INTRODUCTION

The foreign trade of a country refers to its import and export of merchandise from
and to other countries under contract of sale. No country in world produces all the
commodities it requires. The commodities which country produces in surplus, it
exports, while those producing in deficit, it imports. In short, foreign trade refers to
Exchange of goods and services between two or more different countries. Such
trade is also known as International Trade. If the seller is abroad and the buyer is in
the home country, exchange of goods between them is called Import. If the seller is
in home country and the purchaser is abroad, the Trade between them is called
Export. A foreign trade can be further classified in to two according to visibility. a)
Visible b) Invisible. A trade which can seen i.e. exchange of goods, merchandise
is a visible trade. Whereas, exchange of services between the purchaser and seller
is invisible trade i.e. technical know-how, insurance etc.
Definition: The exchange of goods or services along international borders. This
type of trade allows for a greater competition and more competitive pricing in
the market. The competition results in more affordable products for the consumer.
The exchange of goods also affects the economy of the world as dictated by supply
and demand, making goods and services obtainable which may not otherwise be
available to consumers globally.
Balance of payments (BOP) accounts are an accounting record of all monetary
transactions between a country and the rest of the world. These transactions
include payments for the country's exports and imports of goods & Capital
transfers which are concerned with capital receipts and capital payment. Invisible
items which include all those services whose export and import are not visible. e.g.
transport services, medical services etc. Visible items which include all types of
physical goods exported and imported. A country has to deal with other countries
in respect of 3 items: services, financial capital, and financial transfers.
According to Kindle Berger, "The balance of payments of a country is a systematic
record of all economic transactions between the residents of the reporting country
and residents of foreign countries during a given period of time".

FOREIGN TRADE
International trade is the exchange of capital, goods,
and services across international borders or territories, which could involve the
activities of the government and individual. In most countries, such trade
represents a significant share of gross domestic product (GDP). While
international trade has been present throughout much of history
(see Uttarapatha, Silk Road, Amber Road, salt road), its economic, social, and
political importance has been on the rise in recent centuries. It is the presupposition
of international trade that a sufficient level of geopolitical peace and stability are
prevailing in order to allow for the peaceful exchange of trade and commerce to
take place between nations.
Trading globally gives consumers and countries the opportunity to be exposed to
new markets and products. Almost every kind of product can be found on the
international market: food, clothes, spare parts, oil, jewelry, wine, stocks,
currencies and water. Services are also traded: tourism, banking, consulting and
transportation. A product that is sold to the global market is an export, and a
product that is bought from the global market is an import. Imports and exports are
accounted for in a country's current account in the balance of payments.
Industrialization, advanced technology,
including transportation, globalization, multinational corporations,
and outsourcing are all having a major impact on the international trade system.
Increasing international trade is crucial to the continuance of globalization.
Without international trade, nations would be limited to the goods and services
produced within their own borders. International trade is, in principle, not different
from domestic trade as the motivation and the behavior of parties involved in a
trade do not change fundamentally regardless of whether trade is across a border or
not. The main difference is that international trade is typically more costly than
domestic trade. The reason is that a border typically imposes additional costs such
as tariffs, time costs due to border delays and costs associated with country
differences such as language, the legal system or culture.
Another difference between domestic and international trade is that factors of
production such as capital and labor are typically more mobile within a country

than across countries. Thus international trade is mostly restricted to trade in goods
and services, and only to a lesser extent to trade in capital, labor or other factors of
production. Trade in goods and services can serve as a substitute for trade in
factors of production. Instead of importing a factor of production, a country can
import goods that make intensive use of that factor of production and thus embody
it. An example is the import of labor-intensive goods by the United States from
China. Instead of importing Chinese labor, the United States imports goods that
were produced with Chinese labor. One report in 2010 suggested that international
trade was increased when a country hosted a network of immigrants, but the trade
effect was weakened when the immigrants became assimilated into their new
country.
International trade is also a branch of economics, which, together
with international finance, forms the larger branch called international economics.
Trading is a value-added function: it is the economic process by which a product
finds its market, in which specific risks are to be borne by the trader.
HISTORY
The history of international trade chronicles notable events that have affected the
trade between various countries.
In the era before the rise of the nation state, the term 'international' trade cannot be
literally applied, but simply means trade over long distances; the sort of movement
in goods which would represent international trade in the modern world.
In the 21st century, the European Union, United States and China are the three
largest trading markets in the world.

MODELS
Adam Smith's model[edit]
Adam Smith displays trade taking place on the basis of countries
exercising absolute advantage over one another.

Ricardian model[edit]

The Ricardian model focuses on comparative advantage, which arises due to

differences in technology or natural resources. The Ricardian model does not
directly consider factor endowments, such as the relative amounts of labor and
capital within a country.
The Ricardian model is based on the following assumptions:

Labor is the only primary input to production

The relative ratios of labor at which the production of one good can be
traded off for another differ between countries and governments

HeckscherOhlin model[edit]
In the early 1900s, a theory of international trade was developed by
two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory has
subsequently been known as the HeckscherOhlin model (HO model). The results
of the HO model are that countries will produce and export goods that require
resources (factors) which are relatively abundant and import goods that require
resources which are in relatively short supply.
In the HeckscherOhlin model the pattern of international trade is determined by
differences in factor endowments. It predicts that countries
will export thosegoods that make intensive use of locally abundant factors and will
import goods that make intensive use of factors that are locally scarce. Empirical
problems with the HO model, such as the Leontief paradox, were noted in
empirical tests by Wassily Leontief who found that the United States tended to
export labor-intensive goods despite having an abundance of capital.
The HO model makes the following core assumptions:

Labor and capital flow freely between sectors

The amount of labor and capital in two countries differ (difference in

endowments)

Technology is the same among countries (a long-term assumption)

Tastes are the same

Applicability[edit]
In 1953, Wassily Leontief published a study in which he tested the validity of the
Heckscher-Ohlin theory.[8] The study showed that the United States was more
abundant in capital compared to other countries, therefore the United States would
export capital-intensive goods and import labor-intensive goods. Leontief found
out that the United States' exports were less capital intensive than its imports.
After the appearance of Leontief's paradox, many researchers tried to save the
Heckscher-Ohlin theory, either by new methods of measurement, or by new
interpretations. Leamer[9]emphasized that Leontief did not interpret H-O theory
properly and claimed that with a right interpretation, the paradox did not occur.
Brecher and Choudri[10] found that, if Leamer was right, the American workers'
consumption per head should be lower than the workers' world average
consumption.[11][12] Many textbook writers, including Krugman and Obstfeld and
Bowen, Hollander and Viane, are negative about the validity of H-O model.[13]
[14]
After examining the long history of empirical research, Bowen, Hollander and
Viane concluded: "Recent tests of the factor abundance theory [H-O theory and its
developed form into many-commodity and many-factor case] that directly examine
the H-O-V equations also indicate the rejection of the theory."[14]:321
In the specific factors model, labor mobility among industries is possible while
capital is assumed to be immobile in the short run. Thus, this model can be
interpreted as a short-run version of the Heckscher-Ohlin model. The "specific
factors" name refers to the assumption that in the short run, specific factors of
production such as physical capital are not easily transferable between industries.
The theory suggests that if there is an increase in the price of a good, the owners of
the factor of production specific to that good will profit in real terms.

