International Trade & Finance
International
Trade
Meaning: International trade,
external trade or foreign trade means trade between countries. In short it
means trade between one country and another country.
Advantages of International Trade:
- International
trade contributions to regional or territorial specialization or division
of labour. That is, it helps a country to specialize in the production of
goods and services for which it enjoys natural advantages.
- By
enabling a country to concentrate on the production of those goods for
which its resources are best suited, foreign trade facilitates fuller and
better utilisation of the available resources.
- It
enables a country to obtain from other countries goods which it cannot
produce or goods which it cannot produce economically.
- It
helps a country to dispose of goods which it has in surplus.
- It
widens the market for goods, and thereby, encourages large-scale
production, innovation and technical progress, which will contribute to
lower costs and lower prices of goods.
- By
widening the markets for goods, foreign trade contributes to the expansion
of domestic industries of a country.
- It
helps under-developed countries to import plant and machinery and
technical know – how required for industrial development from the
industrially developed countries.
- Foreign
trade helps a developing country to procure foreign capital required for
economic development.
- Foreign
trade countries to equilisation of prices throughout the world. In other
words, it helps every country to have goods as the same price, of course,
making allowance for transport costs, taxes, etc.
- Foreign
trade i.e., imports, help a country in checking rising prices by
increasing the supply of goods.
- Competition
from foreign goods, resulting from foreign trade, includes domestic
producers to become more efficient and to improve the quality of their
products.
- Foreign
trade promoter revolution in transport, in the sense that the desire to
take more goods to far off places in less time leads to improved means of
transport.
Disadvantages
of International Trade:
- Foreign
trade dependence creates serious difficulties for a country, especially in
times of war when foreign trade becomes impossible.
- Because
of foreign trade, a country may recklessly exhaust her limited natural
resources for the purpose of export without thinking of her own future
needs.
- Foreign
trade gives rise to foreign competition. Foreign competition may ruin domestic industries, especially small
and cottage industries which are unable to face such competition.
- Foreign
trade may encourage the importation of luxury goods which are not useful
to the masser.
- Because
of foreign trade, some developed countries may resort to the practice of
dumping their goods in under-developed and developing countries.
- Foreign
trade speacialisation resulting from the foreign’s trade, a country may
develop a certain sector of her economy, neglecting other sectors.
- Foreign
trade may cause serve balance of payments problem, and a country may be
forced to borrow from international sources. Huge foreign debts may
impair, a country’s capacity to import goods.
- Foreign
trade is likely to ruin an economy which exports only raw materials to
other countries.
- Foreign
trade leads to international competition and rivalry, and sometimes, leads
to international frictions and wars.
- Foreign
trade dives an opportunity to foreigners to intervene in the domestic
affairs of a country.
Difference
between Internal Trade and International Trade:
- Internal
trade takes place between the geographical boundaries of a nation, whereas
international trade takes place between different nations.
- In
the trade of any nation, the volume of its internal trade will be more
than that of external trade. Internal trade accounts for about 95% of the
total volume of the trade of a country, whereas foreign trade accounts for
only about 5% of the total volume of the trade of a country.
- Though
both internal trade and international trade are based on the principle of
specialization or division of labour, regional specialization within a
country leads to internal trade or inter-regional trade, whereas country
wise specialization leads to international trade.
- In
the case of home trade, there is much scope for the operation of forces of
demand and supply. But, in the case of foreign trade, there is not much
scope for the full operation of the forces of demand and supply.
- The
number of documents of trade required for home trade is less than the
required for foreign trade.
- Home
trade is subject to regulations and laws of only one country, whereas
foreign trade is subject to regulations and laws of two or more countries.
- Home
trade is, generally, free from restriction, whereas foreign trade is
subject to a number of restrictions.
- The
cost of transport in home trade is much less than that in foreign trade.
- The
interval between the dispatch of goods by the seller and the receipt of
the same by the buyer in home trade is not much.
- Goods
are subject to greater risk in foreign trade than in home trade.
- As
goods are subject to more risks in foreign trade, in the case of
international trader, goods are, generally, insured against the risks.
- Home
trade involves the currency of only one country whereas foreign trade
involves the currencies of two or more countries.
Basis of International Trade
International trade arises
because of geographical speacialisation among countries. Due to geographical
factors like physical features, climatic conditions, soils, etc. Some countries
have the monopoly of certain minerals. Uneven distribution of natural
resources, some countries are able to produce some commodities more efficiently
and cheaply than the other countries. So, each country finds it advantageous to
speacialise in the production of goods which the other countries can produce
more cheaply.
