UGC NET

Commerce
SAMPLE

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 International Business

6. Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI)

Foreign Direct Investment (FDI)

The investment made by company in new manufacturing or marketing facilities in a
foreign country is known as Foreign Direct Investment. In other form Foreign direct investment
(FDI) is an investment made by a company or individual in one country in business interests
in another country, in the form of either establishing business operations or acquiring business
assets in the other country, such as ownership or controlling interest in a foreign company.
Foreign direct investment is an individual or business owns 10 percent or more of a
foreign company's capital. All later financial transactions are extra direct investments, according
to the International Monetary Fund.
Businesses that make foreign direct investments are often called multinational
corporations (MNCs) or multinational enterprises (MNEs). An MNE may make a direct
investment by creating a new foreign enterprise, which is called a Greenfield investment, or
by the acquisition of a foreign firm, either called an acquisition or brownfield investment.
Greenfield Investment
A Greenfield Investment is when a parent company chooses to begin operations in a
foreign country establishing the construction of new production facilities “from scratch”,
including all the necessary offices, living quarters and distribution hubs. The developing
countries constantly offer various benefits and incentives to call the attention of multinational
companies willing to perform Greenfield investments. These benefits include tax breaks,
preferential rates for import/export, subsidies and other incentives, which in exchange improves
the economy in the target country and enhances the human capital in the area by offering
additional job opportunities.
The name “green” comes from building in a pristine literally green new land, often
covered with vegetation prior to the construction and that has never been used for production.
Brownfield Investment
When a company or government chooses to purchase an already built production facility
within a foreign market, this is called a Brownfield investment. The investing company can buy
or lease the existing facility eliminating building costs of the project, focusing on remodeling
or upgrading, and skipping some of the initial paperwork and requirements from operating
with a new property. This sometimes could be a good advantage for new companies as well,
and a good short-term startup opportunity.
The name “brown” comes from the fact that the used land may be contaminated by
previous activities from the last existing company. When there is contamination the absence of
vegetation is portrayed by a brownfield lacking green, when speaking about a new land which
has not been used before for production, this is a Greenfield.

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 Commerce (Sample Theory)

Types of FDI
 Horizontal : In case of horizontal FDI, the company does all the same activities
abroad as at home. For example, Toyota assembles motor cars in Japan and the
UK.
 Vertical : In vertical assignments, different types of activities are carried out abroad.
In case of forward vertical FDI, the FDI brings the company nearer to a market
(for example, Toyota buying a car distributorship in America). In case of backward
Vertical FDI, the international integration goes back towards raw materials (for
example, Toyota getting majority stake in a tyre manufacturer or a rubber
plantation).
 Conglomerate : In this type of investment, the investment is made to acquire an
unrelated business abroad. It is the most surprising form of FDI, as it requires
overcoming two barriers simultaneously - one, entering a foreign country and
two, working in a new industry.
Forms of Foreign Direct Investment
 Purchase or Acquired and takeover of existing assets in a foreign country.
 New investment in Land, Plan and Machinery, and equipment.
 Merger and Joint Venture with local partner.
Factors Affecting of FDI
 The rules and regulations to the entry and operations of foreign Investors.
 The functioning and efficiency of local market.
 Trade policy and privatization policy.
 National Income and growth rate.
 Exchange rate stability.
 Liquidity stock and bond market.
 Banking Policy and interest Rate.
 Regulation of stock market.
 Infrastructure Facility.
 The degree and protection of investor's right.
 Taxes and Subsidies Etc.
Advantage of FDI
 Promotion of investment in key areas
 Promote of New technologies
 Increase in Capital inflow
 Increase in Exports
 Promotion of Employment opportunities
 Promotion of financial services Exchange rate stability
 Development of backward areas
 Utilization of natural resources
 Change in the lifestyle of people
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 Commerce (Sample Theory)

