GLOBAL BUSINESS VI SEMESTER BCOM/TM/BBA

INTERNATIONAL FINANCE
MEANING
 International finance deals with
the economic interactions
between multiple countries, rather
than narrowly focusing on
individual markets. It is focusing
on areas such as foreign direct
investment and currency exchange
rates.
FOREIGN EXCHANGE
Currency that facilitates the payment to other
countries to complete the transactions is called
foreign exchange. Foreign exchange includes
foreign currency, foreign drafts and foreign
cheques.
The participants of foreign exchange markets
includes, the buyers the sellers and the
intermediaries.
Intermediaries include
a) Exchange banks dealing in foreign
exchange
b) Bill brokers
c) acceptance houses
d) Central bank of the country
Exchange rate determination
Meaning
Exchange rate is the price paid in
the home currency for a unit of
foreign currency. It can be quoted in
two ways :
a) One unit of foreign money to a
number of units of domestic currency
b) A certain number of units of
foreign currency to one unit of
domestic currency.
Exchange Rate determination
Exchange rate in a free market is determined by the demand for and the
supply of exchange of a particular country. The equilibrium exchange rates
the rate at which demand for foreign exchange is equal to supply of foreign
exchange.
 The equilibrium exchange rate can be determined by two methods
a) The exchange rate between US dollars and Indian rupees can be
determined by demand for supply of US dollars in India or by Indians. The
price of US dollars is fixed in Indian rupees.
b) The exchange rate between Indian rupees and US dollars can also be
determined by demand for and supply of Indian rupees by Americans or in
the USA. The price of Indian rupee is determined in US dollars
The prices are the same in both these methods.
Exchange Rate determination
Demand for foreign exchange
 Import of goods and services
Investment in foreign countries
Payments involved in international
transactions
Outflow of foreign capital like
giving donations
The demand curve indicates the
amount of foreign exchange
demanded.
Exchange Rate determination
Supply of foreign exchange.
Supply of foreign exchange of a particular country indicates the availability of
foreign currency of a particular country to the country concerned in its foreign
exchange markets.
The supply of foreign exchange includes:
Country’s exports of goods and services to foreign countries.
Inflow of foreign capital.
Payments made by the foreign govts to Indian Govt for settling their transactions.
Other types of inflow of foreign capital like remittances by the NRIs, donations
received etc.
Rate determination
The supply of foreign exchange is shown by S,
original demand shown by D, and increased
demand is shown by D1. The original quantity of
foreign exchange demanded is OQ1 and the
increase quantity of foreign exchange demanded is
OQ2. Equilibrium price is OP1 and the new price
is OP2. Thus the increased demand for foreign
exchange, when supply is constant, resulted in
increase in price from OP1 to OP2.
 Increase in supply of foreign exchange, when the
demand is constant results in decline in price.
Exchange rate policies
Fixed exchange rate
IMF member Govt used to fix or determine
exchange rates by pegging operations or by
resorting to exchange control. Under this
system, the Govt used to fix the exchange
rates and the central bank to operate it by
creating ”Exchange stabilisation fund”. The
central bank of the country purchases the
foreign exchange when the exchange rates
fall and sells the foreign exchange when the
exchange rates increases.
Exchange rate policies
Advantages of fixed exchange rate.
It ensures certainty and confidence and there by promote international
business.
Fixed exchange rates promote long term investments by various investors
across the globe.
Results in economic stabilisation.
Avoids foreign exchange risk to a greater extent.
 Exchange rate policies
Disadvantages of fixed exchange rate.
Under this system, IMF permits occasional changes, there by resulting in
managed flexibility system. Thus, large foreign exchange reserves are
required to buy or sell foreign exchange in order to manage the exchange
rate, which creates the problem of international liquidity.
Long term foreign capital may not be attracted as the exchange rates are not
pegged permanently.
The economic policies and foreign exchange policies of the countries rarely
co ordinate therefore the pegged exchange rate system does not work.
Deficit of the balance of payments increases under this system.
Exchange rate policies
Flexible exchange rates
It also called floating or fluctuating exchange
rates. Flexible exchange rates are determined
by market forces like demand for and supply
of foreign exchange. The Govt or monetary
authorities do not interfere in the process of
exchange rate determination.
Under this system if the supply of foreign
exchange is more than that of demand, the
exchange rate is determined at a low rate and
vice versa.
Exchange rate policies
Advantages of flexible exchange rates
Simple to operate, this system does not result in deficit or surplus of foreign
exchange.
The adjustment of exchange rate under this system is a continuous process.
It helps in promotion of foreign trade.
This system eliminates the expenditure of maintenance of official foreign
exchange reserves.
Exchange rate policies
Disadvantages of flexible exchange rates.
Market mechanism may fail to bring an appropriate exchange rate.
Exchange rate changes frequently resulting in exchange risks.
