MONETARY POLICY OF RESERVE BANK OF INDIA Q.1: Define Monetar Po!i" . Di#"$## t%e o&'e"ti(e# of RBI)# Monetar *o!

i" . OR +rite note on o&'e"ti(e# of RBI)# Monetar Po!i" . An#.A, MONETARY POLICY :Monetary policy is a regulatory policy by which the central bank or monetary authority of a country controls the supply of money, availability of bank credit and cost of money, that is, the rate of Interest. Monetary policy / monetary management is regarded as an important tool of economic management in India. RBI controls the supply of money and bank credit. The entral bank has the duty to see that legitimate credit re!uirements are met and at the same credit is not used for unproductive and speculative purposes. RBI rightly calls its credit policy as one of controlled e"pansion. B,OB.ECTIVES OF MONETARY POLICY OF INDIA :The main ob#ective of monetary policy in India is $growth with stability%. Monetary Management regulates availability, cost and use of money and credit. It also brings institutional changes in the financial sector of the economy. &ollowing are the main ob#ectives of monetary policy in India '( 1. /ro0t% +it% Sta&i!it :Traditionally, RBI%s monetary policy was focused on controlling inflation through contraction of money supply and credit. This resulted in poor growth performance. Thus, RBI have now adopted the policy of $)rowth with *tability%. This means sufficient credit will be available for growing needs of different sectors of economy and at the same time, inflation will be controlled with in a certain limit. 1. Re2$!ation3 S$*er(i#ion An4 De(e!o*5ent Of Finan"ia! Sta&i!it :&inancial stability means the ability of the economy to absorb shocks and maintain confidence in financial system. Threats to financial stability can come from internal and e"ternal shocks. *uch shocks can destabili+e the country%s financial system. Thus, greater importance is being given to RBI%s role in maintaining confidence in financial system through proper regulation and controls, without sacrificing the ob#ective of growth. Therefore, RBI is focusing on regulation, supervision and development of financial system. 6. Pro5otin2 Priorit Se"tor :,riority sector includes agriculture, e"port and small scale enterprises and weaker section of population. RBI with the help of bank provides timely and ade!uately credit at affordable cost of weaker sections and low income groups. RBI, along with -.B.R/, is focusing on microfinance through the promotion of *elf 0elp groups and other institutions. 7. /eneration Of E5*!o 5ent :Monetary policy helps in employment generation by influencing the rate of investment and allocation of investment among various economic activities of different labour Intensities. 8. E9terna! Sta&i!it :1ith the growth of imports and e"ports India%s linkages with global economy are getting stronger. 2arlier, RBI controlled foreign e"change market by determining ea"change rate. -ow, RBI has only indirect control over e"ternal stability through the mechanism of $managed &le"ibility%, where it influences e"change rate by buying and selling foreign currencies in open market. :. En"o$ra2in2 Sa(in2# An4 In(e#t5ent# :RBI by offering attractive interest rates encourage savings in the economy. . high rate of saving promotes investment. Thus the monetary management by influencing rates of interest can influence saving mobili+ation in the country. ;. Re4i#tri&$tion Of in"o5e An4 +ea!t% :By control of inflation and deployment of credit to weaker sectors of society the monetary policy may redistribute income and wealth favouring to weaker sections. <. Re2$!ation Of NBFI#:-on 3 Banking &inancial Institutions 4-B&Is5, like 6TI, I/BI, I& I plays an important role in deployment of credit and mobili+ation of savings. RBI does not have any direct control on the functioning of such institutions. 0owever it can indirectly affects the policies and functions of -B&Is through its monetary policy. Q.1:Di#"$## = E9*!ain t%e (ario$# f$n"tion# of RBI. An#. A.RESERVE BANK OF INDIA >RBI, :The Reserve Bank of India is the central bank of India it was established as a shareholder%s bank on 7 st .pril 789:. Its share capital was Rs. : crore, divided in to : lakhs fully paid up shares of Rs. 7;; each. <n 7 st =anuary 78>8 it was nationali+ed. Its head!uarters is at Mumbai. RBI, like any other bank performs almost all traditional entral banking functions. /ue to country%s development it has also undertaken developmental and promotional functions. .. F?NCTIONS OF RBI :RBI performs many functions, some of them are'(

7. I##$e Of C$rren" Note# :6nder section ?? of RBI .ct, the bank has the sole right to issue currency notes of all denominations e"cept one rupee coins and notes. The one(rupee notes and coins and small coins are issued by entral )overnment and their distribution is undertaken by RBI as the agent of the government. The RBI has a separate issue department which is entrusted with the issue of currency notes. 1. Ban@er To T%e /o(ern5ent :The RBI acts as a banker agent and adviser to the government. It has obligation to transact the banking business of entral )overnment as well as *tate )overnments. 2.g.'( RBI receives and makes all payments on behalf of government, remits its funds, buys and sells foreign currencies for it and gives it advice on all banking matters. RBI helps the )overnment 3 both entral and state 3 to float new loans and manage public debt. The bank makes ways and meets advances of the government. <n behalf of central government it sells treasury bills and thereby provides short(term finance. 6. Ban@er)# &an@ An4 Len4er Off La#t Re#ort :RBI acts as a banker to other banks. It provides financial assistance to scheduled banks and state co( operative banks in form of rediscounting of eligible bills and loans and advances against approved securities. RBI acts as a lender of last resort. It provides funds to bank when they fail to get it from other sources. It also acts as a clearing house. Through RBI, banks make interbanks payments. 7. Contro!!er Of Cre4it :RBI has power to control the volume of credit created by banks. The RBI through its various !uantitative and !ualitative techni!ues regulates total supply of money and bank credit in the interest of economy. RBI pumps in money during busy season and withdraws money during slack season. 8. E9"%an2e "ontro! An4 C$#to4ian Of Forei2n Re#er(e :RBI has the responsibility of maintaining fi"ed e"change rates with all member countries of IM&. &or this, RBI has centrali+ed all foreign e"change reserves 4&<R2@5. RBI functions as custodian of nations foreign e"change reserves. It has to maintain e"ternal valu of Rupee. RBI achieves this aim through appropriate monetary fiscal and trade policies and e"change control. :. Co!!e"tion An4 P$&!i"ation Of Data :The RBI collects and complies statistical information on banking and financial operations of the economy. The Reserve Bank <f India% Bulletian is a monthly publication. It not only provides information, but also results of important studies and investigations conducted by reserve bank are given. $The Report on currency and finance% is an annual publication. It provides review of various developments of economic and financial importance. A. Re2$!ator An4 S$*er(i#or F$n"tion# :The RBI has wide powers of supervision and control over commercial and co(operative banks, relating to licensing, establishment, branch e"pansion, li!uidity of .ssets, management and methods of working, amalgamation, re(construction and li!uidation. The supervisory functions of RBI have helped a great in improving the standard of banking in India to develop on sound lines and to improve the methods of their operation. <. C!earin2 Ao$#e F$n"tion# :The RBI acts as a clearing house for all member banks. This avoids unnecessary transfer of funds between the various banks. B. De(e!o*5ent An4 Pro5otiona! F$n"tion# :The RBI has helped in setting up Industrial &inance orporations of India 4I& I5, *tate &inancial orporations 4*& s5, /eposit Insurance orporation, .gricultural Refinance and /evelopment orporation 4.R/ 5, units Trust of India 46TI5 etc. these institutions were set up to mobili+e savings, promote saving habits and to provide industrial and agricultural finance. RBI has a special .gricultural redit /epartment 4. /5 which studies the problems of agricultural credit. &or this Regional Rural banks, o(operative, -.B.R/ etc. were established. The RBI has also taken measures to promote organi+ed bill market to create elasticity in Indian Money Market in order to satisfy seasonal credit needs. Thus RBI has contributed to economic growth by promoting rural credit, industrial financing, e"port trade etc. B.95' E9*!ain t%e C$antitati(e an4 #e!e"ti(e methods of"re4it "ontro!$#e4 & RBI.<R E9*!ain t%e Monetar Po!i" of RBI Imeasures taken& RBI to control credit. +rite note on Q$antitati(e I Se!e"ti(e 5et%o4# of"re4it "ontro!. E9*!ain Monetar Mana2e5ent of RBI. An#. .5 M<-2T.RC ,<DI C <& RBI '( The Monetary ,olicy of RBI is not merely one of credit restriction, but it has also the duty to see that legitimate credit re!uirements are met and at the same time credit is not used for unproductive and <R <R

speculative purposes RBI has various weapons of monetary control and by using them, it hopes to achieve its monetary policy. I, )eneral I Buantitative redit ontrol Methods '( In India, the legal framework of RBI%s control over the credit structure has been provided 6nder Reserve Bank of India .ct, 789> and the Banking Regulation.ct, 78>8. Buantitative credit controls are used to maintain proper !uantity of credit o money supply in market. *ome of the important general credit control methods are'( 1. Bank Rate ,olicy '( entral bank lends money to the commercial banks for their li!uidity Bank rate is the rate at which the

re!uirements. Bank rate is also called discount rate. In other words bank rate is the rate at which the central bank rediscounts eligible papers 4like approved securities, bills of e"change, commercial papers etc5 held by commercial banks. Bank rate is important because its is the pace setter to other marketrates of interest. Bank rates have been changed several times by RBI to control inflation and recession. By ?;;9, the bank rate has been reduced to EF p.a. ?. <pen market operations '( It refers to buying and selling of government securities in open market in order to e"pand or contract the amount of money in the banking system.This techni!ue is superior to bank rate policy. ,urchases in#ect money into the banking system while sale of securities do the opposite. /uring last two decades the RBI has been undertaking switch operations. These involve the purchase of one loan against the sale of another or, vice(versa. This policy aims at preventing unrestricted increase in li!uidity. 6. Ca#% Re#er(e Ratio >CRR, The )ash Reserve Ratio 4 RR5 is an effective instrument of credit control. 6nder the RBl .ct of, l89> every commercial bank has to keep certain minimum cash reserves with RBI. The RBI is empowered to vary the RR between 9F and 7:F. . high RR reduces the cash for lending and a low RR increases the cash for lending. The RR has been brought down from 7:F in 7887 to A.:F in May ?;;7. It further reduced to :.:F in /ecember ?;;7. It stood at :F on =anuary ?;;8. In =anuary ?;7;, RBI increased the RR from :F to :.A:F. It further increased in .pril ?;7; to EF as inflationary pressures had started building up in the economy. .s of March ?;77, RR is EF. 7. Stat$tor LiC$i4it Ratio >SLR, 6nder *DR, the government has imposed an obligation on the banks to ,maintain a certain ratio to its total deposits with RBI in the form of li!uid assets like cash, gold and other securities. The RBI has power to fi" *DR in the range of ?:F and >;F between 788; and 788? *DR was as high as 9G.:F. -arasimham ommittee did not favour maintenance of high *DR. The *DR was lowered down to ?:F from 7; th<ctober 788A.It was further reduced to ?>F on -ovember ?;;G. .t present it is ?:F. 8. Re*o an4 Re(er#e Re*o Rate# In determining interest rate trends, the repo and reverse repo rates are becoming important. Repo means *ale and Repurchase .greement. Repo is a swap deal involving the immediate *ale of *ecurities and simultaneous purchase of those securities at a future date, at a predetermined price. Repo rate helps commercial banks to ac!uire funds from RBI by selling securities and also agreeing to repurchase at a later date. Reverse repo rate is the rate that banks get from RBI for parking their short term e"cess funds with RBI. Repo and reverse repo operations are used by RBI in its Di!uidity .d#ustment &acility. RBI contracts

credit by increasing the repo and reverse repo rates and by decreasing them it e"pands credit. Repo rate was E.A:F in March ?;77 and Reverse repo rate was :.A:F for the same period. <n May ?;77 RBI announced Monetary ,olicy for ?;77(7?. To reduce inflation it hiked repo rate to,A.?:F and Reverse repo to E.?:F II, *2D2 TIH2 / B6.DIT.TIH2 R2/IT <-TR<D M2T0</* '( redit ontrol, credit is provided to selected borrowersfor selected purpose, depending 6nder *elective The *elective 1. The ?.

