INTERNATIONAL BUSINESS THEORIES.doc

8/13/2019 INTERNATIONAL BUSINESS THEORIES.doc

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Unit II - INTERNATIONAL BUSINESS THEORIES

2.1 INTRODUCTION

International business began with international trade operations, facilitated by the

laissez faire in the world economy. It improved the well-being of many nations, and the

imposition of trade barriers reduced the gains from trade, giving rise to the search for

alternate avenues to exporting. The latter resulted in the establishment of subsidiaries in

foreign countries through FDI. In this context, it is pertinent to understand the

determinants of and the effects of international trade and FDI on the trading partners,

international operations of multinationals and the economies of the home and host

countries. everal theories have been formulated, from time to time, which form the

bases of international trade and FDI.

2.2 THEORY OF MERCANTILISM

During the sixteenth to the three-fourths of the eighteenth centuries, the world

trade was being conducted according to the doctrine of mercantilism. It comprised many

modern features li!e belief in nationalism and the welfare of the nation alone, planning

and regulation of economic activities for achieving the national goals, curbing imports

and promoting exports.

The mercantilists believed that the power of a nation lied in its wealth, which

grew by ac"uiring gold from abroad. This was considered possible by increasing exports

and impeding imports. uch reasoning gathered support on the ground that gold could

finance military expeditions and wars, and the exports would create employment in the

economy. #ercantilists failed to realize that simultaneous export promotion and import

regulation are not possible in all countries, and the mere possession of gold does not

enhance the welfare of a people. $eeping the resources in the form of gold reduces the

production of goods and services and, thereby, lowers welfare. The concentration in the production of goods for domestic consumption by using resources in a less efficient

manner would also mean lower production and smaller gains from international trade.

The theory of mercantilism was re%ected by &dam mith and 'icardo by stressing

the importance of individuals, and pointing out that their welfare was the welfare of the


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nation. They believed in liberalism and enlightenment, and treated the wealth of the

nation in terms of the (the sum of en%oyments( of the individuals in society. &ny activity,

which would increase the consumption of the people, was to be considered with favour.

Their trade doctrines were based upon the principles of free trade and the specialisation in

the production of those goods where resources were most suitable.

2.3 THEORY OF ABSOLUTE COST ADVANTAGE

The theory of absolute cost advantage was propounded by &dam mith )*++ ,

arguing that the countries gain from trading, if they specialize according to their

production advantages. is doctrine may be understood with an example presented in

Table /.*.

TABLE 2.1

LABOUR COST OF PRODUCTION (in Ho !"#

* unit of goods&

* unit of goods 0

1ountry I *2 /2

1ountry II /2 *2

Table /.* shows that, in the absence of trade, both the goods are produced in both the

countries, because of their demand in the domestic mar!ets. The cost of production is

determined by the amount of labour re"uired in the production of the respective goods.

The greater the amount of labour, the higher will be the cost of production, and the

commodity will have a larger value in exchange. The pre-trade exchange ratio in country

I would be /&3*0 and in country II I&3/0.

If trade ta!es place between these two countries then they will specialise in terms

of absolute advantage and gain from trading with each other. 1ountry I en%oys absolute

cost advantage in the production of good & and country II in good 0. 4ne unit of good &

may be produced in country I with *2 hours of labour, whereas it costs /2 hours of labour

in country II. The production of the unit of good 0 costs /2 hours of labour in country I


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and *2 hours of labour in country II. &fter trade, the international exchange ratio would

lie somewhere between the pre-trade exchange ratio of the two countries. If it is nearer to

country I domestic exchange ratio then trade would be more beneficial to country II and

vice versa. &ssuming the international exchange ratio is established I&3I0, then both the

trading partners would be able to save *2 hours of labour, which may be used either for

the production of other goods and services or may be en%oyed by the wor!ers as leisure,

which improves their welfare in either way. The terms of trade between the trading

partners would depend upon their economic strength and the bargaining power.

