| @PUR'SSINOD sWe'JO sNqENAS Pas|ray Jog sy 1 {fp lor tems © uensexerdindys syrom-sy HOS) (BORG ABET / LLL tacx mann. [Raia 5 ages G00 Ooh —Feawam. PPL iene t we er ‘peuuesep ‘191 LOO ar S¥NVUd INdIA « oe ot STARE GNOAS SES ORGO™ C8 SPIE eenensu suciuatiownyy snowy “eno Fuss my) zarssamye ® TANDOA WSIO WOSE “emmy TMI CAD var woop - WLLWH8 ‘A TONWW PL i na ‘pons steep Jo suoudodnc ‘Gpnou, ei gmes imate eee ALNVeVHRIVH VEONVHO™“~a (2499913 - dno’ eoueul4) (tessetus§ yds : ee, pays swe) IWNOLLVNWALNI Seaday Sas Stir Fem EAT Ra |if Published by: N. V. Maroo For Vipul Prakashan 161, J. S. Seth Road Mumbai - 400 004. International Finance (BMS) © Authors Exclusive Rights reserved by Vipul Prakashan, Mumbai for manufac.ure and market, this and subsequent editions. ISBN: 978-93-86825-75-9 ‘and binding of the book. 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MMXVIL « Preface 1ade keeping in mind about the basic needs of the st ple language, easy understanding, syllabus oriented and tried o: ost effective. ided practice ques examination prep: the end of every chapter which will We have tried to put the best in Please point out any errors or omissions due to oversight and Sugg for the improvement of this book. Thank you...thank you all Authors. Sn Acknowledgment importantly, | would sincerely like to thank my co-author for her guidance and encouragement, ‘manojphatia1220@gmail.com MeV. HS (iii)@ ‘Ran = SoAbINpEL eday ‘Auedwo> seo yewwowes2u) Suueaw, jeuonei aye aBuey>xa 1434 J0 2469 “tas 5/4 104 “4aBEUEW, x8I04 Jo 2IOu ‘syayseWn eBuey>xg UBla10s Jo sDURDYWUAIS *B ageDs "YR S/n Wad “ie UeW a8ue\x3 UBe104 feuoReUeIU! Jo BUILeEpN + ssvoyrewn aBueyorg uBjei04 euonewowy) (2) nea! 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International r uae Bae nM ise follows techniques for allocation of funds and | are restricted to a limit to invest and manage their portfolio. resources , in international trade. However, it faces certain (4) Political Risk: International financial system affected by hindrances regarding mobility of capital and foreign currencies, as government policies and political issues. So there is a risk of well as the foreign exchange rates prevalent in different countries. 1 and government issues. Due to unfavourable International finance also tries to solve the problem of human 1 policies, international finance can be affected. resource exploitation carried out by MNCs in the poor and Similarly a favourable political decision can increase developing countries by applying its own principles. Three international financial stabil conceptually distinct but interrelated parts are identifiable in 43. SCOPE OF INTERNATIONAL FINANCE: international finance: Introduction to International Finance re 3 finance and domestic finance. So, it is said that there is always an imperfect market. Due to imperfection in market, inv . : Currently, international finance has become — more + International Financial Economics: concerned with catses comprehensive or broader in scope and is dealing with matters and effects of financial flows among nations - application of related to globalization, fair trade, multinational banking, and macroeconomic theory and policy to the global economy, multinational corporations) International finance consists of International Financial Management: concerned with how foreign exchange market, currency convertibility, BOP, individual economic units, especially MNCs, cope with the ternational finance and international monetary system. So, there complex financial environment of international business. a big scope of international finance. It is discussed below: Focuses on issues most relevant for making sound business (J) International monetary system: For better economic g decision in a global economy. © International Financial Markets: concerned with international financial/investment instruments, _ foreign exchange markets, international banking, international securities markets, financial derivatives etc. 1.2 FEATURES OF INTERNATIONAL FINANCE: International finance has some unique features which are discussed below: () Expanded opportunity to business: Due to globalization in business there is an expanded opportunity to the businesses. Business can raise more funds through less cost of capital. (2) Foreign Exchange Risk: It is a financial risk that exists when a financial transaction is denominated in a currency other than that of the base currency of the company. (3) Imperfect market: Due to difference in law and customs among the countries, tax systems, cultural difference, business practices, there is distinction between international (4) Currency convert and to do trade and investments efficiently, a count have its own monetary system and an author control the system.IFor example, RBI of India control the monetary system of India through controlling inflation, supply of money and maintaining interest rate. International financial system: The growth in world «rade, eralization and globalization in business brought smendous change in international financial systen| It instruments, payments and receipts between the countries. Compar past, the volume of transactions has increased in interna finance, Foreign exchange market: This is a market where one country’s currency denominated in that currency can be purchased through sales of another country’s currency. International financial system provides this facility. The currency of a country is f when the resident or non resident of the ccuntrypinoss suoneu Te ‘amseaur aoueuy pros e inowEM “suoneL aij Suowe aoved sureyureur wayshs aoueuy JeuoeuzajT UY (8) -wayp Suowe yoeur aouereq ayy sdoay pue suopeztueSs0 jeuoneusayUt Te jo soseq am pueisiopun sdjay yy “uoneziteqols 0} onp ames uy umor® sey aoueuy jeuoneUIaUT (Z) prepurys SuuNosde afBuIs & uo Supiodas jo sana ayy Supmomroy Aq Sovowr Buraes ut sdjoy ose ‘soueuy TeuoHeUIazut jo zed e& st yoTM “wAyShs SUT (9) -surajshs Sunzodar reppunts mo][O} 03 SIUNOD Auew sdjoy ay “zeus are gaat paidope ary yep soryuno2 ayy omg, ‘MON “S}SEq BARDA|S B UO sanssr asayy BuIBueze axe syUEG yeuoneurazur pue Supesado THs ore saxUa> asayy ur siaryreW puog ‘Samus asou; wT spuNy jo Ayoress pue suonDNSaT s ANS ‘soueuly jeuoeUsa1U} 01 uoRINPOLUT Teuoneu 07 anp Aysendod snayp jo your ysoy savy “332 YUN ‘YOK MAN ‘UOpUO] sv YAS syaxyreu Teydeo peuoReUIaIUT ay :syexyeur spuog pue syaxzeUr yendes peuoneusauy + “ayjoue 103 Aduazm> auo jo aBueypxa ue Sutajoaut uonpesuen afueyoxe uSjai0j y yoxrew aSuryoxe uBjoi0g + ‘sajouazno uBtaz03 uy payeurwouap sjasse