upon the use to which the control try to regulate the !uality of credit ( the direction towards thecredit flows. ontrols are '( eiling <n redit eilingon level of credit restricts the lending capacity of a bank to grant advances against certain MarginRe!uirements '( ollateral *ecurity. Margin means that proportion of the value of security

controlled securities. . loan is sanctioned against

against which loan is not given. Margin against a particular security is reduced or increased in order to encourageor to discourage the flow of credit to a particular sector. It varies from ?;F to G;F. &or agricultural commodities it is as high as A:F. 0igher the margin lesser will be the loan sanctioned. 9. /iscriminatory Interest Rate 4/IR5 Through /IR, RBI makes credit flow to certain priority or weaker sectors by charging concessional rates of interest. RBI issues supplementary instructions regarding granting of additional credit against sensitive commodities, issue of guarantees, making advances etc. . >. /irectives'( The RBI issues directives to banks regarding advances. /irectives are regarding the purpose for which loans may or may not be given. :. /irect .ction It is too severe and is therefore rarely followed. It may involve refusal by RBI to rediscount bills or cancellation of license, if the bank has failed to comply with the directives of RBI. E. Moral *uasion 6nder Moral *uasion, RBI issues periodical letters to bank to e"ercise control over credit in general or advances against particular commodities. ,eriodic discussions are held with authorities of commercial banks in this respect. B. > '2"amine the recent changes that have taken place in RBIs Monetary ,olicy. 4Mar. $775 .ns. .5R2 2-T 0.-)2* I- RBI%s M<-2T.RC ,<DI C '( *ince 7887 RBI%s monetary management has undergone some ma#or changes. Det us e"plain 75 Multiple Indicator .pproach '( 6pto late 788;s, RBI used the $Monetary targeting approach% to its monetary policy. Monetary targeting refers to a monetary policy strategy aimed at maintaining price stability by focusing on changes in growth of money supply. .fter 7887 reforms this approach became difficult to follow. *o RBI adopted Multiple indicator .pproach in which it looks at a variety of economic indicators and monitor their impact on inflation and economic growth. ?5 *elective Methods Being ,hased <ut '( 1ith rapid progress in financial markets, the selective methods of credit control are being slowly phased out. Buantitative methods are becoming more important. 95 Reduction In Reserve Re!uirements '(

In post(reform period the growth of economy. >5

RR and *DR have been progressively lowered. This has been done as a part of

financial sector reforms. .s a result, more bank funds have been released for lending. This has led to the /eregulation <f .dministered Interest Rate *ystem '(

2arlier lending rate of banks was determined by RBI. *ince 788;s this system has changed and lending rates are determined by commercial banks on the basis of market forces. :5 /elinking <f Monetary ,olicy &rom Budget /eficit '( In788> government phased out the use of adhoc treasury Bills.These bills were used by government to borrow from RBI to finance fiscal deficit. 1ith phasing out of Bills, RBI would no longer lend to government to meet fiscal deficit. E5 Di!uidity .d#ustment &acility 4D.&5'( D.& allows banks to borrow money through repurchase agreement D.& was introduced by RBI during =une, ?;;;, in phases. The funds under D.& are used by banks to meet day(to(day mismatches in li!uidity. A5 ,rovision <f Micro &inance By linking the banking system with *elf 0elp )roups, RBI has introduced the scheme of micro finance for rural poor. .long with -.B.R/, RBI is promoting various other microfinance institutions. G5 2"ternal *ector 1ith globalisation large amount of foreign capital is attracted. To provide stability in financial markets, RBI uses sterli+ation and D.& to absorb the e"cess li!uidity that comes in with huge inflow of foreign capital. 85 2"pectation .s . hannel <f Monetary Transmission Traditionally, there were four key channels of monetary policy transmission '(Interest rate, credit availability, asset prices and e"change rate channels. Interest rate is the most dominant transmission channel as any change in monetary policy has immediate effect on it. In recent years fifth channel, 2"pectation has been added. &uture e"pectations about asset prices, general price and Income levels influence the four traditional channels. B.:'/iscuss RBI%s short term Di!uidity Management.<R 1hy has short term Di!uidity Management gained importance in post reform IndiaI /iscuss measures taken by RBI for Management of short term Di!uidity. 4Mar. $775 .ns...RBI%* *0<RT T2RM DIB6I/ITC M.-.)2M2-T '( Di!uidity Management of entral bank means supplying to the market the amount of li!uidity that is consistent with a desired level of short(term interest rate. It is defined Jas the framework, set of instruments and the rules that the central bank follows in order to manage the amount of money supply to control short term interest rates with the ob#ective of price stabilityK. In RBI%s overall management short term li!uidity management occupies a very important place due to following factors'( 75 In financial sector, in 788;%s, many reforms were introduced. The important reforms are deregulation of interest rates and e"change rates. 2arlier these rates were determined by RBI, after reforms, they are determined by demand and supply. RBI in absence of direct intervention indirectly influences these rates by using multiple indicators approach. ?5 /ue to liberali+ation capital flows between countries have increased. &rom 6* L77G Million during 7887( 8?, capital flows to. India rose to 6* L7: billions in ?;;>(;:. 95 &oreign capital flows have increased employment. It adds to the supply of foreign e"change and have resulted into appreciation of domestic currency.1ith this, thee"ports have become more e"pensive.

>5 1hen capital inflows are converted into rupees, they get in#ected into the economy thereby, increasing the money supply. *o to maintain price stability RBI has to mange the e"change rate and Interest rate. B5 RBI%* M2.*6R2* &<R *0<RT T2RMDlB6I/ITC M.-.)2M2-T 1. Repo I Reverse Repo To improve short term li!uidity management, RBl. introduced repos in /ecember 788?. Repo is *ale and Repurchase .greement. It is a swap deal involving the immediate *ale of *ecurities and simultaneously purchase of those securities at a future date, at a predetermined price. *uch deals takes place between RBI and banks. /ue to lack of demand repos auctions were discontinued in March 788:, they were resumed again in 788A. Reverse repo rate is the rate that banks get from RBI for parking their short term e"cess funds with RBI. 1. Interim Di!uidity .d#ustment &acility 4ID.R5 ommittee 788G recommended D.&. .ccordingly in To develop short term money market -arasimham

7888 RBI introduced ID.&. It 4ID.&5 provided a mechanism for li!uidity management through a combination of repos, e"port credit refinance and collateralised lending facilities supported by <pen Market <perations. 6. Di!uidity .d#ustment &acility 4D.,5 V RBI introduced(full(fledged D.&. It has been revised further. 6nder D.&, Reverse repo auctions and Repo auctions are conducted on daily basis. In India, the emergence of D.& was a single biggest factor which helped RBI to manage short term li!uidity and maintain interest rate stability. In ?;;8(7;, li!uidity absorption through reverse repo reached its peak on >th *eptember ?;;8 at Rs. 7,EG,?7:crore. 7. *terli+ation '( *terli+ation means re(cycling of foreign capital inflows to prevent appreciation of domestic currency and to check the inflationary impact of such capital. *terli+ation is carried out through open market operations. But *terli+ation can also leads to some problems. Thus RBI also,uses a variety of other measures to manage interest rates. 8. Market *tabili+ation *cheme 4M**5'( Till ?;;9(;> the impact of large capital inflows was managed through day(to(day D.& and <M<. In the process, the government securities available with RBI declined, as they were being used for absorbing e"cess li!uidity. In order to handle these issues, RBI signed a Memorandum of 6nderstanding 4M<65 with )overnment for issuance of Treasury Bills and dated government securities under Market *tabili+ation *cheme 4M**5. These Bills and *ecurities are used to absorb e"cess li!uidity from market and' maintain stability in foreign e"change market. Q. : :E(a!$ate RBI)# Monetar Po!i" .OR. /i(e an a**rai#a! >A"%ie(e5ent# an4 Fai!$re#, of 5onetar *o!i" of RBI. An#. A,2H.D6.TI<- <& M<-2T.RC ,<DI C '( The RBI aims at one time was controlled e"pansion. <n one hand it was taking steps to e"pand bank credit. <n other hand RBI uses !uantitative and !ualitative methods to control credit. These two contradictory ob#ectives limited the success of monetary policy. The performance of monetary policy can be seen from its achievements and failures, let us discuss. I. 7. .chievements I ,ositive .spects <f Monetary ,olicy '( *hort Term Di!uidity Management '(

RBI has developed various methods to maintain stability in interest rate and e"change rate like D.&, <M< and M**. RBI has also managed its sterli+ation operations very well. ?. &inancial *tability '( 1ith the help of controls, regulation and supervision mechanism, RBI has been successful in maintaining financial stability. /uring the period of global crisis it has also been able to maintain macro economic stability. 9. &inancial Inclusion '( .long with -.B.R/, RBI has made a great impact in the growth of microfinance. RBI has supported *elf 0elp )roup Model and promoted other microfinance institutions. >. .daptability'( In India monetary policy is fle"ible, as it changes with time. RBI has developed new methods of credit control and shifted from monetary targeting to multiple indicator approach. :. Increase In )rowth'( hina. Thus monetary policy has played an important role. To maintain the growth of economy RBI has used its instrumentsM effectively. .t present India has the second highest rate of )/, growth after E. Increase In Bank /eposits'( The increase in bank deposits over the years indicates trust and confidence of people in banking sector. 2ffective supervision of RBI over banks and financial institutions is largely responsible for trust and confidence of public in banking sector. A. ompetition .mong Banks '( The monetary policy of RBI has resulted in healthy competition among banks in the country. The competition is due to deregulation of interest rates and other measures taken by RBI. -ow(a(days due to professionalism banks provide better service to customers. II. 7. &.ID6R2* I DIMIT.TI<-* <& M<-2T.RC ,<DI C 0uge Budgetary /eficits '(

RBI makes every possible attempt to control inflation and to balance money supply in the market. 0owever entral )overnmentMs huge budgetary deficits have made monetary policy ineffective. 0uge budgetary deficits have resulted in e"cessive monetary growth. ?. overage <f <nly ommercial Banks '( Instruments of monetary policy cover only commercial banks so inflationary pressures caused by banking finance can be controlled by RBI, but in India, inflation also results from deficit financing and scarcity of goods on which RBI may not have any control. 9. ,roblem <f Management <f Banks .nd &inancial Institutions '( The monetary policy can succeed to control inflation and to bring overall development only when the management of banks and &inancial institutions are efficient and dedicated. Many officials of banks and financial institutions are corrupt and inefficient which leads to financial scams in this way overall economy is affected. >. 6norganised Money Market '( ,resence of unorganised sector of money market is one of the main obstacle in effective working of the monetary policy. .s RBI has no power over the unorganised sector of money market, its monetary policy becomes less effective. :. Dess .ccountability'(

.t present time, the goals of monetary policy in India, are not set out in specific terms and there is insufficient freedom in the use of instruments. In such a setting, accountability tends to be weak as there is lack of clarity in the responsibility of governments and RBI. E. Black Money '( There is a growing presence of black money in the economy. Black money falls beyond the purview of banking control of RBI. It means large proposition of total money *upply in a country remains outside the purview of RBIMs monetary management. A. Increase Holatility '( The integration of domestic and foreign e"change markets could lead to increased volatility in the domestic market as the impact of e"ogenous factors could be transmitted to domestic market. The widening of foreign e"change market and development of rupee ( foreign e"change swap would reduce risks and volatility. G. Dack <f Transparency '( .ccording to *. *. Tarapore, the monetary policy formulation, in its present form in India, cannot be continued indefinitely. &or a more effective policy, it would be necessary to have greater transparency in the policy formulation and transmission process and the RBI would need to be clearly demarcated. B. <- D6*I<- '( Thus, from above we can say that despite several problems RBI has made a good effort for effective implementation of the monetary policy in India. *TR6 T6R2 <& B.D.- 2 <& ,.CM2-T* N /I*2B6IDIBRI6M I- B<, B. 7' 2"plain the *tructure of Balance of ,ayments. <R 1rite note on India%s Balance of Trade. .ns. .5 *TR6 T6R2 <& B.D.- 2 <& ,.CM2-T*'( The Balance of ,ayment 4B<,5 of a country is a systematic account of all economic transactions between a country and the rest of the world, undertaken during a specific period of time. B<, is the difference between all receipts from foreign countries and all payments to foreign countries. If the receipts e"ceed payments, then a country is said to have favourable B<,, and vice versa. .ccording to harles Oindle Berger PThe B<, of a country is a systematic recording of all economic transactions between residents of that country and the rest of the world during a given period of timeP. The Balance of payments record is maintained in a standard double ( entry book ( keeping method. International transactions enter into record as credit or debit. The payments received from foreign countries enter as credit and payments made to other countries as debit. The following table shows the elements of B<,. B.D.- 2 <& ,.CM2-T* . Receipts 4 redits5 1. 2"port of goods. <6-T ,ayments 4/ebits5 Imports of goods.