2.$ THEORY OF COMPARATIVE COST ADVANTAGE

'icardo )*5*+ , though adhering to the absolute cost advantage doctrine of &dam

mith, pointed out that cost advantage to both the trade partners was not a necessary

condition for trade to occur. It would still be beneficial to both the trading countries even

if one country can produce all the goods with less labour cost than the other country.

&ccording to 'icardo, so long as the other country is not e"ually less productive in all

lines of production, measurable in terms of opportunity cost of each commodity in the

two countries, it will still be mutually gainfull for them if they enter into trade. 'icardo6s

theory may be explained by referring to Table /./.

TABLE 2.2

LABOUR COST OF PRODUCTION (in Ho !"#

* unit of goods&

* unit of goods 0

1ountry I 52 72

1ountry II */2 *22

In Table /./, country I en%oys absolute cost advantage in the production of 8both the

goods & and 0 as compared to their production in country II. 0ut country I has

comparative cost advantage in good & and country II in good 0. 9e ta!e the help of the

concept of opportunity cost in order to !now the relative comparative advantage in the


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production of the goods in the two countries me opportunity cost to produce one unit of good

& is the amount of good 0 which has to be sacrificed for producing the additional unit of good &.

2.% HEC&SEHER-OHLIN TRADE MODEL

&dam mith and 'icardo6s trade models considered labour as the only factorinput and the differences in the labour productivity determining the trade. :li ec!scher

)*7*7 and 0ertin 4hlin )*7;; developed the international trade theory ) .4. Trade

#odel with two factor inputs, labour and capital, pointing out that different countries

have been bestowed with different factor endowments, and the differences in factor

endowments cause trade between the trading partners.

The theory is based on the assumption that there are impediments to trade, and

that there is perfect competition in both the product and factor mar!ets. Further, thetheory is based on the comparative advantage in terms of the relative factor prices. &

country specialising in the production of the goods which re"uire its abundant factor can

export them. Thus, if a country is rich in capital, it will produce capital intensive products

and export them in exchange for the labour intensive products. 4n the other hand, another

country, rich in labour, will produce labour intensive goods and export them. It will

import capital intensive goods.

In the .4. trade theory, the factor abundance has two meanings the factorabundance in terms of the factor prices, and the, factor abundance in terms of the physical

amount of the factors. &ssume there are two countries< I and II, then the richness of the

country in terms of factor prices means relatively low price of the factors of production.

1ountry I is rich in capital as compared to country II, if = ic>=ig ? =/c>=/c. =ic is the price

of capital in country I and = i@ is the price of labour in country I, and =/c is the price of

capital in country II and = /@ is the price of labour in country II. The second definition of

the factor abundance compares the overall physical amount of labour and capital.

1ountry I is capital rich, if the ratio of capital to labour in this country is larger. 1 *>@I A

1 / >@/ , where 1 * and @* are the total amount of capital and labour in country I, and 1 / @/

are the total amount of capital and labour in country II, respectively. The .4. trade

theory holds good, if the factor abundance is defined in terms of factor prices, because of

the incorporation of the demand factor in it. The importance of this theory, which has the


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effect of determining the trade patterns and the gains from trade, may be summarised in

Figure /.;.

Figure /.; illustrates the pre-trade and after-trade production and consumption in the twocountries. 1ountry I--capital rich, is measured along the B axis and country II-labour

abundant, is measured along the C axis. There are two goods. & and 0. ood & is capital

intensive and good 0 is labour intensive. 0efore trade country I is producing and

consuming at and country II at . The II, II * community indifference curve in the two

countries is tangent to their production possibility curves &0 and & *0 * at and ,

respectively. In the domestic mar!et of country I, good & is cheaper and good 0 is

expensive. In country II, it is good 0 which has lower price, good & being costly.In the overseas mar!et, the price is given by the = / =/ international price line. Eow,

the countries move to the points and $ tangent to the international price line, and

country I is producing more of good & and country II more of good 0. 0y exchanging

goods of their specialisation under free trade, they reach to the I / I*/ indifference curve at


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point : and en%oy gains from the international trade as : lies on the higher indifference

curve.