Disadvantage of FDI
 Suffer of cottage and small scale industries
 Inflation in the Economy
 Promote Political corruption
 Suffer domestic Cultural
 Trade Deficit : The introduction of TRIPs (Trade Related Intellectual Property
Rights) and TRIMs (Trade Related Investment Measures) has restricted the
production of certain products in other countries.
Foreign Portfolio Investment (FPI)
It is the investment by Non- resident in Indian securities including shares, govt. bonds,
corporate bonds, convertible securities, infrastructure securities etc. who make investment in
these securities are known as Foreign Portfolio Investors (FPI). Foreign Portfolio investors
include investment groups of foreign institutional investors (FII), qualified Foreign investors
(QFIs) and sub account etc.
FII Role in Indian Capital Market
The Union Government allowed the entry of FIIs in order to encourage the capital
market and attract foreign funds to India. Today, FIIs are permitted to invest in all securities
traded on the primary and secondary markets, including equity shares and other securities
listed or to be listed on the stock exchanges. The original guidelines were issued in September
1992. Subsequently, the Securities and Exchange Board of India (SEBI) notified the SEBI (Foreign
Institutional Investors) Regulations, 1995 in November 1995.
Over the years, different types of FIIs have been allowed to operate in Indian stock
markets. They now include institutions such as pension funds, mutual funds, investment trusts,
asset management companies, nominee companies, incorporated/institutional portfolio
managers, university funds, endowments, foundations and charitable trusts/societies with a
track record. Proprietary funds have also been permitted to make investments through the FII
route subject to certain conditions.
FIIs can invest in all securities traded on the primary and secondary markets. Such
investments include equity/debentures/warrants/other securities/instruments of companies
unlisted, listed or to be listed on a stock exchange in India including the Over-the-Counter
Exchange of India, derivatives traded on a recognized stock exchange and schemes floated by
domestic mutual funds. A major feature of the guidelines is that there are no restrictions on
the volume of investment - minimum or maximum - for the purpose of entry of FIIs. There is
also no lock-in period prescribed for the purpose of such investments.
Further, FIIs can repatriate capital gains, dividends, incomes received by way of interest
and any compensation received towards sale/renouncement of rights offering of shares subject
to payment of withholding tax at source. The net proceeds can be remitted at market rates of
exchange.
All secondary market operations would be only through the recognized intermediaries
on the Indian stock exchanges, including OTCEI. Forward exchange cover can be provided to
FIIs by authorized dealers both in respect of equity and debt instruments, subject to prescribed
guidelines. Further, FIIs can lend securities through an approved intermediary in accordance
with stock lending schemes of SEBI.

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 Commerce (Sample Theory)

According to Ernst and Young's (EYs) Global Capital Confidence Barometer (CCB) :
Technology report, India ranks third among the most attractive investment destinations for
technology transactions in the world. India is the third largest start-up base in the world with
more than 4,750 technology start-ups, and about 1,400 new start-ups being founded in 2016,
according to a report by Nasscom. FII's net investments in Indian equities and debt have
touched record highs in the past financial year, backed by expectations of an economic recovery,
falling interest rates and improving earnings outlook. FIIs net investments in Indian equities
and debt stood at US$ 7.46 billion in 2016-17 (up to April 14, 2017).
Requirement FII in Indian Capital Market
 Growth of Economy : FII leads to more competition leads to more sophisticated
financial technology, adaptation of the technology to local environment and greater
investment in information processing and financial services. The results are greater
efficiencies in allocating capital, risk sharing and monitoring the issue of capital
which help in economy growth.
 Improving Capital Markets : FII's as professional bodies of asset managers and
financial analysis, enhance competition and efficiency of financial markets. Equity
market development aids economic development by increasing the availability of
riskier long term capital for projects and increasing firm incentives to supply
more information about themselves, FII's can help in the process of economic
development.
 Development of Basic Infrastructure : The development of any economy depends
on the available infrastructure in that country. Government of India could not
able to raise necessary investments. To fill the gap foreign capital is highly suitable.
 Rapid Industrialization : The need for foreign capital arises due to the policy
initiatives of the government to intensify the process of industrialization
 To Undertake The Initial Risk : Many developing countries suffer from severe
scarcity of private investors. The risk problem can be diverted to the foreign
capitalists by allowing them to invest.
 To Remove The Technological Gap : The developing countries have very low
level of technology compared to the developed countries. This raises the necessity
for importing technology from the advanced countries. That technology usually
comes with foreign capital when it assumes the form of private foreign investment
or foreign collaboration.
Cost and Benefit of FDI to Home and Host Countries
(A) Benefit of Host Country
1. Resource Transfer Effects : FDI can make a positive contribution to a host economy
by supplying capital, technology, and management resources that would otherwise not be
available
Capital : As far as capital concerns, multinational enterprises (MNEs) invest in long-term
projects, taking risks and repatriating profits only when the projects yield returns. The free
flow of capital across nations is likely to be favored by many economists since it allows capital
to seek out the highest rate of return. Many MNEs, by virtue of their large size and financial
strength, have access to financial resources not available to host- country firms.

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 Commerce (Sample Theory)

