy principles, rules and ideologies. The global firms in
order to be successful must navigate with country specific economic system. The economic system issue is
not possible to address but MNC’s may harness for their economic gains.
Barriers are of two types (a) Tariff and (b) Non-Tariff. By imposing a high tariff (a kind of tax in international
trade) rates foreign trade is scuttled. The WTO is the agency to reduce tariffs. The other route to restrain the
imports is rejecting the goods for the reasons of environmental safety, health hazards, labor standards, and
subsidy and so on. This is called protectionism or non-tariff barriers.
Political Risks
The instability in the governance by political system in different countries is a major setback for international
business and finance. The rules and policies of some countries restrict market access. The change in
government policies puts MNCs on the back burner on many occasions.
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Dumping
Dumping refers to selling a product at a high price in the home country and at relatively low price in the
host country by an MNC. This practice ruins industries and employment opportunities in the host country
especially small scale industries. The Dispute Settlement Mechanism (DSM) at WTO is the authority to
address the issue of dumping practices.
Cultural Differences
Different countries have unique cultural heritages that shape values and influence the conduct of the
business. MNCs find matters such as defining the appropriate goals of the firm, attitudes toward risk, dealing
with employees and the ability to curtail and make profitable operations, vary dramatically from one country
to the next.
Language Differences
The ability to communicate is critical in all business transactions. The Indian and US citizen are often at a
disadvantage because they are generally fluent in English, while European and German people are fluent in
several languages including English
The trinities of intellectual properties are patents (for inventions), trademark (for brand name, image, etc.,)
and copyright (for author, musicians, and filmmakers). The invention of the new things requires world class
R&D set up by firms. The council for trade related aspects of intellectual property rights is the body at WTO
to address the IPR related issues.
Cyber Crimes
It is a crime committed with the use of computer and internet. Today all around the globe e- commerce and
e-business are flourishing. The flip side of e-commerce is cybercrimes where privacy is interrupted, money
is some other accounts are withdrawn, manipulated and transferred. The WTO has asked all countries to
have in place a proper and comprehensive cyber law in order to check the maladies and anomalies of
cybercrimes.
International Taxation
Tax have a significant impact on areas as diverse as making foreign investment decisions, managing
exchange risks, planning capital structures, determining financing costs and managing inter-affiliate fund
flows. A typical firm uses several strategies to manage Tax issues. These are,
a. Tax Havens: It is a state or a country or territory where certain taxes are levied at a low rate
or not at all while offering due process, good governance and a low corruption rate.
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b. Off Shore Financial Center: International business may also use the advantages presented by an off-
shore financial center which offers ample opportunities for more effective International tax
planning. For example, Malaysia had established the International off- shore financial center at
Labuan, a small island located off the North East coast of Sabah in East Malaysia. Labuan operated
as a free port where no sales tax, excise, import or export duties are imposed and was established
by the Malaysian government to promote off-shore business activity.
c. Transfer Pricing: It refers to the setting, analysis, documentation, and adjustment of charges made
between related parties for goods, services, or use of property (including intangible property).
Transfer prices among components of an enterprise may be used to reflect allocation of resources
among such components, or for other purposes.
d. Fronting Loan: It is also called as back-to-back loan or link financing. A fronting loan is a loan
between parent and its subsidiary channeled through a financial intermediary, usually a large
international bank. In a typical arrangement, the parent company deposits funds with a bank in
country ‘A’ that in turn lends money to a subsidiary in country ‘B’.
The Asian crisis, the Mexican Crisis, the Malaysian Crisis are in relation to economic crisis wherein they
have experienced recession and adverse BOP position. The same countries along with Japan experienced
currency crisis wherein the value of currencies were either depreciated or devalued and further exposed to
shortage of foreign exchange reserves. During these disordered, disorganized and chaotic situations,
international business and finance is jeopardized.
Interest Rates
The equity cost of capital; is less compared to debt funds in the global capital market. The increasing interest
rate raises cost of capital and profitability of the firm is lessened. Interest rate is the parameter in global
finance which plays a dominant role in production and operational risks of the global firms.
Foreign exchange risk refers to the difficulties encountered by a country, a firm or an individual owing to
the fluctuations in the exchange rate. Exchange rate is the rate at which one country’s currency is exchanged
for another. The exchange of currency happens in two ways – fixed exchange rate and floating exchange
rate.