jepueuy Surpey 30 sapuarms 210) Ut suoyezado Surpua] pue Supmozog 3jayseu Aouazind uBjosog 10} ast1 aai8 suonpesueR WL "S]UEAAND sNoHwA uaaMyeq se aBULYDXA aajoaut PUe Plos pue paseypind sapuezn> uBies0j snoprea ut pareurwousp aq Avur sues ayy ‘sjesse UBio10} 10/pue spueuNsoaut pue sysodap uBra10y ‘fouarsn uBrer03 uo sux se Aavyauout asayz, ‘stasse Areyauour pur Aouour Surpen pue jo juawaSeurw ayy o} soyejer waysds jeoueuy feuoneUsaruy SONWNIA TVNOLLWNUALNI JO SLNENOdMWOD PT -pazapuas sastaias 10 payodxa spoo8 uo sjusuAed pur sidrazaz [Te smoys yorym juNoD2e Ue Inq Sungou sty] “sazyUNOD uBje10y pue AzjUNO? sAseWOP W22MI9q SuoHDesuEN oTWOUODA [Te SMOYs YoIyM uaWIaIE3s SuTUNOIIe ue sty -Aajuno> ayy wo payodxe pur payodwy are yprun suzy apqBueqUr pue a[qxSue ye Suypsozaz £q yMs01 you aip stay “Aouazm sy UO uBrai0y so pue sajouasin9 uBraroy uo sume ayy 5 Ins pue pueurep juan sAqunoo jo uoweumuns v syuasardar yf “1eaA e Atjensn ‘potiad uaalS e Burmp Anunos v jo suoppesuey aiqista-uou pue ySIA [Te SapnpoUr sjuaurded Jo aouejeq snyy fxa8seqaipURy -,2uH jo poned uaa ev Sump saiguno>s uStezo; jo sjuapisez pue Ayunos Supsodar e jo sjuapisax ay) YIM suoHDesuen siUIOUOD [Ie JO p10rI INPWA'SAS, ‘Se Paap si Aquos v jo (qOg) JuawAeg jo soue[eg quauted Jo aourjeg (<) AINE ssoursng, euoHeusajUE ayy saxeur yy “Ajaaxy AouaM> ayy SunsaAu0D moje Ou Op samUNO> snoueA “sy op 0} sjuspisaz-uoU pur squaptsaz aip sioensex AqUMOD ayy jo juaWTUIACS ay INg (Aouain> uBrax03 ut ADUaxIn9 peD0] ayp HaAuO> o} pamorfe az (sWe) soueul, jeuonewsoqu) ysamdea, INAS. y16 a 2) @ @) 6) wwe work for their self-interest. International finance helps in keeping that issue at bay. PRINCIPLES OF INTERNATIONAL FINANCE: The principles of International Finance are as below: Advantages to. — become __—international:. ~The internationalization advantages attract companies to invest directly in foreign countries. Comparative merits: Every country is special product or has some special feature. Through trade, exchange of variety of goods, culture and services takes place through trade. It increases the standard of living. It also considers the profit of individual organization by the trade. Economies of sca‘e: Synergistic effect direct to Economies of scale. When the whole is more profitable than the part of it then synergistic effect exists. Economies of scale can be increased by deploying the real capital and monetary assets on global basis rather than introducing new products in domestic market. Effect of portfolio: As per the principle of portfolio it is said that the risk is diverted by increasing the portfolio. In same way the company can diversify its risk by working on global level rather than restricting in domestic level. Perfect completion: International trade allows every country to enter in the market and exit from the ma. ket freely. Under this condition goods and services are freely transferable. So, the balance of cost and return exists. Risk and Profitability Trade off: It is well known that there is a close relation between risk and profitability. But the trade-off between risk and profitability decides the maximization of stockholders wealth. It has to determine an optimum balance between risk and profitability. Valuation of assets: This principle says that the value of an asset is the expected earning of the asset. For MNCs better marketability, earning more profit, capitalization at lower rate compared to domestic companies leads to) higher price ‘Viput’s™ international Finance (BMS) roo 7 Introduction to International Finance earnings ratio and lower required rate of return. So, the value of MNC is more than the domestic compani 1.7 ADVANTAGES OF INTERNATIONAL FINANCE: ‘There are some advantages of international finance which are as below: (1) Promotion: International finance helps to promote domestic investment and growth through capital market. Better banking system: International finance helps to healthy competition due to which it provides better banking system. (3) More equality: It helps to integrate the economy of two countries and easy flow of capital. Due to free flow of capital results into more equality between the countries, Effective capital allocation: It helps to allocate the country’s capital effectively by providing information related ‘to different areas, (5) Capital in need: It helps to access the capital market around the world which enables the country to lend money in good ‘imes and borrow capital in need. (©) Corrective measures: Due to worldwide cash flows, international finance helps to take corrective measures to bad Q) a) government policies. Be GLOBALIZATION OF THE WORLD ECONOMY: Globalization refers to growing interdependence of countries resulting from the increasing integration of trade, finance, people, and ideas in one global marketplacej International trade and cross-border investment flows are the main elements of this integration. Globalization has changed the picture of World Economy, by increasing the cross-border trade, exchanges of currency, free flow of Capital, movement of people and flow of information. Globalization has introduced the concept of border- less and integrated world economy, Globalization has given a new thought to the businesses worldwide. A lot of Strategic changes have been occurred in the businesses. 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Removal of Cross-Border Trade barriers has made formation of Global Markets more feasible. International Institutions: the institutions like Uni ‘ Insti H it ited Nations Organization, International Monetary Fund, World Trade Organization and World Bank are near to the concepts of those groups because they are regulati 1g the relationship between different countries and governing issues of Justice, Human relations or political factors. Changes in World Trade Picture: Before the a ; phase of Globalization, United States of America was dominant in world export. After the advent of globalization, Germany, Japan, South Korea and China have seriously challenged the position of America. Changes in Foreign Direct Investment: Foreign Direct Investment is considered as significant indicator of economic development. Corporation Changes: Globalization has increased the tre1 " 7 nd of Multi-National Companies in all over the world. Technological Effects: By the development of technologies specifically related to Telecom as internet, telephones, wireless technologies, undersea fibres, a global technological infrastructure has been developed so information can be moved more smoothly across the borders. Effect on the Standard of Living: ij : e St ing: The major effect of globalization is in the shape of expansion of trade and investment. It is evident that poverty rate has decreased in the regions, where investment and trade is expanding. Effect on Employment: After the advent of globalization, it was an apprehension that the job will shift to developing countries from developed and advanced countries. But Supporters argue that this shift will result in the long term benefit to the country. Critics argue that Globalization will result in inequalities and insecurity about the Jobs. And will imately cause the changes in employment str labour demand will fall. ployment seucture a er a (9) Industrial Effects: Globalization has also affected the Industrial sector of the world.