Technology : Technology can be incorporated in a production process (e.g., the

technology for discovering, extracting and refining oil) or it can be incorporated in a product
(e.g., personal computers). Technologies that are transferred to developing countries in
connection with foreign direct investment tend to be more modern, and environmentally 'cleaner',
than what is locally available. Moreover, positive externalities have been observed where local
imitation, employment turnover and supply-chain requirements led to more general
environmental improvements in the host economy.
Management : Foreign management skills acquired through FDI may also produce
important benefits for the host countries. By transferring knowledge, FDI will increase the
existing stock of knowledge in the host country through labour training, transfer of skills, and
the transfer of new managerial and organizational practice.
2. Employment Effect : The effects on employment associated with FDI are both direct
and indirect. In countries where capital is relatively scarce but labour is abundant, the creation
of employment opportunities - either directly or indirectly - has been one of the most prominent
impacts of FDI. The direct effect arises when a foreign MNE employs a number of host country
citizens. Whereas, the indirect effect arises when jobs are created in local suppliers as a result
of the investment and when jobs are created because of increased local spending by employees
of the Multinational Companies.
3. Balance of Payments Effects : A country's Balance-of payments account is a record of
a country's payments to and receipts from other countries.
 The current account is a record of a country's export and import of goods and
services.
 Governments typically prefer to see a current account surplus than a deficit.
 FDI can help a country to achieve a current account surplus if the FDI is a substitute
for imports of goods and services, and if the MNE uses a foreign subsidiary to
export goods and services to other countries.
4. Effects on Competition and Economic Growth
 FDI in the form of greenfield investment increases the level of competition in a
market, driving down prices and improving the welfare of consumers.
 Increased competition can lead to increased productivity growth, product and
process innovation, and greater economic growth.
5. International Trade : FDI can have a great contribution to economic growth in
developing countries by supporting export growth of the countries. Output resulting from
efficiency-seeking FDI is typically intended for export, and therefore the impact of such FDI is
likely to be an increase in exports from the host country. FDI openness offers many benefits
including access to global market, technology and to appropriate intermediate and capital
goods and raw materials; the benefits associated with economies of scale and market competition.
(B) Cost of FDI to Host Country
1. Adverse Effects on Employment : The high unemployment represents the biggest
economic problem and it has a direct effect on low economic growth and the small number of
newly opened work places. The restructuring process of the enterprises in the course of transition
resulted in increased unemployment in the short run.

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 Commerce (Sample Theory)

2. Adverse Effects on Competition : Subsidiaries of foreign Companies may have greater

economic power than indigenous competitors because they may be part of a larger international
organization. If it is a part of large international organization, the foreign Companies may be
able to draw on funds generated elsewhere to subsidize its costs in the host market, which
could drive local companies out of business and allow the firm to monopolize the market. This
concern tends to be greater in countries that have few large firm of their own (i.e. less developed
countries) or minor concern in most advanced industrialized nations.
3. Adverse Effects on the Balance of Payments :
 With the initial capital inflows that come with FDI must be the subsequent outflow
of capital as the foreign subsidiary repatriates earnings to its parent country.
 when a foreign subsidiary imports a substantial number of its inputs from abroad,
there is a debit on the current account of the host country's balance of payments.
(C) Benefit of Home Country
The benefits of FDI for the home country include :
 The effect on the capital account of the home country's balance of payments from
the inward flow of foreign earnings.
 The employment effects that arise from outward FDI.
 The gains from learning valuable skills from foreign markets that can subsequently
be transferred back to the home country.
(D) Cost of FDI to Home Country
The home country's balance of payments can suffer :
 From the initial capital outflow required to finance the FDI.
 If the purpose of the FDI is to serve the home market from a low cost labor
location.
 If the FDI is a substitute for direct exports.
 Employment may also be negatively affected if the FDI is a substitute for domestic
production.
India’s FDI Policy And Trends
FDI is allowed through two different routes namely, Automatic and the Government
route. The previous Foreign Investment Promotion Board (FIPB) has been phased out recently.
In the automatic route, foreign entities do not need the prior approval of the government to
invest. However, they have to inform the RBI about the amount of investment within a stipulated
time period.
In the government route, any investment can be made only after the prior approval of
the government. Various other conditions as defined in the consolidated FDI policy are applicable
to various sectors. In specific sectors, the FDI is prohibited.
Introduction of the Goods & Services Tax (GST) applied on the growth rate in the country,
recent reports issued by the International Monetary Fund (IMF) suggest that India has stepped
up the gas on its rate of development.
Government of India is planning to consider 100 per cent FDI in Insurance intermediaries
in India to give a boost to the sector and attracting more funds.
The following are some of the key amendments in the FDI policy during the past 12
months :

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 Commerce (Sample Theory)

