Session 12

Macro Economics
Prof Chandrika Raghavendra
 Learning Objectives

• To understand the basics of Open Economy

• To explore the Balance of Payment by studying the India's data
Open-Economy Macroeconomics: Basic Concepts
• Open and Closed Economies
– A closed economy is one that does not interact with other economies
in the world.
• There are no exports, no imports, and no capital flows.
– An open economy is one that interacts freely with other economies
around the world.
 Open-Economy Macroeconomics: Basic Concepts

• An open economy interacts with other countries in two ways-

– It buys and sells goods and services in world product markets.
– It buys and sells capital assets in world financial markets.
 Balance of Payments

• The balance of payments (BOP) is a systematic accounting record that provides a

comprehensive summary of all economic transactions between residents of one country and
the rest of the world over a specific period, typically a year
• It reflects the country's interactions with other nations in terms of trade in goods, services,
income, and financial transactions
• At the global level, International Monetary Fund maintains BOP
• At the national level, Central Bank maintains BOP
 BOP

Current A/c Capital A/c Forex

Autonomous Transactions Accommodative Transactions

 Current
A/c

Visible Invisible

Goods

Imports Exports

If Exports = Imports = Balanced Trade

If Exports > Imports = Trade Surplus
If Exports < Imports = Trade Deficit
(In USD Billion)
(In USD Billion)
(In USD Billion)
 Current A/c

Visible Invisible

Goods Services Income Transfer

IPR, Tourism, Profits,

Banking Services
Imports Exports Consultancy Dividends, Remittances
Services, IT/BPO Interest
 Current A/c

Visible Invisible

Deficit Surplus

Visible + Invisible = Current account balance

(In USD Billion)
Lower Current Higher Current
A/c Deficit A/c Deficit

Less Dollars More Dollars

needed to needed to
finance gap finance gap

Rupee Rupee
appreciates depreciates
because we because we
demand less demand more
for Dollars for Dollars
(USD Billion)
 What are they
doing with it?

(USD Trillion)
 Capital A/c

External
Banking
Commercial Investments
Capital
Borrowings

FDI, FPI, ADR, FCNR, NRE,

GDR, IDR NRO
 What is FDI and FPI?

An investment made by a company or individual in one country into a company or business based in
another country is known as Foreign Direct Investment

An FPI is a foreign investment made by a foreign entity in the financial assets of another country, such
as stocks, bonds, and real estate, in which they hold passive stakes in a country's financial assets.
Difference between FDI and FPI
Though both of these looks alike in terms of accessing a foreign market, both of these terms have few
differences as mentioned below.
1.Level of control: In FDI, the investor acquires a controlling interest in a foreign company by purchasing
at least 10% of the company's shares. This gives the investor a say in the management of the company. In
FPI, the investor does not have any control over the company's management, and the investment is
subject to the performance of the financial markets.
2.Investment horizon: FDI is a long-term investment, while FPI is a short-term investment. FDI is usually
a strategic investment, as it allows the investor to have a long-term interest in the company and access the
local market. In contrast, FPI is subject to short-term market trends, and investors buy and sell securities
based on short-term market movements.
3.Purpose of investment: FDI is typically made to establish a long-term business interest in a foreign
country. This includes setting up a manufacturing facility, acquiring a local company, or establishing a joint
venture. FPI is typically made to diversify investment portfolios, participate in the growth of foreign
economies, and take advantage of short-term market opportunities.
4.Risks: FDI involves higher risks than FPI. FDI requires a significant investment in infrastructure, plant,
and equipment. It is also subject to political, economic, and regulatory risks in the host country. FPI, on the
other hand, is subject to the volatility of the financial markets and can be affected by currency fluctuations,
interest rates, and other macroeconomic factors.
(USD Million)
A depositary receipt (DR) is a type of negotiable financial security that allows investors to hold shares
in a foreign public company.

They are represented by a physical certificate and trade on national stock exchanges.

The most common example of a depositary receipt is the American depositary receipt (ADR). Other
examples include the global depositary receipt (GDR) and international depositary receipt (IDR).

ADRs typically trade on a U.S. national stock exchange, such as the New York Stock Exchange, while
GDRs are commonly listed on the London Stock Exchange.
 Learning outcomes

• We understood-
– Open Economy
– Balance of Payment account
• Current Account
• Capital Account