(Now in this era of globalization, the focus of industries is to produce foreign te the consumers in all over the Introduction to International Finance (10) Cultural Changes: Through the development of Globalization world is getting into an identical culture that is understood by every nation, we may call it intermixing of the cultures. (11) Environmental Effects: On the one hand globalization has resulted in making the man more interested toward its planet in which he is living and its ecology ie. its environment through the technological advancements. But on the other hand it is considered that the growth of transport has resulted in destruction of Ozone layer and many species on the earth. But in spite all these adverse facts, Globalization has become an unavoidable necessity for Economic Development. 1.9 GOALS OF INTERNATIONAL FINANCE: a) ancial Management is designed to provide anagers with an understanding of the and the tools necessary to be effective International today’s financial fundamental conce| global managers. (2) It helps in understanding and managing foreign exchange isks and coping with market imperfections. nal finance emphasizes how to deal with exchange risk and market imperfections, using the various instruments and tools that are available, while at the same time maximizing the benefits from an expanded global opportunity set. (4) International finance is concerned with how individual the complex @) financial environment of international business. (5) International finance focuses on issues most relevant for making sound business decision in a global economy. (6) International finance maintains peace among the nationsAna tup @)0u (24 midy) Leouruiy (2 ur soBuajreyo Buf eBeIuenpy equosed (s) “eouBul, feuoNeW}U} jo eoUeLodLU} UIEIAS (p) ‘@2/92BAg-H2S 40 SUOISEND uoneziTeqoyS Tepueuy jo saBeuBapestp arp are UM (€) quonezieqo(8 epucuy jo saewueape arp aze3eyM (Z) gsotunon Surdojaaap 203 [ePYyaueq onEzTTeqo]s feu ayy s] uopezeqo(? jeDueUY fq pueysrpun nod op YM (1) -sysp29 yeOUBUY ay 0} panqisyuOD aavy 01 348n0Ky Sept sy waysks epueuys avg jo uopeTSas ayenbapeuy ‘santouo>e Surdojenep 105 wonesaquy [eDUEUI YO S999 axB UO sop A>10 pure orurapese yioq ut paBxauia sey ayeqap asuaqur ue ‘[hs9x e sy ‘53805 [e108 PUR DPUIOUOSIOIDEUT JO SULTA} UT 110} SMO}IIS B panne aavy ily sas ‘poyad aures ayy 19A0 sastD [eDuEUY juEDyTUsIS pur sojes ysou8 ur asdejoo oypoyid paouosiadxe ancy sontuno> Jo zoquimu v ‘saununos Suidojesap auos ur saver yMorB YsTY yan pareposse uaeq aacy sMmoy Teudes asamp amyM “sonntmo> jojaasp pue eMsnput usemiaq ‘Aiqejou sow ‘pur sarsyumo> Temsnpur Suowre smop Teydes ur ams e fq payzeur usq sey SOR6I-PRE ayp aoUIS UOHEZTTEqoTS [eDUBUY Jo BAeM 3UOI01 OY SHOLLDWUd UO AGALSASVD UT -wasis 8 axojaq aBuaTteyp & st ABojouya; voREWIO;T Ur senuvape sowie pue “siginduios jo ash aaisuaxa (2) et A soueuly euoneusau} 03 uonsnposu} ae] “suoRoUny Jou0> pue juawaSeueur Amsvay oy) uaemjaq uoneurpio0> ava “Suruaeyd Pur Suyseoaios ‘sissjeue jeroueuy uo aouesfaz roivor8 10} s|te> sofueyp [eiauruostaua jo aed pue Ayrxaidto> pasearout ay] (9) ‘D8 sanbrypay Suppuny aaneaouut “Aypmby aseaiur 0} sjasse jo uonesntnses quawa8eueur ys eapoaya 10; samyny pue sdems ‘suondo jo sasn ‘ajdurexa 10g “Asoa\p jepueuy ut ssouvape pue sjoyreur ayy Aq paieyo sanpmoddo ow jo afeyueape axe 0} suopNjos aanraye juourjduy pue uBisxp o1 (6) aSeurep 24H [OHUCD 0} punoy aq ysnur sXe ‘sapUTeaUN snouLZoUD 2u) JO ade ay UF aIqeIAeUT axe YAM yuaWZpni Jo Sioa JayPO Jo yoy e PUL suOPUOD jUaZIND JapuN aaneroUMUTDT Spuapyysuy sowossq yrym yoejuo Ajddns aoud-xy 8 “uoIsipap roaoaye) Suorm e ‘afdurexa 404 “yoedu asioape Wp aztumutur oy sarfeysyur pue sainyrey ysed apes UI axe) OL (F) ssasuodsex s0170 jo Ayourea v pu saSeq01 Axezodura awoo1940 0} ‘219 safes jasse ‘saf>yod puapiatp ur saBuvy> ‘sarSayens Surpuny eaneaouut jo uoReso[dxa ‘sy[nsaz Sunviedo ur a8uey> juesyrusis e ‘uoNEoyisiealp jo aoed paseaiour ‘ajdurexa oq -ainysod >:8ayex3s umo s,UuiNy ay ut saBuey> jueoyrudis 0} oRDuny aouBUY aya ydepe o1 arqe 2q 01, (6) guounsaaur aes ampongsexpy jy a8rawia IM sou Jog “wayy yy jwos pue umo sasuodsaz ayeiodio> pur saiqeiea juoumuoiaua jueasqer usamiaq sdrysuonejaxiayuy xajdwos ay) askteue pue puvisrapun of (z) ‘uo os pue sjonpoud pue syuaunasut Tepueuy mou jo soueBiewa ‘syuaurdojeaap A1ejsu0W! pute [eosy ‘spuan yaxzeur yDoIs ‘sa!oqjod apex uBiax0} pue xe} Temsnpur ur seSuey ayy 207 suoneonduy xiayy asdjeue pue se8uey> [ewusuuosaua yueryTuSis wim ayep-or-dn doax ol (1) ONVNH TWNOLLWNWALNI NI SHONITIVHD ONIOWNG aHL Ort soueuy [PuoReUZa}UT jo safes Auew uy dem quapye ue ur gaat Suna (swe) aoueur, jeuonewow y,samdsa, A trViput’s™ international Finance (BMS) Chapter 2 | BALANCE OF PAYMENT Introduction to Balance of Payment 22” Components of the BOP Account 2.3 Balance of Payment and Balance of Trade 23.1 Balance of Trade 23.2 Unilateral Transfers 223 234 235 Accommodating (Below the Line i In_B0P) ‘Autonomous. (Above. the Line “in” BOP)” Hog Concept ‘The BOP always Balance BOP vs. BOT BOP Deficit 2.4 Accounting Principles in Balance of Payment 2.5 Balance of Payment identity 26 Case Study with Suggested Solution 2.7 Case Study for Practice = ___Questions tor Seit-Practice oo BY, INTRODUCTION TO BALANCE OF PAYMENT: inition: The Balance of payments : systematic account, in the form ‘of summarized Second of all economic transactions between residents of a counury and residents over a given period of time Normally the BOP covers « period of one year. The account is prepared using the double entty accounting system with both the debit and credit aspects of each transaction being recorded under different heads ‘the wer a5 account which implies that the BOP account always balances. i.e. Debit and Credit summations are equal. ‘The BoP is a statistical statement that comprises transactions between residents and non-residents during a period} It consists of the goods and services account, the primary income account, the secondary income account, the capital account, and the financial account. \The different accounts within the BoP are distinguished according to the nature of the economic values provided and received, under the double-entry system of accounting in the BoP.