Trade .ccount Balance

?. 9. 7.

2"port of services. Interest, profit and dividends received. 6nilateral receipts.

Import of services. Interest, profit and dividends paid.

urrent .ccount Balance 47 to >5 8. :. ;. &oreign investments. *hort term borrowings. Medium and long term borrowing.

6nilateral payments. Investments abroad. *hort term lending.

apital .ccount Balance 4: to A5 <. B. 2rrors and omissions. hange in reserves. 4Q5 Total Reciepts Total payments. R Medium and long term lending. 2rrors and omissions. hange in reserve 4(5 Total ,ayments

7.

Trade Balance '(

Trade balance is the difference between e"port and import of goods, usually referred as visible or tangible items. If the e"ports are more than imports, there will be trade surplus and if imports are more than e"ports, there will be trade deficit. /eveloping countries have most of the time suffered a deficit in their balance of payments. The trade balance forms a part of current account. In ?;;G(;8, trade deficit of India was 77G.E 6* L billion. ?. urrent .ccount Balance '( It is the difference between the receipts and payments on account of current account which includes trade balance. The current account includes e"port of services, interest, profits, dividends and unilateral receipts from abroad and the import of services, profits, interest, dividends and unilateral payments abroad. There can be either surplus or deficit in current account. 1hen debits are more than credits or when payments are more than receipts deficit takes place. debits are less. urrent account balance is very significant. It shows a countryMs earning and payments in foreign e"change. . surplus balance strengthens the countryMs international financial position. It could be used for development of the country. . deficit is a problem for any country but it creates a serious situation for developing countries. In ?;;8(7; India%s current account deficit was 9G.> 6* L billion. 9. apital .ccount Balance '( It is the difference between receipts and payments on account of capital account. The transactions under this title involves inflows and outflows relating to investments, short term borrowings I lending, and medium term to long term borrowings / lending. There can be surplus or deficit in capital account. 1hen credits are urrent account surplus will take place when credits are more and

more than debits surplus will take place and when debits are more than credits deficit will take place. In ?;;8(7;. India%s capital account surplus was :7.G 6* L billion. >. 2rrors and <missions '( The double entry book ( keeping principle states that for every credit, there is a corresponding debit and therefore, there should be a balance in B<, as well. In reality B<, may not balance, due to errors and omissions. 2rrors may be due to statistical discrepancies 4differences5 and omissions may be due to certain transactions may not get recorded. &or 2g., remittance by an Indian working abroad to India may not get recorded etc. If the current and capital account shows a surplus of ?;,;;; L, then the B<, should show an increase of ?;,;;; L. But, if the statement shows an increase of ??,;;; L, then there is an error or omission of ?,;;; L on credit side. :. &oreign 2"change Reserves '( The balance of foreign e"change reserve is the combined effect of current and capital account balances. The reserves will increase when'( a5 The surplus capital account is much more than the deficit in current account. b5 The surplus in current account is much more than deficit in capital account. c5 Both the current account and capital account shows a surplus. In ?;;8(7; India%s foreign e"change reserves increased by 79.> 6* L billion. B.?. 1rite note on India%s Balance of Trade .-*. .. I-/I.%* B.D.- 2 <& TR./2'( Balance of trade is the difference between e"ports and imports. India%s Balance of trade is mostly in deficit. This is due to low share off 2"ports in world market. Imports are high due to petroleum, oil and lubricant products. I-/I.%* B.D.- 2 <& TR./2 46* L Billion5 SSSSSSSSSSSSSSSSSSSSI Cear 2"ports Imports Trade Balance (8.> ( 99.A (77G.> 788;(87 7G.: ?A.8 ?;;>(;: G:.? 77G.8 ?;;8(7; 7G?.? 9;;.E

India%s e"port performance is poor. .t present, India%s share off world e"port trade is 7F. The share of e"ports of other developing countries is much more than India. B. R2.*<-* &<R ,<<R ,2R&<RM.- 2 <& I-/I.%* 2@,<RT TR./2 I. 7. 2"port ( Related ,roblems '( 0igh ,rices '( ountries the price of Indian goods is high. ,rices are high due to There are *everal reasons for India%s ,oor performance. *ome off them are'

.s compared to other .sian ?. ,oor ( Buality '(

documentation formalities, high transaction costs N also to make higher profits. Many Indian e"porters do not give much importance to !uality control, so their products are of poor !uality. /ue to low !uality many times Indian goods are re#ected N sent back to India by foreign buyers. 9. ,oor -egotiation *kills '(

Indian e"porters lack -egotiation *kills due to poor training in Marketing. They fail to foreign buyers to place orders. >. Inade!uate ,romotion '(

onvince N induce the

&or 2"port Marketing, ,romotion is important. Many Indian 2"porters do not give much importance to promotion. . good no. of Indian e"porters are not professional in advertising N *ales promotion. They do not take part in trade fairs N e"hibitions. :. ,oor follow(up of sales '( Indian e"porters are ineffective in providing after(sale(service. They do not bother to find out the reactions of buyers after sale. This results in poor performance of India%s e"port trade. II. 7. )eneral auses )ood /omestic Market

*ellers find a ready market for their goods within the country, so they do not take patns to get orders from overseas markets. ?. -umber of formalities There are number of documentation N other formalities due to which the some rnarketers do not enter the e"port field. *o there is a need to simplify formalities. 9. ,roblem of Trading Blocs Trading blocs reduce trade barriers on member nations, but they impose trade barriers on non(members. .s India is not a member of some powerful trading blocs, it has to face some problems. >. -egative .ttitude *ome of the overseas buyers have a negative attitude towards Indian goods. They feel that Indian goods are inferior goods. Thus there is a need to correct this attitude. :. ,oor Infrastructure Indian infrastructure is poor. Indian e"porters find it difficult to get orders N also to deliver them at time. B. 9 ' 1hat are the Types of B<, /ise!uilibriumI +rite note on T *e# of Di#eC$i!i&ri$5 in Ba!an"e of Pa 5ent# . .ns. .. 2B6IDIBRI6M .-/ /I*2B6IDIBRI6M I- B<, '( Balance of payments is the difference between the receipts from and payments to foreigners by residents of a country. In accounting sense balance of payments, must always balance. /ebits must be e!ual to credits. *o, there will be e!uilibrium in balance of payments. *ymbolically, B D R - P 1here ' ( B R Balance of ,ayments R R Receipts from &oreigners P R ,ayments made to &oreigners 1hen B R Tero, there is said to be e!uilibrium in balance of payments. 1hen B is positive there is favourable balance of paymentsU 1hen N. B is negative there is unfavourable or adverse balance of payments.M 1hen there is a surplus or a deficit in balance of payments there is said ' to be dise!uilibrium in balance of payments. Thus dise!uilibrium refers to imbalance in balance of payments. B. TYPES OF DISEQ?ILIBRI?M IN BOP <R

The following are the main types of dise!uilibrium in the balance of payments'( 1. Str$"t$ra! Di#e2$i!i&ri$5 :-

*tructural dise!uilibrium is caused by structural changes in the economy affecting demand and supply relations in commodity and factor markets. *ome of the structural dise!uilibrium are as follows '( a. . shift in demand due to changes in tastes, fashions, income etc. would decrease or increase the demand for imported goods thereby causing a dise!uilibrium in B<,. b. c. d. e. f. If foreign demand for a countryMs products declines due to new and cheaper substitutes abroad, then the countryMs e"ports will decline causing a deficit. hanges in the rate of international capital movements may also cause structural dise!uilibrium. If supply is affected due to crop failure, shortage of raw(materials, strikes, political instability . war or natural calamities also result in structural changes which may affect not only goods but also factors of production causing dise!uilibrium in B<,. Institutional changes that take place within and outside the country may result in B<, dise!uilibrium. &or 2g. if a trading block imposes additional import duties on products imported in member countries of the block, then the e"ports of e"porting country would be restricted or reduced. This may worsen the B<, position of e"porting country. 1. C "!i"a! Di#eC$i!i&ri$5 '( 2conomic activities are sub#ect to business cycles, which normally have four phases Boom or ,rosperity, Recession, /epression and Recovery. /uring boom period, imports may increase considerably due to increase in demand for imported goods. /uring recession and depression, imports may be reduced due to fall in demand on account of reduced income. /uring recession e"ports may increase due to fall in prices. /uring boom period, a country may face deficit in B<, on account of increased imports. yclical dise!uilibrium in B<, may occur because a. Trade cycles follow different paths and patterns in different countries. b. Income elasticities of demand for imports in different countries are not identical. c. ,rice elasticities of demand for imports differ in different countries. 6. S%ort - R$n Di#eC$i!i&ri$5 '( This dise!uilibrium occurs for a short period of one or two years. *uch B<, dise!uilibrium is temporary in nature. *hort ( run dise!uilibrium arises due to une"pected contingencies like failure of rains or favourable monsoons, strikes, industrial peace or unrest etc. Imports may increase e"ports or e"ports may increase imports in a year due to these reasons and causes a temporary dise!uilibrium e"ists. International borrowing or lending for a short ( period would cause short ( run dise!uilibrium in balance of payments of a country. *hort term dise!uilibrium can be corrected through short ( term borrowings. If short ( run dise!uilibrium occurs repeatedly it may pave way for long ( run dise!uilibrium. 7. Lon2 - R$n I Se"$!ar Di#eC$i!i&ri$5 '( Dong run or fundamental dise!uilibrium refers to a persistent deficit or a surplus in the balance of payments of a country. It is also known as secular dise!uilibrium. The causes of long ( term dise!uilibrium are a. b. ontinuous increase in demand for imports due to increasing population. onstant price changes ( mostly inflation which affects e"ports on continuous basis. such the importing countries depend less on imports. The long run dise!uilibrium can be corrected by making constant efforts to increase e"ports and to reduce imports. etc., then there would be deficit in B<,.

c. /ecline in demand for e"ports due to technological improvements in importing countries, and as

8.

Monetar Di#e2$i!i&ri$5

Monetary dise!uilibrium takes place on account of inflation or deflation. /ue to inflation, prices of products in domestic market rises, which makes e"ports e"pensive. *uch a situation may affect B<, e!uilibrium. Inflation also results in increase in money income with people, which in turn may increase demand for imported goods. .s a result imports may turn B<, position in dise!uilibrium. :. E9"%an2e Rate F!$"t$ation# :. high degree of fluctuation in e"change rate may affect the B<, position. &or 2g. if Indian Rupee gets appreciated against dollar, then Indian e"porters will receive lower amounts of foreign e"change, whereas, there will be more outflow of foreign e"change on account of higher imports. *uch a situation will adversely affect B<, position. But, if domestic currency depreciates against foreign currency, then the B<, position may have positive impact. Q. 7 : +%at are t%e 5ain "a$#e# of BOP Di#eC$i!i&ri$5E OR Di#"$## t%e "a$#e# of 4i#eC$i!i&ri$5 in Ba!an"e of Pa 5ent#E >M.11, .ns. .. .6*2* <& /I*2B6IDIBRI6M I- B<, .ny dise!uilibrium in the balance of payment is the result of imbalance between receipts and payments for imports and e"ports. -ormally, the term dise!uilibrium is interpreted from a negative angle and therefore, it implies deficit in B<,. I. The dise!uilibrium in B<, is caused due to various factors. *ome of them are I5*ort - Re!ate4 Ca$#e# The rise in imports has been the most important factor responsible for large B<, deficits. The causes of rapid e"pansion of imports are '( 7. ,opulation )rowth ,opulation )rowth may increase the demand for imported goods such as food items and non food items, to meet their growing needs. Thus, increase in imports may lead to B<, dise!uilibrium. ?. /evelopment ,rogramme Increase in development programmes by developing countries may re!uire import of capital goods, raw materials and technology. .s development is a continuous process, imports of these items continue for a long time landing the developing countries in B<, deficit. 9. Imports <f 2ssential Items ountries which do not have enough supply of essential items like rude oil or apital

e!uipments are re!uired to import them. .gain due to natural calamities government may resort to heavy imports, which adversely affect the B<, position. >. Reduction <f Import /uties 1hen import duties are reduced, imports becomes cheaper as such imports increases. This increases the deficit in B<, position. :. Inflation Inflation in domestic markets may increase the demand for imported goods, provided the imported goods are available at lower prices than in domestic markets. E. /emonstration 2ffect

.n increase in income coupled with awareness of higher living standard of foreigners, induce people at home to imitate the foreigners. Thus, when people become victims of demonstration effect, their propensity to import increases.

