International Trade 

Trade between residents of two different countries:

Problems:
  • Different monetary units.
  • Restrictions on imports and exports.
  • Restrictions on payments.
  • Different legal practices.
Foreign Exchange
  • The rate at which one currency is converted into another currency is the rate of exchange between the currencies concerned.
  • The banks operating at a financial centre and dealing in foreign exchange constitute the foreign exchange market.

Foreign Exchange as Stock
  • In another sense, the term foreign exchange is used to refer to the very balance held abroad.
  • FEMA, 1999: foreign exchange includes foreign currency, balances kept abroad, instruments payable in foreign currency and instruments drawn abroad but payable in Indian currency .

Balance of Payments
Balance of payments ( BOP ) is the systematic summary of the economic transactions of the residents of a country with the rest of the world during a specified time period, normally a year.

BOP Accounting

In compilation of balance of payments, double entry principle of accounting is used:

⇒Export of goods USD 200 Mn. – realisation deposited in bank abroad.
⇒Import of goods USD 150 Mn. – payment made from bank account abroad.
⇒Amount spent by foreign tourists in the country USD 40 Mn.
⇒Received goods as gift from another country USD 60 Mn.
⇒Export of commodities for USD 80 Mn. On a government deal – payment in gold by the importing country’s government.

BOP Statement

BOP statement is presented with three major components:
  1. Current Account
  2. Capital Account
  3. Official Reserve Account

URL Diagram:


Importance of BOP

  1. Judge economic and financial status of a country in the short-term.
  2. Deficit signifies a tendency to take stiff measures for diminishing imports, exchange control and restrictions on repatriation of dividends/ interest.
  3. Consistent BOP deficit has an unfavourable effect on exchange rate – depreciation of the currency.
  4. Central bank intervenes through its regulatory stock to control volatility of exchange rate.
Link between the National Economy & International Activities

⇒National Income = Consumption + Savings

⇒National Spending = Consumption + Investment

So that,

⇒National Income – National Spending = Savings – Investment

⇒If a nation’s income exceeds its spending, savings will exceed domestic investment.

⇒A nation that produces more than it spends will save more than it invests domestically and will have a net capital outflow.

⇒This capital flow will appear as a combination of capital account deficit and an increase in official reserves.