| The sixth edition of the Balance of Payments and Internat ial Investment Position Manual (BPM6) of the International Monetary Fund (IMF) defines the Balance of Payments (BoP) as a statistical statement that summarises economic transactions between residents and non-residents during a specific time period. The BoP, thus, includes all transactions showing: (a) Transactions in goods, services and income between an economy and the rest of the world, (b) changes of ownership and other changes in that economy's monetary gold, special drawing rights (SDRs), and financial claims on and liabilities to the rest of the world, Balance of Payment actions are categorised including “goods and and the “secondary and (iii) the “financial © services”, the i the “capital account 23" COMPONENTS OF THE BOP ACCOUNT: e BOP account has three major components: Current ‘Account, Capital Account and Reserve Account (2) Current Account: Import and exports of goods and services and unilateral transfer of goods and services including transfer of money for family living expensesy The current account of the BOP is made up of three balances namely Merchandise (Visible) balance, Services (Invisibles) balance and Unilateral Transfers balance. Current account effectivelyuapiser-uou wo pue (syodxe) syuaprsar-uou 0} syuapisar thoy} sedueyp spoo8 jo drysiouno ap aime spoo8 2[qea0u ©} paar suopDesueR Te sisa0> 3 pur ‘epen asmpueypiow JO aoUepeq se UMOUY Ose st apeH aIqIsIA jo auLTeg rpen aiqista Jo aouepeg TTEZ (dtddns yo ssauaatsuodsar ayy Aq paouanyut) awoy ye pamyemueur spo98 so sand « pu? ‘syiodunt 105 Sed 0} yor. WIM aBueypxe uBzaz0y ayenbape jo Aqepreae ayy ‘sprepueys Apayes 10 \pleoy ‘ewauUOMAUe se YpNs sieHIeG HIIe-UON + fapen uo suoRoHysex JO Saxe} TeIBIETAM pue yes ‘TAIN + ‘squauresou ayer aBueysxg + tsyndur zayjo pue year pueySOD ayL + ‘urouona Suprodury ayy Soup s{a-R-sta Awouona Suprodxe ayy uy (939 ‘SaAHUEOUT vcore) ese “moqe, Purp) woponpoid jovee> q+ :apen Jo aourjeq Suppazye siopeT TET -saqqrSuey uy apes) au ary syuasardo Lod oR sj suodusy pue surodio Jo suauio[® Suyétapun au jo sisdjeue uy myers ojusouode Aspulls you s20p stem Aa 104 (aapeBou) aarssed, 10 (eantsod) aanoe, uy uonendod ay jo suawazmbaz jepayeut apraoud 0} Ayisedes s Anyuno9 oy s}D21J01 aouvjeq StU, *,aPex], as;pueyuayy Jo aUE[eG, ayy 10 ,adueTeG Spood, aif $e paquosep aq ose ue> yf “syodurt asrpueyprau JO anqea ayy pue syodxe (spoo8) asypueysiaur jo anjen au uaasyag auazayzIp ayy se PaqHosap st (LO) apex], Jo auejeg pen yoaoureg Lez |GVUL JO JONVIVE GNV LNAWAVd dO aDNVIVE ET spoo8 ayerpauuayuy ‘sperrayeur mer Jo Aa “suoysspuo pur s10119 0 anqea ayy squapr 0} sn smoTfe 3exR SUIaHT PrODa1 TOyIO axp J yu aly pue saazasar ut saBueys ayy uaemjaq Asuedaxsip au) sf 3 pur “Ajayemooe paprooar aq asmmoo Jo [LM se8uey> a Ae quawsed Jo souejeg asoyy [Siuaurded jo aouezeq ayy ur sua}! popzora1 say,0 ax Ile Jo anea you ayy joayar asinoo jo ysnur saasasa1 s,AnUNOD aM UL saBueY ay) ‘syue [eHUAD UBIaI0; YM GuNosDe uy ssatasax sip Jo Uorodoid & pjoy sated ysour paapuy ‘Auunos ayy UAE play aq o} avy JOU op saaraso4 1ey AION, AINE 248 ULo4y pamosog (SIGS) sidie>oy ysodaq] jeIsadg se pur ‘pjo8 se “reljop sn ayy sdempe ang Aqfensn ‘ouazm> uSra1oy up :sunoy aany UF pay ase soazsay -sjuawuded JO suvaur [euOHUIARUT se pasn aq URS yey sjosse [eoueUL, soup are sasse aarasax [eI>4YO -1ayIa80} UDye} SaTIOBA}LD OM] JOU}O BY} UO ste JeYY SPY a4p o[Has 0} sasn AajuNOD ayy Jo Ayroyne Are;ou0w ayy 7eyR sjasse ayy “at Sjasse aAz0Sa1 ay Sopnpout junoae sty [syuMoD>" Jo sa1I0Ba}eD OAAj JYTO ayy UO ase yup sasnidins pue s>Yap ay; apyas o} sash sanToWNe Avejouour s,AqunoD ayy YoIyM suonsesURN Yons soy soMTTgeIT Pue sjosse [euOHeUZD}UT Oo} sajejar os|e i] |UNODIe azasoy \uonsesuey ay jo amyeu ay Wo yng jesse ay} Jo asnje ay uO puadap rou s30p a1oJa1043 Teudes 10 yuozm> soypia se uopaesuen v jo UoHROYISSED oy) ‘aunany ayy ur wntiqrmba 4tddns — puewap au yoedurt prnom wenim ,saiqeked pue sajqeataoas, je spiova: sm junoose Tende ayy ‘2e[d a2) pinom moyino (asiaaas) ax “ueoy au Jo Aumpeut uo -apqused/Arrqery ainyny Su:puodsario v yarn sogur Apear e sayvor> Souaimn> uBfaroy v ut uax{e} ULO} v "S'9 MOY asi0H04, ¥ 2afoaut suoHDEsUeL asay {saPUILIND UsTOIO} UF S@HTgeH| PUL sjasse yo UOHRaID aafoalt yey) suCRIeSUEH Teuoneuseyur qe sproses junoa.e [eydeo ayy aunoosy pepde-y ouazno saseurop ayp Jo ayes a8treypxa ayg UO j2eduHT joanp 8 sey sniq 4] “porrad usai8 v s9a0 AwioUo2a uv 405 sofouazN> Jo Ajddns pue 40; puewap avipauun 10 pear, aynynsuos upRym suoKoesueN Buyepmnbrpsjas Je sitasordos juno2y ALND oy 1 suLoUT sy] “suOHDesULH jUNOD>e yuazM> UL Moy asi9401 OU st oxy] “SaURH WAI [eUOSied pue apex HO yo Bursue susused pue sydraoas qe sxaoo snyy junos>" quaLMe Uo dOg “siasuBH [eIa}EIFUN pur ape} aiqistaut ‘oper alqista Jo saouvjeq ayy jo anes jou ayp se pouyap oq smp lupo junos08 juaxIND Uo aoUETEA (‘249 sarDeBay ‘suORBUOP ‘sy18) sraysuen [exa}e[TUM pur sadtAz9s ‘spoo$ Jo Moy Jou au 819997 AA (iia) soueuy jeuoneuioiu) « samdia «@ @ or18 rrr residents (imports). The valuation should be on FOB basis so that international freight and insurance are treated as distinct services and not merged with the value of goods themselves. Exports valued on FOB basis are the credit entries. Data for these items are obtained from the various forms that the exporters have fill and submit to the designated authorities. Imports valued at CIF are the debit entries. Valuation at CIF though inappropriate, is a forced choice due to data inadequacies. The difference between the total of debits and credits appears in the “Net” column. the ‘Balance of Visible Trade.’ In visible trade if the receipts from exports of goods happen to be equal to the payments for the imports of goods, we describe the situation as one of zero “goods balance.’ Otherwise there would be either a positive or negative goods balance, depending on whether we have receipts exceeding payments (positive) or payments exceeding receipts (negative) 2.3.1.3 Balance of invisible trade: Just as a country exports goods and innports goods a country also exports and imports what are called as services (invisible). The service account records all the service exported and imported by a country in a year. Unlike goods which are tangible or visible services are intangible. Accordingly services transactions are regarded as invisible items in the BOP. They are invisible in the sense that service receipts and payments are not recorded at the port of entry or exit as in the case with the merchandise imports and exports receipts. Except for this there is no meaningful difference between goods and services receipts and payments. Both constitute earning and spending of foreign exchange. Goods and services accounts together constitute the largest and economically the most significant components in the BOP of any country. “Balance of Invisible Trade” is a sum of all invisible service receipts and payments in which the sum could be positive or negative or zero. A positive sum is regarded as favourable to a country and a negative sum is considered as unfavourable. The terms are descriptive as well as prescriptive. 23.2 Unilateral transfers: It is an economic transactions between residents of two nations over a stipulated’ period of time, usually a calendar year. ‘Typically, these transactions consist of gift exch-nges, pension ‘Viput’s™ international Finance (BMS) owe 19 payments and the like, but they can encompass other goods and services as well. Unilateral transfers are included in the current account of a nation’s balance of payments. They are distinct from international trade, encompassing such things as humanitarian aid and payments made by immigrants to their former country of residence. Unilateral transfers or ‘unrequited receipts’, are receipts which the residents of a country receive ‘for free’, without having to make any present or future payments in return. Receipts from abroad are entered as positive items, payments abroad as negative items. Thus the unilateral transfer account includes all gifts, grants and reparation receipts and payments to foreign counti Unilateral transfer cor of two types of transfer government transfers (b) private transfers. Foreign economic aid or assistance and foreign military aid or assistance received by the home country’s government (or given by the home government to foreign governments) constitutes government to government transfers. 2.3.3 Errors and omissior Errors and omissions is a “statistical residue.” It is used to balance the statement because in practice it is not possible to have complete and accurate data for reported items and because these cannot, therefore, ordinarily have equal entries for debits and credits. The entry for net errors and omissions often reflects unreported flows of private capital, although the conclusions that can be drawn from them vary a great deal from country to country, and even in the same country from time to time, depending on the reliability of the reported information. Developing countries, in particular, usually experience great difficulty in providing reliable information. Errors and omissions (or the balancing item) reflect the difficulties involved in recording accurately, a wide variety of transactions that occur within a given peri ‘usually 12 months) (2.3.4 Overall balance: The overall BOP is determined by computing the cumulative balance of payments including the current account, capital account, and the statistical discrepancies. 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To spot whether it is becoming more difficult for debtor countries to repay foreign creditors, one needs a set of accounts that shows the accumulation of debts, the repayment of interest and principal and the country’s ability to earn foreign exchange for future repayment. A set of BOP accounts supplies this information. © What do you understand by IIP? The IP is a subset of the national balance sheet. Apart from the IIP, the national balance sheet incorporates the stock of both non- financial as well as financial assets and liabilities between residents (domestic assets and liabilities). While the simple IP statement sets out the stock of assets and liabilities of a country at a point in time, the integrated IIP statement has an opening value (as at the beginning of the period) and a closing value (as at the end of the period). Further, the opening and closing values of the IP are reconciled through the financial account (flows arising from transactions) of the BoP and the “other changes in financial assets and liabilities account” (other volume changes and revaluation). Therefore, the values in the IP at end-period are essentially made up of transactions and other flows recorded till date. * Whatis the linkage between BOP and I"P? Transactions affecting international rlows can be recorded in the “BOP” accounts, while changes in external financial assets and liabilities are recorded in the account of International Investment Position (IP). Some of the important linkages between these two sets of accounts are: The end of period values that appear in the IP are the summation of the values at the beginning of the period in IIP and net transactions put through in assets and liabilities during the period (BOP) together with, inter alia, the changes arising out of valuation. The balance on the sum of the current and capital accounts is equal to the balance on the financial account with the opposite Viput’s™ international Finance (8MS) | | Ba ance of Payment sign (including errors and omissions). This bal lending / net borrowing to the rest of the world and influences the IIP. Financial assets and liabilities generally give rise to investment income, which should broadly correspond to net interest receipt/payment under BOP. The rate of return could be derived as the ratio of income to the corresponding stock of assets. This may be inclusive of holding gains or losses. 