II.

E9*ort Re!ate4 Ca$#e# :2ven though e"port earnings have increased but they have not been sufficient enough to meet the rising imports. 2"ports may reduce without a corresponding decline in imports. &ollowing are the causes for decrease in e"ports 1. In"rea#e In Po*$!ation '( )oods which were earlier e"ported may be consumed by rising population. This reduces the e"port earnings of the country leading to B<, dise!uilibrium. 1. Inf!ation :1hen there is inflation in domestic market, prices of e"port goods increases. This reduces the demand of e"port goods which in turn results in trade deficit. 6. A**re"iation Of C$rren" '( .ppreciation of domestic currency against foreign currencies results in lower foreign e"change to e"porters. This demotivates the e"porters. 7. Di#"o(er Of S$&#tit$te# :1ith technological development new substitutes have come up. Dike plastic for rubber, synthetic fibre for cotton etc. This may reduce the demand for raw material re!uirement. 8. Te"%no!o2i"a! De(e!o*5ent '( Technological /evelopment in importing countries may reduce their imports. This can be possible when they start manufacturing goods which they were e"porting earlier. This will have an adverse effect on e"porting countries. :. Prote"tioni#t Tra4e Po!i" :,rotectionist trade policy of importing country would encourage domestic producers by giving them incentives, whereas, the imports would be discouraged by imposing high duties. This will affect e"ports.

III.
1.

Ot%er Ca$#e# :F!i2%t of Ca*ita!

/ue to speculative reasons, countries may lose foreign e"change or gold stocks. Investors may also withdraw their investments, which in turn puts pressure on foreign e"change reserves. 1. /!o&a!i#ation )lobalisation and the rules of 1T< have brought a liberal and open environment in global trade. It has positive as well as negative effects on imports, e"ports and investments. ,oor countries are unable to cope up with this new environment. 6ltimately they become loser and their B<, is adversely affected. 6. C "!i"a! Tran#5i##ion International trade is also affected by Business cycles. Recession or depression in one or more developed countries may affect the rest of the world. The negative effects of trade cycle 4low income, low demand, etc.5 are transmitted from one country to another. &or eg. The current financial crisis in 6.*... is affecting the rest of the world. 7. Str$"t$ra! A4'$#t5ent# Many countries in recent years are undergoing structural changes. Their economies are being liberalised. .s a result, investment, income and other variables are changing resulting in changes in e"ports and imports. 8. Po!iti"a! fa"tor#

The e"istence of political instability may result in disrupting the productive apparatus of the country causing a decline in e"ports and increase in imports. Dikewise, payment of war e"penses may also serious affect dise!uilibrium in the country%s B<,. Thus political factors may also produce serious dise!uilibrium in the country%s B<,s. B. : ' 2"plain the different measures to correct dise!uilibrium in B<,. 2"amine the measures taken by government to overcome the B<, crisis. 1hat are the measures to be undertaken to correct B<, dise!uilibrium. .ns. .. M2.*6R2* T< <RR2 T /I*2B6IDIBRI6M I- B<, '( .ny dise!uilibrium 4deficit or surplus5 in balance of payments is bad for normal internal economic operations and international economic relations. . deficit is more harmful for a country%s economic growth, thus it must be corrected sooner than later. The measures to correct dise!uilibrium can be broadly divided into four groups MEAS?RES Monetar Po!i" I. 1, Fi#"a! Po!i" E9"%an2e Rate Po!i" Non-5onetar Po!i" <R <R

Monetar Mea#$re# :Monetar Po!i" '( entral Bank may

The monetary policy is concerned with money supply and credit in the economy. The prices. A.

e"pand or contract the money supply in the economy through appropriate measures which will affect the Inf!ation '( entral Bank through its monetary policy will make an attempt to entral Bank will adopt tight monetary policy. Money supply will be controlled by

If in the country there is inflation, the reduce inflation. The

increase in Bank Rate, ash Reserve Ratio, *tatutory Ratio etc. The monetary policy measures may reduce money supply, and encourage people to save more, which would reduce inflation. If inflation is reduced, the prices of domestic market will decrease and also that of e"port goods. In foreign markets there will be more demand for e"port goods, which would correct B<, dise!uilibrium. B. Def!ation :/uring deflation the entral Bank of the country may adopt easy monetary policy. It will try to increase money supply and credit in the economy, which would increase investment. More investment leads to more production. *urplus can be e"ported, which in turn may improve B<, position. 1, Fi#"a! Po!i" &iscal policy is governmentMs policy on income and e"penditure. )overnment incurs development and non ( development e"penditure,. It gets income through ta"ation and non ( ta" sources. /epending upon the situation governments e"penditure may be increased or decreased. a5 Inf!ation /uring inflation the government may adopt easy fiscal policy. The ta" rates for corporate sector may be reduced, which would encourage more production and distribution including e"ports. Increased e"ports will bring more foreign e"change there by making the B<, position favourable. b5 Def!ation /uring deflation the government would adopt restrictive fiscal policy.It may impose additional ta"es on consumers or may introduce ta" saving schemes. This may reduce the consumption of citi+ens, which in turn may enable more e"port surplus.

To restrict imports the government may also impose additional tariffs or customs duties which may improve the B<, position. 6, E9"%an2e Rate Po!i" &oreign e"change rate in the market may directly or indirectly be influenced by the )overnment. a5 De(a!$ation 1hen foreign e"change problem is faced by the country, the government tries to reduce imports and .increase e"ports. This is done through devaluation of domestic currency. 6nder devaluation, the( government makes a deliberate effort to reduce the value of home country. If devaluation is carried out, then the e"ports will become cheaper and imports costlier. This is turn will help to reduce imports and increase e"ports. b5 De*re"iation /epreciation like devaluation lowers the value of domestic currency or increases the value of foreign currency. /epreciation of a countryMs currency takes place in free or competitive foreign e"change market due to market forces. /epreciation and devaluation have the same effect on e"change rate. If there is high demand for foreign currency than its supply, it will appreciate and vice versa. 0owever, in several countries the system of managed fle"ibility is followed. If there is more demand for foreign e"change, the central bank will release the foreign currency in the market from its reserves so as to reduce the appreciation of foreign currency. If there is less demand for foreign e"change, it will purchase the foreign currency from market so as to reduce the depreciation of foreign country and appreciation of domestic currency. /ue to devaluation and depreciation of domestic currency, the e"ports become cheaper and imports become e"pensive. This helps to increase e"ports. I, Non-Monetar = /enera! Mea#$re# : . deficit country along with monetary measures may adopt the following non(monetary measures too, which will either restrict imports or promote e"ports. 75 Tariffs '( Tariffs refer to duties on imports to restrict imports. Tariff is a fiscal device which may be used to correct an adverse balance of payments. The imposition of import duties will raise the prices of imports. This will lead to a reduction in demand for imports thereby improving the balance of payments position. ?5 Buotas '( 6nder Buota *ystem, the government may fi" and permit the ma"imum !uantity or value of a commodity to be imported during a given period. By restricting imports through !uota system, the deficit is reduced and the balance of payments position is improved. 95 2"port ,romotion '( The government may introduce a number of e"port promotion measures to encourage e"porters to e"port more so as to earn valuable foreign e"change, which in turn would improve B<, *ituation. *ome of the incentives are *ubsidies, Ta" Marketing facilities etc. >5 Import *ubstitution )overnments, especially, that of the developing countries may encourage import substitution so as to restrict imports and save valuable foreign e"change. The government may encourage domestic producers to produce goods which were earlier imported. The domestic producers may be given several incentives such oncessions, )rants, <ctroi refund, 2"cise e"emption, /uty /rawback,

as Ta" holiday, A.

ash *ubsidy, .ssistance in Research N /evelopment, ,roviding technical assistance,

,roviding *carce inputs etc. CONCL?SION :&rom the above measures it is clear that more e"ports with import substitution based on economic strength of the country are the real effective solutions to correct the dise!uilibrium in the balance of payments. EMER/IN/ TRENDS IN INDIA)S BOP POSITION SINCE 1BB1 B.7' 2"plain the emerging trends in India%s B<, position since 7887. <R 2"amine the structure of B<, in India since 7887. <R E9a5ine t%e "%an2e# in "$rrent a""o$nt an4 "a*ita! a""o$nt &a!an"e of In4ia)# BOP #in"e 1BB1. An#. A, INDIA)S BOP SINCE 1BB1:The Balance of ,ayments of a country is a systematic record of all transactions between the residents of a country and the rest of the world carried out in a specific period of time. In 788;(87 India was facing B<, crisis. India faced huge trade deficit of 8.> 6* L billion and the net invisibles were also negative. This was mainly due to rise in imports of petroleum products. B<, situation improved since 7889(8>. In ?;;8(7;, B<, position showed increase in foreign e"change reserves of over 8.: 6* L Billion. INDIA)S BOP POSITION >?S F BILLION5 Ite5# 1BBG-B1 1. 1. 6. 7. 8. :. ;. E9*ort# I5*ort# Tra4e Ba!an"e In(i#i&!e# >net, C$rrent A""o$nt Ba!an"e Ca*ita! A""o$nt Ba!an"e Re#er(e# ?#e >- in"rea#e, 1<.8 1;.B -B.7 -G.6 - B.; <.7 1GGG-G1 78.7 8;.B -11.8 B.< - 1.; <.8 1GGB-1G 1<1.1 6GG.: -11<.7 <G.G -6<.7 81.<

So$r"e: - E"ono5i" S$r(e 1GG8-G: I 1G1G-11

-16.7

Note :- Reserves 4Q *ign5 indicates use of reserves. H 1.6 Reserves 4( *ign5 indicates reserves have increased. Det us 2"plain '( 1, Tra4e Ba!an"e :-

-8.<

Trade balance is a difference between e"port earnings and import payments. In India, trade deficit is mostly negative. In 788;(87, trade deficit was over 8 6* L billion which increased to over 77G.> 6* L billion in ?;;8(7;. There was negative growth in e"ports, due to recession in world markets on account of sub(prime crisis of 6*.. 1, Invisibles 4net5 '( The net invisibles include the difference between receipts and payments on account of -on(factor services 4insurance, transport, travel etc.5, Income 4Interest, profit, dividend5, private transfers and official transfers. In 788;(87, the net invisibles were negative to the e"tent of about ;.9 6* L billion. In ?;;8(7;, the net invisibles were positive to the e"tent of over G; 6* L billion. 6, urrent .ccount Balance '( It is the difference between the receipts and payments on current account which includes trade balance. In India the current account balance is mostly negative due to huge trade deficit. In 788;(87, the current account deficit was 8.A 6* L billion, which increased to 9G.> 6* L billion in ?;;8(7;. 7, apital .ccount Balance '( It is the difference between the receipts and payments on capital account. In India, the capital account always showed a surplus mainly due to inflow of foreign investments in India and net borrowings. In 788;( 87, the capital account showed a surplus of G.> 6* L billion, which increased to about :? 6* L billion in ?;;8(7;. 8, &oreign 2"change Reserves '(