Need for a Separate Theory of International
Trade
The classical school of economists like Adam
Smith and David Ricardo held that there are certain fundamental difference
between inter-regional or internal trade and inter-national trade, and so,
there is a need for a separate theory of international trade, and they
propounded a separate theory of international trade.
Modern economist like Bertil Ohlin and
Heberles are of the view that international trade is just a special case of
inter-regional or internal trade, and the differences between inter-regional
and international trade are of degree rather than of kind, and so, these is no
need for a separate theory of international trade.
The fundamental reasons which underline
international trade and which emphasize the need for a separate theory of
international trade are
a)
Difference
in Natural Resources: Different countries are endowed with different types of
natural resources. So, they specialize in the production of commodities for
which they are richly endowed. The difference in natural resources between
countries is not only responsible for international trade, but also emphasizes
the need for a separate theory for international trade.
b)
Immobile
Factors of Production: The factors of production, especially labour and capital
are perfectly mobile within each country, but they are not perfectly mobile
between countries. The immobility of factors of production between countries
contribute to difference in factor prices and differences in costs of
production in different countires.
c)
Different
Markets: Goods which are traded within the regions of a country may not be sold
in other countries. Even the system of weights and measures, differ from one
country to another country. In short, internal markets are different from
inter-national markets.
d)
Different
Currencies: In international trade, different currencies are used. It is not
the differences in currencies alone that are important in international trade,
but also the changes in their relative values. The differences in currencies
involved in international trade also justify the need for a separate theory of
international trade.
e)
Balance
of Payments Problem: In internal trade, there is no balance of payments
problem. But, in international trade, there is the balance of payments problem,
and the balance of payments problem is perpetual. This reason also justifies
the need for a separate theory of international traded.
f)
Transport
cost: In the case of internal trade, transport cost are not of much
significance. But trade between countries involves high transport cost because
of geographical distance. This factor also justifies the need for a separate
theory of international trade.
g)
Different
Trade Policies: The policies relating to trade and commerce, taxation, etc. are
the same within a country. But the policies relating to trade and commerce,
taxation, etc. are quiet different from country to country.
Classical Theory of International
Trade:
The classical economist like Adam Smith and
David Ricardo developed a theory of international trade called the classical
theory of international trade.
Adam smith analyzed the causes for and the
benefits of international trade in terms of absolute cost advantage, and David
Ricardo analyzed the causes for and the benefits of international trade in
terms of comparative cost advantage. So, Adam smiths analyses of the theory of
international is called theory of absolute cost advantage, and David Ricardo’s
analysis of the theory of international trade is called the theory of
comparative cost advantage.
Adam Smith’s theory of Absolute Cost Advantage
Adam smith’s theory of absolute cost advantage: According to Adam
Smith, if one country has absolute cost advantage over another country in one
commodity, and the other country has absolute cost advantage over the first
country in another commodity, both the countries could gain by trading. (It may
be noted that between two countries, a country is aid to have absolute
advantage or absolute cost advantage in a commodity, if it can produce that commodity
absolutely more efficiently and cheaply than the other country).
The theory of absolute cost advantaged can be
explained with an example. Suppose it takes 10units of labour to produce 1 unit
of product in country A, but 20 units of labour to produce one unit of the same
product in country B, and it takes 20 units of labour A, but 10 units of labour
to produce 1 unit of the same product in country B. In this case, both the
countries would gain, if country a speacialises in the production and export of
product X, and country B speacialise in the production and export of production
Y. country A can get 1 unit of production Y in exchange of 1 unit of product X.
Similarly, country B can get 1 unit of product X in exchange of 1 unit of
production Y.
Assumptions:
- He
assumed that the costs of the commodities were determined by the relative
amounts of labour involved in their production.
- He
assumed that labour was mobile within the country but immobile between the
countries.
- He
took into considerations only two countries and only two commodities for
his analysis.
- He
argued that trade between the two countries would take place if each of
the two countries has absolutely lower cost in the production of one of
the commodities.
Criticisms against Adam Smith’s Theory
of Absolute Cost Advantage:
- Adam
Smith’s analysis of the causes for and benefits of international trade was
no doubt simple. But it was not deep.
- Adam
Smith’s analysis was based on the assumption that for international trade,
an exporting country should have, an absolute cost advantage.
David
Ricardo’s Theory of Comparative Costs:
David Ricardo analysed the causes for and the
benefits of international trade in terms of comparative costs. (David Ricardo’s
theory of international trade is a modified and improved theory of
international trade).
David Ricardo agreed with the analysis of
Adam Smith the international trade would be mutually advantages if one country
has absolute advantage over another country in one commodity, and the other
country has an absolute advantage over the first country in another commodity.
He went further and pointed out that any two
countries could very well gain by trading even if one of the countries is
having an absolute advantage in both the products overx the other country,
provided the extent of absolute advantage is different in the two commodities
in question.