Example: Finland produces ocean cruisers and leather products such as reindeer
fur, mink and fox coats.Lapland, the northern part of Finland, is sparsely inhabited
by mostly Indians who hunt these wild animals. This cold climate or forest is a
factor specific in the leather goods industry.
In the urban areas Finns are also engaged in cruise ship building and Finland
exports cruisers to European countries. In addition to well educated workers, the
ship building industry requires a large amount of capital, which is specific to that
industry in that it cannot be used in the leather goods industry. Finnish workers are
mobile between the two industries.
Additionally, owners of opposing specific factors of production (i.e., labor and
capital) are likely to have opposing agendas when lobbying for controls over
immigration of labor. Conversely, both owners of capital and labor profit in real
terms from an increase in the capital endowment. This model is ideal for
understanding income distribution but awkward for discussing the pattern of trade.

New Trade Theory[edit]

Main article: New Trade Theory
New Trade Theory tries to explain empirical elements of trade that comparative
advantage-based models above have difficulty with. These include the fact that
most trade is between countries with similar factor endowment and productivity
levels, and the large amount of multinational production (i.e., foreign direct
investment) that exists. New Trade theories are often based on assumptions such
as monopolistic competition and increasing returns to scale. One result of these
theories is the home-market effect, which asserts that, if an industry tends to cluster
in one location because of returns to scale and if that industry faces high
transportation costs, the industry will be located in the country with most of its
demand, in order to minimize cost.
Although new trade theory can explain the growing trend of trade volumes of
intermediate goods, Krugman's explanation depends too much on the strict
assumption that all firms are symmetrical, meaning that they all have the same

production coefficients. Shiozawa, based on much more general model, succeeded

in giving a new explanation on why the traded volume increases for intermediate
goods when the transport cost decreases.[15]

FREE TRADE
Free trade is a policy followed by some international markets in which countries'
governments do not restrict imports from, or exports to, other countries. Free trade
is exemplified by the European Economic Area and the North American Free Trade
Agreement, which have establishedopen markets. Most nations are today members
of the World Trade Organization (WTO) multilateral trade agreements. However,
most governments still impose some protectionist policies that are intended to
support local employment, such as applying tariffs to imports orsubsidies to
exports. Governments may also restrict free trade to limit exports of natural
resources. Other barriers that may hinder trade include import quotas, taxes,
and non-tariff barriers, such as regulatory legislation.
FEATURES OF FREE TRADE
Free trade policies generally promote the following features:

Trade of goods without taxes (including tariffs) or other trade barriers (e.g.,
quotas on imports or subsidies for producers)
Trade in services without taxes or other trade barriers
The absence of "trade-distorting" policies (such as taxes,
subsidies, regulations, or laws) that give some firms, households, or factors of
production an advantage over others

Unregulated access to markets

Unregulated access to market information

Inability of firms to distort markets through governmentimposed monopoly or oligopoly power

Trade agreements which encourage free trade.

LARGEST COUNTRIES BY TOTAL INTERNATIONAL TRADE

Ran
k

Country

International Trade of Date of

Goods
informatio
(Billions of USD)
n

% GDP
(nominal)

World

37,706.0

2013 est.

50.5%

European Union 4,485.0

2013 est.

24.2%

China

4,201.0

2014 est.

40.5%

United States

3,944.0

2014 est.

22.6%

Germany

2,866.0

2014 est.

74.3%

Japan

1,522.4

2014 est.

33.0%

France

1,212.3

2014 est.

42.6%

United Kingdom 1,189.4

2014 est.

40.4%

South Korea

1,170.9

2014 est.

82.6%

Hong Kong

1,088.4

2014 est.

375.8%

Netherlands

1,041.6

2014 est.

120.2%

10

Italy

948.6

2014 est.

44.2%

11

Canada

947.2

2014 est.

51.1%

12

India

850.6

2014 est.

41.5%

13

Russia

844.2

2014 est.

41.3%

14

Singapore

824.6

2014 est.

262.8%

15

Mexico

813.5

2014 est.

61.2%

16

Switzerland

721.8

2014 est.

101.4%

17

United Arab
Emirates

676.4

2014 est.

156.7%

18

Belgium

663.6

2014 est.

181.1%

19

Spain

655.2

2014 est.

48.2%

20

Taiwan

595.5

2014 est.

112.5%

TOP TRADED COMMODITIES

Ran
k

Commodity

Value in US$
('000)

Date of
informatio
n

Mineral fuels, oils, distillation

products, etc.

$2,183,079,941

2012

Electrical, electronic equipment

$1,833,534,414

2012

Machinery, nuclear reactors, boilers,

$1,763,371,813
etc.

2012

Vehicles other than railway

2012

$1,076,830,856

Ran
k

Commodity

Value in US$
('000)

Date of
informatio
n

Plastics and articles thereof

$470,226,676

2012

Optical, photo, technical, medical,

etc. apparatus

$465,101,524

2012

Pharmaceutical products

$443,596,577

2012

Iron and steel

$379,113,147

2012

Organic chemicals

$377,462,088

2012

10

Pearls, precious stones, metals,

coins, etc.

$348,155,369

2012

BALANCE OF PAYMENT
The balance of payments (BOP) is the method countries use to monitor all
international monetary transactions at a specific period of time. Usually, the BOP is
calculated every quarter and every calendar year. All trades conducted by both the
private and public sectors are accounted for in the BOP in order to determine how
much money is going in and out of a country. If a country has received money, this
is known as a credit, and if a country has paid or given money, the transaction is
counted as a debit. Theoretically, the BOP should be zero, meaning that assets
(credits) and liabilities (debits) should balance, but in practice this is rarely the
case. Thus, the BOP can tell the observer if a country has a deficit or a surplus and
from which part of the economy the discrepancies are stemming.
The Balance of Payments Divided
The BOP is divided into three main categories: the current account, the capital
account and the financial account. Within these three categories are sub-divisions,
each of which accounts for a different type of international monetary transaction.
The Current Account
The current account is used to mark the inflow and outflow of goods and
services into a country. Earnings on investments, both public and private, are also
put into the current account.

