Components of Balance of Payments:

Current Account:

• The current account is a country’s trade balance plus net income and direct payments. It reflects trade position of the country. The current account also measures international transfers of capital.
• The trade position of the country is reflected by the current account. It shows the merchandise exports and imports and also the transfers and grants.
• A current account is in balance when the country’s residents (people, government and businesses) have enough reserves to fund all purchases in the country.
• In India, we have always had a current account deficit.
• The current account is divided into four components: trade, net income, direct transfers of capital and asset income.
• Trade:Trade in goods and services is the largest component of the current account. Hence a trade deficit  is enough to create a current account deficit.
• Net Income: Net income is an income received by the country’s residents minus income paid to foreigners. The two sources of income received by residents are i)  income from asset hold overseas and interest, dividends from an investment held overseas. ii) income earned by a country’s residents who work overseas. The two sources of income paid to foreigners are i)  income from asset held in the country and interest, dividends from an investment held in the country. ii) income earned by a foreigner who works in the country. If the income received by a country’s individuals, businesses and government from foreigners is more than the income paid out, then net income is positive (surplus). If it is less, then net income is negative (deficit).
• Direct Transfers: This includes remittances from workers to their home country.  Direct transfers also include a government’s direct foreign aid, foreign direct investment, and the direct transfer is bank loans to foreigners.
• Asset Income: This is composed of increases or decreases in assets like bank deposits, the central bank, and government reserves, securities and real estate. The asset income includes country’s liabilities to foreigners such as deposits of foreign residents at the country’s banks, loans made by foreign banks abroad to domestic banks, foreign private purchases of a country’s government bonds, sales of the securities made by a nation’s businesses to foreigners. FDI, such as reinvested earnings, equities, and debt. Other debts owed to foreigners. Assets, like those described, held by foreign governments. Net shipments of the country’s currency to foreign governments.

Capital Account:

• The former balance of payments capital account has been redesignated as the capital and financial account as per the fifth edition of Balance of Payments Manual(IMF). The revised account has two major components:
  – The Capital Account and The Financial Account

• Capital Account:

  • The investment part of the international transactions is included in the capital account. The major components of the capital account are (a) capital transfers and (b) acquisition/disposal of non produced, nonfinancial assets. This is further categorized into equity and debt investment.
  • The money of a foreign institutional investor (FII) and Foreign Direct Investment (FDI) are a part of the equity investments. Debt investments include the External Commercial Borrowings (ECBs), money deposited in banks by non-resident Indians and trade credits.

• Financial Account:

  • The financial account records an economy’s transaction in external financial assets and liabilities. The components of account are classified according to the type of investment or by functional subdivision ((a) direct investment, (b) portfolio investment, (c) other investment,(d) reserve assets

Official Reserve Account:

• The official reserve account is a part of the capital account, are the foreign currency and securities held by the central bank of a country and used to balance the payments from year-to-year.
• The reserves increase in case of a trade surplus and decrease when there is a trade deficit.
• The central banks use it to change the exchange rate to what the government perceives as more favourable.
• The difference between the current account and the capital account of a country is reflected in the change in the foreign exchange reserves of that country.

Foreign Exchange Reserves:

• Foreign exchange reserves are the foreign currencies held by a central bank.
• The foreign exchange reserve comprises Special Drawing Rights (SDRs), Foreign Currency Assets (FCA) and Reserve Tranche Position (RTP) at the IMF. The level is determined largely by the central bank’s open market operations in the Forex exchange market to even out the volatility in exchange rates and its valuation changes
  according to the movement of the dollar against the other major currencies.
• These reserves are accumulated when the central bank absorbs excess foreign exchange flows through intervention in the foreign exchange market and through the receipt of aid and interest payments.
• The International Bank for Reconstruction and Development (IBRD), International Development Association (IDA) and Asian Development Bank (ADB) funding also add to the foreign exchange reserves.
• Foreign currency assets are maintained in key international currencies such as the US dollar, pound sterling, euro, yen and Australian dollar.