So, the central point of Ricardo’s theory of
comparative costs is that two countries stand to gain by specializing in the
production and export of those commodities in which they enjoy a higher
comparative cost advantage or a lower comparative cost disadvantage in exchange
for those commodities for the production of which they have lower comparative
cost advantage or higher comparative cost disadvantage.
The theory of comparative costs of Ricardo
can be explained with an example. Suppose in country A 5 units of labour
produce 1 unit of product X, and 10 units of labour produce 1 unit of product
Y, and in country B, 20 units of labour produce 1 unit of product X and 15
units of labour produce 1 unit of product Y. In this case, country A can
produce both product X and product Y at lower cost than country B. But, in
country A, the comparative cost advantage is higher in the production of
product X than in the production of product Y, and in country B, the
comparative cost disadvantage is lower in the production of product Y than in
the production of product X.
In the given example, the opportunity cost of
product X and product Y in country A and country will be as follows:
Country
A Country B
Product X 5/10
= 0.5 90/15 = 1.33
Product Y 10/5
= 2 15/20 = 0.75
From the opportunity cost of the product it
is clear that country A has comparative advantage in producing product X, and
country B has comparative advantage in producing product Y. So, country A can
speacilise in the production of product X and country B can specialize in the
production of product Y and can gain from trading.
Assumptions:
- There
are only two countries, say, A and B, and there will be only two
commodities, say, X and Y.
- There
is the existence of the barter system under which one commodity will be
exchanged for the other commodity.
- The
cost of production of the two commodities is determined only by labour
cost, i.e., the number of labour units involved in the production of each
commodity, since labour is regarded as the only factor of production.
- All
labour units all over the world are homogeneous
- The
supply of labour is unchanged.
- The
factors of production are perfectly mobile within a country, but are
immobile between countries.
Criticisms Against the Comparative Cost Theory of Ricardo
a)
In
actual practice the operation of this theory is affected by several factors
like differences in language, customs and religion.
b)
This
theory assumes, that the law of constant returns, so that additional production
can be abtained at an unchanging labour cost per unit irrespective of the size
of the scale of production.
c)
This
theory assumes labour cost as the only cost of production. It ignores altogether
other costs like cost of raw materials, cost of capital, rent, etc. This makes
the theory unrealistic.
d)
This
theory is based on the unrealistic assumption that labour is used in the same
fixed proportion in the production of all commodities. But the fact is that
labour is used in varying proportions in the production of different
commodities.
e)
This
theory assumes perfect mobility of factors of production within the country,
but complete immobility between countries. Mobility of factors between
countries has considerably increased in recent years.
f)
This
theory assumes the existence of free trade, facilitating the unrestricted flow
of commodities between the countries. But such a situation does not exist in
practice.
g)
The
theory ignores the costs of transport in international trade. But, in practice,
transport cost affect the movement of goods from one country to another
country.
h)
This
theory takes into consideration only two countries and two commodities. This is
a restrictive analysis. In actual practice, international trade involves
several countries and many commodities.
i)
Bertil
Ohil criticized this theory as clumsy and dangerous. It is clumsy because it
taken into account the supply side, but ignores the equally important demand
side.
j)
This
theory rate essentially on the assumption that we live in a world of fixed
tastes, fixed resources and fixed technology. But such a static world no longer
exists. Actually, we live in a dynamic and changing world.
k)
It
has failed to explain how the gains from international trade are shared between
the countries.
Terms of Trade
Meaning:
The
rate at which a given quantity of a country’s export goods are exchanged for a
given quantity of import goods is called the terms of trade.
Concepts of Commodity and Income Term or Measures of
Terms of Trade
Different Measures of Terms of Trade:
There
are several measures of terms of trade, each representing a different concept.
The three important measures or concepts of terms of trade are:
a)
Net
barter Terms of Trade or Commodity Terms of Trade.
b)
Gross
Barter Terms of Trade.
c)
Income
Terms of Trade
a)
Net barter Terms of Trade or Commodity Terms of Trade: The concept of net
barter terms of trade is the contribution of Mill and Marshall. The net barter
terms of trade is the ratio of the index of export prices to the index of
import prices. It is obtained by dividing the index of export prices by the
index of import prices.
In symbols, the net barter terms of trade is
expressed as follows:
Here, Px stands for the index number of
export prices, and pm stands for the index number of import prices.
Let us discuss the net barter terms of trade
with an example. If the index number of quantity of exports, i.e., Qx is 100,
and the index number of quantity of imports, i.e., QM is 80, then gross barter
terms of trade will be equal to 100/80 x100 = 125%. This means that the gross
barter terms of trade has shown an improvement of 25%.
c)
Income Terms of Trade: The concept of income
terms of trade is also referred to as a country’s capacity to import. The income
terms of trade is obtained by dividing the value of exports by the index of
import prices.
