Concepts of Foreign Trade

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External Sector

• India’s external sector consists of our

• Foreign trade

• Trade – in – services

• Foreign capital flows like FDI, FII

• Balance of Payments

• Exchange rate management

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Foreign Trade

• Foreign trade, also called as international trade is as old as history.

• Trade among countries is normal & desirable and exists for different reasons.

• One country has product A in surplus and lacks in respect of Product B.

• One country produces a particular commodity at less cost than it is done in another country.

• Foreign trade is significant for the economic development of all countries, particularly developing countries

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Extent of foreign trade

( Amount in Rs. Crores )

Year Exports Imports Total trade Balance of trade

85 – 86 10895 19658 30553 -8763

90 – 91 32553 43198 75751 -10645

95 – 96 106353 122678 229031 -16325

02 – 03 255137 297206 552343 -42069

06 – 07 563800 820568 1384368 -246768

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Foreign Trade

• Volume of foreign trade has been increasing

• Trade to GDP ratio has gone up from 13% in 1980 to about 20% as of now.

• Composition of our foreign trade has been changing

• India is exporting manufactured goods like Gems & Jewellery, Pharma drugs, software , Engg. Goods

• Fastest growing export destinations include EU, USA, UAE, China, Singapore.

• Value of imports has been on the increase due to increase in domestic consumption.

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Significance of exports

• Export earnings are required to finance our imports

• Require to spend more foreign exchange earnings on the import of crude oil, machinery.

• India has huge debts and we need foreign exchange earnings to service the debts.

• Exports would make our economy highly vibrant.

• It calls for quality products produced at reasonable costs

• India’s exports increased @ 5.9% during 1980-97 whereas for countries like China, Singapore it is @ 11%

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Reasons for our exports lagging behind

• Problem with quality of our goods.

• Lack of competitive advantage when compared to other countries due to higher cost of production.

• Our exports are pitted against tariff barriers imposed by the developing countries

• Supply is not adequate to meet demands of home market, thus hampering exports.

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EXIM Policy

• Government announces EXIM policy once in every five years

• Policy can be changed through annual policy statements.

• New EXIM policy was announced in Aug 2009 and valid upto March 2014

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New EXIM Policy

• The new policy seeks to assign a major role to foreign trade, helping India to further integrate with world economy

• Achieving annual export growth rate of 15% with an annual export target of US$200 bn by March 2011, and export growth of 25% per annum during 2011 – 2014.

• By 2014, to double India’s exports of goods and services.

• To act as an effective instrument of economic growth by giving a thrust to employment generation.

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Strategy of new EXIM Policy

• Removing controls and creating an atmosphere of trust and transparency to encourage Indian entrepreneurs.

• Facilitating development of India as a global hub of manufacturing, trading and services.

• Facilitating technological and infrastructural up gradation of all sectors of the economy

• Activating India’s Embassies as key players in our export strategy

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Trade in Services

• Services include telecom, banking, tourism, insurance, transportation, software services and professional services.

• Receipts from travel depend on tourist facilities in the country

• Transportation receipts depend on merchandise exports originating from country

• Receipts of repatriation of international investment income of India depend growth of world economy.

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Balance of payments

• BoP is a systematic and summary record of a country’s economic and financial transactions with the rest of the world over a period of time

• All transactions between the citizens of a nation and those of other nations are recorded in the balance of payments for a given period of time.

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Balance of payments

• Balance of trade takes into account only the transactions arising out of exports and imports of merchandise goods ie. visible items

• Balance of trade does not consider the exchange of invisible items such as services rendered by shipping, insurance,banking, tourism

• Balance of payments takes into account the exchange of both visible and invisible items

• Balance of payments presents a better picture of a country’s transactions with the rest of the world than the balance of trade.

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Recording International Payments

• The basic technique is standard, double-entry accounting.

• A flow of funds statement that shows changes in assets, liabilities and net worth over time.

• The balance of payments statement is to inform government authorities of the international position of the country to assist them with monetary-fiscal

questions as well as trade and payments policies.