Within the current account are credits and debits on the trade of merchandise,
which includes goods such as raw materials and manufactured goods that are
bought, sold or given away (possibly in the form of aid). Services refer to receipts
from tourism, transportation (like the levy that must be paid in Egypt when a ship
passes through the Suez Canal), engineering, business service fees (from lawyers
or management consulting, for example) and royalties from patents and copyrights.
When combined, goods and services together make up a country's balance of
trade (BOT). The BOT is typically the biggest bulk of a country's balance of
payments as it makes up total imports and exports. If a country has a balance of
trade deficit, it imports more than it exports, and if it has a balance of trade surplus,
it exports more than it imports.
Receipts from income-generating assets such as stocks (in the form of dividends)
are also recorded in the current account. The last component of the current account
is unilateral transfers. These are credits that are mostly worker's remittances, which
are salaries sent back into the home country of a national working abroad, as well
as foreign aid that is directly received.
The Capital Account
The capital account is where all international capital transfers are recorded. This
refers to the acquisition or disposal of non-financial assets (for example, a physical
asset such as land) and non-produced assets, which are needed for production but
have not been produced, like a mine used for the extraction of diamonds.
The capital account is broken down into the monetary flows branching from debt
forgiveness, the transfer of goods, and financial assets by migrants leaving or
entering a country, the transfer of ownership on fixed assets (assets such as
equipment used in the production process to generate income), the transfer of funds
received to the sale or acquisition of fixed assets, gift and inheritance taxes, death
levies and, finally, uninsured damage to fixed assets.
The Financial Account
In the financial account, international monetary flows related to investment in
business, real estate, bonds and stocks are documented. Also included are
government-owned assets such as foreign reserves, gold, special drawing
rights (SDRs) held with the International Monetary Fund (IMF), private assets held

abroad and direct foreign investment. Assets owned by foreigners, private and
official, are also recorded in the financial account.
The Balancing Act
The current account should be balanced against the combined-capital and financial
accounts; however, as mentioned above, this rarely happens. We should also note
that, with fluctuating exchange rates, the change in the value of money can add to
BOP discrepancies. When there is a deficit in the current account, which is a
balance of trade deficit, the difference can be borrowed or funded by the capital
account.
If a country has a fixed asset abroad, this borrowed amount is marked as a capital
account outflow. However, the sale of that fixed asset would be considered a
current account inflow (earnings from investments). The current account deficit
would thus be funded. When a country has a current account deficit that is financed
by the capital account, the country is actually foregoing capital assets for more
goods and services. If a country is borrowing money to fund its current account
deficit, this would appear as an inflow of foreign capital in the BOP.
Liberalizing the Accounts
The rise of global financial transactions and trade in the late-20th century spurred
BOP and macroeconomic liberalization in many developing nations. With the
advent of the emerging market economic boom - in which capital flows into these
markets tripled from USD$50 million to $150 million from the late 1980s until the
Asian crisis - developing countries were urged to lift restrictions on capital and
financial-account transactions in order to take advantage of these capital inflows.
Many of these countries had restrictive macroeconomic policies, by which
regulations prevented foreign ownership of financial and non-financial assets. The
regulations also limited the transfer of funds abroad.
With capital and financial account liberalization, capital markets began to grow,
not only allowing a more transparent and sophisticated market for investors, but
also giving rise to foreign direct investment (FDI). For example, investments in the
form of a new power station would bring a country greater exposure to new
technologies and efficiency, eventually increasing the nation's overall GDP by

allowing for greater volumes of production. Liberalization can also facilitate less
risk by allowing greater diversification in various markets.
The Bottom Line
The balance of payments is divided into the current account, capital account, and
financial account. Theoretically, the BOP should be zero.

FOREIGN TRADE IN INDIA

Foreign trade in India includes all imports and exports to and from India. At the
level of Central Government it is administered by the Ministry of Commerce and
Industry. As of 2014.
HISTORY
There are records throughout history of India's trade with foreign countries.

Around 100CE[edit]
The Periplus of the Erythraean Sea is a document written by an anonymous sailor
from Alexandria about 100CE describing trade between countries, including India.
Around 1500[edit]
In 1498 Portuguese explorer Vasco da Gama landed in Calicut (modern
day Kozhikode in Kerala as the first European to ever sail to India. The
tremendous profit made during this trip made the Portuguese eager for more trade
with India and attracted other European navigators and tradesmen.[2]
Pedro lvares Cabral left for India in 1500 and established Portuguese trading
posts at Calicut and Cochin (modern day Kochi), returning to Portugal in 1501
with pepper, ginger, cinnamon, cardamom, nutmeg, mace, and cloves. The profits
made from this trip were huge.[3]
1991 economic reform[edit]
Prior to the 1991 economic liberalisation,India was a closed economy due to the
average tariffs exceeding 200 percent and the extensive quantitative restrictions on
imports. Foreign investment was strictly restricted to only allow Indian ownership
of businesses. Since the liberalisation, India's economy has improved mainly due
to increased foreign trade.[4]

EXPORTS & IMPORTS OF INDIA

David Cameron has strongly expressed his want for a 'special relationship' with
India and with the largest trade delegation ever to accompany a British prime
minister to any country in the world, the message couldn't be clearer.
India's total merchandise trade has increased over three-fold from $252bn in 2006
to $794 in 2012 - both exports and imports have trebled during this period
according to the Export-Import Bank of India (Exim bank). The bank is the
premier export finance institution of the country and was set up for the purpose of
financing, facilitating, and promoting foreign trade of India.

How does India's trade break down?

Exports
A publication on India's trade and investment by Exim bank highlights the trend in
exports moving towards southern countries, particularly in the Asia and Africa
regions. Asia is a key destination of India's exports - in 2001-02 Asia's share stood
at 40.2% but in 2011-12 it grew to to 51.6%. Europe, however has seen a decline in
its share, down to 19% in 2011-12 from 24.8% in 2001-02.
India's key exports in 2012 were petroleum products which generated $56bn,
followed by gems and jewellery with $47bn. Pharma products, transport
equipment, machinery and readymade garments are also big exports for India.
The 2012 data shows that the United Arab Emirates (UAE) was India's biggest
export market, closely followed by the USA. The latest data available from the
Indian Government's Ministry of Commerce and Industry covering AprilSeptember 2012, shows the US to have slightly overtaken the UAE. Explore the
graphic above to see India's imports and exports by value and year. The UK is the
eighth biggest export market for India and held 2.9% of the market share in AprilSeptember 2012.

Top ten exporters to India, by value of trade in US$m and share of total
Country

2012-2013 (Apr- Sep)

%Share (2012-2013 (Apr- Sep)

CHINA

28025.57

11.92

UAE

19622.81

8.35

SAUDI ARABIA

16094.83

6.85

Top ten exporters to India, by value of trade in US$m and share of total
Country

2012-2013 (Apr- Sep)

%Share (2012-2013 (Apr- Sep)

USA

12208.05

5.19

SWITZERLAND

10779.45

4.59

IRAQ

9803.79

4.17

QATAR

8144.45

3.47

KUWAIT

8134.73

3.46

GERMANY

7154.41

3.04

INDONESIA

6944.86

2.95

Imports
Crude petroleum is India's biggest import with $155bn spent on it in 2012. Imports
of gold and silver amounted to $62bn and electronic goods and pearls and precious
stones are also top import items for the country.
India's top import source is China followed by the UAE, Switzerland and Saudi
Arabia. The UK came in at 21st place in 2011-12 with India importing a total of
$7.7bn. In the six months recorded so far for 2012-13, the UK has dropped a place
and has a 1.4% share of the India's import sources.
The table below shows India's imports and exports by country including the share.
The downloadable spreadsheet also has data on the top import and export products
for the country.