In symbols, the income terms of trade is:
Here QX represents quantity index of exports,
PX represents the price index of exports, and PM represents the index of import
prices.
Factors Determining the Terms of Trade:
- Elasticity of
Demand:
Elasticity of demand is one of the factors determining the terms of trade.
If the demand of a country for its exports is relatively less as compared
with its demand for imports, then, the prices of its exports may be higher
as compared with the prices of its imports. This will make the terms of
trade favorable to that country.
- Elasticity of
Supply:
Elasticity of supply is another important factor determining the terms of
trade. If the supply of exports from a country is relatively elastic as
compared with the supply of its imports, then, the country may be able to
enjoy favorable terms of trade.
- Availabilty of
Substitutes: Availability
of substitutes is one of the factors influencing the terms of trade; A
country may be able to enjoy favourable terms of trade, given the demand
conditions, if the products exported by her do not have close substitutes.
- Size of Demand: The terms of trade of a country are also
considerably influenced by the size of effective demand. A highly
populated country like India. May be relatively in a stronger position to
bargain over price from its imports.
- Rate of
Exchange: Rate of exchange influences the terms of
trade of a country. A country may be able to have favourable terms of
trade by appreciating the exchange value of its currency. This is because
of the fact that the prices of its exports will become relatively higher
as compared with the prices of its imports by currency appreciation.
- Production
Structure: The production structure of a country
also influence its terms of trade. If a country produces primary goods,
such as tools and raw materials, there is very possibility that the
country may experience unfavourable terms of trade, because the demand for
these products normally declines with economic development.
Role
of Terms of Trade in Economic Growth:
- Improved terms
of trade enable a country to import a larger quantity of goods from her
trading partner in return for the same quantity of her exports or the same
quantity of imports in exchange for a smaller quantity. This greatly
influences the income of the countries engaged in international trade.
- The terms of
trade play a significance role in explaining the changes in income differentials
among countries. Changes in terms of trade affect the international
distribution of income.
- Fair terms of
trade are very important for the economic development of under-developed
countries. They are a potential source of capital formation.
- Unfavourable
terms of trade accentuate the balance of payments and budgetry
difficulties of underdeveloped countries.
It may also be noted that the analysis of
terms of trade is very important in the case of developing countries for a
number of reasons. Some of those reasons are:
1.
The
volume of international trade is, generally very large in relation of their
national income.
2.
International
trade is vital for them because it helps them to acquire technical skills,
plant and machinery, etc. which are quiet essential for economic development.
Free Trade Policy
Meaning:
Free trade policy is a trade policy which
permits the flow of international trade in its perfectly natural course, free
of artificial restriction. In other words, free trade policy is the policy which
places no restrictions on the movement of goods between countries.
Advantages
of Free Trade:.
a)
Maximization
of output: Under
free trade, a country speacilises in the production of those commodities for
which it is relatively best suited and exports them in exchange for imports
which it can obtain more cheaply.
b)
Optimum
Utilisation of Resources:
Free trade contribute to international speacialisation or division of labour.
This international speacialisation facilities the optimum utilisation of
resources in each trading country.
c)
Expansion
of Markets: Free
trade contributes to expansion of markets for goods. Under free trade, the
demand for goods comes from a number of countries. This would contribute to
expansion of market for goods.
d)
Production
of Quality Goods at Low Prices:
As stated above, under free trade, there is expansion of markets for goods. The
expansion of markets for goods leads to more production. Increased production
results in lower prices of goods.
e)
Preventive
of Monopolies:
Under free trade, there is would competition. The presence of world competition
will prevent the growth of monopoly in trading countries. Thus, free trade
prevents the growth of monopolies in trading countries.
f)
Beneficial
for consumers:
Free trade benefits consumers in a number of ways. Free trade helps consumers
to get maximum supplies at minimum price. Further, free trade helps consumer to
get a variety of goods. Again, free trade helps consumers to get quality goods.
g)
Helpful
to Producers:
Free trade helps domestic producer to obtain raw materials from other countries
at cheaper prices. It helps the producers to import technology from developed
countries.
h)
Best
Policy for Economics Development:
According to some economists, free trade policy in the best policy for the
economic development of a country. In the words of Haberler, “Substantial free
trade with marginal, insubstantial corrections and deviations is the best
policy from the point of view of economic development”.
i.
Political
Advantage:
Free
trade has political advantages also. It contribute to strengthing of
international relations, and fasters international good will.