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Components of balance of payments

• BoP is generally grouped under the heads

• Current account

• Capital account

• Unilateral payments account

• Official settlement account

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Current account

• Current account consists of 2 major items

• Merchandise exports and imports

• Invisible exports and imports ( Services )

• Merchandise exports ie., the sale of goods abroad, are the credit entries in the BoP of India

• All transactions giving rise to monetary claims on foreigners represent credit entry in the BoP of India

• Merchandise imports ie., the purchase of goods from abroad are debit entries in the BoP of India

• All transactions giving rise to foreign money claims on the home country ( India ) represent a debit entry in the BoP of India

Current account

• Merchandise exports and imports form the most important international transactions of many countries.

• Invisible exports ie., sales of services are credit entries in the BoP of India and debit entries in the BoP of other nation ( USA )

• Invisible imports ie., purchase of services are debit entries in the BoP of India and credit entries in the BoP of other nation ( USA )

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Capital account

• Capital account consists of short term and long term capital transactions.

• A capital outflow represents a debit entry in the BoP of India.

• A capital inflow represents a credit entry in the BoP of India.

• For example, if an Amercian company invests Rs.100 Mn in India, this transaction will be represented as a credit entry in the BoP of India and a debit entry in the BoP of USA.

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Capital account

• Payment of interest on loans and dividend payments are recorded in the current account since they are really payments for the services of capital.

• Interest paid on loans given by foreigners, dividend payments to foreigners are debit entries in the BoP of India ( Home country )

• Interest received and dividends received on foreign investment are credit entries in the BoP of India

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Unilateral transfers account

• These unilateral transfers include private remittances, government grants, disaster reliefs

• Unilateral transfers is another term for gifts received or gifts donated

• Unilateral payments received from abroad are credit entries in the BoP of India

• Unilateral payments made abroad are debit entries in the BoP of India

Official settlement accounts

Official reserves represent holdings by the government or official agencies

It is a means of payment that are generally accepted for settlement of internatonal claims

Balance of Payments Items

Credits Debits.

Current Account Current Account

1. Merchandise Exports 1.Merchandise Imports

(Sale of Goods) (Purchaseof Goods)

2. Invisible Exports 2.Invisible Imports

(Sale of Services) (Purchase of Services)

(a) Transport Services sold Transport Services purchased from abroad

(b) Insurance services sold abroad Insurance Services purchased from abroad

(c) Foreign tourist expenditure in country Tourist Expenditure abroad

(d) Incomes received on Income paid on loans and investments abroad.

loans and Investment in

Home country

 

Credits Debits.

Capital Account Capital Account

Foreign long-term investments in the home Long-term investments abroad.

Direct investments in the home country Direct investments in abroad country.

Foreign investments in domestic securities Investments in foreign securities

Other investments of foreigners Other investments abroad

Foreign short-term invest. In home country Short-term investments abroad

Credits Debits.

Unilateral Transfers Account Unilateral Transfers Account

Private remittances received from aborad Private remittances abroad

Pension Payments received from aborad Pension payments abroad.

Government grants received from aborad Government grants abroad

Credits Debits.

Official Settlements Accounts Official Settlements Accounts

Official sales of foreign currencies Official purchases of foreign currencies abroadabroad

Balance of Payments Equilibirum

The balance of payments of a country is said to be in equilibrium when the demand for foreign exchange is exactly equivalent to the supply of it.

The balance of payments is in disequilibrium when there is either a surplus or a deficit in the balance of payments.

When there is a deficit in the balance of payments, the demand for foreign exchange exceeds the supply for it.

 

Exchange Rate Management

Countries make use of their respective exchange rates while dealing with other countries

Every country wants to maintain an equilibrium exchange rate.

The objectives of our exchange rate policy are

• Reduce excess volatility in exchange rates

• Maintain an adequate level of foreign exchange reserves

Exchange Rate Management

The United Exchange Rate system ( UERS) brought into force in March 1992, has the following features

• The rates of exchange are determined in the market

• RBI intervention in the market to modulate the volatility and sharp depreciation of the rupee

• The US dollar is the principal currency for the RBI transactions