 100% FDI under the automatic route for Single Brand Retail Trading
 100% FDI under the automatic route in Construction Development
 Foreign airlines being allowed to invest in Air India up to 49% under the approval
route
 FIIs and FPIs being allowed to invest in power exchanges through the primary
market
 Definition of 'medical devices' amended in the FDI Policy
India's FDI Policy and Trends
According to the Department for Promotion of Industry and Internal Trade (DPIIT), FDI
equity inflows in India in 2019-20 (till August) stood at US$ 19.33 billion, indicating that
government's effort to improve ease of doing business and relaxation in FDI norms is yielding
results.
The net foreign direct investment stood at US$ 1.8 billion in August 2019 and US$ 3.8
billion in July 2019. India invited US$ 2.73 billion of foreign investment in month of August
2019 as compared to US$ 2.54 billion in previous year.
Data for Q1 2019-20 indicates that the telecommunications sector attracted the highest
FDI equity inflow of US$ 4.22 billion, followed by service sector - US$ 2.79 billion, computer
software and hardware - US$ 2.24 billion, and trading - US$ 1.13 billion. Most recently, the total
FDI equity inflows for the month of June 2019 touched US$ 7.28 billion.
During Q1 2019-20, India received the maximum FDI equity inflows from Singapore
(US$ 5.33 billion), followed by Mauritius (US$ 4.67 billion), Netherlands (US$ 1.35 billion), USA
(US$ 1.45 billion), and Japan (US$ 0.47 billion).
Investments/ developments
India emerged as the top recipient of greenfield FDI Inflows from the Commonwealth,
as per a trade review released by The Commonwealth in 2018.
Some of the recent significant FDI announcements are as follows:
 In October 2019, French oil and gas giant Total S.A. have acquired a 37.4 per cent
stake in Adani Gas Ltd for Rs 5,662 crore (US$ 810 million) making it the largest
Foreign Direct Investment (FDI) in India's city gas distribution (CGD) sector.
 In August 2019, Reliance Industries (RIL) announced one of India's biggest FDI
deals, as Saudi Aramco will buy a 20 per cent stake in Reliance's oil-to-chemicals
(OTC) business at an enterprise value of US$ 75 billion.
 In October 2018, VMware, a leading software innovating enterprise of US has
announced investment of US$ 2 billion in India between by 2023.
 In August 2018, Bharti Airtel received approval of the Government of India for
sale of 20 per cent stake in its DTH arm to an America based private equity firm,
Warburg Pincus, for around $350 million.
 In June 2018, Idea's appeal for 100 per cent FDI was approved by Department of
Telecommunication (DoT) followed by its Indian merger with Vodafone making
Vodafone Idea the largest telecom operator in India
 In February 2018, Ikea announced its plans to invest up to Rs 4,000 crore (US$ 612
million) in the state of Maharashtra to set up multi-format stores and experience
centers.
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 Commerce (Sample Theory)

 Kathmandu based conglomerate, CG Group is looking to invest Rs 1,000 crore

(US$ 155.97 million) in India by 2020 in its food and beverage business, stated Mr
Varun Choudhary, Executive Director, CG Corp Global.
 International Finance Corporation (IFC), the investment arm of the World Bank
Group, is planning to invest about US$ 6 billion through 2022 in several sustainable
and renewable energy programmes in India.
Government Initiatives
In August 2019, government permitted 100 per cent FDI under the automatic route in
coal mining for open sale (as well as in developing allied infrastructure like washeries).
In Union Budget 2019-2020, the government of India proposed opening of FDI in aviation,
media (animation, AVGC) and insurance sectors in consultation with all stakeholders.
100 percent FDI is permitted for insurance intermediaries.
As of February 2019, the Government of India is working on a road map to achieve its
goal of US$ 100 billion worth of FDI inflows.
In February 2019, the Government of India released the Draft National E-Commerce
Policy which encourages FDI in the marketplace model of e-commerce. Further, it states that
the FDI policy for e-commerce sector has been developed to ensure a level playing field for
all participants.
Government of India is planning to consider 100 percent FDI in Insurance intermediaries
in India to give a boost to the sector and attracting more funds.
In December 2018, the Government of India revised FDI rules related to e-commerce. As
per the rules 100 percent FDI is allowed in the marketplace-based model of e-commerce. Also,
sales of any vendor through an e-commerce marketplace entity or its group companies have
been limited to 25 per cent of the total sales of such vendor.
In September 2018, the Government of India released the National Digital
Communications Policy, 2018 which envisages increasing FDI inflows in the telecommunications
sector to US$ 100 billion by 2022.
In January 2018, Government of India allowed foreign airlines to invest in Air India up
to 49 per cent with government approval. The investment cannot exceed 49 percent directly or
indirectly.
No government approval will be required for FDI up to an extent of 100 percent in Real
Estate Broking Services.
The Government of India is in talks with stakeholders to further ease foreign direct
investment (FDI) in defence under the automatic route to 51 percent from the current 49 percent,
in order to give a boost to the Make in India initiative and to generate employment.
Determinants of FDI
The determinant varies from one country to another due their unique characteristics and
opportunities for the potential investors. In specific the determinants of FDI in India are :
(i) Stable Policies : India stable economic and socio-policies have attracted investors
across border. Investors prefer countries which stable economic policies. If the
government makes changes in policies which will have effect on the business.
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 Commerce (Sample Theory)