Reasons for Holding Foreign Exchange Reserves:

• Countries use their foreign exchange reserves to keep the value of their currencies at a fixed rate.
• Countries with a floating exchange rate system use reserves to keep the value of their currency lower than the dollar. Reserve Bank of India buys U.S. Treasuries to keep its value of rupee lower than the dollar. This keeps India’s exports relatively cheaper, boosting trade and economic growth.
• To maintain the liquidity in case of an economic crisis. For example, a natural calamity may temporarily suspend local exporters’ ability to produce goods. That cuts off their supply of foreign currency to pay for imports. In that case, the central bank uses the reserve to fund imports. The central bank supplies foreign currency to keep markets steady. It also buys the local currency to support its value and prevent inflation.
• To provide confidence. The central bank assures foreign investors that it’s ready to take action to protect their investments.
•  It is needed to make sure a country will meet its external obligations like international payments,  commercial debts, financing of imports and to absorb any unexpected capital movements.
• To fund sectors, such as infrastructure.
• To boost returns without compromising safety. They do that by diversifying their portfolio. They also hold gold and other safe, interest-bearing investments.

Relationship between Current Account, Capital Account and Official Reserve Account and Balance of Payments:

• The current account and the capital account should balance because every transaction is recorded as both a credit and a debit in double-entry accounting and since credits must equal debits and the balance of payments is equal to credits minus debts, the sum of the balance of payments statements should be zero.
• Current account deficit is when payments exceed receipts from the trade of goods & services, transfers, and net income.  It indicates a country is borrowing and is a net debtor to the rest of the world. A current account deficit is when a country’s government, businesses, and individuals import more goods, services and capital than it exports.
• A deficit in the current account leads to depletion of foreign currency assets as these assets are used as a source to fund deficit which forms part of the capital account. Depletion of foreign currency assets reduces money supply which in turn results in liquidity issues.
• If the payments are more than the receipts under the current account, there will be a deficit. If the receipts are more than the payments, the current account will show a surplus. Thus, any surplus in the current account of a country is offset by a net outflow of a country (net export of capital), and any deficit in the current account is offset by a net inflow of capital (or net import of capital). In such a situation, the current account balance is equal to the capital account balance so that the country’s BoP achieves equilibrium in the absence of the official reserve account. For example, during a particular year, the exports and imports of India were $ 600 billion and $ 450 billion, respectively. The surplus on the current account was $ 150 billion. There was, thus, a net capital outflow of $ 150 billion. The surplus on the current account was exactly matched by the deficit in the capital account and, therefore, the balance of payments was in equilibrium.
• A country may take various measures in order to balance its current account deficits. Such measures include the issuance of securities like bonds or equity stocks and, the sale of some of its business operations abroad. If a country acquires some surplus in her current account transaction, it may buy foreign assets, including financial assets. The balance of payment on current account, thus, results in changing strategies in respect of capital assets.
• A country that produces more than it consumes will save more than its domestic investment. This will result in a net capital outflow. Conversely, a country that spends more than its produce will invest domestically more than it saves and has a net capital inflow.
• Net capital outflows (capital account surplus) would result in an increase in official reserves and net capital inflows (capital account surplus) would result in a decrease in official reserves. Hence, the sum of the current account balance, capital account balance, and the official reserve account balance are always zero.
• BOP = Current Account Balance + Capital Account Balance – Official Reserve Account = 0

The post Balance of Payments appeared first on The Fact Factor.

• The number of systemically important trading nations increased over time, their trade links have also
  multiplied. It is due to the increase in supply chain system facilitated by lower tariffs and a decline in transportation and communication costs.
• The increase in international trade is due to liberalization and specialization.
• The multilateral and bilateral liberalization has led to significantly lower trade barriers in advanced economies.
• Advanced countries and emerging market economies play different roles in global supply chains.
  Advanced economies tend to be upstream in the supply chain. This position is characterized by relatively small foreign contents in their exports and relatively large contributions towards other downstream countries’ exports.

Ease of Doing Global Business:

• Restrictions like the forbidding movement of labour, resources, and capital make international trade cumbersome. These restrictions may change at any time. Hence the ability to sustain international trade is always uncertain.
• However, governments today impose fewer restrictions on cross-border movements than they did a decade or two ago, allowing companies to better take advantage of international opportunities.
• Due to liberalization consumers have better access to a greater variety of goods and services at lower prices and local producers become more efficient by competing against foreign companies.
• liberalization or granting most favoured nation (MFN) status is a reciprocative process. If they reduce their own restrictions, other countries will do the same. and thus trade becomes easier.

Emerging market economies as major players:

• In the early 1970s, trade was largely confined to a handful of advanced economies, like the United States, Germany, and Japan, which together accounted for more than a third of the global trade. By 1990, several emerging market economies, especially in East Asia entered in global trade.
• The emerging markets have increased the potential size and worth of current major international trade and facilitated the emergence of a whole new generation of innovative companies. These economies now rival the rich countries for business innovation.