&s in the case of the classical trade model, the .4. trade theory also cannot

guarantee the.

)desired income distribution among different classes in the country. Incountry I, the returns to capital are higher and, in country II, the returns to labour are

higher because of the greater demand for producing respective goods for the world

mar!et.

The basic trade models are based upon certain assumptions, such as no

transportation cost and free flow of information to all the producers and consumers. They

do not ta!e into account the effect6s of trade on the world prices. These trade theories are

static, and ignore the effects of technological progress on the growth of the world

economy. These are the real issues and need to be incorporated in a modified version of

the classical and neo-classical theories.

If a nation has monopoly in certain products, it may influence the world price. It

may enhance its gains by (optimum tariffs66, which see! to maximize the welfare of the

country. Trade may complicate the growth process. It may affect the employment and

may even reduce the welfare of the country. This may occur in the case of immeserising

growth )when benefits from the higher output are neutralised by the unfavourable terms

of trade . The country ends up with lower real income after growth because the gains

arising from higher output are wiped out by the deteriorating terms of trade. It may,

however, by noted that the modified version of the basic theory does not alter the

conclusion that a country produces and exports the commodity in which it has

comparative advantages, and uses the abundant factor in its production. Trade benefits

the nation, but the distribution of gains may be s!ewed. &d%ustment to trade is not

costless but the short-term cost to ad%ustment should be weighted against the long-term

gains from trade.

2.' INSTRUMENTS OF TRADE POLICY

Trade policy uses seven main instruments< tariffs, subsidies, import "uotas,

voluntary export restraints, local content re"uirements, administrative policies, and

antidumping duties. Tariffs are the oldest and simplest instrument of trade policy. &s we


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shall see later in this chapter, they are also the instrument that &TT and 9T4 have

been most successful in limiting. & fall in tariff barriers in recent decades has been

accompanied by a rise in nontariff barriers, such as subsidies, "uotas, voluntary export

restraints, and antidumping duties.

2.'.1 TARIFFS

& t !i)) is a tax levied on imports. Tariffs fall into two categories. S*+,i)i, t !i))"

are levied as a fixed charge for each unit of a good imported )for example, G; per barrel

of oil . A /o!+0 t !i))" are levied as a proportion of the value of the imported good.

The :uropean Hnion has imposed such a tariff on imports of bananas from @atin

&merica the tariff amounts to *J to /2 percent by value on the first /.J million tons of

imports of bananas from @atin &merica )see the opening case .

& tariff raises the cost of imported products. In most cases, tariffs are put in place

to protect domestic producers from foreign competition. In the mid-*752s when the H. .

automobile industry was losing share to apanese competitors, the H. . government

placed a /J percent by value tariff on the importation of light truc!s into the Hnited

tates )light truc!s include sport utility vehicles . The tariff raised the price of light truc!s

imported into the Hnited tates and gave H. . automobile companies some protection

from foreign competition )although a cynic might note that all the tariff did was speed up

the plans of :uropean and apanese automobile companies to build light truc!s in the

Hnited tates . 9hile the principal ob%ective of most tariffs is to protect domestic

producers and employees against foreign competition, they also raise revenue for the

government. Hntil the income tax was introduced, for example, the H. . government

raised most of its revenues from tariffs.

The important thing to understand about a tariff is who suffers and who gains.

The government gains, because the tariff increases government revenues. Domestic

producers gain, because the tariff affords them some protection against foreign

competitors by increasing the cost of imported foreign goods. 1onsumers lose because

they must pay more for certain imports. 9hether the gains to the government and

domestic producers exceed the loss to consumers depends on various factors such as the


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amount of the tariff, the importance of the imported good to domestic consumers, the

number of %obs saved in the protected industry, and so on.