Managing foreign exchange risk is a challenging task for an international business. Changes in the value of
currencies both devaluations and revaluations adds risk in handling foreign currencies.
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Cold War
A state of rivalry and tension between two factions, groups or individuals that stops short of open,
violent confrontations is a cold war. The cold war stultifies international business.
By having open discussion, transparency and shedding of ego between and among trading partner. Cold
war can be doused to help achieve international peace and harmony.
Countries in the world are subject to the time s of good and bad trade. Business cycle or trade cycle is
international in character, recurring in nature and time period of each stage of the cycle such as inflation,
deflation, revival and recession are uncertain.
Operational Risks
These risks arise out of operations and management of a global firm. The operational risk encompasses
commercial risks, foreign exchange risks, political risks and country specific risks.
Global Terrorism
Terrorism obstructs the smooth flow of economic activities. It pushes the economy into bankruptcy and
insolvency. It worsens import and export trade. Thus the free flow of investment is affected due to terrorism.
While managing cash, the international financial manager needs to address three issues.
Credit Worthiness
International business and finance stands on and runs through the credibility, trustworthy and credentials of
the borrowers of goods and services, technology or information. As credit worthiness principle applies to
individual borrowers it also extends to MNC’s and countries in the international business and finance. The
bulk of the trade depends on credit worthiness for credit transactions.
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Methods of Payments
In this competitive world, exporters must offer their clients attractive sales terms; which has to be supported
by the appropriate payment methods. So it accommodates the needs of the byer and reduces the risk of
defaults in the hands of seller.
i. Cash in advance
v. Consignments
i. Cash in advance
The importer has to make payment before goods are delivered to them by the exporters. So that the
exporters can avoid credit risk as the payment is received before the goods are transferred. However,
this method is least attractive to the importer as it creates cash flow problem.
Letters of credit (LCs) are one of the most secured instruments available to international traders.
An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter,
provided that the terms and conditions are met as per LC. An LC is useful when reliable credit
information about a foreign buyer is difficult to obtain. It protects the buyer since no payment
obligation arises until the goods have been shipped or delivered as promised.
A documentary collection (D/C) is a transaction whereby the exporter delegates the collection of a
payment to remitting bank (exporter’s bank), which sends the documents to the collecting bank
(importer’s bank), along with instructions for payment. Funds are received from the importer and
remitted to the exporter through the banks involved in the collection in exchange for those
documents. D/Cs involve using a draft that requires the importer to pay the face amount either at
sight (document against payment) or on a specified date (document against acceptance).
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The collection letter gives instructions that specify the documents required for the transfer of title to
the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process
and limited recourse in the event of non-payment. D/Cs are generally less expensive than LCs.
An open account transaction is a sale where the goods are shipped and delivered before payment is
due, which is generally in 30, 60 or 90 days. Obviously, this is mode of payment is the most
advantageous to the importer in terms of cash flow and cost, but it is consequently one of the highest
risk options for an exporter. Because of intense competition in export markets, foreign buyers often
press exporters for open account terms since the extension of credit by the seller to the buyer is more
common. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors.
Exporters can offer competitive open account terms while substantially mitigating the risk of non-
payment by using export credit insurance.
v. Consignments
Consignment in international trade is a variation of open account in which payment is sent to the
exporter only after the goods have been sold by the foreign distributor to the end customer. An
international consignment transaction is based on a contractual arrangement in which the foreign
distributor receives, manages, and sells the goods for the exporter who retains title to the goods until
they are sold. Exporting on consignment is very risky as the exporter is not guaranteed any payment
and the goods are in a foreign country in the hands of an independent distributor or an agent.
Consignment helps exporters become more competitive on the basis of better availability and faster
delivery of goods. Selling on consignment can also help exporters to reduce the costs of storing and
managing inventory.
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Evolution of IMF
Bimetallism….(Before 1875)
Prior to 1870s, many countries had bimetallism which was having double standard in the free coinage period
both maintained by gold and silver; which were used as international means of payment and the exchange rate among
countries were determined either by their gold and silver contents. Countries that were on the bimetallic standards often
experienced the well-known phenomenon referred to as Gresham’s Law which articulates that “bad money (abundant
money) drives out good money (scarce money)”. For example, when gold from newly discovered mines in California
and Australia poured into the market in 1850’s, the value of the gold became depressed, causing overvaluation of gold
under French official ratio, which resulted to a gold Franc to silver Franc 15.5 times as heavy. As a result Franc
effectively became a gold currency.
