International Finance
 An English princess with an Egyptian
boyfriend, crashes in a French tunnel,
driving a German car with a Dutch
engine, driven by a Belgian who was
drunk on Scottish whisky, followed
closely by Italian paparazzi, on
Japanese motorcycles, treated by an
American doctor, using Brazilian
medicine. And we read it in Indian
news paper.
 This is GLOBALIZATION…
Globalization
•“Globalization is shift towards not independent but
interdependent and integrated economic system.” wherein
the economies are brought together for trade and
commerce and in this sense opening of economies by
removal of Trade and investment barriers. The idea has
been the whole world is conceived as “Global Village” with
an objective of Global welfare and harmony among
nations.
Globalization of Markets
Globalization of Products
Globalization
PROS
CONS
Access to New Markets
Increased Competition
Spread of Knowledge and
Technology
Exploitation of Labour and
Resources
Enhanced Global
Cooperation and Tolerance
Imbalanced Trade
Promotes Economic Growth Adverse effect on domestic
market
Balance of Payment

A systematic record of all economic transactions
between the residents of two countries during a specific
period of time.

Presents a classified record of all receipts on account of
goods exported, services rendered and capital received
by residents.

BoP is merely a way of listing receipts and payments in
international transactions for a country.
Balance of Payment
 A
country’s balance of payments accounts keep track of
both its payments to and its receipts from foreigners.
 Any
transaction resulting in a payment to foreigners is
entered in the balance of payments accounts as a debit and
is given a negative (—) sign.
 Any
transaction resulting in a receipt from foreigners is
entered as a credit and is given a positive (+) sign.
Balance of Payment

The balance of Payment consists of two parts:

The Current Account

The Capital Account

The current account includes the visible trade
(tangible goods) & the invisible trade (services).

The Balance of trade is another term used to
describe the balance of only visible items –
goods.

The balance of trade is included in the current
account.
The Current Account includes :
 The Current Account consists of:
 Balance of Trade Account (Visible Trade)
 Plus Invisible Trade
 Invisible includes:
 Services – Tourism, Banking etc.
 Income – Profits, Interest and Dividends
 Transfers – Remittance, Donations, Gifts
The Capital Account includes :
 The Capital Account includes:
 Investments – FDI & FII
 Loans – Sovereign and Commercial
 Banking Capital – FCNR accounts etc.
 Reserves
Current Account transactions
Cash ( Receipt)
Item
Goods Exported
Services Exported
Income from Foreign
Investment
Unilateral receipts
Sub Total
Deposits ( Payments)
$ ( in bn)
200
100
200
100
-----600
------
Item
$ ( in bn)
Goods Imported
Service Imported
Foreign income from
investment at home
Unilateral payments
Sub Total
300
200
200
100
-----800
------
Capital Account transactions
Cash ( Receipt)
Item
Deposits ( Payments)
$ ( in bn)
Long Term Borrowings 200
Short Term Borrowings 100
Sale of Gold / Assets 100
-----Sub Total
400
------
Item
$( in bn)
Long term Lendings
Short term Lendings
Purchase of Gold / Assets
Sub Total
080
060
050
-----190
------
Current & Capital Account Together
Cash ( Receipt)
Current Account
Deposits ( Payments)
Sub Total
600
Sub Total
800
Capital Account
Cash ( Receipt)
Deposits ( Payments)
Sub Total
400
Grand Total
1000
Sub Total
Errors & Omissions
Grand Total
190
010
1000
Exchange Rates
 When
individuals, businesses and governments in one
country want to trade, borrow or lend in another
country, they must convert their currency into the other
country’s currency for the transaction.
 Exchange rates are important because they enable us to
translate different counties’ prices into comparable
terms.
 Exchange rates are determined in the same way as other
asset prices i.e. supply and demand.
Exchange Rates

We get foreign currency and foreigners get
Indian rupees in the foreign exchange
market—the market where currency of one
country is exchanged for another.

The price at which one currency exchanges for
another is called a foreign exchange rate.

Currency depreciation is the fall in the value of
the currency in terms of another currency.

Currency appreciation is the rise in value of the
currency in terms of another currency.
Foreign Exchange Market
Kindelberg – Foreign exchange market is a place where
foreign money is bought and sold.
Features of Foreign Exchange Market
a) Electronic Market
b) Transfer of Purchasing Power
c) Intermediaries
d) Geographical dispersion
e) Volume
f) Credit provision
g) Minimizing risk