The business requires a lot of funds to be deployed and any change in policy
against the investor will have a negative effect.
(ii) Economic Factors : Different economic factors encourage inward FDI. These include
interest loans, tax breaks, grants, subsidies and the removal of restrictions and
limitation. The government of India has given many tax exemption and subsidies
to the foreign investors who would help in developing the economy.
(iii) Cheap and Skilled Labour : There is abundant labor available in India in terms
of skilled and unskilled human resources. Foreign investors will to take advantage
of the difference in the cost of labor as we have cheap and skilled labors. Example:
Foreign firms have invested in BPO's in India which require skilled labor and we
have been providing the same.
(iv) Basic Infrastructure : India though is a developing country, it has developed
special economic zone where there have focused to build required infrastructure
such as roads, effective transportation and registered carrier departure world -
wide, Information and communication network/technology, powers, financial
institutions, and legal system and other basic amenities which are must for the
success of the business. A sound legal system and modern infrastructure
supporting an efficient distribution of goods and services in the host country.
(v) Unexplored Markets : In India there is large scope for the investors because there
is a large section of markets have not explored or unutilized. In India there is
enormous potential customer market with large middle class income group who
would be target group for new markets. Example: BPO was one sector where the
investors had large scope exploring the markets where the service was provided
with just a call, with almost customer satisfaction.
(vi) Availability of Natural Resources : As we know that India has large volume of
natural resources such as coal, iron ore, Natural gas etc. If natural resources are
available they can be used in production process or for extraction of mines by the
foreign investors.

7. Balance of Payments (BOP)

Balance of Payment is a double entry system of record of all economic transactions between
the resident of the country and the rest of the world carried out in a specific period of time. The
balance of payments is the record of a country's transactions with the rest of the world.
All economic transactions mean transactions of both visible goods (Merchandise) and
invisible goods (Services). In other words the BOP shows how money is spent foreign (Payment)
and how money is received domestically (Receipt). Balance of Payment of presents an account
of comprehensive economic and financial transaction of a country with the rest the world.

In the words of C. P. Kindle Berger "The balance of payments of a country is a systematic

record of all economic transactions between the residents of the reporting and the residents of
the foreign countries during a given period of time." Here by 'residents' we mean individuals,
firms and government.

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 Commerce (Sample Theory)

The Internationally Monetary Fund defines BOP as a "Statistical Statement that

Subsequently Summaries for a specific time period, the economic transactions of an economy
with the rest of the world."

It includes visible exports and imports and invisible items such as Receipt and payments
for various services.
Characteristics
 All receipts and payments on account of goods exported are recorded
 Service rendered of receipts and payment are recorded.
 Capital received by residents.
 Capital transferred to a Non-Resident/Foreigners are Recorded in BOP.
 The balance of payment is a statistical statement for a given period showing.
 Transaction in goods and services and income are recorded between an economy
and the rest of the world.
Balance of Payment V/s Balance of Trade
Balance of trade takes only the transactions arising out of the exports and import of the
visible item. It is not included invisible items (Service Sector) like service of banking, payment
of dividend, transactions of Banking sector, insurance sector, transport, tourism etc.
While Balance of Payment is wider term as compared to balance of trade. It is included
visible (Manufacture Sector) and Invisible Items ( Service Sectors) in to account of export and
import of all kind of goods including consumer goods, consumer durable, fast moving consumer
goods, capital goods and in service sectors like insurance, banking, tourism, transportations
sector etc.
Components of BOP

(a) (b)
Current Capital
Account Account

Components
of BOP

(c)
Official
Settlement
Account

(a) Current Account : The current account of BOP includes all transaction arising from
trade in currently produced goods and services. Current account contains credit and debit.
Credit of Current Account Includes : Export of trade (Income from sales of goods or
provide services in to foreign)

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 Commerce (Sample Theory)

Debit of Current Account Includes : Import of Trade or Services (Expenditure form

purchase of goods or payment to services into foreign)
The current Account divided in to three parts :
(i) Visible Account (Merchandise Account or Trade Account or Trade in Goods
Accounts)
(ii) Invisible Account
(iii) Unilateral transfers.
(i) Visible Account (Merchandise Account or Trade Account or Trade in Goods
Accounts) : This account records imports and exports of physical goods. The
balance of visible exports and visible imports is called balance of visible trade or
balance of merchandise trade.
(ii) Invisible Account : It records all export and imports of services such as banking
services, transportations services, insurances services etc.
(iii) Unilateral Transfers : Unilateral transfers are receipts which resident of a country
receive or payments that the residents of a country make without getting anything
in return e.g. gifts. These include government grants, reparations, private
remittance, disaster relief etc.
It is basically consist of credit and Debits. Credits include private remittance received
from foreign and debits side includes private remittance to abroad.
Thus the first three items of the BOP account are included in the current account. The
current account may be favorable and unfavorable. If receipts (Export) exceed comparison to
payment (Import) that is called favorable current account and if payment (Import) exceed
comparison to receipts (Export) that is called unfavorable current account.
(b) The Capital Account : The capital account shows transactions relating to the
international movement of ownership of financial assets such as Shares, Property or Direct
Acquisition of companies, bank loans, Government securities etc.
Capital Account is divided into three parts :
(i) Private Capital
(ii) Banking Capital
(iii) Official Capital
(i) Private Capital : Private capital is further divided into short term and long term
capital.
Short Term Capital is one which matures in one year or less such as bank account.
Long Term Capital It is one whose maturity period is longer than one year such as long
term bonds or physical capital.
Long term Private Capital Includes
 Foreign investment (Direct and Portfolio)
 Long Term Loans
 Foreign Currency Deposits
 Unclassified Receipts Allocated to The Capital Account
(ii) Banking Capital : Banking Capital are included external financial assets and liabilities
of commercial and co-operative bank authorized deal in foreign exchange.
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 Commerce (Sample Theory)