A monetary system in which a country's government allows its currency unit to be freely converted into fixed amounts
of gold and vice versa. The exchange rate under the gold standard is determined by the economic difference for an ounce
of gold (i.e.1ounce = 28.3495grams) between two currencies.
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Though in Great Britain currency notes from the Bank of England were made fully redeemable for gold during 1821,
the first full-fledged gold standard was adopted by France (as mentioned in the bimetallic period) in 1878. Later on
United States adopted it in 1879 and Russia and Japan in 1897, Switzerland, and many Scandinavian countries by 1928.
As of 2013 no country used a gold standard as the basis of its monetary system, although some countries
hold substantial gold reserves.
Bretton Woods is the name of the town in the state of New Hampshire, USA, where the delegations from over
forty five countries met in 1944 to deliberate on proposals for a post-war international monetary system. The two main
contending proposals were “the White plan” named after Harry Dexter White of the US Treasury and the “Keynes plan”
whose architect was Lord Keynes of the UK. Following the Second World War, policy makers from victorious allied
powers, principally the US and UK, took up the task of thoroughly revamping the world monetary system for the non-
communist world. The outcome was the so called “Bretton Woods System” and the birth of new supra-national
institutions, the International Monetary Fund (the IMF or simply the “Fund”) and the World Bank.
Under this system US Dollar was the only currency that was fully convertible to gold; where other countries’
currencies were not directly convertible to gold. Countries held US dollars, as well as gold, for use as an international
means ofpayment.
The system proposed an international clearing union that would create an international reserve asset called
“bancor”. Countries would accept payment in bancor to settle international transactions without limit. They would also
be allowed to acquire bancor by using overdraft facilities with the clearing union.
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In return for undertaking this obligation, the member countries were entitled to have access to credit facilities from the
IMF to carry out their intervention in the currency markets.
The novel feature of regime which makes it an adjustable peg system rather than a fixed rate system like
the gold standard was that the parity of a currency against the dollar could be changed in the face of a fundamental
equilibrium. **A fundamental equilibrium is said to exist when at the given exchange rate, the country repeatedly faces
balance of payment disequilibria, and has to constantly intervene and sell foreign exchange (persistent deficits) or buy
foreign exchange (persistent surpluses) against its own currency. The situation of persistent deficits is much more
difficult to deal with and calls for a devaluation of the home currency. Changes of upto 10% in either direction could
be made without the consent of the Fund and obtaining their approval.
Under the Bretton Wood System, the US dollar in effect became international money. Other countries
accumulated and held dollar balances with which they could settle their international payments; the US could in principal
buy goods and services from other countries simply by paying with its own money. This system could work as long as
other countries had confidence in the stability of the US dollar and in the ability of the US treasury to convert dollars
into gold on demand at the specified conversion rate.
Professor Robert Triffin warned that gold exchange system was programmed to collapse in the long run. To satisfy the
growing needs of reserves, the US had to run BOP deficits continuously which would eventually impair the public
confidence in the dollar, triggering a run on the dollar. If reserve currency country runs BOP deficits to supply reserves,
they can lead to a crisis of confidence in the reserve currency itself causing the down fall of the system. This dilemma
is known as Triffin Paradox.
The system came under pressure and ultimately broke down when this confidence was shaken due to various political
and some economic factors starting in mid-1960s. On August 15, 1971, the US government abandoned its commitment
to convert dollars into gold at the fixed price of $35 per ounce and the major currencies went on a float. An attempt was
made to resurrect the system by increasing the price of gold and widening the bands of permissible variation around
the central parity. This was the so called Smithsonian Agreement. That too failed to hold the system together,
and by early 1973, the world moved to a system of floating rates.
After a period of wild fluctuation in exchange rates – accentuated by real shock such as the oil price crises in
1973 – policy makers in various countries started experimenting with exchange rate regimes which were hybrids
between fixed and floating rates. A group of countries in Europe entered into Bretton Woods like engagement of
adjustable pegs within themselves. This was the European monetary system. Other countries tried various mixed
versions.