&lthough detailed consideration of these issues is beyond the scope of this boo!,

two conclusions that can be derived from a more advanced analysis.* First, tariffs areunambiguously pro-producer and anti-consumer. 9hile they protect producers from

foreign competitors, this restriction of supply also raises domestic prices. Thus, as noted

in the opening case, the tariff on banana imports into the :uropean Hnion has raised

prices for bananas in the :H, and cost consumers some G/ billion a year. &nother study

by apanese economists calculated that tariffs on imports of foodstuffs, cosmetics, and

chemicals into apan in *757 cost the average apanese consumer about G572 per year in

the form of higher prices./ &lmost all studies that have loo!ed at this issue find that

import tariffs impose significant costs on domestic consumers in the form of higher

prices.; For another example, see the accompanying 1ountry Focus, which loo!s at the

cost to H. . consumers of tariffs on imports into the Hnited tates.

econd, tariffs reduce the overall efficiency of the world economy. They reduce

efficiency because a protective tariff encourages domestic firms to produce products at

home that, in theory, could be produced more efficiently abroad. The conse"uence is an

inefficient utilization of resources. For example, tariffs on the importation of rice into

outh $orea have caused the land of outh $orean rice farmers to be used in an

unproductive manner. It would ma!e more sense for the outh $oreans to purchase their

rice from lower-cost foreign producers and to utilize the land now employed in rice

production in some other way, such as growing foodstuffs that cannot be produced more

efficiently elsewhere or for residential and industrial purposes.

2.'.2 SUBSIDIES

& " "i is a government payment to a domestic producer. ubsidies ta!e many

forms including cash grants, low-interest loans, tax brea!s, and government e"uity

participation in domestic firms. 0y lowering production costs, subsidies help domestic

producers in two ways< they help them compete against foreign imports and they help

them gain export mar!ets.


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&griculture tends to be one of the largest beneficiaries of subsidies in most

countries. In *775, for example, developed countries paid some G; 2 billion in support to

farmers. In apan, agricultural subsidies amounted to a staggering / percent of the value

of gross farm receipts, or G/*,222 per farmer. In the :uropean Hnion, where the 1ommon&gricultural =olicy )1&= has long provided subsidies to help farmers stay in business,

subsidies amounted to K; percent of the value of gross farm receipts, or G*7,222 per

farmer. In the Hnited tates, subsidies were // percent of gross farm receipts, which

again amounts to G*7,222 per farmer. In 1anada, subsidies were *5 percent of gross farm

receipts, or G5,222 per farmer.

4utside of agriculture, subsidies are much lower, but they are still significant.

4ne study found that government subsidies to manufacturing industries in most

industrialized countries amounted to between / percent and ;.J percent of the value of

industrial output. The average rate of subsidy in the Hnited tates was 2.J percent in

apan it was * percent, and in :urope it ranged from %ust below / percent in reat 0ritain

and 9est ermany to as much as to + percent in weden and Ireland.J These figures,

however, almost certainly underestimate the true value of subsidies, since they are based

only on cash grants and ignore other !inds of subsidies )e.g., e"uity participation or low-

interest loans .

The main gains from subsidies accrue to domestic producers, whose international

competitiveness is increased as a result of them. &dvocates of strategic trade policy

)which, as you will recall from 1hapter K, is an outgrowth of the new trade theory favor

subsidies to help domestic firms achieve a dominant position in those industries where

economies of scale are important and the world mar!et is not large enough to profitably

support more than a few firms )e.g., aerospace, semiconductors . &ccording to this

argument, subsidies can help a firm achieve a first-mover advantage in an emerging

industry )%ust as H. . government subsidies, in the form of substantial 'LD grants,

allegedly helped 0oeing . If this is achieved, further gains to the domestic economy arise

from the employment and tax revenues that a ma%or global company can generate.

0ut subsidies must be paid for. overnments typically pay for subsidies by taxing

individuals. Therefore, whether subsidies generate national benefits that exceed their


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national costs is debatable. In practice, many subsidies are not that successful at

increasing the international competitiveness of domestic producers. 'ather, they tend to

protect the inefficient, rather than promoting efficiency, and promote excess production.