Cooperation among Countries:

• Countries cooperate with each other by signing treaties and having consultations. It helps in eliminating restrictions on trade and by laying the frameworks that reduce uncertainties.
• They do so to gain reciprocal advantages, to tackle a problem they cannot solve alone.
• G20 or BRICS or SARC countries have agreed to protect the property of foreign-owned companies and to permit foreign-made goods and services to enter their territories with fewer restrictions.

Transfer of Technology:

• Technology transfer is the process by which commercial technology is disseminated.  It will involve the communication, by the transferor, of the relevant knowledge to the recipient.
• This technology transfer may be in the field of infrastructure or agricultural development or in the defence sector. or in the fields of research, education, employment, and transport.

Forced Dynamism:

• International trade is forced to succumb to trends that shape the global political, cultural, and economic environment. In today’s world, it is changing day by day. Such environment ads dynamism to global trade.

Rising Share of Higher Technology Goods:

• Previously, international trade was restricted to agricultural goods and raw material.
• The role of global supply chains for trade in high technology goods has increased over time, especially in China. The increase is particularly pronounced for China.

The Asian supply chain is more dispersed compared to those in North America or Europe:

• In the Asian supply chain, goods-in-process cross borders several times, including through the hub (Japan), before reaching their final destination. In the case of the United States in NAFTA and EU15 in Europe, almost all foreign input is imported directly from the hub.
• There is the possibility of disruptive trade flow in the Asian supply chain due to seen,  unseen and uncontrollable events like a natural disaster.

The post Challenges and Emerging Trends in Global Trade appeared first on The Fact Factor.

Benefits of International Finance:

• International finance integrates world economies and thus facilitates easy flow of capital across countries worldwide. For a developing country, with high return on domestic capital, investment can be financed more cheaply by borrowing from abroad than out of domestic saving alone.
• International finance moderates domestic regulations through global financial institutions
• International finance leads to healthy competition among domestic financial sector and hence, results in more effective banking and financing services. Letting foreign financial institutions into the country improves the efficiency of domestic financial markets.
• International finance promotes domestic growth and investment through capital import.  Investors in richer countries can earn a higher return on their saving by investing in the emerging market than they could domestically.
• International finance leads to effective capital allocation by providing information on vital areas of investment
• International finance gives countries access to capital markets across the world and,  thus, enables a country to lend in good times and borrow in bad times. Everyone benefits from the opportunity to smooth out disturbances and by diversifying the risks.
• Governments face the discipline of the international capital markets in the event they make policy mistakes.

The Scope of International Finance:

• Multinational corporations have subsidiaries or joint ventures in different countries. Their operations, organizational structures and lines of business depend on the global, political, socio-cultural, economic and legal environment of the countries in which they do the business. For this purpose, international treaties like Basel norms, Kyoto Protocol and WTO guidelines lay down a uniform framework for how business should be conducted between different countries.
• The economics of international trade and international finance are much the same except that international finance involves greater risks and uncertainties as the assets being traded are claimed to flow of returns that extend for many years in the future. Besides, the markets of financial assets are more volatile as compared to the market in goods and services as financial decisions in financial assets are more rapidly revised and implemented.
• International finance has two functions namely, treasury and control. The treasurer is responsible for financial planning analysis, fund acquisition, investment financing, cash management, investment decision and risk management. While, controller deals with the functions related to external reporting, tax planning and management, management information system, financial and management accounting, budget planning and control, and accounts receivables etc.
• To maximize the returns from investment and to minimise the cost of finance, the organization has to make portfolio decisions. A wide variety of financial instruments, products, funding options and investment vehicles are available for corporate finance hence decision making in international finance is complex. Understanding of economic theories and principles is required.
• Due to changing nature of environment at international level, the knowledge of latest changes in forex rates, volatility in capital market, interest rate fluctuations, macro-level charges, micro-level economic indicators, savings, consumption pattern, interest preference, investment behaviour of investors, export and import trends, competition, banking sector performance, inflationary trends, demand and supply conditions etc. is required by the practitioners of international financial management.

