Globalization, Foreign Trade &

Balance of Payment

Hersch Sahay
Assistant Professor
Department of Economics
School of Management, Pondicherry University
 Globalisation
WHAT IS GLOBALISATION
“Globalization is a term used to describe the increasing
connectedness and interdependence of world cultures
and economies.” – National Geographic “Globalisation is the process of interaction
and integration among people, companies,
and governments worldwide.” - Wikipedia
“Globalization is the increase in the flow of goods, services,
capital, people, and ideas across international boundaries” - HBS

“Economic "globalization" is a historical process, the result of

human innovation and technological progress. It refers to the
increasing integration of economies around the world,
particularly through the movement of goods, services, and
capital across borders. The term sometimes also refers to the
movement of people (labor) and knowledge (technology)
across international borders.” IMF
 Stages of Globalisation
Watch: https://www.youtube.com/watch?v=PPZZQ0fmI2Y
Production and Marketing facilities
located in home country
Stage 1
Domestic Stage
Increase in import & export across
international borders
Stage 2
International Stage
Production and Marketing facilities
located in multiple countries across
Stage 3 the World
Multinational Stage

Strategies are focussed towards

adopting best global practices Stage 4
Global Stage
 Innovation & Creative Destruction
Watch: https://www.youtube.com/watch?v=lH2kSCPyZQ8

➢ Creative destruction is the dismantling of long-

standing practices in order to make way for
innovation and is seen as a driving force of
capitalism.

➢ The term was first coined by Austrian economist

Joseph Schumpeter in 1942.

➢ Creative destruction is most often used to describe

disruptive technologies.

➢ Example: The mobile internet added many more

losers, from taxi cab drivers to mapmakers.
 Elephant Curve
Watch:
https://www.youtube
.com/watch?v=t1mW
p2qp7A0

Read:
https://www.brookings.edu/r
esearch/whats-happening-to-
the-world-income-
distribution-the-elephant-
chart-revisited/
 Why do Countries Trade?

Click the Icon above to Watch Click the Icon above to Read
 Absolute & Comparitive Advantage

➢ Britain has Absolute Advantage (lower cost) in production of both Wheat (4 < 8) and Cloth (3 < 9).

➢ But Britain has Comparative Advantage (relative lower cost) in production of cloth (3/4 < 9/8)

➢ United States has Comparative Advantage in production of Wheat (8/9 < 4/3)
 Merchandise Exports from India 2021-22
Rank Commodity % Share Rank Commodity % Share
1 Engineering Goods 26.58 17 Spices 0.92
2 Petroleum Products 15.99 18 Ceramic & Glassware 0.82
3 Gems & Jewellery 9.27 19 Iron Ore 0.77
4 Chemicals 6.96 20 Fruits & Veg 0.68
5 Other Commodities 6.91 21 Processed Food 0.54
6 Drugs & Pharma 5.83 22 Handicrafts Items 0.49
7 Readymade Garments 3.79
23 Carpet 0.42
8 Electronic Goods 3.71
24 Oil seeds 0.26
9 Cotton & Handloom 3.63
10 Plastic & Linoleum 2.33 25 Other cereals 0.26
11 Rice 2.29 26 Oil Meals 0.24
12 Marine Products 1.84 27 Coffee 0.24
13 Man-made Yarn 1.33 28 Tobacco 0.22
14 Minerals Ores 1.24 29 Tea 0.18
15 Leather Products 1.04 30 Jute Products 0.12
16 Meat & Dairy 0.98 31 Cashew 0.11

Watch: https://public.flourish.studio/story/1745813/
 Merchandise Imports to India 2021-22
Rank Commodity % Share Rank Commodity % Share
1 Petroleum & Crude 26.39 17 Ores & Other Minerals 1.46
2 Electronic goods 12.02
18 Instrument & Optical goods 1.04
3 Gold 7.53
4 Machinery & electrical 6.52 19 Wood products 1.00
5 Coal & Coke 5.17 20 Machine tools 0.69
6 Precious Stones 5.06 21 Dying & Tanning Materials 0.65
7 Chemicals 4.94 22 Silver 0.53
8 Other Commodities 3.92 23 Fruits & Veg 0.43
9 Transport equipment 3.40 24 Pulses 0.36
10 Plastic materials 3.30 25 Textile Yarn 0.34
11 Vegetable Oil 3.10 26 Pulp & Waste paper 0.26
12 Non-ferrous metals 2.87 27 Project goods 0.22
13 Iron & Steel 2.82 28 Leather Products 0.13
14 Fertilisers 2.31 29 Cotton 0.09
15 Chemical materials 1.82 30 Sulphur 0.08
16 Pharmaceutical products 1.48 31 Newsprint 0.06
Watch: https://public.flourish.studio/story/1745814/
 Balance of Payments (BoP)
➢ The balance of payments (BoP) records all
economic transactions in goods, services, and
assets of the country with the rest of the world
for a specified time period, usually a year.