&gricultural subsidies )* allow inefficient farmers to stay in business,

)/ encourage countries to overproduce heavily subsidized agricultural products,

); encourage countries to produce products that could be grown more cheaply

elsewhere and imported, and, therefore, )K reduce international trade in agricultural

products. 4ne recent study estimated that if advanced countries abandoned subsidies to

farmers, global trade in agricultural products would be J2 percent higher and the world as

a whole would be better off to the tune of G* 2 billion. This increase in wealth arises

from the more efficient use of agricultural land.

2.'.3 IMPORT UOTAS AND VOLUNTARY E4PORT RESTRAINTS

&n i0*o!t 5 ot is a direct restriction on the "uantity of some good that may be

imported into a country. The restriction is usually enforced by issuing import licenses to a

group of individuals or firms. For example, the Hnited tates has a "uota on cheese

imports. The only firms allowed to import cheese are certain trading companies, each of

which is allocated the right to import a maximum number of pounds of cheese each year.

In some cases the right to sell is given directly to the governments of exporting countries.This is the case for sugar and textile imports in the Hnited tates.

& variant on the import "uota is the voluntary export restraint )M:' . &

o/ nt ! +6*o!t !+"t! int is a "uota on trade imposed by the exporting country,

typically at the re"uest of the importing countryNs government. 4ne of the most famous

examples is the limitation on auto exports to the Hnited tates enforced by apanese

automobile producers in *75*. & response to direct pressure from the H. . government,

this M:' limited apanese imports to no more than *. 5 million vehicles per year. Theagreement was revised in *75K to allow *.5J million apanese vehicles per year. The

agreement was allowed to lapse in *75J, but the apanese government indicated its

intentions at that time to continue to restrict exports to the Hnited tates to *.5J million

vehicles per year.+ Foreign producers agree to M:'s because they fear far more

damaging punitive tariffs or import "uotas might follow if they do not. &greeing to a


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M:' is seen as a way of ma!ing the best of a bad situation by appeasing protectionist

pressures in a country.

&s with tariffs and subsidies, both import "uotas and M:'s benefit domestic

producers by limiting import competition. &s with all restrictions on trade, "uotas do not benefit consumers. &n import "uota or M:' always raises the domestic price of an

imported good. 9hen imports are limited to a low percentage of the mar!et by a "uota or

M:', the price is bid up for that limited foreign supply. In the case of the automobile

industry, for example, the M:' increased the price of the limited supply of apanese

imports. &ccording to a study by the H. . Federal Trade 1ommission, the automobile

industry M:' cost H. . consumers about G* billion per year between *75* and *75J.

That G* billion per year went to apanese producers in the form of higher prices.5 The

extra profit that producers ma!e when supply is artificially limited by an import "uota is

referred to as a 5 ot !+nt.

If a domestic industry lac!s the capacity to meet demand, an import "uota can

raise prices for both the domestically produced and imported good. This happened in the

H. . sugar industry, where an import "uota has long limited the amount foreign producers

can sell in the H. . mar!et. &ccording to one study, as a result of import "uotas the price

of sugar in the Hnited tates has been as much as K2 percent greater than the world

price.7 These higher prices have translated into greater profits for H. . sugar producers,

who have lobbied politicians to !eep the lucrative agreement in place.

They argue that H. . %obs in the sugar industry will be lost to foreign producers if

the "uota system is scrapped.

&nother industry that has long operated with import "uotas is the textile industry,

which has a complex set of multinational agreements that govern the amount one country

can export to others. In this industry, "uotas on imports into the Hnited tates haverestricted the supply of certain apparel products and increased their price by as much as

+2 percent.*2 Ouotas also encourage firms to engage in strategic actions de-signed to

circumvent "uotas. The accompanying #anagement Focus loo!s at how one company,

ong $ong-based :s"uel, has altered the geographic distribution of its production system

to circumvent "uotas on the importation of certain textile products into the Hnited tates.


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The Hnited tates is not alone in imposing "uotas on textile imports. #ost other

developed nations have similar "uotas. Hnder a 9orld Trade 4rganization agreement

struc! in *77J, many of the "uotas on textile products are scheduledto be phased out by

/22J.

2.'.$ ADMINISTRATIVE POLICIES

In addition to the formal instruments of trade policy, governments of all types

sometimes use informal or administrative policies to restrict imports and boost exports.