(iii) Official Capital : Official capital are in terms of foreign currency and special Drawing
Rights held by govt. are categories into loans, amortizations and miscellaneous receipt and
payment.
Thus sales and purchase of assets by exports and imports. Equipment does not appear
in capital account. Capital account consists of credit and debits.
 Credits includes foreign long term investment to the home country such as Foreign
Direct Investment (FDI), Foreign Investment in Domestic Securities, foreign loan
to domestic countries etc. this is called capital Import.
 Debits includes long term investment in foreign countries such as investment in
foreign securities, govt. loan to foreign countries, Direct investment in Foreign
etc. this is called capital Export.
(c) Official Settlement Account : Official settlement Account represents the official sale
of foreign currencies (Credit Side) and reserves to foreign countries or Official purchase of
foreign currencies (Debit Side). This account covers purchase and sales of reserve assets such
as gold, Convertible foreign exchanges, special Drawings Rights (SDR).

We can Summaries the BOP

Current account balance + Capital account balance + Official settlement
and reserve account balance = Balance of payments.
 Current Account balance = Current Exports- Current Imports
 Capital Account balance = Capital investment inflow - Capital Outflows
 Forex is foreign exchange reserve Balance

A BOP account is prepaid according to the principle of Double- Entry book keeping.
This accounting procedure gives rise to two entries one Debit side and other Credit side.
Any transaction giving rise to a receipt form the rest of the world is a credit item in the
BOP account and any transaction giving to a payment to the rest of the world is a Debit side.
The left hand side of the BOP account shows the receipt of the country such receipts
of external purchasing power arise from the commodity export, form sales of invisible services,
form the receipts of gift and grants form foreign government, international lending institutions
and foreign individuals etc.
The right side shows the payments made by the country on different items to foreigners.
It shows external purchasing power is used for acquiring imports of foreign goods and services
as well as the purchase of foreign assets.
Autonomous and Accommodating Item
(a) Autonomous Items : Autonomous items in the B.O.P refer to international economic
transactions that take place due to some economic motive such as profit maximization. These
items are often called above the line items in the B.O.P.
The balance of payments is in a deficit if the autonomous receipts are less than
autonomous payments. The monetary authorities may finance a deficit by depleting their
reserves of foreign currencies, or by borrowing from I.M.F.
(b) Accommodating Items : Accommodating items in the B.O.P. refer to transactions that
occur because of other activity with the B.O.P such as government financing. Accommodating
items are also referred to as below the line of items.

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 Commerce (Sample Theory)

Difference between Capital Account & Current Account

The Basis of Comparison Current Account Capital Account

Between Current
Account vs Capital
Account
Meaning A current account is one of the The capital account is another
components of BOP that deals key component of BOP that
with a trade of 'goods' & deals with 'capital investment'
'services' of one country with and 'expenditures' of one
another country with another
Measures It measures the inflow and It measures the inflow and
outflow of 'goods and services' outflow of 'capital' in the
in the economy economy
Key components The key components of Current The key components of Capital
account are 'Merchandise trade', account are 'Foreign direct
'Services' 'Income receipts' and investment (FDI)' and 'Foreign
'Unilateral transfers' portfolio investment (FPI)'
Evaluation It helps the investors in It helps the investors in
evaluating 'Trade surplus' or evaluating the 'Net investment'
'Trade deficit' of any country' position of a country
Impacts Current account impacts the net Capital account impacts the
income and output of a country foreign assets & liabilities of a
country
Transaction Current account deals with Capital account deals with
receipts and disbursements in sources & utilization of 'capital'
'cash' and 'non-capital items'
Disequilibrium of Balance of Payment
When demand and supply of foreign currency should be equal both surplus and deficit
represent the disequilibrium in the balance of the payment.
Cause of the Disequilibrium : There are a number of factors that cause disequilibrium
in the balance of payments showing either a surplus or deficit. These causes are categorized
into 3 factors.
(i) Economic Factors : Large scale development expenditure that may cause large
imports.
 Development Disequilibrium : Developing countries take up development
activities such as establishment of industries, Construction Bridge, roads,
power plants, and other industries development. These activity increased
import of the capital goods.
 Cyclical Disequilibrium : Cyclical disequilibrium is concerned with the
fluctuations in import and export due to business cycle.
 Secular Disequilibrium : Secular Disequilibrium is due to increase in
imports consequent upon highly aggregate demand.
 Structural Disequilibrium : Structural Disequilibrium is due to increase in
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 Commerce (Sample Theory)