Drawbacks of
Free Trade:
a)
Not
Suitable to less Development Countries: Free trade policy encourages competition from advanced
countries. Less-developed countries cannot withstand the competition from
advanced or developed countries.
b)
Excessive
Interdependence:
Under free trade, these is excessive inter-dependence. Excessive
inter-dependence is always risky, especially in times of depression and war.
c)
Cut-throat
Competition:
Under free trade, there is the danger of cut-throat competition. Cut-throat
competition will be detrimental to the interest of less-developed countries.
d)
Danger
of Dumping: Free
trade policy may lead to dumping of goods by developed countries in developing
and under-developed countries in developing and under-developed countries.
Dumping of goods will be detrimental to domestic industries of less developed
countries.
e)
Encouraged
Importation of Luxury Goods:
Free trade may lead to importation of luxury goods and harmful goods by certain
countries. This will be detrimental to the interests of the masses of the
importing countries.
f)
No
Safeguard Against Monopoly:
One of the arguments in favour of free trade is that it helps to prevent the
formation of monopolies. But free trade provides no safeguard against the
formation of monopolies.
g)
Not
Advantageous When Applied Only by a Few Countries: Free trade will be advantageous only
when it is adopted by aall countries involved in trade. If it is adopted by all
countries involved in trade. If it is adopted only by a few countries, it is
not advantages.
Protections Policy or Policy of
Protection
Meaning:
Protectionist
policy refer to that trade policy or commercial policy of international trade
under which there will be deliberate imposition of restrictions on the
movements of goods and services between countries with a view to safeguarding
home industries or domestic industries or domestic industrie from foreign
competition.
Advantages
of Protection:
a)
Infant
Industry Argument:
This argument suggests that if the infant industry are not duly protected
against strong and well – established foreign industries the infant domestic
industries are bound to die.
It may be noted that the infant
industry argument has been refuted on several grounds. Those grounds are:
i. It is difficult to decide which
industries are infant industries and need protection
ii. When the industry us able to face
foreign competition. But it is difficult to decide about this because of lack
of reliable criteria.
iii. Once protection is granted to an
industry, vested interests are created, and it becomes almost impossible to
withdraw protection.
iv. Once an industry is protected, it will
encourage lethargy on the part of the industry. It may not have initiative to
grow at all. It is said, “Once an infant always an infant”
b)
Diversification
of Industries Argument:
According to this argument, depending on one industry or a few industries is
dangerous for a country both politically and economically, because it means too
much dependence on foreign trade, which may be cut off during war. So, a
country should have as many industries as possible.
It may be noted that this argument is
against the principle of comparative cost, which suggests that each country must
speacialise in the production of articles in which it has comparative
advantage.
c)
Key
Industry Argument:
Key or basic industries, which lay the foundation of industrial development,
must be developed. The key industry argument suggests that key industries,
which are crucial for the industrial development of a country.
d)
Balance
of Payments Argument:
Protection is also advocated on the ground of balance of payments. It is argued
that it is necessary to check imports by means of tariff in order to rectify an
advice balance of payments.
e)
Employment
Argument: It is
argued that industrial development through protection increases employment in a
country. If protection is not given to established industries, foreign
competition may ruin those industries and this would create unemployment in the
country.
f)
Conservation
of Natural Resources Argument:
This argument suggests that protection should be given to industries in order
to converse the natural resources of the country.
g)
Defence
Argument: The
defence argument implies that a country must actively encourage the development
of those industries which are essential from the point of view of defence, even
though it may result in uneconomic distribution of natural resources.
h)
Revenue
Argument:
Protection is also advocated for purposes of revenue. For instance, when
protective import duties and export duties are imposed, they will certainly
during in revenue.
Disadvantages of Protection:
a)
Vested
interests are created under protection. Once certain industries are given
protection, they claim it as a matter of right, and it becomes very difficult
to take away the protection.
b)
Once
foreign competition is removed through protection, the home industries may not
try to make any improvements. As a result technical progress comes to stand
still.
c)
There
sis the danger of corruption under protection. The protected industries may
bribe the legislator so that protection is not taken away.
d)
Protection
creator monopoly. When protection is given and foreing competition is removed,
the domestic industries are tempted to combine themselves.
e)
Protection
is harmful to consumers in many respects. Consumers have to pay higher prices
for the products of protected industries.
f)
The
distribution of wealth becomes more uneven under protection. This is because
protection favours the rich capitalists who become still richer. As a result,
the gulf between the rich and the poor is widened still further.
g)
Protection
leads to conflict, friction and retaliation in international dealings. It may
even lead to wars between countries.
h)
Protection
hamper against optimum utilisation of resources. It hampers international
division of labour, and as a result, labour, capital and other factors of
production do not find their most remunerative employment.