A 0ini"t! ti + t! + *o/i,i+" are bureaucratic rules that are designed to ma!e it difficult

for imports to enter a country. ome would argue that the apanese are the masters of this

!ind of trade barrier. In recent years apanNs formal tariff and nontariff barriers have been

among the lowest in the world. owever, critics charge that the countryNs informal

administrative barriers to imports more than compensate for this. For example, the

Eetherlands exports tulip bulbs to almost every country in the world except apan. In

apan, customs inspectors insist on chec!ing every tulip bulb by cutting it vertically down

the middle, and even apanese ingenuity cannot put them bac! together againP Federal

:xpress has had a tough time expanding its global express shipping services into apan

because apanese customs inspectors insist on opening a large proportion of express

pac!ages to chec! for pornography, a process that can delay an QexpressR pac!age for

days. apan is not the only country that engages in such policies. France re"uired that all

imported videotape recorders arrive through a small customs entry point that was both

remote and poorly staffed. The resulting delays !ept apanese M1's out of the French

mar!et until a M:' agreement was negotiated.** &s with all instruments of trade policy,

administrative instruments benefit producers and hurt consumers, who are denied access

to possibly superior foreign products.

2.'.% ANTIDUMPING POLICIES

In the context of international trade, 0*in7 is variously defined as selling

goods in a foreign mar!et at below their costs of production, or as selling goods in a

foreign mar!et at below their QfairR mar!et value. There is a difference between these

two definitions the QfairR mar!et value of a good is normally %udged to be greater than

the costs of producing that good because the former includes a QfairR profit margin.


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Dumping is viewed as a method by which firms unload excess production in foreign

mar!ets. ome dumping may be the result of predatory behavior, with producers using

substantial profits from their home mar!ets to subsidize prices in a foreign mar!et with a

view to driving indigenous competitors out of that mar!et. 4nce this has been achieved,

so the argument goes, the predatory firm can raise prices and earn substantial profits.

&n alleged example of dumping occurred in *77+, when two outh $orean

manufacturers of semiconductors, @ emicon and yundai :lectronics, were accused of

selling dynamic random access memory chips )D's in the H. . mar!et at below

their costs of production. This action occurred in the middle of a worldwide glut of chip-

ma!ing capacity. It was alleged that the firms were trying to unload their excess

production in the Hnited tates.

&ntidumping policies are designed to punish foreign firms that engage in

dumping. The ultimate ob%ective is to protect domestic producers from QunfairR foreign

competition. &lthough antidumping policies vary somewhat from country to country, the

ma%ority are similar to the policies used in the Hnited tates. If a domestic producer

believes that a foreign firm is dumping production in the H. . mar!et, it can file a petition

with two government agencies, the 1ommerce Department and the International Trade

1ommission. In the $orean D' case, #icron Technology, a H. . manufacturer of

D's, filed the petition. The government agencies then investigated the complaint. If

they find it has merit, the 1ommerce Department may impose an antidumping duty on

the offending foreign imports )antidumping duties are often called ,o nt+! i/in7

ti+" . These duties, which represent a special tariff, can be fairly substantial and stay in

place for up to five years. For example, after reviewing #icronNs complaint, the

1ommerce Department imposed 7 percent and K percent countervailing duties on @

emicon and yundai D' chips, respectively.

Unit 8 III FOREIGN E4CHANGE DETERMINATION SYSTEMS

BASIC CONCEPTS RELATING TO FOREIGN E4CHANGE

INTRODUCTION


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&n Indian resident, who is dealing, day in and day out in various commodities and

to buy and sell them, uses legal currency of India i.e., Indian 'upee. 0ut to buy and sell

commodities and services, if he has a currency, which is other than his countryNs

currency, what will happenS ay for example, an Indian resident receives H Dollar

*,222 from his relative, for using in India, he cannot straightaway use the Dollar, but has

to convert in Indian 'upees and use it to buy commodities>services.

ence can we define Foreign :xchange in the following mannerS

* The currencies of other countries in the form of 1urrency Eotes, TravellersN 1he"ues,

Drafts, Telegraphic Transfers, #ail Transfers etc.