Import consequence upon structural changes in an economy from

agricultural to industries etc.
(ii) Political Factors : Political instability may cause large capital outflows and hamper
the inflows of foreign capital.
(iii) Social Factors : Changes in tastes, preferences and fashions may affect imports
and exports.
Measures to Correct Disequilibrium in the BOP are :
l. Monetary Measures :
(a) Monetary Policy : The monetary policy is concerned with money supply and
credit in the economy. The Central Bank may expand or contract the money
supply in the economy through appropriate measures which will affect the prices.
(b) Fiscal Policy : Fiscal policy is government's policy on income and expenditure.
Government incurs development and non - development expenditure, It gets
income through taxation and non - tax sources. Depending upon the situation
governments expenditure may be increased or decreased.
(c) Exchange Rate Depreciation : By reducing the value of the domestic currency,
government can correct the disequilibrium in the BOP in the economy. Exchange
rate depreciation reduces the value of home currency in relation to foreign
currency. As a result, import becomes costlier and export become cheaper. It also
leads to inflationary trends in the country,
(d) Devaluation : Devaluation is lowering the exchange value of the official currency.
When a country devalues its currency, exports becomes cheaper and imports
become expensive which causes a reduction in the BOP deficit.
(e) Deflation : Deflation is the reduction in the quantity of money to reduce prices
and incomes. In the domestic market, when the currency is deflated, there is a
decrease in the income of the people. This puts curb on consumption and
government can increase exports and earn more foreign exchange.
(f) Exchange Control : All exporters are directed by the monetary authority to
surrender their foreign exchange earnings, and the total available foreign exchange
is rationed among the licensed importers. The license-holder can import any
good but amount if fixed by monetary authority.
II. Non-Monetary Measures :
(a) Export Promotion : To control export promotions the country may adopt measures
to stimulate exports like :
 Export duties may be reduced to boost exports
 Cash assistance, subsidies can be given to exporters to increase exports
 Goods meant for exports can be exempted from all types of taxes.
(b) Import Substitutes : Steps may be taken to encourage the production of import
substitutes. This will save foreign exchange in the short run by replacing the use
of imports by these import substitutes.

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 Commerce (Sample Theory)

(c) Import Control : Import may be kept in check through the adoption of a wide
variety of measures like quotas and tariffs. Under the quota system, the government
fixes the maximum quantity of goods and services that can be imported during
a particular time period. Tariffs are duties (taxes) imposed on imports.
Importance of BOP
The balance of payments records flows of goods and assets over a period of time, just
like the income statement of a firm. By analogy, just as a firm has a balance sheet, at a point
in time, a country owns a certain stock of foreign assets, and foreigners own a certain stock of
domestic assets. The difference between the values of these two stocks is called net foreign
assets. Consequently, at any given point in time, a country has a net international investment
position; it is either a net creditor or a net debtor with the rest of the world.
The value of all the final goods and services produced within a country, within a year,
is called the country's gross domestic product (GDP).
The value of what is produced in a country must be purchased either by domestic
residents or foreign residents. Hence, the country's total consumption purchases, C, plus its
total government purchases, G, plus its total investment purchases, l, plus the value of its net
exports, NX, must equal its GDP:
GDP = C + I + G + NX.
The value of all the final goods and services must be paid to factors of production. In
an open economy, net factor income from abroad (NFI) from either labor that works in foreign
countries or capital that is invested in foreign countries provides a flow of resources that
separates gross national income (GNI) from GDP (GNI = GDP + NFI)
By subtracting a country's total expenditures on consumption, investment, and
government purchases from its gross national income, we are left with net exports plus net
factor income from abroad, which is equal to the current account (CA) of the balance or payments.
If a country has a current account surplus, it must have national income that exceeds
national expenditures. If a country has a current account deficit, the country's expenditures
exceed its income.