2.7 CASE STUDY FOR PRACTICE: The India’s balance-of-payments (BoP) position impr: dramatically in 2013-14, particularly in the last three quarters. owed in large part to measures taken by the government and the Reserve Bank of India (RBI) and in some part to the overall macroeconomic slowdown that fed into the external sector. Current account deficit (CAD) declined sharply from a record high of US$ 88.2 billion (4.7 per cent of gross domestic product {GDP} in 2012-13 to US$ 32.4 billion (1.7 per cent of GDP) in 2013- 14, After staying at perilously unsustainable levels of well over 4.0 per cent of GDP in 2011-12 and 2012-13, the improvement in BoP position is a welcome relief, and there is need to sustain the position going forward. This is because even as CAD came down, net capital flows moderated sharply from US$ 92.0 billion in 2012- 13 to US$ 47.9 billion in 2013-14, that too after a special swap window of the RBI under the non-resident Indian (NRI) scheme/overseas borrowings of banks alone yielded US$ 34.0 billion. This led to some increase in the level of external debt, but it has remained at manageable levels. © What is BOP crisis? Comment on India’s BOP crisis. Questions for Self-Practice lowing concepts: ‘account deficit, (1) Explain the‘eonoeidwes 40) suonsenD ow eonovid 10} Apmis esd Ole ‘suopniog peyseBBng yum Apmgesea GE. sweweBussiy oyu eGueyoxg wweLIND wioyshs Areyeu0" ueedoung soyey eBusyoxa Sunemonid Jo pexig ueomyeg uonoUNsIa —e eyey eBueyoxg biywoj4 Jo seBeyueapesiqg "5" e1ey eBusyoxg Buneoiy jo seBeuenpy = ‘eujBou eeu oGueyoxa o1q)xo14 jo sumed 15°C ‘s00y eBuayoxa Bunemonis Se ioyehs eve eBusyoxa ports jo seBqueApeSIa eye weyehs evey eBuByoxa porta jo eeBmueNpY — Zp’ owjGou oyey eBuByoxg pexid Jo seunjeey seyoy eBueyoxa poria He (€261-1261) wowseiby usjuosyus 9S ‘SM 10 ouNIje4 10} euOSPOH S*E'e AP0US UOXIN,, OuL EE SMa 10 soBouLapesia —s'e SMa jo seBqUEpY Zee SMAJO somes Lee werskg spoomucneg = ee (ee6i-s261) piwpurig oBueyoxa pion ze (161-0281) weeks piwpusis PIOD LE wiarsés Puspums PION :PoHed SMEMd = ZE werekg ArereuoW jeuoABUseWY| JoUONNIONT =e SINALSAS AYVLANOW IWNOILVNYSLNI € 4aqdeys suiayshs Arejauoy [euo}}eU19}4) ez AAA jowouoiny ‘iWeuuKed Jo eouR!EG EU) U! \uNODOY SUO}SSIUIO PUe $10.13 ‘smo ‘OA Ul euI| ey) enoge suonoesUE:| vejsuei, je1ereiun (p) (sa) e2ueuis jevonewaaiul ,,sandsa, S818 a30 err 3.1 EVOLUTION OF INTERNAifONAL MONE’ SYSTEI __ The international monetary system is the framework within which countries borrow, lend, buy, sell and make payments across political frontiers. The framework determines how balance of payments disequilibrium is resolved. Numerous frameworks ‘Viput’s™ international Finance (BMS) are possible and most have been tried in one form or another. The International Monetary system can be broadly classified as below: 3.2. PRE BWS PERIOD: GOLD STANDARD SYSTEM: 3.2.1 Gold standard system (1870-1914): The gold standard was the first universally implem« system for valuing currencies. It was promoted by banks of England. It was an exchange rate in which gold coins were freely minted by the central bank of a country. The gold standard was adopted by UK in 1821, Germany in 1875, France in 1878, US in ere Taine Russia in 1897. The Gold Standard system has 3 a nts: ( ) The gold specie (2) The gold exchange and (3) the The gold standard is a system in which international currencies are tied to a specific amount of gold. Almost from the dawn of the history gold was considered as the medium of exchange because gold was durable, storable, portable and easily divisible. Under International Monetary Systems row 31 the gold standard (specie system), gold jewellery could be converted into gold coins and used as legal tender. In some countries both gold and silver coins were used for circulation which was termed as “bimetallism’, however, it was abolished by US in 1873 when they proposed that only gold coins should be used and that there should be ‘monometallic’. The foundation of the gold standard is that a currency’ is supported by some weight in gold. Inherently, it makes sens value currency by some tangible and precious resources; otherwise, currency is just paper bills. Therefore, by tying paper money to an amount of gold, it gives the holder of the paper money the right to exchange the paper bills for actual gold. Ideally, this requires that paper money be readily exchangeable for gold. If a bank does not have gold, then the paper money has ne value. But theoretically, actual gold would flow between nations to ensure that ies would be supported by gold. Another reason for considering gold as the medium of exchange was that the value of gold remained consistent over short-run due to limited availability of gold. At the turn of the 20th century, many major trading nations used the gold standard to adjust their monetary supply. India and China minted only silver coins at that time. Some countries adopted the gold bullion standard, in which gold coins were withdrawn from circulation and paper currency was used for transactions within a country, however, intra-country transactions were still made in gold. If there was any imbalance the market value of one currency in terms of another, the a\ of market participants resorted equilibrium by using the concept of gold points. Under pure gold standard gold coins were traded freely and their inherent values were considered as their market values. The pure gold standard was used till 1870. Under the pure gold standard system, all participating currencies were convertible based on its gold value. For example, if currency X was equal to 100 grains of gold, and currency Y was equal to 50 grains of gold, then 1X was equal to 2Y. 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(9) Currency devaluation limit: In case of structural imbalance in country’s BOP the IMF undertook to help members to devalue their currency approximately. Member countries may devalue the currencies up to 10°, However, beyond that limit, IMF permission was required. (10) International vehicle currency: International payments could be made either in gold or in US dollars. Officially dollar became an International Reserve Currency and vehicle currency which could be used for cross border payments. The concept of dual exchange rate was abolished. 