/ The mechanism by which our legal tender is converted into another currency and vice

versa.

9HY CONVERSION IS NECESSARY:

1onversion of 1urrencies with each other has become a necessity. 0ecause no

country in this Hniverse can claim that they manufacture all the goods and services, that

their people re"uire to consume. :ven the mighty H & is no exception. They import

1offee from 0razil, India etc. for their consumption. imilarly India imports 1apital

goods, Technology etc. from 9estern 1ountries.

&ll are aware that there is no Hniversal 1urrency through which such settlements

across the national barriers and borders could be made and settlements ta!e place in the

sellersN>buyersN>any mutually accepted currency. ence the invention of conversion

mechanism.

9HY E4CHANGE CONTROL:

India is having the following Inflows and 4utflowsTravel related expenses

J TouristsN income @oan repayments > servicing of loans

Eormally in India, there is a shortfall of inflows than outflows. 4ur import payments are

very crucial for the countryNs economy and e"ually important are our payments towards

repayment of loans and its servicing. 9hen demand outplays supply, it is only prudent

that we manage our foreign exchange reserves %udiciously.

ence 'eserve 0an! of India, under the provisions of Foreign :xchange

'egulation &ct *7+;, controls the inflow and outflow of foreign exchange. Through the

:xchange 1ontrol #anual )*77; :dition and subse"uent &D )#& 1irculars, it enforces

the proper management of countryNs foreign exchange.

TRADE CONTROL

It is e"ually important for any country to effectively monitor the movement of

goods. 9hile the movement of foreign exchange is being controlled through :xchange

1ontrol #anual )*77; and subse"uent &D )#& circulars, goods movement in and out

of the country is being monitored under the provisions of Foreign Trade )Development

and 'egulations &ct, *77/. The controlling authority in this case is Director eneral of

Foreign Trade, Eew Delhi and their various offices in other places headed by oint

Director of Foreign Trade. D. .F.T. and .D.F.T. are guided by the :CI# =4@I1B

)*77+-/22/ , which is being provided by the #inistry of 1ommerce, overnment of

India. 1ustoms are the authorities who are ensuring the movement of goods according to

the above-said provisions, besides collection of revenues by way of duty on goods

imported or exported.

HO9 THE FOREIGN E4CHANGE IS HANDLED:

'eserve 0an! of India under the provisions of F:'& *7+;, has delegated the

authority of handling Foreign :xchange to tate 0an! of India )and its subsidiaries ,

=ublic ector 0an!s, =rivate ector 0an!s and Foreign 0an!s. They have delegated the


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authority of handling Foreign :xchange and they are explained through various 1hapters

of :xchange 1ontrol #anual, a boo! released by 'eserve ban! of India, the latest one

being *77; edition. Hnder :1#, designated &uthorised Dealers )of Foreign :xchange

will be dealing in various Foreign :xchange transactions, to comply with all terms and

conditions. &gain 0an!s that are authorised to handle Foreign :xchange, designate

certain branches to handle the Foreign :xchange transactions, depending the necessity

and potentiality of branchNs location and they are called &uthorised dealing branches.

0esides the above, 'eserve 0an! of India also authorises reputed otels and other

private establishments to handle Foreign :xchange in a limited way )say they can issue >

encash Foreign 1urrency TravellersN 1he"ues > Foreign 1urrency Eotes to cater to the

foreign touristsN re"uirements. They are called &uthorised #oney 1hangers ) .

They are classified as FH@@-F@:D :D > ': T'I1T:D #4E:B1 &E :' .

TYPES OF FOREIGN E4CHANGE TRANSACTIONS;

&uthorised Dealers can handle two types of transactions viz. =urchase and ale of

Foreign :xchange. 9hen customers tender export bills denominated in Foreign

1urrency, &Ds shall purchase the Foreign 1urrency 0ill. @i!ewise, when customers

re"uest for a remittance in Foreign 1urrency towards payment of Import bills, then &Ds

have to sell Foreign 1urrency to him. From this, we understand that both selling and

purchasing transactions are from the ban!Ns angle.