Foreign
Exchange
Meaning:
The term
‘foreign exchange’ is, generally used to refer to foreign currencies. But the
foreign exchange is also used to refer to the mechanism by which the curreny of
one country is converted into the currency of another country.
Need
for Foreign Exchange:
In the case
of foreign trade, there is trade between one country and another. Each country
has its own currency. So, for the settlement of foreign trade transactions, the
currency of one country is required to be exchanged for the currency of another
country.
Reasons
for the People to Acquire Foreign Country:
I. To purchase goods and services from
for other countries
II. To purchase financial assets in
foreign countries
III. To send gifts abroad
IV. To speculate on the value of foreign
currencies.
Meaning
of Foreign Exchange Rate:
The rate at
which the currency of one country is exchanged for the currency of another
country is called the exchange rate or the rate of exchange. In other words the
exchange rate is the price which paid in domestic currency for a foreign
currency.
Significance
of Foreign Exchange Rate:
I. By linking the currencies of different
countries foreign exchange rate facilities the comparison of international
costs and prices.
II. Foreign exchange rate also governs the
flow and direction of foreign trade.
Factors
Affecting Exchange Rate:
I. Balance of payments: Balance of payments is one of the
important factors influencing the exchange rate. For instance, if the balance
of payments of a country is a surplus, the demand for the currency of that country
in the exchange market will be higher than its supply.
II. Inflation: Inflation is another factor that
influences the exchange rate, with inflation in a country; the prices of the
products produced in a country will not be competitive in the world market. As
a result, the exports from that country would decline.
III. Interest Rates: Interests rates are
one of the factors influencing the exchange rate. Increase in interest rates in
a country attracts short term funds from abroad and results in increase in the
demand for the currency of that country.
IV. Money Supply: Money supply also
influences the exchange rate. Increase in money supply in a country causes
inflation in that country, and this would lead to decline in the value of the
currency of that country.
V. National Income: National income is
one of the factors influencing the exchange rate. Increase in national income
of a country will result in higher demand for goods and higher production.
Higher production may lead to higher exports from that country.
VI. Movement of Capital: Movement of
capital also influences the exchange rate. Better investment climate may
encourage movement of capital to that country from abroad. Inflow of foreign
capital will result in higher demand for the currency of that country.
VII. Political Stability: Political
stability also influences the exchange rate. Political stability in a country
infuses confidence in the investors. As a result, there will be capital inflow
into that country.
Types
of Exchange Rates:
a) Fixed Exchange Rate: Fixed exchange
rate refers to the maintenance of the external value of the currency at a
pre-determined level. Under the fixed exchange rate system, the exchange rate
is officially declared and is fixed. It is not determined by the supply of and
demand for foreign exchange.
Advantages of Fixed Exchange Rate System
i. Fixed exchange rate system helps in
the promotion of international trade and investment, as it prevents risk and
uncertainty in transactions.
ii. Fixed exchange rate system ensures
that major economic disturbances, which will weaken the economic policies of
member countries, do not occur.
iii. Fixed exchange rate system helps to
co-ordinate the macro policies of countries in an inter-dependent world
economy.
iv. Fixed exchange rate system facilitates
long-range planning.
v. Fixed exchange rate system prevents
speculation.
Floating
or Flexible Rate Exchange:
Floating
exchange rate refers to the exchange rate which is determined by the conditions
of demand for and supply of the foreign exchange in the exchange market.
Advantages
of Floating or Flexible Exchange Rate System:
i. Under the flexible exchange rate
system, foreign exchange market clears automatically by supply of and demand
for foreign exchange. There is no need for any agency to intervene in the
exchange market.
ii. It is helpful to do away with the
barriers to international trade and international capital movements.
iii. Under the floating exchange rate
system, there is no need for the central bank to hold international reserves.
iv. Flexible exchange rate system increase
the efficiency in the econom by achieving optimum resources allocation.
Concept of
Euro
What is Euro?
Euro is the
single common currency of 12 countries of the European Union.
international
financial institutions
1.
International Monetary Fund (I.M.F.) or The Fund
Introduction:
The
international economic and monetary conference at Beetton Woods in New
Hampshire in the U.S.A. at July 1944. At the conference, the ‘Keynes’ plan were
discussed in detail by 44 countries, and it was decided to start two international
financial institution namely
I. International Monetary Fund and
II. The International Bank for
Reconstruction and Development for helping member countries.
Objectives of
the I.M.F.
- To promote international monetary
co-operation for the solution of international monetary problems.
- To ensure stable exchange rates
and avoid competitive exchange depreciation.
- To eliminate exchange controls
- To encourage international trade
by removing exchange restrictions.
- To establish multinational trade
and payments system.