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International monetary systems are sets of internationally agreed rules, conventions and supporting
institutions that facilitate international trade, cross border investment and generally the reallocation of capital
between nation states. They provide means of payment acceptable between buyers and sellers of different
nationality, including deferred payment. To operate successfully, they need to inspire confidence, to provide
sufficient liquidity for fluctuating levels of trade and to provide means by which global imbalances can be
corrected. The systems can grow organically as the collective result of numerous individual agreements
between international economic actors spread over several decades.
The first modern international monetary system was the gold standard. Operating during the late 19th and
early 20th century, the gold standard provided for the free circulation between nations of gold coins of
standard specification. Under the system, gold was the only standard of value.
The advantages of the system lay in its stabilizing influence. A nation that exported more than it imported
would receive gold in payment of the balance; such an influx of gold raised prices, and thus lowered the
value of the domestic currency. Higher prices resulted in decreasing the demand for exports, an outflow of
gold to pay for the now relatively cheap imports, and a return to the original price level.
A major defect in such a system was its inherent lack of liquidity; the world's supply of money would
necessarily be limited by the world's supply of gold. Moreover, any unusual increase in the supply of gold,
such as the discovery of a rich lode, would cause prices to rise abruptly. For these reasons and others, the
international gold standard broke down in 1914.
During the 1920s the gold standard was replaced by the gold bullion standard, under which nations no longer
minted gold coins but backed their currencies with gold bullion and agreed to buy and sell the bullion at a
fixed price. This system, too, was abandoned in the 1930s.
In the decades following World War II, international trade was conducted according to the gold- exchange
standard. Under such a system, nations fix the value of their currencies not with respect to gold, but to some
foreign currency, which is in turn fixed to and redeemable in gold. Most nations fixed their currencies to the
U.S. dollar and retained dollar reserves in the United States, which was known as the “key currency” country.
At the Bretton Woods international conference in 1944, a system of fixed exchange rates was adopted, and
the International Monetary Fund (IMF) was created with the task of maintaining stable exchange rates on a
global level.
During the 1960s, as U.S. commitments abroad drew gold reserves from the nation, confidence in the dollar
weakened, leading some dollar-holding countries and speculators to seek exchange of their dollars for gold.
A severe drain on U.S. gold reserves developed and, in order to correct the situation, the so-called two-tier
system was created in 1968. In the official tier, consisting of central bank gold traders, the value of gold was
set at $35 an ounce, and gold payments to non central bankers were prohibited. In the free-market tier,
consisting of all nongovernmental gold traders, gold was completely demonetized, with its price set by
supply and demand. Gold and the U.S.
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dollar remained the major reserve assets for the world's central banks, although Special Drawing Rights were
created in the late 1960s as a new reserve currency. Despite such measures, the drain on U.S. gold reserves
continued into the 1970s, and in 1971 the United States was forced to abandon gold convertibility, leaving
the world without a single, unified international monetary system.
Widespread inflation after the United States abandoned gold convertibility forced the IMF to agree (1976)
on a system of floating exchange rates, by which the gold standard became obsolete and the values of various
currencies were to be determined by the market. In the late 20th century, the Japanese yen and the German
Deutschmark strengthened and became increasingly important in international financial markets, while the
U.S. dollar—although still the most important national currency—weakened with respect to them and
diminished in importance. The euro was introduced in financial markets in 1999 as replacement for the
currencies (including the Deutschmark) of 11 countries belonging to the European Union (EU); it began
circulating in 2002 in 12 EU nations. The euro replaced the European Currency Unit, which had become the
second most commonly used currency after the dollar in the primary international bond market. Many large
companies use the euro rather than the dollar in bond trading, with the goal of receiving a better exchange
rate.
The IMF is an independent international organization. It is a cooperative of 191 member countries, whose
objective is to promote world economic stability and growth. The member countries are the shareholders of
the cooperative, providing the capital of the IMF through quota subscriptions. In return, the IMF provides
its members with macroeconomic policy advice, financing in times of balance of payments need, and
technical assistance and training to improve national economic management.