The Impact of Globalization:

• Globalization is defined as a concept which connects countries across the world through information, trade and technology.
• Globalization has many dimensions as social, political, cultural and of course economic. Globalization integrates economies and societies through the flow of ideas, information, technologies, capital, finance, goods, services and people from one country to another. This integration is also called as ‘cross-border integration’.
• This integration can take place through movement of capital, the flow of finance, trade in goods and services and through movement of human resources

Characteristics of Globalization:

• Globalization provided advanced and faster transportation system (road, sea, and air), and communication system between countries,
• Due to globalization, there is a movement of capital between countries in the form of investments from countries abundant in finances to the possible profitable destination worldwide.
• It increased cross-border and large scale transaction of finance, goods (raw/ semi-finished/ finished), resources (material/ human) and services,
• Due to it, there is easy migration, movement and settling up of people in foreign countries and exchange of skilled and unskilled labours increased.
• It uses modern technologies like the internet and there are a huge sharing and exchange of knowledge between countries.

Impact of Globalization on Society:

• Globalization broadened our mind and gave the concept of the global village.
• It helps people to understand manners, habits, and customs of different countries. It helped in the exchange of cultures between different countries.
•  It helped to compare the nation with developed nations and help to fight illiteracy and to improve the level of education and standard of living of people.
• It helped to compact social issues like hunger, poverty, and give away bad practices of child labour, child marriages etc.
• Students can go to different countries for higher education.

Impact of Globalization on Commerce:

Movement of capital:

• It has been seen that foreign capital flows in the form of Foreign Direct Investment (FDI) and Foreign Institutional/Portfolio Investments (FIIs)
• It plays a very important role in the development of an economy by enhancing the production base of a developing economy by the trade in goods and services and financial flows: It develops the capital market.
• Developing countries have more opportunities such as better access to developed markets, technology transfer
  leading to improved standards of living and better productivity.

Production of Quality Goods and Services:

• It helps people to understand manners, habits, and customs of different countries. Hence a merchant can gather valuable information about different commodities produced and required in different countries and can shape his business strategy according to the needs.
• Sometimes it is better to import than to produce locally. In such cases, the country which can source such products economically can be found very easily.

Impact of Globalization on World Politics:

• Due to globalization, the government can obtain useful knowledge of the people, the forms of government around the world and their aspirations.
• It contributes to improving international relations and friendliness among different nations which have a clear vision of future developments.

Disadvantages of Globalization:

• It has increased the disparities between the developed and developing nations, thus increasing the gap between the rich and the poor. Rich and wealthy people are able to exercise more control over the national resources through the application of science and technology.
• The local industries which are based on traditional methods of production could not compete with their global counterpart using mass production and high-end, specialized automatic methods.
• The economies of the world are now interconnected. Hence the economic downfall of one major economic nation adversely affects the entire global community.
• Globalization requires skilled labours hence there is a chance of unemployment of unskilled labour.
• Less developed nations become dependent on developed nations.
• It leads to pollution of soil, water and air. Developed countries have shifted their polluting industries to less developed countries.
• There is exploitation of natural resources.  Some places on earth, which was once rich in minerals and forests can no longer claim their richness. Forests have been cut for setting up large industries. The industrial discharges have widely contributed towards environmental degradation.
• Globalization has a homogenising effect on the society hence old tradition, custom, and cultures are on the verge of extinction. Less developed nations have shed their traditional dress, food, and rituals.
• Unequal distribution of international trade gains is another main disadvantage of globalization.
• There is a cost to this globalization.
• Developing countries have underdeveloped capital markets and high-risk premiums, they cannot fully participate in this growth and increased investment brought about by globalization. The country getting foreign investment can get into a debt trap.
• Developing nations have to face problems in international trade due to rising tariff and trade barriers.
• It leads to volatility in the financial markets, inequalities within and across different nations, and slow participation of Third World countries due to trade, investment and financial barriers.
• Due to easier migration and movement of people, there is a possibility of the spread of some diseases.
• Profit is the buzzword for companies in the era of globalization due to which many companies do not provide a good working condition to the workers.

The Impact of Globalization on India:

• Increased GDP and increase in the rate of growth of GDP
• Increased foreign exchange reserves
• More investment in the form of FDI and FII investment in the capital market.
• Rise in the share in the world’s export. Increase in import to cope with development.
• Broadening trade deficits
• Greater volatility in foreign portfolio investment than FDI
• The slow pace of industrialization due to the easy availability of the product in the international market.
• The decrease in the share of agriculture in the GDP
• The increase in the number of rural, landless families.

The post Globalization and its Impact on Commerce and Society appeared first on The Fact Factor.