Speculation adversely influences fluctuations in supply and demand for
foreign exchange.
Reduction in foreign exchange rates causes inflation.
Convertibility of rupee
The term convertibility of a currency means that it
can be freely converted into any other currency. It
helps in the removal of quantitative restrictions on
trade and payments on current accounts.
 Government of India announced partial
convertibility of the rupee from March 1 st 1992 in
order to integrate the Indian economy with the rest
of the globe.
Under this, 40% of the earnings were convertible
in rupees at officially determined exchange rate
and 60% of the exchange earnings were
convertible at market determined exchange rate.
Convertibility of rupee
Implication on current account
Convertibility of current account is defined as the freedom to buy or sell foreign
exchange for the following international transactions.
1. All payments due in connection with foreign trade, other current business including
services.
2. Payments due as interest on loans
3. Payments of moderate amount of amortisation of loans or for
depreciation of direct investments.
4. Moderate remittances for family living expenses.
Current account convertibility relates to removal of restriction on payments relating
to the imports and exports of goods, services and factors of income.
Convertibility of rupee
Implications on capital account.
Capital account convertibility refers to the removal of the restrictions on
payments relating to capital transactions like inflow and outflow of short term
and long-term capital
1. The authorised dealers are empowered to release exchange without prior
approval of RBI.
2. Exporters find it easy to transact the business
3. Many bureaucratic hurdles are eliminated in the process of obtaining foreign
exchange for imports
Foreign institutional investors FII
Meaning
FIIs are the foreign institutions like pension funds,
mutual funds investment trusts and portfolio managers.
According to regulations issued by the
government of India, FFIs, NRIs, PIO( Persons of
Indian origin ) are allowed to invest in the primary
and secondary capital markets in India through the
portfolio investment scheme. Under this scheme
FIIs/ NRIs can acquire shares or debentures of Indian
companies through the stock exchanges in India.
Limits of FIIs permitted in India
The ceiling for overall investment for FIIs is 24% of the paid-up capital of the Indian
company and 10% of NRIs /PIOs.
The limit of 20% of the paid up capital in case of public sector banks including SBI.
The ceiling of 24% of FIIs investment can be raised up to sartorial cap/ statutory
ceiling subject to the approval of the board and the general body of the company
passing a special resolution to that effect.
Ceiling of 10% for NRIs/PIOs can be raised to 24% subject to approval of general
body of the company passing a resolution to that effect
The ceiling of FIIs is independent of the ceiling of 10/24% for NIIs/PIOs
Regulations on FIIs
The government of India issued the regulations on FIIs on 14 th Nov 1995.
According to these regulations FIIs may invest only in:
1. Securities in primary and secondary markets including shares, debentures
and warrants of companies listed in recognized stock exchange in India.
2.Units of schemes floated by domestic mutual funds including UTI,whether
listed on recognised stock exchange or not.
3.Govt approved joint ventures between domestic and FIIs in the following
areas:
Stock Broking ,Merchant Banking, Asset management and Non Banking
financial sector.
BALANCE OF PAYMENT
Meaning.
 Balance of payment is a double entry system of record of all
economic transactions between the residents of a country and
the rest of the word carried out in a specific period of time.
Balance of payments statement presents a classified record
of the following.
1.All receipts on account of goods exported
2. Services rendered
3.Capital received by residents
4. Payment made by the residents due to goods imported and
services received from.
5. Capital transferred to non-resident or foreigners.
Components of BOP
BOP comprises of the following
1. Current account
2. Capital account
3. Unilateral payments account
4. Official settlement account
Components of BOP
Current account
Current account includes visible exports and imports and invisible items like
receipts and payment for various services. Current account contains credits
and debits. Credits of current account includes merchandise exports and
invisible exports.
Invisible export consists of transport services insurance services, foreign
tourist services and other services. Debits of current account includes
merchandise imports, payments for goods purchased from foreign countries
and invisible imports.
Components of BOP
 Capital account
 Capital account is divided into three parts
1.Private capital
2.Banking capital and
3.Official capital
1.Private capital
It is further divided into long term and short term. Long term private capital includes
 Foreign investment both direct and portfolio
 Long Term Loans
 Foreign Currency Deposits
 Estimated Portion Of The Unclassified Receives Allocated To The Capital Account.
Capital account
Banking capital.
It covers moments in the external financial assets and liabilities of
commercial and cooperative banks authorised to deal in foreign exchange
Official capital.
Reserve Bank of India's Holdings in terms of foreign currency and special
drawings special drawing rights held by the government are categorised into
loans amortization and miscellaneous receipts and payments.
Components of BOP
Unilateral payments account.
Unilateral transfers are ‘giving the gifts’ these include governments,
reparations, Private remittances, disaster relief etc.