The IMF is one of several autonomous organizations designated by the United Nations (UN) as “Specialized
Agencies,” with which the UN has established working relationships. The IMF is permanent observer at the
UN. The Articles of Agreement that created the IMF and govern its operations were adopted at the United
Nations Monetary and Financial Conference in Bretton Woods, New Hampshire, on July 22, 1944, and
entered into force on December 27, 1945. Article I set out the mandate of the IMF as follows:
a. To promote international monetary cooperation through a permanent institution which provides the
machinery for consultation and collaboration on international monetary problems;
b. To facilitate the expansion and balanced growth of international trade, and to contribute thereby to
the promotion and maintenance of high levels of employment and real income
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and to the development of the productive resources of all members as primary objectives of
economic policy;
c. To promote exchange stability, to maintain orderly exchange arrangements among members, and to
avoid competitive exchange depreciation;
e. To give confidence to members by making the general resources of the IMF temporarily available
to them under adequate safeguards, thus providing them with opportunity to correct maladjustments
in their balance of payments without resorting to measures destructive of national or international
prosperity; and
f. To shorten the duration and lessen the degree of disequilibrium in the international balances of
payments of members.
This mandate gives the IMF its unique character as an international monetary institution, with broad
oversight responsibilities for the orderly functioning and development of the international monetary and
financial system. The IMF pursues the various facets of its mandate in a number of ways.
Since its inception, the IMF’s size and structure, responsibilities and priorities, and mode of operations have
undergone considerable expansion or transformation in response to changes in the world economic
environment. To continue to fulfill its core mandate as set out in the Articles of Agreement, the IMF has
continuously adapted to meet new challenges in the evolving world economy. Since 1945, membership has
expanded steadily to include nearly all countries in the world today.
Eligibility for membership is based on three basic requirements: the applicant must be a country; it must be
in control of its foreign affairs; and it must be willing and able to fulfill the obligations of membership.
The size of the IMF is often also viewed in terms of the total quota of all its members. In nominal Special
Drawing Rights (SDR) terms, the total quota has expanded significantly over time, reflecting the growth in
membership, in the size of the world economy, and in the financing needs of the membership. However, the
total quota has been declining relative to world GDP.
Each member of the IMF is assigned a quota expressed in special drawing rights (SDRs), the IMF’s unit of
account for financial transactions with member countries. The member’s capital subscription to the IMF is
equal to its quota. Members pay up to 25 percent of their quota in the form of reserve assets and the remainder
in their own currency. A member borrows from the IMF by purchasing reserve assets using its own currency,
and repays the IMF by repurchasing its own currency using reserve assets.
The total quota or capital subscription of all members is currently SDR 212.8 billion. Quotas determine the
size of the IMF and play a central role in the IMF’s operations.
Quota subscriptions by members provide by far the bulk of the resources (reserve assets) available to the
IMF to finance its lending operations. Therefore, quotas to a large extent determine the lending capacity of
the IMF.
Quotas largely determine the distribution of the voting power of the IMF and, therefore, the relative influence
of individual members in decision-making at the IMF.
The limit of members’ access to IMF resources is stated as a per cent of quota, so that quotas in principle
determine the maximum level of a country’s access. These access limits vary according to the type of
borrowing arrangement between the member and the IMF. For example, under the
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credit tranches and the Extended Fund Facility, borrowing is subject to an annual limit of 100 percent of
quota and a cumulative limit of 300 percent of quota.
BALANCE OF PAYMENTS
Balance of payments records commercial, financial and economic flows between residents of a given
country and those of the rest of the world during a certain period of time, generally a year. It measures flows
rather than stock.
A resident of a country in this context means any individual, business organization, government agency or
any other institution legally domiciled in the country concerned; it does not necessarily mean a citizen. For
example, transactions with a subsidiary of a French company established in India form a part of records of
BOP; transactions between only local residents are outside the purview of BOP. However, the exception
occurs when a transaction involves a foreign currency that is exchanges between a private resident of the
country and its monetary authority or the central bank.
A BOP statement is kept in the form of sources (credits) and uses (debits) of funds. This record enables us
to know whether the country has/had a net surplus or deficit during the referred period. If a country receives
more funds from abroad then it spends, it has a surplus of BOP. If expenditures abroad by residents exceed
what the residents earn or receive from abroad, the country has a deficit of BOP.
The major sources of funds or Credit transactions for a country accrue from:
Thus, the ‘sources’ increase the external purchasing power of a country. Conversely ‘uses’ decrease its
purchasing power.