SETTLEMENT OF FOREIGN E4CHANGE TRANSACTIONS;

ettlements of Foreign :xchange Transactions are made through the following

accounts< -

* E4 T'4 &ccount< 4ur &ccount with you

ex< The account maintained by an &uthorised Dealer with a foreign ban! is called

(E4 T'4( &ccount or (4ur &ccount with Bou(. 9hen an instrument li!e a che"ue or

an export bill is purchased the same is sent to the overseas ban! )correspondent for

realisation, the amount is collected and credited to &uthorised DealerNs account with

them.


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imilarly, when a draft is issued on a ban!s foreign correspondent it will be paid

at the overseas centre by debiting the E4 T'4 &ccount of the issuing ban!.

/ M4 T'4 &ccount< Bour &ccount with us

:x.< Foreign ban!s )1orrespondents also maintain accounts with any ban! inIndia in Indian 'upees for the purpose of settling their rupee transactions and these

accounts are called (M4 T'4( &ccounts meaning (Bour &ccount with us(.

; @4'4 &ccount< Their account with them

:x.< ust li!e tate ban! 4f India maintaining an account with foreign

correspondent say 0T1, Eew Bor!, 1anara 0an! may also maintain a Eostro &ccount

with them. 9hen 0I advises 0T1 Eew Bor! for transfer of funds to 1anara 0an!

&ccount with them, 1anara 0an! &ccount is titled as @oro &ccount (i.e. their account

with you(.

9hen our ban! deals in an export credit bill on collection basis>on realisation of

export bills negotiated >purchased>discounted, the foreign currency funds is to be credited

to our account. For this purpose, we maintain Foreign 1urrency accounts with our

various correspondents abroad. The account is called E4 T'4 account. 4nce the

proceeds are credited in our E4 T'4 account, we receive the statement, based on

which, the concerned branch, who have handled the transaction, will be informed.

@i!ewise, when we would li!e to ma!e remittances, on behalf of our customers

towards import payments, miscellaneous remittances etc., we give instructions to our

correspondents, to debit our E4 T'4 account and effect payment.

ometimes our correspondents maintain M4 T'4 accounts )'upee accounts of

Eon-resident ban!s with our ban! and payment or receipts are made through this

account. For exports, they will authorise us to debit their M4 T'4 account and for

imports, they will give instructions to credit their account.

@i!ewise whenever the account of one ban! in the boo!s of the same

correspondent, where we are maintaining our E4 T'4 account, the other ban!Ns

account with the correspondent is referred as @4'4 account. That is the account


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maintained by Indian 0an! with our correspondent 0an!ers Trust 1o Eewyor!, will be

referred as @4'4 account of Indian 0an!.

E4CHANGE RATES

The rate, at which a currency is converted into another currency, is called the rateof exchange. uch rates are arrived from the base rate, which is decided by mar!et forces

and is "uoted on a daily basis. 0an!s "uote various rates for different types of operations

li!e 0ill buying, 0ill selling, TT )DD>#T>TT buying , TT )DD>#T>TT elling etc. The

rates are arrived after loading suitable margins, as per F.:.D.&.I. )Foreign :xchange

Dealers &ssociation of India guidelines.

FOREIGN E4CHANGE MAR&ET

Foreign :xchange #ar!et is an 4ver the 1ounter #ar!et. It means that there is no

fixed mar!et place. #ar!et players are differently and distantly located. It has no borders

and barriers. &ll the transactions are put through over telecommunications followed up

by written confirmations. ence there is the need of high level professionalism for the

mar!et players, which is in place.

#ar!et =layers are &uthorised Dealers, 'ecognised Foreign :xchange bro!ers,

:xporters, Importers, 'eserve 0an! of India. ometimes mar!et dealers include foreign

ban!s abroad.

&s such, Foreign :xchange #ar!et is a three tier mar!et viz.

Documents

INTERNATIONAL BUSINESS THEORIES.doc