- To
provide short-term funds to member countries and enable them to correct
the temporary deficits in their balance of payments without resorting to
measures destructive of national or international propriety.
- To
help the member countries, particularly the backward countries their
productive resources, maintain higher levels of employment, secure more
national income and achieve balanced economic growth.
Membership of the Fund:
The IMF started functioning with an
initial number of 44 members i.e., all the 44 members of the U.N.O. present at
the Bretton Woods conference. The IMF has 151 members. New members may be
admitted to the Fund at any time at the discretion of the Fund.
Organisation and Management of the
Fund:
The fund is an autonomous
organisation. It is affiliated to the U.N.O. Its headquarters are, at present,
located at Washington in the U.S.A.
The management of the fund is
entrusted to a board of Governors, a Board of Executive directors, a managing
Directors, a Managing Director and other staff.
Resources of the Fund:
The contribution of each member
country is payable partly in gold or U.S. dollars and partly in its own
national currency. The gold part of each member’s contribution is 25% of its
quota or 10% of its total gold holdings, which ever is less.
The initial capital of the Fund as per
the quotas fixed for the original members was 8,800 million U.S. dollars. The
quarters of member countries had been increased from time in order to enable
the Fund to increase its resources.
Functions of
the Fund:
- Granting
of Loans of its Financial Resources: The fund can use its resources for granting loans
to member contrives. A member country facing a temporary deficit in its
balance of payments (i.e., shortage of foreign exchange) can purchase from
the fund the required foreign currency to meet the deficit by offering its
own currency in exchange.
The amount of loans that a country can
borrow from fund in any one year should not exceeds ¼ of its quota, and the
total amount of its loans outstanding at any time should not exceed 1¼ of its
quota.
- Promotion
of Exchange Stability:
The fund is convinced that stable exchange rates are essential for the
balanced growth of multilateral trade with this and in view, it has takes
upon itself the responsibility of maintaining stable exchange rates among
the currencies of member countries.
- Management
of Scare Currencies:
Some times, it may so happen that many member countries may demand from
the fund the currency of one particular country. If such a situation
arises, the fund will try to increase the supply of that currency either
by borrowing from the country concerned.
If the supply of that currency still
proves to be insufficient to satisfy the needs of all the needy members, the
fund declares the currency scare.
- Elimination
of Exchange Control and other Exchange Restrictions: The funds feels that, if there
are restrictions on purchase and sale of foreign exchange, the rates of
exchange agreed upon case to be effective. So, if wants to ensure that
there are no exchange control and other exchange restrictions on ordinary
trade and current transactions.
Critical
Appraisal of the Working of the Fund
The Fund
started functioning the noble objectives, such as promotion of international
monetary co-operation, avoidance of competitive exchange depreciation and
maintenance of exchange stability, promotion of international liquidity,
removal of exchange controls and restrictions.
Achievement
of IMF
- Promotion of International
Monetary Co-operation: The IMF has really promoted international monetary
consultation and co-operation. It has provided machinery for consultation
in international monetary affairs. Its considered opinion has influenced
the policies and decisions of many member countries.
- Promotion of Exchange Stability:
Today, most of the member countries enjoy the benefits of fixed as well as
fluctuating exchange rates.
This
is due to the efforts of the IMF by avoiding competitive exchange devaluations,
and permitting devaluations, wherever necessary.
- Avoidance of Multiple Exchange
Rates: The removal of multiple exchange rates, which are harmful to
international trade, is one of the aims of the fund.
The
IMF has been successful in preventing the members from adopting the practice of
multiple exchange rates.
- Elimination f Exchange Control
and others Restrictions: The fund has stimulated the growth of
international trade by preventing the members from imposing exchange
controls and restrictions.
IMF
also has permitted them to impose exchange controls. But those exchange control
were permitted only under special circumstances.
- Promotion of International
Liquidity: The term “International liquidity” refers to the financial are
sources and facilities available to the members of the I.M.F. for setting
the deficit in their international balance of payment.
Importance features of SDRs are:
a. The special drawings rights are over
and above the ordinary or general drawing rights. In other words, they are
additional rights.
b. The special drawing rights are not
available for ordinary commercial uses, i.e., for buying goods and services in
other countries. They are meant for use only by the central bank of a member
country for meeting the balance of payments deficit.
c. There are certain restrictions on the
use of SDRs by the participating members. They are:
i. A member country can use its SDR’s
only when it faces a deficit in its balance of payments SDR’s cannot be used
for ordinary commercial purposes.
ii. A member country can, normally, use
only 70% of its SDR allocations in a year. In case a greater proportion of SDR
allocation has been used by a country in any one year.
iii. A country which receives SDRs in
exchange for convertible currencies is also required to provide convertible
currencies only upto a certain limit.
iv. A country whose holdings of SRDs are
in access of its cumulative allocations is entitled to interest on the excess,
while a country, which has deficiency of SDRs, is required to pay interest on
the deficit.