➢ It is a systematic accounting balance sheet of

the country and includes both debit and credit
transactions.

➢ BoP is used to monitor all international

monetary transactions.

➢ All trades conducted by both the private and

public sectors are accounted for in the BoP in
order to determine how much money is going
in and out of the country.
 Components of BoP
Balance of Payment

Current Account Capital Account Monetary Account

Foreign Investment Foreign Currncy Assets
Merchandise Net External Assistance Gold
Trade Invisibles
Commercial Borrowings Reserve Trach Position

Merchandise Merchandise Rupee Debt Service SDRs

Export Import
NRI Deposits

Trade Balance = Merch. Other Capital

Export - Import
Circular flow of BoP (Basic Illustration)
 BoP Implications
➢ The current account will be in surplus on account of excess of export bill over payments made for imports or
due to net inflow of remittances from domestic residents working abroad and vice-versa.

➢ The capital account will show surplus if the net inflow of investments and net of borrowings is positive.

➢ Any inflow of funds are denoted as positive and outflow as negative.

➢ A rise in FCA is denoted as negative as it entails outflow of domestic currency in exchange of foreign
currency assets and similarly a fall in FCA is denoted as positive.

➢ If the surplus in one of the accounts is offset by deficits in the other, there may not be any net change in
Monetary Account due to balancing effect.

➢ If the Overall Balance is positive, Monetary Account will be negative to accommodate the rise in inflow of
foreign funds thereby keeping BoP balanced.
 Key Terms – Current Account
BPM6: Balance of Payments and International Investments Position Manual, 6th Edition – Manual published by
IMF to standardise BoP accounting and reporting.

F.O.B: Free on Board - the market value of goods at the customs frontier of the economy from which the goods
are first exported.

C.I.F.: Cost, Insurance and Freight – the market value of goods at the frontier of importing country including
transportation charges and insurance premium.

Trade Balance: Value of Merchandise Exports – Value of Merchandise Imports

Invisibles: Invisible trade is an international transaction that does not include an exchange of tangible goods. It
includes trade in services, income associated with non-resident assets and liabilities, labour, property and cross
border transfers, mainly workers’ remittances. Click here to read more

Current Account Balance: Trade Balance + Net of Invisibles

Understanding Current Account – National Income Identity Approach
Absorption Approach

Y = C + I + G + (X – M); Current Account (CA) = (X – M)

Domestic Demand (Absorption) = A = C + I + G
Hence, CA = Y – A
Current account is an excess of a nation's production (= income Y) over absorption (= domestic demand or A).

CA surplus means the country underspends its income (China, Japan, Singapore) and
CA deficit means it overspends its income (USA and many developing countries).

Usually, the latter is the bigger problem for policy makers. If a country is experiencing a CA deficit, there are only
two solutions according to this model: increase Y or decrease A.

✓ Increasing Y is a supply-side problem. The IMF thinks that economic liberalization (free trade,
privatization, deregulation, etc.) will unleash private sector dynamism and boost output. But this will
take time, even if it is successful.

✓ Decreasing A is a demand-side problem. Usually, it means austerity--tight budget and tight money. This is
the most traditional IMF conditionality, which is supposed to work immediately as the policy is
implemented.
Understanding Current Account – National Income Identity Approach
Savings - Investment Approach

National Income Identity (Expenditure Side): Y = C + I + G + (X – M) --- (1)

National Income Identity (Disposal Side): Y= C+S+T --- (2)

Subtracting (2) from (1): (X – M) = (S – I) + (T – G)

Hence, CA is the sum of net private savings (S – I) and net government savings (T – G)
CA deficit means that either the private sector or the government (or both) has negative saving (called
dissaving). In many cases, it is the government that overspends its budget. Or maybe both sectors are dissaving
(i.e., suffer from savings shortage).

To reduce the CA deficit, there are only two ways. Increase net private saving or increase net government saving.

✓ To increase (S - I), discouraging investment is generally undesirable. The better solution is to encourage
private saving. This can be done by various institutional adjustments to strengthen incentives to save and
remove incentives to consume too much.