. negative foreign e"change reserve position shows a weak economy and a positive balance shows comfortable position of the country. In 788;(87, the foreign e"change reserves were reduced by 7.9 6* L billion. In ?;;8(7;, the foreign e"change reserves increased by 79.> 6* L billion. B. ?' 2"plain the reasons for satisfactory performance of B<, since 7887. .ns. .5 R2.*<-* &<R *.TI*&. T<RC ,2R&<RM.- 2 <& B<, *I- 2 7887'( The Balance of ,ayment situation started improving since 7887 e"cept for the years 788:(8E and ?;;G(;8. .s on 97st March, ?;;8 foreign e"change reserves were ?:? 6* L billion. It further increased to ?A8 6* L billion oh 97st March ?;7;. The reasons for satisfactory performance of B<, are as follows '( 1, Increase In &/I In India '(

The policies of liberalisation and privatisation have been instrumental in attracting huge foreign investment. .t present &/I is allowed even upto 7;;F in certain sectors. In 788;(87, the net &/I in India was about ;.7 6* L billion, which increased to 7G.G 6* L billion in ?;;8(7;. This has improved the net foreign investment in India. 1, Increase In ,ortfolio Investment 788;(87, portfolio

,ortfolio investment includes investment by &Ils in the Indian stock 5ar@et#. In

investment was nil. In ?;;A(;G it was ?A.> 6* L billion. .gain in ?;;G(;8 portfolio investment was negative as withdrawls were more due to collapse of stock markets 1orld wide in ?;;G(;8. 0owever, in ?;;8(7;, the net portfolio investments again picked up at 9?.> billion. 6, Increase In 2"ternal ommercial Borrowings

2"ternal commercial borrowings have been an important source of funds for the government. <ver the years the net e"ternal commercial borrowings have increased. In 788;(87, they were about ?.? 6* L billion, which increased to A.8 6* L billion in ?;;G(;8, but it reduced to 6* L ?.G in ?;;8(7;. 7, Increase In ,rivate Transfers

,rivate transfers include inward remittances from Indian workers working abroad, personal gifts received from abroad, donations received from abroad by religious / charitable trusts etc. ,rivate transfers were about ?.7 6* L billion in 788;(87. It increased to 7?.G 6* L billion in ?;;;(;7. 1hich further increased to >>.E 6* L billion. 8, Increase In *ervice 2"ports

.t present, India ranks 8th in the world for overall services e"ports and ?nd in the world for computer and information services e"ports. In ?;;;(;7 India%s services e"ports have increased from 7E.9 6* L billion to 8E 6* L billion in ?;;8(7;. The invisibles 4net5 on B<, account have increased over the years due to increase in services e"ports. In 788;(87, the net invisibles were negative to the e"tent of ;.9 6* L billion, which increased to G; 6* L billion in ?;;8(7;. The private transfers along with services e"ports have increased the net invisibles on B<, account. :, -on Resident /eposits

The non(resident deposits add to the capital account of B<,. In 788;(87, non(resident deposits 4net5 were 7.: 6* L billion, which increased to ?.8 6* L billion in ?;;8(7;. The various schemes of incentives announced by Indian government helped in attracting huge deposits from non(resident Indians. B.9 ' 1hat are the measures to be taken to maintain the B<, problemI <R /iscuss the various measures to solve the problem of balance of payment. .ns. .. M2.*6R2* / *<D6TI<- <& B.D.- 2 <& ,.CM2-T* ,R<BD2M *ome of the important measures for maintaining / Improving balance of payments in order are as follows'( 1, &oreign .ssistance

/uring the earlier period of planning India received substantial amounts of foreign assistance from a number of countries like 6*., 6O, &rance, )ermany, and also from international institutions like IM& 1orld Bank and I/.. *uch assistance was in concessional terms. In 7887, when we faced B<, crisis India approached IM& and received substantial amount of loan. 0owever, the role of foreign assistance in financing deficits in balance of payments has declined in recent years. 1, Forei2n In(e#t5ent '(

India attracts substantial amount of &oreign e"change both in form of &oreign /irect Investment 4&/I5 and portfolio Investment. )overnment has been announcing numerous concession and incentives to attract foreign investment. 0owever &oreign investment is not an unmi"ed blessing. 0uge payments in terms of royalty and dividends are re!uired to be made every year in foreign e"change. Therefore, it is necessary to ensure that all investments are productively employed. 2ither &/I should be directed to e"port industries or it should be directed in building up of infrastructure. Thus &/I can continue to serve as a reliable source of assistance in future also. ,ortfolio investment is made mainly on the basis of short run returns and hence they may not be treated as a reliable source. 6, 2"ternal ommercial Borrowings '( are must be taken to see that such loans are raised for pro#ects which have direct

This is a high cost method of financing deficits as e"ternal commercial borrowings can generally be obtained at high rates of interest. impact on increasing our e"ports or reducing imports.

7,

-on ( Resident /eposits '(

-on ( Resident deposits are also obtained at high rates of interest. *uch deposits are highly volatile in nature as, their main ob#ective is to ma"imise returns. If conditions are unfavourable, they can withdraw their funds from the country. Thus, both foreign institutional investors and non(residents are fair weather friends. 1e cannot rely upon them at times of crisis. 8, 2arnings &rom Invisibles '( covered the entire trade deficit in the year ?;;7(;?. The prospects of

2arnings from invisibles have played an important role in reducing the current account deficit in balance of payments all through 788;%s. It
v

invisibles in future looks bright for India. :, Merchandise Trade '(

The lasting solution to B<, problem lies in our policy to promote e"ports. .ll possible efforts should be taken to increase e"ports. Reduction in import would be very difficult in India, under the regime of liberalised import policies. The best policy is to promote e"ports with the help of well formulated strategy. Thus promotion of e"ports must be the most important plank of our trade strategy. FOREI/N EJCAAN/E MARKET Q.1 : Define Forei2n E9"%an2e an4 E9*!ain t%e F$n"tion# of Forei2n E9"%an2e Mar@et. >M.1G11, An#. A, FOREI/N EJCAAN/E &oreign 2"change refers to foreign currencies possessed by a country for making payments to other countries. It may be defined as e"change of money or credit in one country for money or credit in another. It covers methods of payment, rules and regulations of payment and the institutions facilitating such payments. A. FOREI/N EJCAAN/E MARKET . foreign e"change market refers to buying foreign currencies with domestic currencies and selling foreign currencies for domestic currencies. Thus it is a market in which the claims to foreign moneys are bought and sold for domestic currency. 2"porters sell foreign currencies for domestic currencies and importers buy foreign currencies with domestic currencies. .ccording to 2llsworth, P. &oreign 2"change Market comprises of all those institutions and individuals who buy and sell foreign e"change which may be defined as foreign money or any li!uid claim on foreign moneyP. &oreign 2"change transactions result in inflow N outflow of foreign e"change. B. F?NCTIONS OF FOREI/N EJCAAN/E MARKET &oreign e"change is also referred to as fore" market. ,articipants are importers, e"porters, tourists and investors, traders and speculators, commercial banks, brokers and central banks. &oreign bill of e"change, telegraphic transfer, bank draft, letter of credit etc. are the important foreign e"change instruments used in foreign e"change market to carry out its functions. The &oreign 2"change Market performs the following functions. 1. Tran#fer Of P$r"%a#in2 Po0er I C!earin2 F$n"tion The basic function of the foreign e"change market is to facilitate the conversion of one currency into another i.e. payment between e"porters and importers. &or eg. Indian rupee is converted into 6.*. dollar and vice(versa. In performing the transfer function variety of credit instruments are used such as

telegraphic transfers, bank drafts and foreign bills. Telegraphic transfer is the !uickest method of transferring the purchasing power. 1. redit &unction The foreign e"change market also provides credit to both national and international, to promote foreign trade. It is necessary as sometimes, the international payments get delayed for E; days or 8; days. <bviously, when foreign bills of e"change are used in international payments, a credit for about 9 months, till their maturity, is re!uired. &or eg. Mr. . can get his bill discounted with a foreign e"change bank in -ew Cork and this bank will transfer the bill to its correspondent in India for collection of money from Mr. B after the stipulated time. 6. 0edging &unction

. third function of foreign e"change market is to hedge foreign e"change risks. By hedging, we mean covering of a foreign e"change risk arising out of the changes in e"change rates. 6nder this function the foreign e"change market tries to protect the interest of the persons dealing in the market from any unforseen changes in e"change rate. The e"change rates under free market can go up and down, this can either bring gains or losses to concerned parties. 0edging guards the interest of both e"porters as well as importers, against any changes in e"change rate. 0edging can be done either by means of a spot e"change market or a forward e"change market involving a forward contract. Q. 1 : E9*!ain t%e 4ea!er# or *arti"i*ant# in forei2n e9"%an2e 5ar@et. >M.1G11, .ns. .5 ,.RTI I,.-T* I /2.D2R* I- &<R2I)- 2@ 0.-)2 M.RO2T &oreign e"change market needs dealers to facilitate foreign e"change transactions. Bulk of foreign e"change transaction are dealt by ommercial banks N financial institutions. RBI has also allowed

private authorised dealers to deal with foreign e"change transactions i.e buying N selling foreign currency. The main participants in foreign e"change markets are 1. Retai! C!ient# Retail lients deal through commercial banks and authorised agents. They comprise

people, international investors, multinational corporations and others who need foreign e"change. 1. Co55er"ia! Ban@# ommercial banks carry out buy and sell orders from their retail clients and of their own account. They deal with other commercial banks and also through foreign e"change brokers. 6. Forei2n E9"%an2e Bro@er# 2ach foreign e"change market centre has some authorised brokers. Brokers act as intermediaries between buyers and sellers, mainly banks. ommercial banks prefer brokers. 7. Centra! Ban@# 6nder floating e"change rate central bank does not interfere in e"change market. *ince 78A9, most of the central banks intervened to buy and sell their currencies to influence the rate at which currencies are traded.

&rom the above sources demand and supply generate which in turn helps to determine the foreign e"change rate. B. 1. TC,2* <& &<R2I)- 2@ 0.-)2 M.RO2T &oreign 2"change Market is of two types retail and wholesale market. Retai! Mar@et The retail market is a secondary price maker. 0ere travellers, tourists and people who are in need of foreign e"change for permitted small transactions, e"change one currency for another. 1. +%o!e#a!e Mar@et The wholesale market is also called interbank market. The si+e of transactions in this market is very large. /ealers are highly professionals and are primary price makers. The main participants are banks, Business corporations and e"change rate. 6. Ot%er Parti"i*ant# a, Bro@er# Brokers have more information and better knowledge of market. They provide information to banks about the prices at which there are buyers and sellers of a pair of currencies. They act as middlemen between the price makers. &, Pri"e Ta@er# ,rice takers are those who buy foreign e"change which they re!uire and sell what they earn at the price determined by primary price makers. ommercial entral banks. Multinational banks are mainly responsible for determining

", i. ii. iii.

In4ian Forei2n E9"%an2e Mar@et It is made up of three tiers 0ere dealings take place between RBI and .uthorised dealers 4./s5 4mainly 0ere dealings take place between ./s 0ere ./s deal with their corporate customers. commercial banks5.

B. 9 ' /efine I 2"plain I 1rite note on spot and forward e"change rates. .ns. .5 2@ 0.-)2 R.T2 Transactions in e"change market are carried out at what are termed as e"change rates. In foreign e"change market two types of e"change rate operations take place. They are spot e"change rate and forward e"change rate. 75 *pot 2"change Rate '( 1hen foreign e"change is bought and sold for immediate delivery, it is called spot e"change. It refers to a day or two in which two currencies are involved. The basic principle of spot e"change rate is that it can be analysed like any other price with the help of demand and supply forces. The e"change rate of dollar is determined by intersection of demand for and supply of dollars in foreign e"change. The Remand for dollar is derived from country%s demand for imports which are paid in dollars and supply is derived from country%s e"ports which are sold in dollars. The e"change rate determined by market forces would change as these forces change in market. The primary price makers buy 4Bid5 or sell 4ask5 the currencies in the market and the rates continuously change in a free market depending on demand and supply. The primary dealer 4bank5 !uotes two(way rates i.e., buy and sell rate.