Failures of IMF
- Fixation of exchange rates: In
the matles of fixation of exchange rates, initially and subsequently, the
fund allowed a weak and passive policy. It had not tried to determine the
correct exchange rates at least in respect of important currencies.
- Free convertibility of
currencies: One of the aims of the fund is to bring about a system of free
convertibility of currencies. But, so far, the fund has not succeeded in
achieving this objective.
- Gold Policy: The articles of the
fund require that no member should buy or sell gold at prices other than
the par value of its currency. But this provision was ignored by the gold
producing countries, and the fund could not do anything in this respect.
- Regulation of scarce currencies:
As per the articles, the fund could declare a currency scarece, when its
holding of that currency are not sufficient to meet the demand for it. The
scarcity of the U.S. dollars was felt all over the world.
International
Bank for Reconstruction and Development, I.BR.D. or World Bank
Introduction:
The
outcome of the Bretton Woods conference held in July 1994. It came into
existence in December 1945 and began its opercition in June 1946.
Need
for the establishment of the World Bank:
No doubt, the
international monetary fund, the first of the twins born at Bretton woods, is
an international financial institution intended for providing financial
assistance from the IMF is available only for correcting a temporary
disequilibrium in the balance of payments of member countries, and not for
adjusting the fundamental disequilibrium in the balance of payments.
Objectives
of IBRD:
- To help in the reconstruction of
economics disrupted by the war and the development then long – term
investment loans on reasonable terms.
- To promote private foreign
investment by guaranteeing the repayment of loans made by private foreign
investors.
- To guide international
investments into productive channels
- To promote multilateralism in
international trade by granting united loans and permitting the borrowing
countries to spend the loans proceeds in purchasing equipments and goods
from any country they like.
- To promote the long-term balanced
growth of international trade and the main tenance of equilibrium in the
balance of payments of member of countries by encouraging foreign
investments for the developments of the productive resources of the member
countries.
- To provide assistance in
improving the economic development and the standard of living of the
people of member countries.
Functions
of the World Bank:
- Granting Loans:
i. Loans are, ordinarily, given either to
the Government or to the central banks of member countries.
Loans
are given even to private enterprises in member countries. But loans will be
given to private enterprises in member countries, only if the repayment of such
and the payment of interest thereon are guaranteed by the Governments.
ii. Loans will be granted to a member
country, only if the bank is satisfied with the capacity of the borrowing
country to marks use of and to repay the loans.
iii. Loans will be given only for specific
projects.
iv. Loans will be given only if the bant
is satisfied with the soundness of the specific projects for which loans are
sought.
v. Loans will be given only if the bank
is convinced with the feasibility of the objects.
vi. Generally, loans will be given only
for projects like transport, power development irrigation, agriculture,
industry, etc. which contribute directly to the productive capacity, and not
for projects of social character, such as housing, education, etc.
vii. Loans will be given only to meet the
foreign exchange requirements of any projects. The borrowing country is
excepted to mobilize its domestic resources for meeting the domestic currency
requirement of the project.
viii. Loans will be given only when the
borrowing country is not able to raise funds from the normal sources on its own
efforts.
- Provision of Technical
Assistance:
Another important function of the Bank is the
provision of technical assistance to the member countries. It sends to the
member countries its economic experts to carry out the general survey of their
physical or economic resources. It assigns highly qualified experts to the
member countries to provide advice on economic development programmes.
- Other Functions:
In
additional to the provision of financial & technical assistance to member
countries, the Bank performs some other functions also. It uses its good
offices for the settlement of disputes between member countries for instance;
it has settled the disputes between India & Pakistan
regarding the sharing of the water of the Indusbarin. Similarly it settled the
dispute between England
and U.A.R.
Evaluations of the Working of the World Bank:
- No doubt, initially, the bank’s
financial resources were limited, and so, it could not provide much
assistance to member countries. But in courses of time, it has increased
its financial resources by raising its capital and by borrowing funds
through the sale of bands in members.
- By providing funds for productive
purpose, such as agriculture, irrigation, electric power, transport &
communication etc, which constitute the infrastructure for the economic
development of a country, the bank has contributed to the economic
development of many developing countries.
- It has encouraged private foreign
investment by giving guarantees and sending to member countries only when
they are not able to raise funds from private investors on liberal terms.
- Besides financial assistance, it
has provided even technical assistance to member countries in soluing
their economic problems.
- It has also settled economic
disputes between member countries, and there by, enabled the member
countries to utilize their resources for rapid economic development.