A. CURRENT ACCOUNT
I. MERCHANDISE
a) Services
i) Travel
ii) Transportation
iii) Insurance
v) Miscellaneous
Of which :
Software Services
Business Services
Financial Services
Communication Services
b) Transfers
i) Official
ii) Private
c) Income
i) Investment Income
Credit Debit
(+) (-) Net
B. CAPITAL ACCOUNT
1. Foreign Investment (a+b)
a) Foreign Direct Investment (i+ii)
i. In India
Direct
b)Portfolio Investment
ii. Abroad
2.Loans (a+b+c)
a) External Assistance
i) By India
ii) To India
b) Commercial Borrowings(Medium Term & Long Term)
i) By India
ii) To India
c) Short Term Borrowings to India
i) Buyers' credit & Suppliers' Credit >180 days
ii) Suppliers' credit up to 180 days
3. Banking Capital (a+b)
a) Commercial Banks
i) Assets
ii) Liabilities
iii) Non-Resident Deposits
b) Others
4. Rupee Debt Service
5. Other Capital
Total Capital Account (1 to 5)
C. Errors & Omissions
D. Overall Balance (A+B+C)
[Total Current Account, Capital
Account and Errors and Omissions
E. Monetary Movements (i+ii)
i) I.M.F.
ii) Foreign Exchange Reserves
( Increase - / Decrease +)
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It relates to international assets and liabilities for such transactions which the country’s monetary
authorities uses to settle the deficits and surpluses that arise on the other two categories of
accounts.
A BOP statement is divided into several intermediate accounts. The three major segments are: (i) Current
Account, (ii) Capital Account, and (iii) Official reserves Account.
The data needed to prepare different accounts are collected from various sources. For instance, the data on
imports and exports are gathered from customs authorities whereas the financing of these transactions
appears largely among the data on changes in foreign assets and liabilities reported by financial institutions.
The Current Account is a record of the trade in goods and services among countries. The trade in goods is
composed of exports (selling merchandize to foreigners) and imports (buying merchandize from abroad).
Exports are a source of funds and result in a decrease in real assets. On the other hand, imports are a use of
funds and result in an acquisition of real assets.
The trade in services (also called invisibles) includes interest, dividends, tourism/travel expenses and
financial charges, etc., Interest and dividends measure the services that the country’s capital renders abroad.
Payments coming from tourists measure the services that the country’s shops and
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hotels provide to foreigners who visit the country. Financial, insurance and shipping charges measure the
services that the country’s financial and shipping sectors render to foreigners. Receipts obtained by servicing
foreigners on these counts constitute source of funds. On the other hand, when the country’s residents receive
the services from foreign owned assets, utilization of funds, takes place.
Unilateral transfers consist of remittances by migrants to their kith and kin, and gifts, donations and subsidies
received from abroad. Remittances so received are obviously sources; remittances made in forms of
gifts/donations, etc., by immigrants cause utilization of funds.
The Capital Account is divided into foreign direct investment (FDI), portfolio investment and private short
term capital flows. FDIs are for relatively longer period of time and portfolio investments have a maturity
of more than one year when they are made. The short term capital flows mature in a period of less than one
year. The distinction between FDI and portfolio investment is made on the basis of the degree of involvement
in the management of the company (and not on the basis of extent of ownership) in which the investment is
made. For example, an ownership of more than 10% of a firm may require direct involvement in the firm’s
management. In the event of the investor exercising / participating actively in the management of the unit,
it amounts to FDI. If the investor decides not to participate, the investment is then referred to as portfolio
investment.
As regards to Official Reserves Account, the monetary authority of a country, using the central bank, owns
international reserves. These reserves are composed of gold, convertible currencies like dollar, euro, yen,
SDRs (Special Drawing rights), etc., since BOP is expressed in national currency; an increase in any of these
assets means a use of funds while their decrease implies a source of funds.
If overall balance (current plus capital) is in deficit, this implies either a reduction in reserves or an increase
in foreign debt or reduction of credit. It is important to note that, by convention, a deficit is shown by a (+)
sign. In other words, it appears on the sources side. As a result, sum of all sources and uses becomes equal.
The reverse is true when overall balance (i.e. the sum of current and capital account) is in surplus.
MODULE 1 – INTRODUCTION TO INTERNATIONAL FINANCE