Top ten importers from India, by value of trade in US$m and share of total
Country

2012-2013 (Apr- Sep)

%Share (2012-2013 (Apr- Sep)

USA

19704.05

13.87

UAE

18601.71

13.09

Top ten importers from India, by value of trade in US$m and share of total
Country

2012-2013 (Apr- Sep)

%Share (2012-2013 (Apr- Sep)

SINGAPORE

6652.77

4.68

CHINA

6417.32

4.52

HONG KONG

6137.9

4.32

SAUDI ARAB

4636.29

3.26

NETHERLANDS

4458.24

3.14

UK

4112.26

2.89

GERMANY

3491.77

2.46

BRAZIL

3042.64

2.14

BALANCE OF PAYMENT IN INDIA

The balance of payments position of the country reflects on its economic health.
The balance of payments of any country is a comprehensive and systematic
accounts of all the different transactions occurred between the residents of a
country and the rest of the world during a particular period of lime.
The balance of payments maintains detailed classified records of different types of
receipts against exports of goods, services and all the capital received by its
residents on the one hand and also of all the payments made by the residents
against imports of goods and services received along with the capital transferred to
non-residents and foreigners, on the other hand. Thus the balance of payments is
much wider than the balance of trade which refers to only merchandise exports and
imports.
The balance of payments is broadly classified into:
(a) Current account and
(b) Capital account.
The current account includes: visible exports and import; invisible items relating to
receipts and payments for various services like banking, insurance, shipping, travel
etc. and other unilateral transfer of payments like donations, grants, taxes etc.
The capital accounts of balance of payments include all the current economic
transaction for the countrys international financial position resulting changes in
the foreign financial assets and liabilities. The capital transaction includes both
private, banking and official transactions.

The balance of payment account is maintained on the basis of double entry system
of book keeping. If a country faces deficits in the current account of its balance of
payment then such deficit is normally met either by liquidating its assets or through
borrowing from abroad. Thus a persistent deficit in the balance of payments of a
country results in a heavy debt burden on the economy.
The Balance of Payment Position of India on Current Account since Independence:
With the introduction of planning in India, the balance of payments position of the
country has been recording considerable changes with the continuous changes in
its imports and exports.
Balance of Payments (BOP) Position during the First Four Plans:
The balance of payments position during the First Plan period was quite
satisfactory as the country experienced a deficit in its current account only to the
extent of Rs. 42.3 crore. In this period, the inflow of foreign capital was only Rs.
13.6 crore and the foreign exchange reserve was about Rs. 127 crore.
During the Second Plan, the deficit in the balance of trade was to the tune of Rs.
2,339 crore and the surplus of invisibles and donations ultimately reduced the
deficit in balance of payment to Rs. 1,725 crore. This higher deficit in the balance
of payment, during the Second Plan was resulted from heavy imports of capital
goods, huge imports of food grains and raw materials and lesser expansion of
exports and higher maintenance imports.

During the Third Plan the country experienced a current account deficit in its BOP
to the extent of Rs. 1,941 crore which was financed by loans from foreign
countries under various schemes. During the Fourth Plan, the Government
introduced both export promotion and import substitution measures for wining out
the deficits in the BOP. Moreover, due to sudden increase in the invisibles accounts
receipts to the extent of Rs. 1,680 crore in 1973-74, the plan ended with a surplus
of Rs. 100 crore in its BOP.
BOP During the Fifth Plan:
During the Fifth Plan period, due to the applicability of two factors like hike in oil
prices arid increase in the value of exports due to promotional measures, although
a surplus in trade balance was attained in 1976-77 (Rs. 316 crore) but the plan
experienced an increasing trend in trade deficit to the extent of Rs. 3,179 crore. But
due to higher entry of net invisibles, the Fifth Plan ended with surplus of Rs. 3,082
crore.
BOP During the Sixth to Tenth Plan:
The balance of payments position has recorded a total change since 1979-80. India
started to record a heavy deficit in its balance of payments since 1979- 80. Table
7.6 shows the growing deficit in trade balance along with the growing deficit in its
balance of payments position during the Sixth to Tenth Plan.

Thus the table reveals that due to the mounting deficit in trade balance, i.e., from
Rs. 5,967 crore in 1980-81 to Rs. 6,721 crore in 1984-85, India maintained a huge
deficit in its balance of payments to the extent of Rs. 11,384 crore during the Sixth
Plan period. Again due to a persistent growing deficit in trade balance the
cumulative deficits in the balance of payment during the Seventh Plan rose further
to Rs. 38,313 crores, showing the annual average deficit of Rs. 7,662 crore.

Again in 1990-91, total amount of deficits in the balance of payments was as high
as Rs. 17,369 crore. But in 1999-2000 and 2000-2001, the total amount of deficits
in the balance of payments was Rs. 20,331 crore and Rs. 11,431 crore respectively.
In 2001-02, total surplus in BOP was Rs. 16,426 crore and the total surplus further
increased to Rs. 47,952 crore in 2003-04. In 2008-09, total deficit in BOP was Rs.
(-) 1,31,614 crore.
This huge deficit in the balance of payments position during the entire Sixth,
Seventh and Eighth and Ninth Plan periods was the result of tremendous rate of
growth of imports accompanied by a poor rate of growth of exports. The trade
deficits during these four plans were so heavy that it could not be offset by the flow
of funds under net invisibles. The following table depicts a clear picture about the
amount of deficits in the balance of payments from the First Plan to the Ninth Plan.