Foreign Exchange Market




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TYPES OF FOREIGN EXCHANGE MARKET
SPOT MARKET
FORWARD MARKET
FUNCTIONS OF FOREIGN EXCHANGE MARKET
TRANSFER
CREDIT
HEDGING
International Trade
Items involved in International trade are
a) Merchandise or Goods (commodity or
brands)
b) Services
c) Investments
d) Technologies etc.
International Investments
 Theory of International Investments
indicate that firms particularly MNC’s
integrate their competitive advantages
with needs of foreign countries to
optimize returns.
 It is carried out in two forms :
 Foreign Direct Investment
 Foreign Portfolio Investment
• Foreign Direct Investments
• Firms carry capital to countries abroad through their
subsidiaries or corporate units to control income-generating
assets (by acquiring more than 10% equity).
• It may create new physical facilities or acquire existing ones
to operate.
• For example, Daimler Benz has set up automobile
manufacturing unit in Pune through 100% FDI; Vodafone
acquired Hutch etc.
• Generally, FDI are long-term in nature undertaken by
Individuals, institutions or business enterprises.
•Generally when a company wants to have more control over
decision making in a host country’s operations, it prefers FDI.
Foreign Portfolio Investments
• When firms or individuals use capital in foreign nations
to earn return without concern about control on use of
capital, it is called FPI (generally, equity acquired is less
than 10%).
• For example, Morgan Stanley, a mutual fund from US
acquires 10000 shares of say Infosys or ITC in Mumbai.
• FPI generally enters host countries through Foreign
Institutional Investors (FII)
• Foreign currency Convertible Bonds like GDR’s, ADR’s
etc
• Investment by NRI’s into Indian companies without
concern for control.
The Gold Standard: A Fixed
Exchange Rate System
 Between 1867 and 1933, most of the world’s
economies used the gold standard.
 Gold standard – a system of fixed exchange
rates in which the value of currencies was
fixed relative to the value of gold and gold
was used as the primary reserve asset.
The Gold Standard: A Fixed Exchange Rate
System
 Under the gold standard, the amount of
money a country issued was directly tied to
gold.
 By fixing its currency’s price to gold, it
automatically fixed its currency’s price to other
currencies.
 Gold flowed out of the country when it
experienced a balance of payments deficit
and into the country with a balance of
payments surplus.
 With the outbreak of World War 1, the gold
standards system came to an end.
 Physical transfer of gold started becoming a
problem. Even a very small piece of gold had
its own value.
 Scarcity of gold fuelled the problems and
most of the nations discarded the Gold
Standards.
Bretton Woods (1944 - 1973)

44 countries met at Bretton Woods, US to design a
new system in 1944

Established:

International Monetary Fund (IMF) and World Bank

IMF: maintain order in monetary system

GATT : Reduction in tariff

World Bank: promote general economic
development

Fixed exchange rates pegged to the US Dollar

US Dollar pegged to gold at $35 per ounce

Countries maintained their currencies ± 1% of the
fixed rate; buy/sell own currency to maintain level
 By the early 1970s, the number of U.S.
dollars held by foreigners exceeded the
amount of U.S. gold.
 When France and other countries demanded
gold for their dollars, the U.S. ended its policy
of exchanging gold for dollars in 1971.
 With that change, the Bretton Woods system
was dead.
International Monetary Fund ( IMF )
 Established on 27th December 1945 and began financial
operations on March 1,1947
 Result of Bretton –Woods Conference of nations
 Open to every country that controls its foreign relations and is
able and prepared to fulfill the obligations of membership.
 Membership is prerequisite for membership in the World
Bank (IBRD)
 In 2020, IMF had a membership of 190 countries.
 India is one of the founder members of IMF and World Bank
IMF RESOURCES
 At the April 2, 2009 G-20 summit, world leaders pledged to
support growth in emerging market and developing countries
by boosting the IMF's lending resources to $750 billion.
 The IMF’s resources are provided by its member countries,
primarily through payment of quotas, which broadly reflect
each country’s economic size.
 A member’s quota is determined by its economic weight in the
global economy.
 A member’s quota determines its voting power and size of
loan it can borrow
PURPOSES
 Monitors economic and financial developments
and policies – gives policy advice
 Lends to member countries with BoP problems
 Provides governments and Central Banks of
member countries with technical assistance and
training in its areas of expertise.
World Trade Organization: History
 Mid-1940s:
Meeting in Bretton Woods, New Hampshire,
Created IMF and World Bank
 US tried to create ITO = International Trade
Organization
 Interim agreement: GATT = General Agreement
on Tariffs and Trade
 When ITO failed to be approved (by US!), GATT
governed trade policy by default

World Trade Organization: History

What GATT (and WTO) Does
 Rules for trade policy
 Forum for negotiation
 Of both trade policies (tariffs) and rules
 Negotiations take place in “Negotiating
Rounds”
 Decisions made at occasional meetings of
trade ministers: “Ministerial Meetings”
Born in 1995, but not so young
The WTO began life on 1 January 1995, but its trading system
is half a century older. Since 1948, the General Agreement on
Tariffs and Trade (GATT) had provided the rules for the
system.
 It did not take long for the General Agreement to give birth to
an unofficial, de facto international organization, also known
informally as GATT. Over the years GATT evolved through
several rounds of negotiations.
 The last and largest GATT round, was the Uruguay Round
which lasted from 1986 to 1994 and led to the WTO’s
creation. Whereas GATT had mainly dealt with trade in
goods, the WTO and its agreements now cover trade in
services, and in traded inventions, creations and designs
(intellectual property).