Ques. Identify the one, from the following, which is not a type of disequilibrium in the balance of payments
of a country : (NTA UGC-NET Dec. 2013 P-II)
(A) Cyclical disequilibrium (B) Secular disequilibrium
(C) Structural disequilibrium (D) Sectoral disequilibrium
Ans. (D) Sectoral disequilibrium

Ques. The instrument chosen for enhancement of international liquidity is :

(NTA UGC-NET June 2015 P-II)
(A) Society for Worldwide Interbank Financial Telecommunications (SWIFT)
(B) Special Drawing Rights (SDRs)
(C) Multilateral Netting
(D) Netting of Payments
Ans. (B) Special Drawing Rights (SDRs)

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 Commerce (Sample Theory)

Ques. Balance of Payment includes components (NTA UGC-NET June 2012 P-III)
(A) Current Account, Capital Account, Unilateral Payments Accounts, Official Settlement
Account
(B) Revenue Account, P & L Account, Capital Account, Official Account
(C) Trade Account, Activity Account, Revenue Account, Currency Account
(D) Forex Account, Trade Account, Funds Account
Ans. (A) Current Account, Capital Account, Unilateral Payments Accounts, Official Settlement
Account

Ques. India suffered from deficit balance both in trade balance and net invisibles, hence took up a number
of steps to manage this problem.
Which one is not appropriate for this ? (NTA UGC-NET June 2012 P-III)
(A) Export control (B) Current Account Convertibility
(C) Liberalised Export Policy (D) Unified Exchange Rate
Ans. (A) Export control

Ques. SDRs are popularly known as : (NTA UGC-NET Dec. 2012 P-III)
(A) Currency Notes (B) Paper Gold
(C) Silver Coin (D) Gold Coin
Ans. (B) Paper Gold

Ques. Any country consistently facing balance of payment deficiency can approach :
(NTA UGC-NET June 2015 P-III)
(A) The World Bank (B) The Smithsonian Institute
(C) IMF (D) The IMF and the IBRD
Ans. (C) IMF

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 Commerce (Sample Questions)

Sample Questions With Solutions

1. Under TRIPS Agreement, patent is granted subject to which of the following ?

(a) The product or the process is new one.
(b) It contains an inventive step.
(c) It is capable of industrial application for 15 years from the grant of the patent.
(d) It is capable of industrial application for 20 years from the grant of the patent.
Codes :
(A) Only (a) and (b) (B) Only (a), (b) and (c)
(C) Only (a), (b) and (d) (D) Only (a) and (d)

2. Balance of payment can be made favourable if

(A) Exports are increased (B) Imports are increased
(C) Devaluation of money (D) (A) And (C)

3. The world trade organization was formed in the year _________ with GATT as it basis.
(A) 1993 (B) 1994
(C) 1995 (D) 1996

4. An international reserve asset created by the IMF taking into account the global need to
supplement existing reserves is called :
(A) Quota (B) International Monetary Right
(C) Special Drawing Rights (D) None of the above

5. Trade between two countries can be useful if cost ratios of goods are _______.
(A) Equal (B) Different
(C) Undetermined (D) Decreasing

6. In Balance of Payment accounts, all goods exported and imported are recorded in
(A) Capital Account (B) Visible Account
(C) Invisible Account (D) Merchandise Account

7. Out of the following one is not related with WTO

(A) TRIPS (B) Ministerial Conference
(C) TRIMS (D) TRAI

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 Commerce (Sample Questions)

8. Which one is not the form of FDI

(A) Purchase of existing assets in foreign currency.
(B) New Investment in property, planet and equipment.
(C) Making investment is the mutual funds
(D) Transfer of many type of asset

9. Where was first ASEAN Summit held?

(A) Manila (B) Singapore
(C) Bali (D) Jakarta

10. Which among the following is closely associated with intellectual property rights ?
(A) GATS (B) TRIMS
(C) TRIPS (D) MFN

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 Commerce (Sample Questions)

Solutions

1. (C) (a) The product or the process is new one.

(b) It contains an inventive step.
(d) It is capable of industrial application for 20 years from the grant of the
patent.
2. (D) (A) And (C)
3. (C) The World Trade organization (WTO) was established to implement the final act
of Uruguay Round agreement of GATT. The world trade organization was
established on 1st January 1995. 31st May 1995 WTO general council approved the
Headquarter in Geneva, Switzerland.
4. (C) Special Drawing Rights
5. (B) Trade between two countries can be useful cost ratios of goods are different.
According to Adam Smith, it is the difference in absolute production cost that
causes the emergence of trade. A country has an absolute advantage over another
country in the production of a good if it can produce good at a lower cost.
It would, thus, be advantageous for the country if it specializes in the production
of a cheapest good. Smith argued that a country would produce and export that
commodity in which it has an absolute advantage or lower cost and import that
commodity in which it has an absolute disadvantage or higher cost.
6. (B) Visible Account
7. (D) TRAI
8. (A) Purchase of existing assets in foreign currency.
9. (C) First ASEAN Summit was held in Bali, Indonesia between Feb. 23-24, 1976.
10. (C) The TRIPS agreement introduced intellectual property law into the internation
trading system for the first time and remains the most comprehensive international
agreement on intellectual property to date. The agreement on Trade related aspects
of intellectual property rights (TRIPS) is administered by WTO. It sets down
minimum standards for many forms of intellectual property (IP) regulation as
applied to national of other WTO members.

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