Recovery in Balance of Payments Position in India since 1991-92, i.e., After

Economic Reforms:
The balance of payments position, which had reached a point of near collapse in
June 1991, gradually stabilized during the course of 1991-92. In 1990-91, foreign
currency reserves had declined to $ 1.1 billion despite heavy borrowing from the
IMF. In order to restore international confidence, the Government negotiated a
stand by arrangement with the IMF in October 1991 for $ 2.3 billion over a 20
month period, a Structural Adjustment Loan with the World Bank of $ 500 billion
and a Hydrocarbon Sector Loan with ADB for $ 250 million.
Along with this effort, the Government also launched the India Development
Bonds aimed at mobilizing NRI sources of funds. With the assurance of external
support through these efforts, the balance of payments position was gradually
stabilized in 1991-92 and the foreign exchange reserves were restored to the level
of $ 5.6 billion at the end of March 1992.
Thus, the balance of payments position in India showed a steady improvement
since 1991-92 with exports covering a larger proportion of imports than in the
earlier years. The export-import ratio has averaged nearly 90 per cent during 199192 to 1993-94 compared to an average of about 65 per cent for the preceding three
years.
In 1994-95, this export-import ratio stood at 91.9 per cent. The current account
deficit has also declined, averaging about 0.7 per cent of GDP for these three years

(1991-94), compared to an average of about 2.6 per cent of GDP in the preceding
three years.
In this connection, Economic Survey, 1995-96 observed, The development in
Indias trade and payments over the past five years mark a noticeable structural
change towards a more stable and sustainable balance of payments. During the
post-liberalization period, there has been a sharp improvement in the coverage of
import payments through export earnings. The coverage ratio has averaged around
88 per cent since 1992-93, compared with only 52.4 per cent at the beginning of
the 1980s and about 70 per cent at the end of the 1980s. There has also been a
marked improvement in the flow of invisible receipts. Together, these changes
brought about a sharp reduction in the ratio of the current account deficit to GDP
from an unsustainable level of 3.2 per cent in 1990-91 to 0.8 per cent in 1994-95.
There has been a structural change in the capital account in terms of a sharp
reduction in debt creating flows and an increased recourse to non-debt creating
foreign investment flows. For example, debt creating flows, as a percentage of total
capital flow in the balance of payments, averaged as much as 97 per cent during
the Seventh Plan Period (1985-86 to 1989-90).
But the ratio declined very sharply to less than 18 per cent in 1994-95. This
declining trend is shared by all the major components of debts flows, namely
external assistance, commercial borrowing and non-resident deposits. This
favourable shift, away from recourse to debt creating flows for financing the

current account deficit, has obvious implications for moderating and reducing
future debt service liabilities.
During the recent years, the balance of payments position of the country
experienced a mixed scenario. The year 2004-05 marked a significant departure in
the structural composition of Indias balance of payment (BOP), with the current
account, after three consecutive years of surplus, turning into a deficit. In a
significant transformation, the current account deficit, observed for 24 years since
1977-78, had started shrinking from 1999-2000.
The contraction gave way to a surplus in 2001-02, which continued until 2003-04.
However, from a surplus of US $14.1 billion in 2003-04, the current account
turned into a deficit of US $5.4 billion in 2004-05. This deficit was caused by a
burgeoning excess of merchandise imports over exports, which was left
uncompensated by the net surplus in invisibles.
Which the magnitude of deficit is one of the highest in recent times, it underscored
the rising investment demand in the economy. As a proportion of LSDPP, the
turnaround in the current account balance was from a surplus equivalent to 2.3 per
cent in 2003-04 to a deficit of 0.8 per cent in 2004-05.
The turn around in the current account during 2004-05 was accompanied by a
significant strengthening of more than 80 per cent in the capital account resulting
in continued reserve accretion. Compared with 2003-04, when loan inflows and
turned not net outflows, such inflows shot up rapidly during 2004-05 and bolstered
the rise of the capital account surplus with good support from robust foreign

investment inflows. Reserve accumulation during 2004-05, at around four-fifths of

such accumulation during 2003-04, maintained Indias status as one of the largest
reserve holding economies in the world.
Rise in Trade Deficit during 1995-96 and Thereafter:
Indias trade deficit during 1995-96 swelled to $ 4,538 billionmore than double
of the deficit of $ 2.027 billion in the previous financial year. The countrys exports
during 1995-96 were estimated at $ 31,830 billion signifying growth of 21.38 per
cent over the exports during the previous fiscal year valued at $ 26,623 billion.
Against a target of 18 to 20 per cent growth rate for the year 1995- 96, the actual
achievement were considerably higher at 21.4 per cent in dollar terms. Import
during 1995-96 were estimated at $ 36,369 billion against $ 28,251 billion during
the previous fiscal year reflecting a growth of 28.74 per cent. Thus the rise in the
trade deficit during 1995-96 has been resulted mostly from the sudden spurt in
imports, in spite of attaining a considerable higher growth in exports.
1996-97:
The balance of payments position of India has been experiencing some changes in
the year 1996-97 as Indias exports went up by only 4.01 per cent and imports
grew by 5.99 per cent during 1996-97 as compared to that of 21.58 per cent and
28.74 per cent recorded respectively during 1995-96.
1998- 99:

The balance of payments (BOP) position of India has been gradually improving in
recent years. Indias BOP remained comfortable in 1998-99 partly due to
anticipatory policy actions, such as issue of Resurgent India Bonds. The deficit in
the current account of the BOP in 1998-99 had declined to about 1.0 per cent of
GDP as against 1.7per cent in 1995-96 and 1.4 per cent in 1997- 98, mainly
reflecting sharp declines in POL and non-customs imports.
Reflecting the trends in exports and imports, the deficit on the trade account of
BOP in 1998-99 narrowed to US $ 13.25 billion from US $ 15.51 billion in 199798 or from 3.8 per cent of GDP in 1997-98 to 3.1 per cent of GDP in 1998-99.
1999- 2000:
Indias Balance of payments position in 1999-2000 remained comfortable. The
current account deficit in 1999-2000 was contained to 0.9 per cent of GDP, despite
an unfavourable international trade and financial backdrop including a near twothird like in Indias oil import bill.
2000- 01:
Indias balance of payments (BOP) position in 2000-01 remained comfortable and
the external sector experienced a distinct improvement. There were, however, some
pressures on the BPO during the first half of the year on account of significant
hardening of international oil prices, the sharp downturn in international equity
prices and successive increases in interest rates in the United Suites and Europe;
but the situation cased with the mobilization of funds under the India Millennium

Deposits, which helped to revert the declining trend in reserves and enhanced
confidence in the strength of Indias external sector. As a result, the BOP situation
experienced a turn around 0.5 per cent of GDP from 1.1 per cent of GDP in 19992000.
2001- 02:
Indias balance Of payments in 2001-02 exhibited mixed developments. While
exports, on BOP basis, remained stagnant at previous years level, but imports
declined by 2.8 per cent, thus resulting in a decline in merchandise trade deficit, as
per cent of GDP, from 3.1 per cent in 2000-01 to 2.6 per cent in 2001-02.
Moreover, the current account BPO turned into a surplus in 2001-02, after a gap of
24 years (last recorded in 1977-78).
2007-08 and 2008-09:
Both the year 2007-08 and 2008-09 were marked by adverse developments in the
external sector of the economy, reflecting impact of global financial crisis on the
emerging economies including India. Indias BOP exhibited considerable resilience
during fiscal 2008-09 despite one of the severest external shock.
The current account balance [(-) 2.4 per cent of GDP in 2008-09 vis-a-vis () 1.3
per cent in 2007-08] remained well within sustainable limits and there was limited
use of foreign exchange reserves despite massive decline in net capital flows to US
$ 7.2 billion in 2008-09 as against US $ 106.6 billion in 2007-08. As a result, the

total net capital account of BOP as per cent of GDP stood at only 0.6 per cent in
2008-09 as compared to that of 8.8 per cent in 2007-08.
Convertibility of Rupee:
For the first time, the Union Budget for 1992-93 has made the Indian rupee
partially convertible. This was an inevitable move for the expeditious integration of
Indian economy with that of the world In order to face the serious current account
deficit in the balance of payments, the Government of India introduced the partial
convertibility of rupee from March 1. 1992.
Under this system, which remained in operation for a period of one year, 60 per
cent of the exchange earnings were convertible in rupees at market determined
exchange rate and the remaining 40 per cent earnings were convertible in rupees at
the officially determined exchange rate.
The entire foreign exchange requirement for meeting import obligations was
required to be purchased at market determined exchange rate, excepting a few
specified imports and imports on the government account.
The term convertibility of a currency indicates that it can be freely converted into
any other currency. Convertibility can also be identified as the removal of
quantitative restrictions on trade and payments on current account. Convertibility
establishes a system where the market place determine the rate of exchange
through the free interplay of demand and supply forces.