✓ To increase (T - G), either increase tax revenue or cut spending. Usually, the IMF recommends both.
 Trends – Current Account
700000
Exports Imports Trade Balance
600000

500000

400000

300000
USD Million

200000

100000

-100000

-200000

-300000

Source: Database on Indian Economy

 Trends – Current Account
200000
Trade Balance Invisibles Curr. Acc Bal
150000

100000

50000

0
USD Millions

-50000

-100000

-150000

-200000

-250000

Source: Database on Indian Economy

Recent Trends in Current Account Balance of India
 Key Terms – Capital Account
Foreign Investment: It is the sum of Foreign Direct Investment and Foreign Portfolio Investment.

Depository Receipts: Shares of foreign stocks offered in foreign markets are comprehensively known as
depositary receipts. American Depository Receipts (ADRs) and General Depository Receipts (GDRs) are two types
of depositary receipts with other types including European depositary receipts (EDRs), Luxembourg depositary
receipts (LDRs), and Indian depository receipts (IDRs)

External Assistance: This is the net of loans repayments under various multilateral and bilateral agreements
except loan repayment to erstwhile “Rupee area” countries.

Commercial Borrowings: Commercial Borrowings by India denote loans extended by the Export Import Bank of
India (EXIM bank) to various countries and repayment of such loans.

Rupee Debt Service: Rupee debt service includes principal repayments on account of civilian and non-civilian
debt in respect of Rupee Payment Area (RPA) and interest payment thereof.

Other Capital: Other capital comprises mainly the leads and lags in export receipts apart from and residual item
of other capital transaction not included elsewhere.
Click here for more details
 Key Trends – Capital Account
120000
Foreign Investment External assistance Commercial borrowings Rupee debt service NRI Deposits Other capital
100000

80000

60000

40000
USD Millions

20000

-20000

-40000

-60000

Source: Database on Indian Economy

 Current Account & Capital Account Balance
150000 100000

Curr. Acc Bal Cap Acc Bal Overall Balance

80000
100000

60000

50000
40000

20000
0

-50000
-20000

-100000 -40000

Source: Database on Indian Economy

 Current Account Convertibility

➢ Convertibility refers to the ability to convert domestic currency into foreign currencies and vice
versa to make payments for balance of payments transactions.

➢ Current account convertibility means freedom to convert domestic currency into foreign currency
and vice versa for trade in goods and invisibles.

✓ Example: When there is current account convertibility for rupee, an exporter can sell the US
Dollars (or other foreign currency) he obtained from exporting a commodity at the market
determined exchange rate in India. Similarly, an importer can buy foreign currency from India’s
foreign exchange market by exchanging rupee to pay for imports.

➢ In India, there is full current account convertibility since August 20, 1993.
 Capital Account Convertibility
➢ Capital Account Convertibility (CAC) is not just the currency convertibility freedom, but it involves
the freedom to invest in financial assets of other countries.

➢ “CAC refers to the freedom to convert local financial assets into foreign financial assets and vice
versa at market determined rates of exchange. It is associated with changes of ownership in
foreign/domestic financial assets and liabilities and embodies the creation and liquidation of claims
on, or by, the rest of the world.” - Committee on Capital Account Convertibility (1997, Chairman Dr. S
S Tarapore).

➢ Hence, CAC is freedom of foreign investors to purchase Indian financial assets (shares, bonds etc.)
and that of the domestic citizens to purchase foreign financial assets.

➢ It provides rights for firms and residents to freely buy into overseas assets such as equity, bonds,
property and acquire ownership of overseas firms besides free repatriation of proceeds by foreign
investors.

➢ Countries prefer capital account convertibility to promote the inflow of foreign capital but it can
lead to excess volatility (sudden stops and reversals) of foreign capital.
 Capital Account Convertibility

➢ India has a partially convertible capital account.

This means the rupee can be converted into
foreign currency and vice versa for restricted
purposes.

Click above to read speech by Shri T Rabi Sankar, DG

➢ FDI has become more or less unrestricted.

➢ FPIs were given access to corporate debt markets

in 1995 and to G-secs in 1997.

Click above to read experts’ opinion on CAC

➢ ECB for users in real estate, capital market, equity
are not permitted.
 FEMA,1999 & PMLA, 2002
➢ Foreign Exchange Management Act, 1999: An Act to
consolidate and amend the law relating to foreign
exchange with the objective of facilitating external trade
and payments and for promoting the orderly
development and maintenance of foreign exchange
market in India.

➢ All transactions involving foreign exchange have been

classified either as capital or current account transactions
and included in its provisions.

➢ Prevention of Money Laundering Act, 2002: Forms the

core of the legal framework put in place by India to
combat Money Laundering.

➢ The Directorate of Enforcement (ED) has registered 14,143

cases under FEMA and PMLA between 2019-20 and 2021-
22 as compared to 4,913 cases in 2014-15 to 2016-17.