World Trade Organization: Rounds
Rounds of GATT
Multilateral Trade Negotiations
No.
Years
Name
Accomplishments
1-5
1947-61
6
1964-67
Kennedy Tariffs + anti-dumping
7
1973-79
Tokyo
Tariffs + NTBs
8
1986-94
Uruguay
Tariffs, NTBs, Services, Intellectual Property,
Textiles, Ag., Dispute Settlement, Created WTO
9
2001-?
Doha
? (Doha Development Agenda)
Reduced tariffs
WTO Principles
 Non-Discrimination (MFN treatment)
 Freer trade, predictable policies, encouraging
competition
 Extra provisions for LDCs.
The different divisions of the World bank
One group - Five agencies
 IBRD (The International Bank For Reconstruction
and Development):
provides loans and development assistance to
middle-income countries
 IDA (International Development Agency):
Interest free loans and grants to poorest
countries
 IFC (International Finance Corporation):
Financing private sector investments and
technical assistance to governments and
business
 MIGA (Multilateral Investment Guarantee
Agency):
Provides guarantees to foreign investors – also
technical assistance to help developing countries
promote investment
 ICSID (International Centre for the Settlement of
Investment Disputes)
Exchange Rates
 An exchange rate can be quoted in two ways:

Direct quote:
 The price of the foreign currency in terms of domestic currency.
 Example: Rs. 46.350 per $.

Indirect quote:
 The price of domestic currency in terms of the foreign currency.
 Example: $ 0.02158 per rupee.
Spot and Forward Markets
 Spot markets: market for immediate delivery
of currency.
 Forward contract: an agreement between two
parties in which one party agrees to buy
currency from the other party at a later date
at an exchange rate agreed upon today.
 No central marketplace.
 Risk in forward markets.
Appreciation and Depreciation of
Currencies
 Appreciation of a currency is the increase
in its value in terms of another currency.
 When Indian rupee in dollar terms
appreciate, the dollar would depreciate.
 If the value of Indian rupee in terms of US $
falls, the Indian rupee is said to depreciate.
Floating and Fixed Exchange Rate
System

Since exchange rate is a price, its determination can be
explained by demand for and supply of currencies.

The system of exchange rate where the value of a
currency is allowed to adjust freely as determined by
demand for and supply of foreign exchange is called
flexible exchange rate system.

If the exchange rate instead of being determined by
demand and supply is fixed by the govt., it is called
fixed exchange rate system.
The Equilibrium of Exchange Rate
The equilibrium rate
is equal to OR.
At a higher price
OR’ the qty.
supplied exceeds
the demand.
Exchange rate will
fall again to OR
If the rate is lower
i.e. OR” there is
excess demand,
pushing the price to
OR

Y
S
D

Price of Dollar
Excess Supply
R’ 44

R
42.50

R”
40
Excess Demand
D
S
O
Q Quantity of Dollars
X
Changes in Exchange Rate

We have assumed that the underlying forces
which determines demand and supply of forex
remains constant.

The equilibrium in the forex market will be
disturbed if some changes occurs in the
underlying factors.

If the income of American increases, it increase
the demand for imported goods and services

This will increase the supply of dollar and affect
the equilibrium rate.
Changes in Exchange Rate
Price of Dollar
D’
Y
D
R
42.50
R’
40

The supply curve SS
would shift to right to
S’S’.

This increase in
supply of dollar will
lower the price of
dollar from rupees OR
(Rs 42.50) to OR’ (Rs
40)

Increase in imports by
US from India will
cause the dollar to
depreciate and Indian
rupee to appreciate.
S
S’
E
F
D’
S
D
S’
O
Q
Q’
Quantity of Dollars
X
Changes in Exchange Rate

Due to increase in income of Indians causing a
rise in demand for American goods, or

Picking up of industrial activity in India
requiring import of materials, machine,
equipment and other capital goods from US.

This will increase the demand for dollar thus
demand curve for dollar would shift to the right
from DD to D’D’.
Changes in Exchange Rate
 This will upset the initial equilibrium at price
OR (Rs 42.50)
 There will emerge excess demand for dollar
which will push the price of dollar to OR” (Rs.
44)
 And the amount of dollar spent by Indian on
imports increases to Q”.
Changes in Exchange Rate
D’
Price of Dollar
Y
R”
R
S
D
G
44
E
42.50
D’
S
D
S’
O
Q
Q”
Quantity of Dollars
X