 Unilateral transfers account basically consists of credits and debits. Credits
include private remittances received from abroad, pension payments received
from abroad and government grant received from abroad.
 Debits includes private remittances to abroad, pension payment to abroad
and government grants to various countries.
Components of BOP
Official settlement account.
 Official settlements account represent the official sales of foreign currencies
and other reserves to foreign countries or official purchase of foreign
currencies or other reserves from foreign countries.
 Credits of this account are the money received from official sale of foreign
currencies and offer reserves in foreign countries. Debits of this account
include official purchases of foreign currencies and other assets.
Disequilibrium in the Balance of payments
 Meaning.
When the demand for and supply of foreign currency of a country are unequal, it is
viewed that the balance of payments of that country is in disequilibrium position.
Causes of disequilibrium
1. Economic factors:
A) Development disequilibrium : Developing countries mostly take up the
developmental activities like establishment of industries, construction of roads,
bridges, the power plants and other infrastructure facilities like hospitals, educational
institutions, etc. Developmental expenditure results in increase of capital goods and
consumer goods imports . This, in turn, leads to deficit in the Balance of payments.
Disequilibrium in the Balance of payments
B) Cyclical disequilibrium : Cyclical disequilibrium is concerned with the fluctuations in
imports and exports due to business cycles. The boom in the business activity in one country
increases consumption aggregate demand and prices more than the production. Therefore, the
countries experiencing boom conditions import consumer goods immediately to meet the
increased aggregate demand. In contrast, depression conditions contribute to the growth in
exports as production is higher than the aggregate demand and consumption .Both the boom
and depression conditions results in disequilibrium in the Balance of payments.

C)Secular disequilibrium : The Balance of payments persists for a longer time due to secular
trends in the economy. The disposable income of the people in developed countries is very
high. Therefore they prefer to import goods from other countries where quality goods are
produced at lower cost of production .This results in increased imports and results in secular
disequilibrium in the Balance of payments.
Disequilibrium in the Balance of payments
D)Structural disequilibrium: Structural changes in the economy include shift
from agricultural sector to service sector, development of alternative sources of
supply, development of effective substitute ,exhaustion of productive resources
,changes in transport channels and costs. These structural changes in enhance
the import of capital goods and consumer goods of the changed structure thus
resulting in Balance of payments deficit.
Disequilibrium in the Balance of payments
2.Political factors:
Political factors like political uncertainties, instability ,internal
disturbances and external war create threatening situation for industry and
investment. Hence, these factors contribute to the outflow of capital, decline in
domestic production and import of goods. They result in deficit of Balance of
payments.
3. Social factors:
The additions to and drop outs from the existing culture , changes in
tastes, fashions and preferences of the people contribute to the increase in
imports and deficit in Balance of payments.
Methods of correction of disequilibrium
 1. Automatic corrections
The deficit Balance of payments indicate that the demand for foreign
exchange is higher than that of supply for the same. These demand for and
supply factors results in the devaluation of domestic currency in terms of
foreign currencies. The increased exchange rate makes imports costlier and
exports cheaper, therefore the country reduces imports and increases exports
which in turn increases Foreign Exchange Reserves and restore equilibrium
position.
Methods of correction of disequilibrium
 Deliberate measures:
Government take certain measures deliberately to control deficit pay
Balance of payments position. These include:
1) Monetary measures
a) Reduction in money supply : Reduction in money supply leads to
decline in income, purchasing power ,aggregate demand and
consumption. The aggregate demand in the domestic price leads to
increase in exports. This process of decline in imports and increase in
exports correct the deficit in the Balance of payments of a country.
Methods of correction of disequilibrium
b) Devaluation:
Under this measure the country deliberately devalues its currency in
order to reduce imports and boost Exports. The imports become costly, once
the currency is devalued as the importer has to pay more domestic currency
for the same quantity of imports. Through this measure, the Government of
the domestic country reduces the imports.
c) Exchange control
The exporters after earning the foreign exchange have to surrender it to
the RBI. Importers get the permission from the RBI for imports and to use
foreign exchange .RBI and the government control imports in this process and
reduces the deficit of the Balance of payments.
Methods of correction of disequilibrium
2. Trade measures
a) Export promotion measures :
Export promotional measures includes abolishing export duties ,export
subsidies ,encouragement to export oriented units ,creations of EPZs, free trade
zones, liberal loans for export oriented units, fiscal incentives marketing
incentives and facilities etc.
b) Import control measures :
Import control measures includes import duties, import quota, import
licenses ,prohibiting import of certain items ,increase in custom duty on
imports etc
Methods of correction of disequilibrium
3. Miscellaneous measures :
These measures include loans in foreign currencies, attracting foreign
investments, attracting NRI deposits, the development of tourism etc.

All these measures helps in reducing imports and enhancing exports, thus
contribute for the reduction of the deficit in the Balance of payments.