4Bid5 Buy Rate 7 6* L R V >:.:; 4.sk5 *ell Rate 7 6* L R V >:.A: The bank is ready to buy 7 6* L at Rs. >:.:; and sell at Rs. >:,A:. The difference of Rs.;.?: is the profit margin of dealer. 1, For0ar4 E9"%an2e Rate 0ere foreign e"change is bought or sold for future delivery i.e., for the period of 9;, E; or 8; days' There are transactions for 7G; and 9E; days also. Thus, forward market deals in contract for future delivery. The price for such transactions is fi"ed at the time of contract, it is called a forward rate. &orward e"change rate differs from spot e"change rate as the former may either be at a premium or discount. If the forward rate is above the present spot rate, the foreign e"change rate is said to be at a premium. If the forward rate is below the present spot rate, the foreign e"change rate is said to be at a discount. Thus foreign e"change rate may be at forward premium or at forward discount. &or 2g. an Indian importer may enter into an agreement to purchase 6* L 7;,;;; si"ty days from today at 7 6* L R Rs. >G. -o amount is paid at the time of agreement, e"cept for usual security margin money of about 7;F of the total amount. E; days form today, the importer will get 7;,;;; 6* L in e"change for Rs. >,G;,;;; irrespective of the *pot e"change rate prevailing on that date. a, i, ii, iii, i(, (, (i, (ii, &, Fa"tor# Inf!$en"in2 For0ar4 E9"%an2e Rate Interest rates. /egree of speculation in foreign e"change market. Inflation rate. &oreign investor%s confidence in domestic country. 2conomic situation in the country. ,olitical situation in the country. Balance of payments position etc. Nee4 For For0ar4 E9"%an2e Rate Contra"t# To overcome the possible risk of loss due to fluctuations in e"change rate, e"porters, importers and investors in other countries may enter in forward e"change rate contracts. In floating or fle"ible e"change rate system the possibility of wide fluctuation in e"change is more. Thus, both e"porters and importers safeguard their position through a forward arrangement. By entering into such an arrangement both parties minimi+e their loss. Q. > ' +rite note on Ar&itra2e. +rite note on Intere#t rate an4 Ar&itra2e. .ns. .. .RBITR.)2 .rbitrage is the act of simultaneously buying a currency in one market and selling it in another to make a profit by taking advantage of e"change rate differences in two markets. If the arbitrages are confined to two markets only it is said Jtwo(pointK arbitrage. If they e"tend to three or more markets they are known as Jthree(pointK or Jmulti(pointK arbitrage. Those who deal with arbitrage are called arbitrageurs. . *pot sale of a currency when combined with a forward repurchase in a single transaction is called J urrency *wapP. The *wap rate is the difference between spot and forward e"change rates in currency swap. <R

.rbitrage opportunities may e"ist in a foreign e"change market.. *uppose the rate of e"change is 7 6* L R V. :; in 6* market and 7 6* L R V. :: in Indian Markets, then an arbitrageur can buy dollars in 6* market and sell it in Indian market and get a profit of V. : per dollar.. In today%s modern well connected and advanced markets, arbitrageurs 4which are mainly banks5 can spot it !uickly and e"ploit the opportunity. *uch opportunities vanish over a period of time and e!uilibrium is again maintained. &or 2g. Bank . Bank B V / L R :;.:; / :;.:: V / L R :;.>; / :;.>:

The above rates are very close. The arbitrageur may take advantage and he can purchase L 7,;;,;;; from Bank B at V. :;.>: / a dollar and sell to it to Bank . at V. :;.:;, thus making a profit of ;.;:. The total profit would be 47,;;,;;; " ;.;:5 R V. :,;;;. The profit is earned without any risk and blocking of capital. B. ARBITRA/E.AND INTEREST RATE Interest arbitrage refers to differences in interest rates in domestic market and in overseas markets. If interest rates are higher in overseas market than in domestic market, an investor may invest in overseas market to take the advantage of interest differential. Interest arbitrage may be covered and uncovered. 1, ?n"o(ere4 Ar&itra2e In this system, arbitrageurs would take a risk to earn profit by investing in a high interest bearing risk free securities in a foreign market. 0is earnings would be according to his calculations if the currency of foreign market where he invested does not depreciate. If depreciation is e!ual to the difference in interest rate, the investor would not incur loss. 0owever, if depreciation is more than interest rate, then the arbitrageur will incur loss. &or 2g. In -ew Cork interest rate on E month Treasury Bill is EF and in *pain it is GF. .n 6* investor may convert 6* dollars in 26R< and invest in *pain, thereby taking an advantage of Q?F interest rate. -ow when bill matures, 6* investor will convert 26R< into dollars. 0owever, by that time 26R< may have depreciated the 6* investor will get less dollars per 26R<. If 26R< depreciates by 7F, 6* investor will gain only Q7F 4Q? 3 7F5. If 26R< depreciates by ?F or more, 6* investor will not gain anything or incur loss. If 26R< appreciates, 6* investor will gain, Q?F and interest rate differential 1, Co(ere4 Ar&itra2e

International investors would like to avoid the foreign e"change risk, thus interest arbitrage is usually covered. The investor converts the domestic currency for foreign currency at the current spot rate for the purpose of investment. .t the same time, investor sells forward the amount of foreign currency which he is investing plus the interest that he will earn so as to coincide with maturity of foreign investment.

The covered interest arbitrage refers to spot purchase of foreign currency to make investment and offsetting simultaneous forward sale of foreign currency to cover foreign e"change risk. 1hen treasury bills mature, the investor will get the domestic currency e!uivalent of foreign investment plus interest without a foreign e"change risk. CAAPTER 1; - DETERMINATION OF EJCAAN/E RATE B. 7 ' 1hat is e"change rateI 0ow is it determinedI .ns. .5 2@ 0.-)2 R.T2 2"change rate refers to the rate at which a country%s currencies are e"changed for currencies of other country. In other words it is the price of one currency in terms of another currency. &or 2g. If the value of 7 6* dollar in Indian rupees is >: then the e"change rate is 7 6* L R V >:. Thus foreign e"change rate indicates the e"ternal value of a country%s currency. It also shows the purchasing power of a country%s currency in terms of currency of another country. <verall we can say that the rate of e"change is nothing but the value or price of a country%s currency e"pressed in terms of a foreign currency. B. /2T2RMI-.TI<- <& 2@ 0.-)2 R.T2 The rate of e"change being a price of national currency in terms of another, is determined in foreign e"change market in accordance with general principle of the theory of value i.e., by the interaction of forces of demand and supply. Thus the rate of e"change in the foreign e"change market will be determined by interaction between demand for foreign e"change and supply of foreign e"change. 7. /emand &or &oreign 2"change &oreign e"change is re!uired by citi+ens or )overnment to make payments abroad. This results in demand for foreign e"change. These payments are recorded in payment side of B<,. The demand for foreign currency arises due to the following payments A. Import <f )oods onsumer as well as capital goods are imported from other countries. &oreign e"change is demanded by people who import these goods. 0igher the value of Imports, higher is the demand for foreign currency. B. I5*ort of #er(i"e# *ervices rendered by other countries which include banking, insurance, transport, communication, educational services, etc. are re!uired to be paid in foreign e"change. C. /ividend. Interest .nd ,rofits In India, many foreign firms have invested in various sectors, which results in outflow of foreign e"change on account of dividend and profits. <n other hand )overnment and Indian firms have also borrowed from foreign countries, which results in payment of Interest. D. 6nilateral ,ayments /onations, gifts etc. are Mone sided payments without corresponding returns. *uch payments create demand for foreign e"change. E. 2"port <f apital Repayment of debt, purchase of assets in foreign countries etc. all re!uire foreign e"change. .ll the above categories of payments abroad result in aggregate demand for foreign e"change. The total demand for foreign currency is inversely related to foreign e"change rate. .t a higher e"change rate, the demand for foreign currency may be low. Det us e"plain with diagram' The demand curve like an ordinary demand curve is sloping downwards from left to right. .t the rate <R per unit of foreign currency, <B amount is demanded. More is demanded at a lower price. ?. *upply <f &oreign 2"change *upply of foreign e"change in a country comes from receipts of its e"ports. The receipts of foreign currency are recorded in the receipt side of B<,. The main sources of supply are' A. 2"ports <f )oods This constitutes a ma#or source of supply of foreign e"change. Both si+e and price of e"ports depends on demand of elasticity for goods. In India, the manufactured items occupy the top position in e"ports.

B. 2"ports <f *ervices In recent years this source is gaining importance. 2"pert *ervices in various fields, tourists coming from other countries, transport, communication, insurance etc. are important services which earn and supply foreign e"change. . /ividend, Interest .nd profits Indian firms have invested in various sectors in foreign countries. Thus there is inflow of foreign e"change on account of dividend and profits. Indian institutions also have lent money abroad, which results in reciept of interest. /. 6nilateral Receipts ,ayments received in form of remittance from domestics working abroad, donations etc. form a part of foreign e"change supply. 2. Import <f apital &oreign investment ( direct and portfolio ( repayment of debts by foreigners, all increase the supply of foreign e"change. .ll the above categories of receipts from abroad result in aggregate supply of foreign e"change. The total supply, like the supply of any other commodity, is directly related to price i.e. the foreign e"change rate. .t a higher e"change rate, the supply of foreign currency may be high. Det us e"plain with diagramThe above diagram shows that the supply curve for foreign e"change slopes upwards from left to right which shows direct relationship between e"change rate and demand for foreign currency. There is higher supply of foreign currency at higher e"change rate. 9. /etermination <f 2"change Rate I /etermination <f 2!uilibrium 2"change Rate The foreign e"change rate is determined by demand for and supply of foreign e"change. The rate established at a point where demand and supply are e!ual is called e!uilibrium rate of e"change. In other words an e!uilibrium rate of e"change is one 1here there is neither a surplus nor a deficit in balance of payments of a country. .ny change in demand and supply will result in a change in e"change rate. In the above figure, the e!uilibrium rate is at 2, where demand and supply curves intersect. <R is e!uilibrium e"change rate when demand for the e"change is e!ual to its supply. <R, and <R? are not e!uilibrium e"change rates. .t <R7, / W * 4i.e. RrM W R,-5, and at <R ?, * W / 4i.e. R?T W R?,5. .t R, and R? e"change rates there will be pressure on the prevailing rate to move towards the e!uilibrium e"change rate i.e. towards point 2. Thus e"change rate, like any(other price is determined by demand and supply forces in the foreign e"change market. .ny change in demand and supply will result in change in e"change rate. R B. 9 ' 2"plain the ,urchasing ,ower ,arity Theory. <R 1rite a note on ,,, Theory. .ns. .5 ,6R 0.*I-) ,<12R ,.RITC 4,,,5 T02<RC The redit of ,urchasing ,ower ,arity 4,,,5 Theory goes to *wedish economist )ustav assel. .ccording to this theory, the e"change rate between two countries is determined by their purchasing power in terms of goods and services. The ,,, Theory is presented in two versions the .bsolute Hersion and the Relative Hersion. 7. .bsolute Hersion <f ,,, The absolute version of the ,,, theory the e"change rates between two currencies of two different countries is decided by their purchasing power. In other words, the rate of e"change will be determined at the point where the internal purchasing powers of the two currencies become e!ual. )ustav assel said that the purchasing power of two different currencies is to be compared only in terms of a basket of goods N services rather than a single commodity. &or eg. a particular basket of goods cost V. >,;;; in India and L 7;; in 6.*... That means the e"change rate would be .V >; R L 7. &ormula Rate of E9"%an2e R Interna! P$r"%a#in2