In India, hawala trade normally handle about 4 billion dollars a year. Until recently,
this was traceable to the increasing differential between official and hawala
exchange rates. This convertibility of rupee has bridged this gap and in check the
hawala trade effectively.
Current Account Convertibility:
Current account convertibility is the next phase for attaining full convertibility of
rupee. Current account convertibility relates to the removal of restrictions on
payments relating to the international exchange of goals, services and factor
incomes, while capital account convertibility refers to a similar liberalization of a
countrys capital transactions such as loans and investment, both short term and
long term.
The International Monetary Fund (IMF) which works towards the establishment of
multilateral system of payments, requires member countries to move towards
restoration of current account convertibility, but permits them to restrict
convertibility for capital transactions.
Current account convertibility has been defined as the freedom to buy or sell
foreign exchange for the following international transactions:
(a) All payments due in connection with foreign trade, other current business,
including services and normal short term banking and credit facilities;
(b) Payments due as interest on loans and as net income from other investments;

(c) Payments of moderate amount of amortization of loans or for depreciation of

direct investment; and
(d) Moderate remittances for family living expenses.
Capital Account Convertibility:
The next and final step in this line is the convertibility of rupee on capital account.
But we must draw a sharp distinction between currency convertibility in the
current and capital accounts. Capital account convertibility refers to a liberalization
of a countrys capital transactions such as loans and investment, both short term
and long term as well as speculative capital flows.
When it comes to capital account convertibility, one has to be more prudent and be
very much sure about its capacity to launch such a system. If the country can build
a large stock of international reserves, then only this system could provide a bonus.
Confidence in the financial system and a steady macro-economic environment are
very much essential to the introduction of capital account convertibility of rupee in
near future.
Capital account convertibility in India can be introduced in stages by gradually
widening access to resident Indians to external financial markets. In the light of
historical experience, the general view is that opening up of the capital account
should occur late in the sequencing of stabilization and structural reforms.
Capital account convertibility is likely to be sustainable only if it is supported by
credible macro- economic policies, listing reduction in fiscal deficit, moderation in

inflation and a flexible financial system which can adapt to changing situations as
some of the essential pre-conditions for capital account convertibility. Thus capital
account convertibility implies the right to transact in financial assets with foreign
countries without restrictions. Although the rupee is not fully convertible on the
capital account, convertibility exists in respect of certain constituent elements.
These are as follows:
(a) Capital account convertibility exists for foreign investors and Non-Resident
Indians (NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad up to US $ 4 million is eligible for automatic
approval by the RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all
applications involving Indian direct foreign investment abroad beyond US $ 4
million or those not qualifying for fast track clearance.
But in the context of the need for attracting higher capital inflows into the country,
it is also important for the Government to introduce convertibility on capital
account, as foreign investors may enter confidently only when there is an assurance
that the exit doors will always remain open.
The Budget 2002-03 has adopted a cautious step towards Capital Account
Convertibility by allowing NRI to repatriate their Indian income. Considering the
present condition along with the comfortable foreign exchange reserve of the
country at present, the government is now favouring a make towards fuller capital

account convertibility in the context of changes in the last two decades. For the
mean time on 18th March, 2006 Prime Minister Dr. Manmohan Singh asked the
Finance Ministry and RBI to work out a roadmap for fuller capital account
convertibility based on current realities. Dr. Singh is of the view that such roadmap
for fuller capital account convertibility would attract greater foreign investments
into the country.
Thus it is expected that the Government of India and the RBI are going to
announce a roadmap soon for the attainment of fuller capital account convertibility
of the country. However, while taking decision for full convertibility of rupee, the
Government should take adequate care of its possible consequences.
In the mean time on 29th March, 2006, 160 renowned Indian economists asked the
government to desist from mowing towards full convertibility of rupee as it was
brought with dangerous consequences. They argued, We urge the UPA
government from such an unnecessary and dangerous measure. This (full float
of rupee) would expose Indian economy to extreme volatility.
The statement made by about 160 leading economists from various institutions
across the country and signed by Prof. Prabhat Patnaik of JNU, Delhi also
expressed apprehension that to expose the country to unpredictable movements in
capital flows would create a potential for fragility and crisis and particularly when
the stock market is witnessing a speculative boom.

Tara-pore Committees Second Report on Capital Account Convertability (July

2006):
With the growing strength of balance of payments in the post-1991 period and with
external sector remaining robust and gaining strength every year and the relative
macro economic stability with high growth providing a conducive environment
relaxation of capital controls, RBI, in pursuance of the announcement the Prime
Minister constituted a committee on March 20, 2006 with Mr. S.S. Tarapore as its
chairman for setting out a roadways towards fuller capital account convertibility.
The committee submitted its Report to the RBI on July 31, 2006.
Keeping itself conscious of the risks involved in the movement towards fuller
convertibility of the Rupee as emanating from cross country experiences in this
regard the committee calibrated the liberalization road map to the specific contexts
of preparednessnamely, a strong macroeconomic framework, sound financial
systems and markets and prudential regulatory and supervisory architectures.
After making review of the existing capital controls, it detailed a broad five year
time frame for movement towards fuller convertibility in three phases: Phase-I
(2006-07); Phase II (2007-08 to, 2008-09) and Phase III (2009-10 to 2010-11).
The report recommended the meeting of certain indicators/targets as a concomitant
to the movement in: meeting FRBM targets; shifting from the present measures of
fiscal deficit to a measure of the Public Sector Borrowing Requirement (PSBR);
segregating government debt management and monetary policy operations through
the setting up of the office of Public Debt independent of the RBI; imparting

greater autonomy and transparency in the conduct of monetary policy; and slew of
reforms in banking sector including a single banking legislation and reduction in
the share of Government/RBI in the capital of public sector bank.
Keeping the current account deficit to GDP ratio under 3 per cent; and evolving
appropriate indicators of adequacy of reserves to cover not only import
requirements, but also liquidity risks associated with present types of capital flows,
short-term debt obligations and broader measures including solvency.
Thus, the committee recommended a three phase strategy for moving towards
capital account convertibility. Although, RBI has not been taken any final decision
on acceptance of the recommendations in totality but it has initiated measures on
an on-going basis beginning with the announcement in Us Mid-term Review of the
Annual Policy Statement for 2007-08.