3.3.2 Advantages of BWS: () The advantage of Bretton Wood’s system was that the member countries had to maintain only the reserves of dollars which helped them in overcoming the problem of maintaining gold reserves. (2) The countries could also earn interest on their dollar reserve unlike in the gold reserve system. (3) The Bretton Woods system sought to secure the advantages of the gold standard without its disadvantages. Thus, a compromise was sought between the polar alternatives of either freely-floating or irrevocably fixed rates, an arrangement that might gain the advantages of both without suffering the disadvantages of either while retaining the right to revise currency values on occasion as circumstances warranted. The Gold Standard imposed monetary discipline on the countries involved. Any country experiencing inflation would have lost gold and therefore would have had a decrease in the amount of money available to spend. This decrease in the amount of money would have acted to reduce the inflation. (6) The Gold Standard maintained fixed exchange rates. Fixed exchange rates were seen as desirable because they reduced the risk of trading with other countries. However, a full return to the Gold Standard was not feasible. Viput’s™ international Finance (BMS) @ International Monetary Systems re 37 (© The United States had emerged from World War Tl as the strongest economy in the world. Unlike Europe and Japary the United States had experienced very little destruction on its own land, Because of the strength of the American economy, the American dollar came to be the fundamenta ‘money in the international financial system, It took over the ole that gold had played under the Gold Standard, anc was ‘iled a “reserve currency”. But to provide faith in the ‘American dollar, it was linked to gold at the rate of $35 per ounce of gold. Foreign governments and central banks could exchange dollars for gold at this rate. (7) The benefits of the Bretton Woods system were a sign expansion of international trade and investment as w' notable macroeconomic performance. 3.3.3. Disadvantages of BWS: (G)_ Weaknesses of the system were capital movement restrictions throughout the Bretton Woods years, governments needed to limit capital flows in order to have a certain extent of control, as well as the fact that parities were only adjusted after speculative and financial crises. (2) Another negative aspect was the pressul on the United States, which was not ‘mount of gold the rest of the world demanded, bi gold reserves declined and eroded the confidence in tne dollar. There was not enough gold available to allow people to buy all the new goods and services that could be produced. And the gold that was available was mainly located in the Soviet Union, a Cold War enemy of the United States and Western Europe, and whose policy of apartheid was strongly condemned b es and the Western European countries. The success of Bretton Wood’s system was essentially basec on the unconditional supply of dollars by US. However US could not do it for a long time as it was still under the syste of gold standard. Bretton Woods put @) @)| | ——EEEEE ——————_§_§_ -Aypmby jeuopeusayut uo yoru aszaape we pey ysTYM saazesar pfo8 jo uoneUBEIS 03 Surpea] saqUMOD snorreA ut uoROMpord pjo8 jo uosuadsns Du) 0} PET SRL “PIB aonposd o} TeoRMOUODaUN auTeD9q IF JuonepUt 04 ang] “pfo8 Jo aorad ayy ur uorstaar Aue 10} apraord jou pip ose wasks snp “prepreg Plo Jo ase arp ur Sv (@) -pro8 yo Aimaerreae Aq paurensuon ose sem IF YaTS Se pur waisXs aBueypxa pjo8 jo juetrea w Ajerou sem SME SUL CE) sung Suoy ut a]qeszomun a pasopusz YR smey Jo yaquinu e pey waysXs spoom wOoHaIg euL ISM JO arnyyes 103 suOsHaY S“E"E -forjod Kxeyauow sojspmunpe 0} sywaunuedcs Aq pasn 3a8re} jedpursd ayy seu} ou arom soyex aBueypxe ‘sp1om Jayjo Ut ‘SuALOY arom sa—uELTD aofew s,ppom ap Te ‘9Z61 WW Aq ‘sxowemoeds our ysurese popuayap aq 30U PINOD Sayer TEOYJO [gay Bou ayy wars Ind ‘yer aBueyoxe paaaSe ayy wos suoBeneadp JUedzed <7'z PAMOTIE yuoyeouay arom YpTyM ‘saFuazM zofeul Jo UORENTeAar [es9UTs e jo ued se [261 xequisoaq ur peddosp sem aBzeyomns oul, “ypoys UOXIN au Paqanp toos sem pur “aUTEd|d aig uMO WIM wade 20 weiss AxejaUoW TeUOREUTIU! au JO Sioquiour SUAMsuCS OWI apeur sem UOISPEP snp ‘AtjeNsnUPL Sayseur uado ay uo idaoxe ‘Kpoamp pros 04 aiqnzaucout aejjop ay Supreur ,/mopurm pro3 awp (SuP)pesop,, ApueHodiuy jsow puv ‘eBreyams yodur %oT e ‘sjonuCS aud pur aBem “Kep-o6 pasodury Aqpexoveyfun UOXIN ‘TZ6I ‘ET asnSny uo ‘asuodsax uy ‘seqeIg PaTUN Bp Pay UOHTTEG ZZS 10F SIASSE “TZET JO SUIUOUT XIS ysnyy aup Uy “squaUASAALT ayeatsd pue samypuadxe AreyyTrur s, uot dup 10y Ked 0} ‘seaszex0 padund Sureq ua ‘uoIurySeM UF pojuuid Surg azam srevjop ax0Ur Pue a0Ur L261 UT 'SHOYEP aPen pur a8pnq sit nd oF ATE “S'A,FU UF WATE, ISO] Peu ZETLOP Ova Jo siapjoy azayas yu1od axp payudsardar ‘sysmurouoDe Teoqsse|20u jo MATA aU UT /STUL “%zz OF YEE WO BeLOHI}aP aBer0A0 pro “SA ates YORUM “OZ6T sea gutod Supumy pens ayy, “(ana yponuaag ayp UF SUA IST a 703) FO"AP epen F ose Inq IPHEP squauded 30 eouereq yen{ you Bunun sem soreis PUD ruonepur payexapanoe sem WeURarA tp se ‘SOZ6T Atte ou AE ee ABB suuayshs Areyauoy jeuojreusorut ‘waysis spoom, uoyasg jo asderjos oj Surpesy wxajshs spoom uowerg Jo aseq ayy Sem Yorya Uax0Iq Sem JeI[OP pur Pjo8 usemjoq AUN] ay aoud}{ * POYs UOXINY, se PaULIa, os[e sem UOREIEPEp siY BDUd_ p03 aTqHreatto> aq saBuo] ou pfnom seIO) ks suogeu roquiaur aip Aq payeymuna.e siefjop jo aBueyoxe ur pfo3 YyBnoua aar¥ oj age aq jou plnom SA ey Mau soMpUMOD JaqUaUI U2Ag “‘panfearapuN arom YL ueuLia5 pure uax asauedel yoryan Jo asnesaq se[Jop SA 0} wodsax YIM asuapyUOI Jo SISHD 0} pat YoREM paysaue aq jou pino> SMOHINO Idd SA ‘SonMOYNe AreaUOW ayy pUue UaUTUZaA03 SA, ayy Aq sidurone peraaas aydsap ‘reaamoH ‘steffop Sf] Jo peeisut sayumos raquiau pre 0} Souasind [er swygny Suemerq jure ue se OZ61 Ut (GS) 1d yo jdasuos ayy Sunpoayut autoy jo saasasar aBny sasmbar yory Axunoe 243 jo saayoa{qo snuouosa Buraayoe useayaq ;s9z9}t JO WIYUOD aea1d plnom 3 se sarmuNOD sayjo 94} 104 AduazINO daresax [euoHeUsayuT pur AzyuNOD auIoY ayy Joy AUDLMD [eUCHeE YIog se BAI—5 0} AGUMOD k IOs a[qissod jou A{jeonDe1d aq Pom 3 jeu panSze ysrwouode uedHOUTY-URS[ag B “UUs Waqoy Jorg 1,POYS UOXIN, UL PEE BA ae (swe) a2ueuty jeuonewarys sander,40 we (3) The system did not provide for any revaluation of parities due to which surplus countries such as West Germany and Japan continued to enjoy export competitiveness against the US economy. This aggravated the US trade deficit. (@) The system did not provide for a revision in the price of gold in terms of USD. Due to this, it was not possible to devalue the US Dollar despite continued trade deficit. The devaluation of the dollar would have adversely affected all countries having USD reserves. (5) Every member country had the right to accumulate dollar reserves and for that obviously tl.ey had to consistently have a positive balance of trade with US. (6) The success of Bretton Woods system was essentially based on the unconditional supply of dollars by US. However US could not do it for a long time as it was still under the system of gold standard. (7) The continued trade deficit of the US created an over-supply of USD in the international financial markets which reduced the acceptability of the USD. When the Gold Convertibility Clause was invoked, the US authorities could not honour their commitment to redeem