Po0er

in

In4ia Interna! ?.S. R , ,; D

P$r"%a#in2

Po0er

in

*ymbolically,

1here '( R R Rate of e"change of domestic currency in relation to foreign currency. , R ,rices of certain goods in domestic currency ,oR ,rices of same goods in foreign currency. .ccording to absolute ,,,, a rise in domestic price level in relation to foreign price level will lead to proportional depreciation of domestic currency against foreign currency. &or 2g. If the price of basket of goods in India increases to V. >,?:;, while the price of basket in 6*. remains same, then the new e"change rate will be R R >?:; R >?.: V 7;; In the above case, the Indian V depreciates N 6* L appreciates. ?. Relative Hersion <f ,,,

The relative version of ,,, Theory states that the e"change rate will ad#ust by the amount of inflation differential between the two countries. .ccording to ,.R. Orugman N M.<bstfeld, JThe relative ,,, states that the percentage change in the e"change rate between two currencies over any period e!uals the difference between the percentage changes in national price levels. 0ere some past e"change rate is taken as base rate. For5$!a:R1 R -ew 2!uilibrium e"change rate RG R 2!uilibrium rate in base period. P1 R -ew price Inde" in domestic country. P1 R -ew price Inde" in foreign country. &or 2g The price inde" in India increases from 7;; to 9;; N in 6*. it increased from 7;; to ?;;.The base rate is >;. Then the new e"change rate will be R R >; " 9;; R E; R 4Rs E;R76* L5. ?;; B(>. ritically evaluate the ,urchasing ,ower ,arity Theory. 2"plain the limitations of ,,, Theory. .ns. .5 RITI .D 2H.D6.TI<- I DIMIT.TI<-* <& ,,, T02<RC <R

The ,urchasing ,ower ,arity theory has following drawbacks 7. Ignores )overnment Intervention The ,,, theory does not consider )overnment or entral Bank intervention in e"change rate

determination. If domestic currency depreciates or appreciates too much, the central bank intervenes as it can have adverse effects on economy. -ormally, under managed float, the central bank intervenes in e"change rate. ?. Ignores Buality <f )oods ,,, ignores !uality of goods while determining prices. Buality of goods in two different countries may be different. This prevents the e!ualisation of prices thus it is difficult to arrive at e!uilibrium e"change rate. 9. Ignores *pecialisation ,,, theory ignores specialisation effect in international trade. ountries specialise in those items in

which they en#oy superior cost advantage and accordingly produce such items. But ,,, theory considers relative purchasing power of currencies for a similar basket of goods and services. >. Ignores The 2ffect <f hange In 2"change Rate <n ,rice Devel

,,, theory assumes that changes in price levels lead to changes in e"change rates and it does not consider the effect of changes in e"change rate on price level. *uch an assumption is unrealistic, as depreciation of domestic currency makes imports e"pensive, thereby increasing price of items. :. &aulty .ssumptions ,,, theory is based on faulty assumptions such as lack of transport cost, lack of trade barriers such as custom duties and !uotas etc. In reality international trade involves higher transportation cost and is also affected by trade barriers. E. /oes -ot onsider *peculation In &oreign 2"change Market

-ow(a(days there is lot of speculation in foreign e"change market, which affects the e"change rate. ,,, theory does not consider speculation in foreign e"change market. A. Dimited .pplication To Darge ountries &or large countries like India, international trade. G. -eglects apital Transfers hina, 6.*.. etc. the application of this theory is limited. The ,,,

theory may have applicability to small countries where a large part of national income comes form

,,, theory takes into account only trade in merchandise. It e"cludes trade in services, capital transfers and unilateral transfers. .ll such items create demand for and supply of foreign e"change. By e"cluding such factors, the theory has limited relevance. 8. Too Much 2mphasis <n ,urchasing ,ower ,,, theory places too much emphasis on purchasing power as a determining factor of rate of e"change. It ignores factors such as reciprocal demand of trading countries which can influence the rate of e"change even with no change in price levels. B. CONCL?SION:-

Though ,,, theory is sub#ect to various limitations, yet it has relevance in long(term. +ORLD TRADE OR/ANISATION B.7 ' /iscuss the ob#ectives and functions of 1T<. 4M.?;775 .ns. .5 2M2R)2- 2 <& 1T< '( .fter the *econd 1orld 1ar, many countries got down together to work on ways and means to promote international trade. The result was signing of )eneral .greement on Tariffs and Trade 4).TT5 by ?9 countries in 78>A. India was one of the founder members of ).TT. ).TT was created to reduce global depression and to liberalise and regulate the world trade by reducing tariff barriers. ).TT has been replaced by 1T< in 788:. 1T< is wider in scope as it regulates world trade in goods, as well as in services intellectual property rights, and investment. In =anuary ?;7;, the membership of 1T< was 7:9 countries. Its rules and policies are the outcome of negotiations among 1T< members. Thus 1T< is a member driven, consensus based organisation. B. 75 ,RI- I,.D <B=2 TIH2* <& 1T< Trade 1ithout /iscrimination '(

Trade without discrimination through the application of Most &avoured -ation 4M&-5 ,rinciple. .s per M&clause, a member nation of 1T< must accord 4give5 the same preferential treatment to other member nations which it gives to any other member nation. ?5 Raising The *tandard <f Diving '( Raising the standard of living and incomes and ensuring full employment of the citi+ens of its member nations. 95 <ptimum 6se <f 1orldMs Resources '( 2nsuring optimum use of worldMs resources and, thereby, e"panding world production and trade of goods as well as services. >5 *ettlement <f /isputes '( *ettlement of disputes among members through consultation, conciliation, and as a last resort through dispute settlement procedures. :5 )rowth <f Dess /eveloped ountries 4D/ s5 '( It recognises the need for positive efforts designed to ensure that developing countries especially the D/ s, secure a better share of growth in international trade. E5 A5 G5 ,rotection <f 2nvironment 2nlargement <f ,roduction .nd Trade 2mployment ,reserving and protecting the environment of the world so as to benefit all the nations of the world. 1T< aims to enlarge production and trade of goods as well as services. 1T< aims at generating full employment and increase in effective demand. 5 &6- TI<-* <& 1T< 1T< has following functions 75 Implementation <f Reduction In Trade Barriers

1T< shall check the implementation of tariff cuts and reduction of non(tariff measures agreed upon the member nations at the conclusion of 6ruguay Round. ?5 &orum &or -egotiation

1T< shall provide the forum of negotiations among its members concerning their multilateral trade relations. 95 >5 *ettlement <f /isputes .ssistance To IM& .nd IBR/ 1T< shall administer the understanding on rules and procedures governing the settlement of disputes. 1T< shall co(operate with IM&, IBR/ and its affiliated agencies to achieve greater coherence in global economic policy. :5 .dministration <f .greements 1T< shall look after the administration of ?8 agreements 4signed at the conclusion of 6ruguay Round in 788>5, plus a number of other agreements, entered into after 6ruguay Round. E5 2"amination <f Trade ,olicies 1T< shall regularly e"amine the foreign trade policies of member nations, to see that such policies are in line with 1T<%s guidelines. A5 onsultancy *ervices 1T< shall keep a watch on the developments in the world economy and it provides consultancy services to its member nations. G5 ollection <f &oreign Trade Information 1T< shall collect information on import ( e"port trade and on various trade measures and other trade statistics of member nations. B.? ' 2"plain the *alient &eatures of 1T< .greements reached on the basis of 6ruguay Rounds. 2"plain the main 1T< .greements. .ns. .5 *.DI2-T &2.T6R2* <& 6R6)6.C R<6-/ I 1T< .)R22M2-T* The main agreements of 1T< are 75 .greement <n .griculture 4.<.5 '( The main ob#ective is to increase market orientation in agriculture trade. It provides for commitments in the area of market access, domestic support and e"port competition. The members have to transform their non( tarrif barriers like !uotas into e!uivalent tariff measures. The tariffs are to be reduced by 9EF within E years in case of developed countries and by ?>F within 7; years in case of developed countries. The least developed countries need not make any commitment for reduction. ?5 .greement <n Trade In Te"tiles .nd lothing 4Multi ( &ibre .rrangement5 '( This provides for phasing out the import !uotas on te"tiles and clothing in force under the Multi ( &ibre .rrangement since 78A>, over aX span of 7; years i.e. by 7st =anuary, ?;;:. 1ith this agreement !uota on te"tile and clothing has now been abolished. 95 .greement <n Manufactured )oods The developed countries agreed to reduce tariffs on manufactured goods other than te"tiles by >;F. The tariffs would now be brought down to an average of 9.GF from earlier E.9F. >5 .greement <n TRIMs .n .greement on Trade Related Investment Measures 4TRIMs5 calls for introducing national treatment of foreign investments and removal of !uantitative restrictions. It identifies : investment measures which are inconsistent with the ).TT provisions on national treatment and on general elimination of !ualitative restrictions. :5 .greement <n TRI,s <R

Trade Related Intellectual ,roperty Rights 4TRI,s5 pertain to ,atents and

opyrights. 1hereas earlier on

process patents were granted to food, medicines, drugs and chemical products, the TRI,s .greement now provides for granting product patents also in all these areas. ,rotection will be available for ?; years for patents and :; years for copyrights. E5 )eneral .greement <n Trade .nd *ervices 4).T*5 &or the first time, trade in services like banking, insurance, travel, maritime transportation, mobility of labour etc. has been brought within the ambit of negotiations. The )eneral .greement on Trade in *ervices 4).T*5 provides a multilateral framework of principles and services which should govern trade in services under conditions of transparency and progressive liberalisation. A5 /isputes *ettlement Body *ettllement of disputes under ).TT was a never ending process. The /isputes *ettlement Body 4/*B5 set up under 1T< seeks to plug the loopholes and provide security and predictability to the multilateral trading system. It has now been made mandatory to settle a dispute within 7G months. The findings of disputes settlement panels will be final and binding on all parties concerned. In addition to the above, the 6ruguay Round also reached agreements on the understanding and implications of certain articles of ).TT 78>A, vi+, pre(shipment inspection, rules of origin, import licensing, anti ( dumping measures and countervailing duties, safeguards, subsidies etc. B.9' 2"plain TRI,s .greement and implication of TRI,s .greement of 1T< on member nations. <R 1rite note on TRI,s .greement. 4M. ?;775 An#. A. A/REEMENT ON TRADE RELATED INTELLECT?AL PROPERTY RI/ATS >TRIP#, :Intellectual property Rights seek to protect the interest of inventors and developers of products and processes from being copied by others. The main features of TRI,s agreements '( Y Y Y Minimum *tandards of protection to be provided by each member. /omestic procedures must be put in place for enforcement of I,Rs by each member nation. /ispute *ettlement between 1T< members. opyright and related rights, trade marks including services

.greement on TRI,s cover the following areas

marks, industrial designs, geographical indications, patents, layout designs of integrated circuits and protection of undisclosed information or trade secrets. 1T<Ms TRI,s agreement is an attempt to narrow down the gaps in the way these rights are protected around the world. /isputes over TRI,s agreement are to be governed by 1T< dispute settlement procedures. TRI,s agreement desires to reduce distortions and impediments to international trade while protecting intellectual property rights. B. 1, POSITIVE IMPLICATIONS OF TRIP# A/REEMENT :Patent# :-

6nder .greement on TRI,s, protection is given to patents, copyrights, layout designs etc. &or 2g.'( when patented drugs get e"clusive marketing rights for certain period, and if some other firm wants M to use that products name, they have to take permission from patent holder. ,ermission may be given only after signing agreement for royalty or fees. TRI,s agreement has also given a boost to Research and /evelopment in the field of pharmaceuticals, engineering, electronics etc. Thus agreement on TRI,s have benefited the member nations of 1T<. 1, P$&!i" Aea!t% :-

The /oha

onference held in /oha, Batar in -ov. ?;;7, recognised the need to protect public health and to ountries like India, hina and Bra+il would

provide medicines to all. 0ere the developing countries need not source their essential medicines at high cost from M- s from developed countries, which have patents. benefit as they possess the resources and technology to manufacture essential medicines and e"port these without having to secure compulsory licensing from patent holders. 6, /eo2ra*%i" In4i"ation Stat$# 4)I*5'( 1T< also provides )I* for certain items. <nce a country gets )I*, the firms from only that country can use the generic brand name. &or 2g. '( India has obtained )I* for /ar#eeling Tea and also for other products. This means, only Indian firms can use /ar#eeling Tea brand, which shows /ar#eeling Tea produced in India is uni!ue. B, 1, NE/ATIVE IMPLICATIONS OF TRIP# A/REEMENT Fa(o$r# De(e!o*e4 Nation#

.greement on TRI,s favours developed countries as under TRI,s protection .is given to I,Rs such as patents, trade marks, layout designs etc. Thus it favours developed nations as they have large number of patents. 1, .griculture In .griculture patenting of plant varieties is done through TRI,s. This may have serious implications for developing countries. M- s are in a position to develop almost all new varieties with the help of their financial resources and e"pertise. This may transfer all gains in the hands of M- s. 6, Micro ( <rganisms Research in Micro(organisms is closely linked with the development of agriculture, pharmaceuticals and industrial biotechnology. ,atenting of Micro(organisms again will benefit M- s. B.> ' 2"plain the implications of TRIMs .greement of 1T< on member nations. <R 1rite note on TRIMs. 4M.?;775 .ns. .5 .)R22M2-T <- TR./2 R2D.T2/ I-H2*TM2-T M2.*6R2* 4TRIMs5 .greement on Trade Related Investment Measures 4TRIMs5 include introduction of measures to be adopted by member countries to treat foreign investments on par with domestic investments and also removal of !uantitative restrictions on imports. It is an attempt by a national government to place conditions on foreign company that wishes to operate within its borders. ertain investment measures that discriminate against foreign investment were to be withdrawn such as a, &, ", 4, e, f, 2, %, <bligation on foreign investors to use local inputs. To produce for e"ports as a condition to obtain imported inputs. To meet e"port obligation. 2mployment of local people. Technology Transfer re!uirements. 6se of specific production technology. Docal e!uity re!uirement. ontrol on use of imported inputs.