ADVANTAGES AND DISADVANTAGES OF FOREIGN TRADE

AND BALANCE OF PAYMENT IN INDIA

Foreign Trade in India

Advantages:
1. Optimal use of natural resources:
Foreign trade helps each country to make optimum use of its natural resources.
Each country can concentrate on production of those goods for which its resources
are best suited. Wastage of resources is avoided.
2. Availability of all type of goods:
It enables a country to obtain goods, which it cannot produce or which it is not
producing due to higher costs, by importing from other countries at lower costs.
3. Specialisation:
Foreign trade leads to specialization and encourages production of different good
in different countries. Goods can be produced at comparatively low cost due to
advantages of division of labour.

4. Advantages of large-scale production:

Due to foreign trade, goods are produced not only for home consumption but for
exports to other countries also. Nations of the world can dispose of goods which
they have in surplus in the foreign markets. This leads to production at large- scale
and the advantages of large-scale production can be obtained by all the countries of
the world.

5. Stability in prices:
Foreign trade irons out wild, fluctuations in prices. It equalizes the prices of goods
throughout the world (ignoring cost of transportation etc.).
6. Exchange of technical know-how and establishment of new industries:
Underdeveloped countries can establish and develop new industries with the
machinery equipment and technical know-how imported from developed countries.
This helps in the development of these countries and the economy of the world at
large.
7. Increase in efficiency:
Due to the foreign competition the producers in a country attempt to produce better
quality of goods and at the minimum possible cost. This increases the efficiency
and benefits the consumers all over the world.
8. Development of the means of transport and communications:

Foreign trade requires the best means of transport and communication. For the
advantages of foreign trade development in the means of transport and
communication is also made possible.
9. International co-operation and understanding:
The people of different countries come in contact with each other. Commercial
intercourse amongst nations of the world encourages exchange of ideas and
culture. It creates co-operation, understanding and cordial relations amongst
various nations.
10. Ability to face natural calamities:
Natural calamities such as drought, floods, famine, earthquake etc., affect the
production of a country adversely. Deficiency in the supply of goods at the times of
such natural calamities can be met by imports from other countries.

11. Other advantages:

Foreign trade helps in many other ways such as benefits to consumers,
international peace and better standard of living.

Disadvantages:
The important disadvantages of foreign trade that you might not know are listed
below:
1. Impediment in the Development of Home Industries:
Foreign trade has an adverse effect on the development of home industries. It poses
a threat to the survival of infant industries at home.

Due to foreign competition and unrestricted imports the upcoming industries in the
country may collapse.
2. Economic Dependence:
The underdeveloped countries have to depend upon the developed ones for their
economic development. Such reliance often-leads to economic exploitation. For,
instance most of the underdeveloped countries in Africa and Asia have been
exploited by European countries.
3. Political Dependence:
Foreign trade often encourages subjugation and slavery. It impairs economic
independence which endangers political dependence. For example, the Britishers
came to India as traders and ultimately ruled over India for a very long time.
4. Mis-utilisation of Natural resources:
Excessive exports may exhaust the natural resources of a country in a shorter span
of time than it would have been otherwise. This will cause economic downfall of
the country in the long run.
5. Import of Harmful Goods:
Import of spurious drugs, Luxury articles, etc. adversely affects the economy and
well being of the people.
6. Storage of Goods:
Sometimes the essential commodities required in a country and in short supply are
also exported to earn foreign exchange. This results in shortage of these goods at
home and cause inflation. For example, India has been exporting sugar to earn
foreign exchange; hence the exalting prices of sugar in the country.

7. Danger to Internal Peace:

Foreign trade gives an opportunity to foreign agents to settle down in the country
which ultimately endangers its internal peace.
8. World Wars:
Foreign trade breeds rivalries amongst nations due to competition in the foreign
markets. This may event fully lead to wars and disturbs world peace.
9. Hardships in times of wars:
Foreign trade promotes lopsided development of a country as only those goods
which have comparative cost advantage are produced in a country. During wars or
when good relations do not prevail between nations, many hardships may follow.

Balance of Payment in India

Advantages
1. It is of great value in forecasting and evaluating its business and economic
condition:

The more accurate the material in the balance of payments, the more valuable it
becomes as a basis for the study of the economical and business conditions of a
country.
2. Balance of payments can also serve as a basis to evaluate a countrys
solvency:
It is to determine the appropriateness of the exchange value of its currency.
3. It also reveals the nature, size, composition and direction of a countrys
international trade:
Trade of visible and invisible items which form part of balance of payments. A
close study of it will give an idea of a countrys industrial production and its
internal and external demands.
4. It clarifies the foreign exchange position of a country:
This can be used as a basis for businessmen in selecting the markets for their
products
5. It also helps to decide the trade, industrial and economic policies of the
Government:
If balance of payments is favourable, the Government will take liberal view of
imports otherwise different types of restrictions (tariffs and non-tariffs measures)
will be imposed as corrective measures. It will naturally effect the International
Trade. Thus it can be said that the study of Balance of Payments position of a
country is very useful for an international business as it helps to decide that his
domestic or foreign trade policies, programmes, procedures and strategies. It is a
basic document that gives a direction to Government Policies and Programmes.

Disadvantages

1. The Prevailing Exchange Rate of the Domestic Currency:

A lower value of the domestic currency results in the domestic price getting
translated into a lower international price. This increases the demand for
domestic goods and services and hence their export. This is likely to result in a
higher demand for the domestic currency. A higher exchange rate would have
an exactly opposite effect.
2. Inflation Rate:
The inflation rate in an economy vis--vis other economies affects the
international competitiveness of the domestic goods and hence their demand.
Higher the inflation, lower the competitiveness and lower the demand for
domestic goods. Yet, a lower demand for domestic goods and services need not
necessarily mean a lower demand for the domestic currency. If the demand for
domestic goods is relatively inelastic, then the fall in demand may not offset
the rise in price completely, resulting in an increase in the value of exports.
This would end up increasing the demand for the local currency. For example,
suppose India exports 100 quintals of wheat to the US at a price of Rs.500 per
quintal. Further, assume that due to domestic inflation, the price increases to
Rs.530 per quintal and there is a resultant fall in the quantity demanded to 96
quintals. The exports would increase fromRs.50,000 to Rs.52,800 instead of
falling.
3. World Prices of a Commodity
: If the price of a commodity increases in the world market, the value of
exports for that particular product shows a corresponding increase. This would
result in an increase in the demand for the domestic currency. A fall in the
demand for domestic currency would be experienced in case of a reduction in
the international price of a commodity. This impact is different from the
previous one. The previous example considered an increase in the domestic
prices of all goods produced in an economy simultaneously, while this one
considers a change in the international price of a single commodity due to
some exogenous reasons.