USD against gold. This failure on the part of the US led to the collapse of the system in 1971 3.3.6 Smithsonian Agreement (1971-1973): ' ‘The breakdown of the Bretton Woods system was preceded by many events, such as (2) the devaluation of the pound in 1967, 2) flight from dollars to gold in 1968 leading to the creation of a two-tiered gold market (with the official rate at $35 per ounce and the private rate market determined) and (3) Finally in August 1971, the British demand that US guarantee the gold value of its dollar holdings. This led to the US decision to give up the link between the dollar and gold. The shock of August 15 was followed by efforts under USS. leadership to develop a new system of international monetary management. Throughout the fall of 1971, there was a series of multilateral and bilateral negotiations of the Group of Ten seeking to develop a new multilateral monetary system. In December of ‘Viput’s™ International Finance (BMS) International Monetary Systems we a. 1971, on the 17th and 18th, the Group of Ten, meeting in the Smithsonian Institute in Washington, created the Smithsonian ‘Agreement which devalued the dollar to $38 dollars an ounce, wih 2.25% trading bands, and attempted balancing the world financial system using SDRs alone. It failed to impose discipline on the US government, and with no other credibility mechanism in place, the pressure against the dollar in gold continued. This resulted in gold becoming a floating asset, and in 1971 it reached $44.20/ounce, in 1972 $70.30/ounce and still climbing. By 1972, currencies began abandoning even this devalued peg against the Gollar, though it would take a decade for all of the industrialized nations to do so. In February of 1973, the Bretton Woods currency exchange markets would close, after a last gasp devaluation of the dollar to $44/ounce, and only would reopen in March in @ floating currency regime. The collapse of the Bretton Woods system is a subject of intense debate ‘After the failure of Bretton Woods system, in December 1971, ‘The G-10 countries (Belgium, Britain, Canada, France, Holland, Italy, Japan, US, Sweden and West Germany) met at Smithsonian Institute in Washington to adopt a new version of Bretton Woods system which came to be known as Smithsonian Agreement Following were the changes made ity clause was withdrawn. ) The gold converti Gi) US dollar was revalued as 1oz of gold=388. (iii) The currencies of the remaining G-10 countries were revalued by 10%. (iv) All other countries were required to refix the parity rates against US dollar. () The variation zone was increased from (+/-) 1% to (+/-) 2.25%. ‘This was an attempt made to increase dollar competitive and to control US trade deficit. However the loss of Vietnam war increased US trade deficit leading to further devaluation of USD to 1 oz of gold = 42.28. Besides this increase in the crude oil prices by PEC countries, further deteriorated US situation of Balance of Payment. 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(3) Control on inflation: As compared to floating system, there is control on inflation as Central bank controls the money supply and therefore keeps the inflation under control. The central bank’s intervention ensures that the rates can be changed as per the requirements in the economy, thus, helping Government to combat inflation in the economy. (4) Elimination of depreciation of currencies: Under the fixed exchange system there is no unhealthy practice of depreciation of currencies to capture international trade like the floating system. Encourage long-term capital flows: Since uncertainty and risk of exchange rates volatility is rare in case of fixed exchange rate, hence it encourage long-term capital flows. (6) Encourages international trade: Commitment to a single fixed exchange .ate encourages international trade by making prices of goods concerned in trade more predictable. ( Monitor responsible financial policies: Fixed exchange rate serve as a commentator and imposes a discipline on monetary authorities to monitor responsible financial policies within countries. Any inflationary monetary expenditure creates balance of payments deficit and thus reserves loss and hence monetary authorities normally do not practice an independent monetary policies. (8) No fear of unfavourable effect of speculation: Since there is no fear of currencies fluctuations, fixed exchange rate creates confidence in the strength of the domest ¢ currency and there Vipul’s™ international Finance (BMS) 5) international Monetary Systems ror as is no fear of adverse effect of speculation on the exchange vote The stable exchange rate avoids the harming possibilities of speculation and so there is no fear of unfavourable effect of speculation on the exchange rate under fixed exchange rate system, Relatively simpler system : It is a relatively simpler system wed can be reed upon as there are no frequent fluctuations in the exchange rate. (10) Comparatively more stable : The exchange rates remain comparatively more stable than the flexible exchange rate. (11) Absence of exchange rate risk: 343 Disadvantages of fixed exchange rate system: (1) Affects domestic economic stability: Fixed exchange rate possibly will achieve exchange rate stability ‘but at the cost of ce enestic economic stability. The exchange rates do not reflect the macroeconomic changes taking place in the economy: Restrictions on monetary policy formulation: Monetary guthorities lose the freedom of monetary policy formulation to preserve exchange rate stability. Any instability in exchange rate needs to be corrected by buying and/or selling Gi foreign exchange reserves or by controlling the domestic money supply. () Managing foreign exchange reserves: The Central bank may have t) maintain adequate reserves of the foreign curtine) every time leading to idle resources. To protect the fixec exchange rate, country needs to have vital foreign exchangt eserves and this imposes heavy load on the monetan authorities for managing foreign exchange reserves. (4) Misallocation of resources: Fixed exchange rate syste" TNS! Mifwult exchange control mechanism which may lead ‘misallocation of resources. This system may result into eithe huge accumulation of reserves or a drain of the country’ foreign exchange reserves which may cause severe Balance ¢ Payment problem. International Trade not Promoted by Fixed Rates: Tr argument that fixed exchange rates promote internation treie is not supported by historical facts of inter-war OF Pos ) Q) ( |