The member nations of 1T< including India have withdrawn the above measures to encourage trade related investment. TRIMs are of two types'(

,ositive TRIMs '(

These include investment incentive to move to the country in !uestion or to move to a specific place within that country. Y -egative TRIMs 'Z These include local e!uity re!uirements, licensing re!uirements, foreign e"change restrictions, transfer of technology re!uirements, trade balancing re!uirements, import ( e"port re!uirements etc. B5 ,<*ITIH2 IM,. T <& TRIMs '(

TRIMs agreement have positive impact on developing countries as foreign investment is treated at par with domestic investment. &or 2g. TRIMs agreement will encourage foreign firms to invest in India. This will generate a good amount of competition. In order to survive, Indian firms will have to be proactive with competitive strategies, which not only would improve their performance, but also would provide better service to customers. 5 -2).TIH2 IM,. T <& TRIMs '( /eveloping countries 4including India5 have withdrawn a number of measures that restricts foreign investments. TRIMs agreement also favours developed nations. M- s from developed countries with their huge financial and technological resources can displace Indian industry and play a dominant role. Besides foreign firms will be free to remit profits, dividends, etc. to parent company. This will cause foreign e"change drain on developing nations. B. : ' /iscuss the implications of ).T* .greement of 1T< on member nations. <R 1rite note on ).T*. .ns. .5 )2-2R.D .)R22M2-T <- TR./2 I- *2RHI 2* 4).T*5 &or the first time, in 6ruguay Round, trade in services like banking, insurance, travel, transport etc. was brought under negotiations. The )eneral .greement on Trade in *ervices 4).T*5 is the first multilateral agreement on trade in services. .ll member nations are bound to open their services sector to domestic private and foreign competition. ).T* has two ma#or re!uirements 1, 1, To grant the *tatus of Most &avoured -ation 4M&-5 to other member nations on non(discriminate Maintenance of transparency. There is also commitment for progressive

basis with regard to trade in services and liberalisation. The inculsion of *ervices in agreement shows their growing importance in world economy. 6nder ).T*, India has made commitment for 99 activities where foreigners are allowed to enter. The choice of activities have been based on national benefit like impact on capital inflows, technology, employment etc. Improvements in the !uality of service that will emerge from liberalisation and increased competition will contribute to increase in efficiency, productivity, consumer welfare and growth in developing countries. -o doubt there is a wide difference in the !uality of services rendered between the developed and developing countries. The inclusion of trade in service sector is likely to be more beneficial to developed countries than to developing countries. B. ,<*ITIH2 IM,. T <& ).T* '( ).T* provide an opportunity not only to avail services from other member countries but also to increase the !uality of its own services due to competition. &oreign firms are allowed in number of service sectors.

Through #oint ventures or partnership foreign firms may enter in India. This will enable Indian firms to e"pand and diversify their service activities with professional e"pertise and foreign support. In many developing countries, sectors like travel and tourism, hotels, retail trading, banking, insurance, education and communication are open for international competition. . -2).TIH2 IM,. T <& ).T* '( In ).T* agreement member nations have to open up the services sector for foreign companies. /eveloping countries including India have opened up the services sector in respect of banking, insurance, communication, telecom, transport etc. to foreign firms. /eveloping countries may find it difficult to compete with giant foreign firms due to lack of resources and professional skills. B.E' 2"plain the impact of 1T< .greements on Indian 2conomy. .nalyse the impact of 1T< agreements on India. 1hat are its ,ros and .ns. .5 IM,. T <& 1T< .)R22M2-T* <- I-/I.- 2 <-<MC '( The signing of 1T< agreements will have far reaching effects not only on India%s foreign trade but also on its internal economy. .lthough the ultimate goal of 1T< is to free world trade in the interest of all nations of the world, yet in reality the 1T< agreements has benefitted the developed nations more as compared to developing ones. The impact of 1T< on India%s economy is staged as follows '( I. 1, Po#iti(e I5*a"t I Benefit# I A4(anta2e# I /ain# fro5 +TO :In"rea#e In E9*ort Earnin2# :The ,ositive impact of 1T< on IndiaMs economy can be viewed from the following points'( 2stimates made by 1orld Bank, <rganisation for 2conomic o(operation and /evelopment 4<2 /5 and the ).TT *ecretariat, shows that the income effects of the implementation of 6ruguay Round package will be an increase in traded merchandise goods. It is e"pected that India%s share in world e"ports would improve. 1, A2ri"$!t$ra! E9*ort# :Reduction of trade barriers and domestic subsidies in agriculture is likely to raise international prices of agricultural products. India hopes to benefit from this in form of higher e"port earnings from agriculture. This seems to be possible because all ma#or agriculture development programmes in India will be e"empted from the provisions of 1T< .greement. 6, E9*ort Of Te9ti!e# An4 C!ot%in2 :1ith the phasing out of M&. 4Multi ( &ibre .rrangement5, e"ports of te"tiles and clothing will increase and this will be beneficial for India. The developed countries demanded a 7: year period of phasing out of M&., the developing countries, including India, insisted that it be done in 7; years. The 6ruguay Round accepted the demand of the latter. But the phasing out *chedule favours the developed countries because a ma#or portion of !uota regime is going to be removed only in the tenth year, i.e. ?;;:. The removal of !uotas will benefit not only India but also every other countryM. 7, M$!ti!atera! R$!e# An4 Di#"i*!ine# :The 6ruguay Round .greement has strengthened Multilateral rules and disciplines. The most important of these relate to anti ( dumping, subsidies and countervailing measures, safeguards and disputes settlement. This is likely to ensure greater security and predictability of the international trading system and thus create a more favourable environment for India in the -ew 1orld 2conomic <rder. 8, /ro0t% To Ser(i"e# E9*ort# :<R oinsI

6nder ).T* agreement, member nations have liberalised service sector. India would benefit from this agreement. &or 2g'( India%s services e"ports have increased from about : billion 6* L in 788: to 8E billion 6* L in ?;;8(7;. *oftware services accounted for about >:F of service e"ports. :, Forei2n In(e#t5ent :India has withdrawn a number of measures against foreign investment, as er the commitments made to 1T<. .s a result of this, foreign investment and &/I has increased over the years. . number of initiatives has been taken to attract &/I in India between ?;;; and ?;;?. In ?;;8(7;, the net &/I in India was 6* L 7G.G billion. II. -egative Impact / ,roblems I /isadvantages <f 1T< .greements on Indian 2conomy '( 1, TRIP# '( The .greement on TRI,s at 6ruguay Round weights heavily in favour of Multinational orporations and developed countries as they hold a very large number of patents. .greement on TRI,s will work against India in several ways and will lead to rponopoly of patent holding M- s. .s a member of 1T<, India has to comply with standards of TRI,s. The negative impact of agreement on TRI,s on Indian economy can be stated as follows a5 ,harmaceutical *ector '( 6nder the ,atents .ct, 78A;, only process patents were granted to chemicals, drugs and medicines. This means an Indian pharmaceutical company only needed to develop and patent a process to produce and sell that drug. This proved beneficial to Indian pharmaceutical companies as they were in a position to sell !uality medicines at low prices both in domestic as well as in international markets. 0owever, under the agreement on TRI,s, product patents needs to be granted. This will benefit the M- s and it is feared that they will increase the prices of medicines heavily, keeping them out of reach of poor. .gain many Indian pharmaceutical companies may be closed down or taken over by large M- s. b5 .griculture '( The .greement on TRI,s e"tends to agriculture through the patenting of plant varieties. This may have serious implications for Indian agriculture. ,atenting of plant varieties may transfer all gains in the hands of M- s who will be in a position to develop almost all new varieties with the help of their huge financial resources and e"pertise. c5 Microorganisms '( The .greement on TRI,s also e"tends to Microorganisms as well. Research in micro ( organisms is closely linked with the development of agriculture, pharmaceuticals and industrial biotechnology. ,atenting of micro ( organisms will again benefit large M- s as they already have patents in several areas and will ac!uire more at a much faster rate. 1, TRIMs '( .greement on TRIMs provide for treatment of foreign investment on par with domestic investment. This .greement too weights in favour of developed countries. There are no provisions in .greement to formulate international rules for controlling restrictive business practices of foreign investors. =n case of developing countries like India, complying with .greement on TRIMs would mean giving up any plan or strategy of self ( reliant growth based on locally available technology and resources. 6, /ATS :<ne of the main features of 6ruguay Round was the inclusion of trade in services in negotiations. This too will go in favour of developed countries. 6nder ).T* agreements, the member nations have to openup

services sector for foreign companies. The developing countries including India have opened up services sector in respect of banking, insurance, communication, telecom, transport etc. to foreign firms. The domestic firms of developing countries may find it difficult to compete with giant foreign firms due to lack of resources N professional skills. 7, -on ( Tariff Barriers '( ommerce Ministry has identified 79 different *everal countries have put up trade barriers and non ( tariff barriers following the formation of 1T<. This has affected the e"ports from developing countries. The 6nion

non ( tariff barriers put up by 7E countries against India. &or eg. M&. 4Multi ( fibre arrangements5 put by 6*. and 2uropean 6nion is a ma#or barrier for Indian te"tile e"ports. 8, .greement <n .griculture 4.<.5 The .<. is biased in favour of developed countries. The issue of food security to developing countries is not addressed ade!uately in .<.. The e"istence of global surpluses of food grains does not imply that the poor countries can afford to buy. The dependence on necessary item like foodgrains would adversely affect the Balance of ,ayment position. :, Ine!uality 1ithin The *tructure <f 1T< There is ine!uality within the structure of 1T< because the agreements and amendments are in favour of developed countries. The member countries have to accept all 1T< agreements irrespective of their level of economic development. ;, D/ 2"ports onference took place at 0ong Oong in /ecember ?;;:. In this onference, it was The Eth Ministerial

agreed that all developed country members and all developing countries declaring themselves in a position to do so, will provide duty ( free and !uota ( free market access on a lasting basis to all products originating from all Deast /eveloped with cheap D/ ountries 4D/ 5. India has agreed to this. -ow IndiaMs e"port will have to compete e"ports will come to Indian market and e"ports internationally. -ot only this, the cheap D/

compete with domestically produced goods. India will face several problems in the process of complying with 1T< agreements, but it can also reap benefits by taking advantage of changing international business environment. &or this it needs to develop and concentrate on its areas of core competencies.