4. Incomes of Foreigners:
There is a positive correlation between the incomes of there sidents of an
economy to which the domestic goods are exported, and exports. Hence, other
things remaining the same, an increase in the standard of living (and hence, an
increase in the incomes of the residents) of such an economy will result in an
increase in the exports of the domestic economy Once again, this would
increase the demand for the local currency.
5. Trade Barriers:
Higher the trade barriers erected by other economies against the exports from a
country, lower will be the demand for its exports a hence, for its currency.
6. Imports of Goods and Services
Imports of goods and services are affected by the same factors that affect the
exports. While some factors have the same effect on imports as on exports, so
of them have an exactly opposite effect.
7. Value of the Domestic Currency:
An appreciation of the domestic currency results in making imported goods
and services cheaper in terms of domestic currency, hence increasing their
demand. The increased demand imports results in an increased supply of the
domestic currency depreciation of the domestic currency have an opposite
effect.
8. Level of Domestic Income:
An increase in the level of domestic income increases the demand for all
goods and services, including imports and it results in an increased supply of
the domestic currency.
9. International Prices:
The International demand and supply positions deter the international price of
a commodity. A higher international price would translate into a higher
domestic price. If the demand for imported goods is inelastic, this would result
in a higher domestic currency value of in increasing the supply of the domestic
currency. In case of the demand elastic, the effect on the supply of the domestic
currency would depend the effect on the domestic currency value of imports.
10.Inflation Rate:
A domestic inflation rate that is higher than the inflation of other economies,

would result in imported goods and services bee relatively cheaper than
domestically produced goods and services would increase the demand for the
former, and hence, the supply domestic currency.
11.Trade Barriers:
Trade barriers have the same effect on imports exports - higher the barriers,
lower the imports, and hence, lower the supply of the domestic currency.
12.Income on Investments
Both payments and receipts on account of interest, dividends, profits etc.,
depend on the level of past investments and the current rates of return that can
be earned in an economy. For payments, it is the level of past foreign
investments and the current domestic rates of return; while for the receipts it is
the past domestic investments in foreign economies and the current foreign
rates of return, which are relevant.
13.Transfer Payments
Transfer payments are broadly affected by two factors. One is the number of
migrants to or from a country, who may receive money from or send money to
relatives. The second is the desire of a country to generate goodwill by
granting aids to other countries along with the economic capability to do so, or
its need to take aids and grants from other countries to tide over difficulties.
14.Capital Account Transactions
Four major factors affect international capital transactions. The foremost is the
rate of return which can be earned on the investments as compared to the
returns that can be earned on domestic investments. The higher the differential
returns offered by a country, the higher will be the capital inflows. Another
factor is the additional risk that accompanies these returns. More the risk,
lower the capital inflows. Diversification across countries may offer some
extra benefit in addition to the returns offered by a particular investment. This
benefit arises from the fact that different economies may be at different stages
of economic cycle at a given time, thus making their performance unrelated.
Higher the diversification benefits, higher the inflows. One more factor, which
has a very significant affect on these transactions, is the expected movement in
the exchange rates. If the exchange rates are quite stable, or the movement is
expected to be in the investors' favor, the capital inflows will be higher

CONCLUSION
Foreign Trade
Foreign trade has become more important to our economy in recent years. Exports
and imports of goods and services have grown rapidly. A growing trade volume
benefits our standard of living in several ways, but, as the recession deepens, my

focus here will be limited to the impact of the trade balance on Americas gross
domestic product and, by implication, its job market. G.D.P and employment
generally move in the same directions; so what I say about the impact on G.D.P
generally applies to employment as well.
G.D.P., as Ive discussed here before, is the way economists calculate how much
an economy is producing in total goods and services. It is usually calculated by
adding together several categories of spending, including consumer spending,
investment and government spending. Exports of goods and services generate
income at home, and so they are also a component of G.D.P. Imports, on the other
hand, generate income abroad, so they are subtracted from the other categories of
spending to get a more complete picture of how much an economy is actually
producing. Higher exports and lower imports add to G.D.P., while reduced exports
and higher imports contract G.D.P.
For many years weve had a deficit, in which imports exceed exports, but in recent
quarters a decline in that deficit has contributed to G.D.P. growth. In 2007, exports
were 12 percent and imports were 17 percent of G.D.P., compared to the third
quarters 13 and 16 percent.
In other words, because the gap between imports and exports has been shrinking, it
has had a much smaller negative effect on G.D.P. thereby allowing the economy
to grow. The drag on G.D.P. becomes less as you move from a larger negative to a
smaller negative. Think about facing a 50 mile-per-hour headwind that is reduced
to 25 miles per hour; youre still facing a headwind, but you can move a little
faster.
The shrinking trade deficit contributed 2.93 percentage points to G.D.P. growth in
the second quarter, and 1.07 percentage points in the third quarter. (You might
know that G.D.P. overall didnt grow nearly this much in fact, in the second
quarter G.D.P. grew at an annual rate of 2.88 percent, and in the third quarter it
shrank 0.5 percent. This is because other forces in particular the decline in
consumer spending offset gains in trade.)
Why has the trade deficit been shrinking? Because changes in the value of the
dollar relative to other currencies have made our products look relatively cheap.

American exports respond positively to higher foreign demand and a cheaper

dollar. Our imports grow with higher domestic demand and a more expensive
dollar. The decline in our trade deficit in recent years resulted primarily from the
depreciation of the dollar, since most countries were growing simultaneously with
the U.S. and thus partially neutralized the influence of differential growth rates.
Dollar depreciation made our exports cheaper to foreigners and our imports more
expensive to us.
However, in recent months, as the financial crisis has worsened and spread abroad,
the dollar has rebounded, presumably the result of a flight to quality. Apparently,
when the chips are down, the dollar is still considered the safest currency in the
world despite the crisis having originated here. Flight to quality is usually
applied to a move from riskier investments into riskless (from a credit standpoint)
Treasury bills.
If the dollar continues to appreciate rapidly, our trade balance will change from a
positive to a negative impact on G.D.P. Growth in exports and the decline in
imports showed smaller changes from the second to the third quarter, as youll see
in the table below. This may mark the beginning of that transition.
If our trade deficit increases at a time when consumer spending is falling and
investment is flat, fiscal policy will be the only game in town. Hopefully, dollar
appreciation will slow enough for net exports to continue growing and supporting
our economy and our jobs.
Balance of Payment
The Balance of Payment in our country is unstable. The imports in our country is
more than the exports of our country, due to which our country is suffering from
deficit market. The Government should try to bring new policies in the monetary
market of the economy which can help the countries BOP to be zero. The balance
of payment surplus side can also help the GDP of the country to grow which can
also create a goodwill of our country in the international market.