Please see Indian Economy on the Eve of Independence Class 11 Economics Revision Notes provided below. These revision notes have been prepared as per the latest syllabus and books for Class 11 Economics issues by CBSE, NCERT, and KVS. Students should revise these notes for Chapter 1 Indian Economy on the Eve of Independence daily and also prior to examinations for understanding all topics and to get better marks in exams. We have provided Class 11 Economics Notes for all chapters on our website.
Chapter 1 Indian Economy on the Eve of Independence Class 11 Economics Revision Notes
The term “Globalization” means the integration of the economy of each country with the world economy. The essence of globalization is the increasing degree of openness in respect of international trade, international investment and international finance. In other words, globalization is the process of transformation of the world into a single integrated economic unit. In a global economy, all the barriers on the flow of trade in goods and services and investment across the national frontiers are removed. According to Guy Brainbant, the process of globalisation not only includes opening up of world trade, development of advanced means of communication, internationalisation of financial markets, growing importance of MNC’s, population migrations and more generally increased mobility of persons, goods, capital, data and ideas but also infections, diseases and pollution.
The process of globalization underlie following trends.
1) Spread of international trade.
2) Increasing migration of people.
3) Increasing flow of money or means of payments.
4) More capital flows.
5) Increased flow of finance capital.
6) Emergence of more and more transnational companies and multi national companies.
7) Increasing trade of technology between different countries.
8) Rapid spread of print, electronic and communication media.
9) Growth in trade and production of services of all kinds – including education.
India opened up the economy during early 1991 following a majorcrisis that led by a foreign exchange crunch with reserves which could hardly finance inputs for two weeks in India. The crisis has dragged the economy close to defaulting on loans. The credit rating of India had gone down and non-resident Indians (NRIs) had started withdrawing their deposits in foreign currency and the country was on the verge of default with regard to the payments of short -term credits incurred from foreign financial institutions.
Hence, drastic policy measures were introduced on the domestic and external sectors to address all these issues. All these policy measures were partly prompted by the immediate needs and partly by the demand of the multilateral organisations like World Bank and International Monetary Fund (IMF). The liberalised policy regime rapidly pushed forward in favour of a more open and market oriented economy.
Policy Measures of Liberalisation Major policy measures have been launched as a part of the liberalisation, privatisation and globalisation (LPG) programmes. The government announced the devaluation of rupee by about 20% in July 1991, new industrial policy, new trade policy in 1991, and a new export and import policy were also announced. Other measures followed are scrapping of the industrial licensing regime, reduction in the number of areas reserved for the
public sector, amendment of the Monopolies and the Restrictive Trade Practices Act, withdrawal of many governmental controls, start of the privatisation programme, sharp reduction in tariff rates, change over to market determined exchange rates,many fiscal and financial sector reforms. All these measures have been grouped together under ‘New Economic Policy’ (NEP) Over the years there has been a steady liberalisation of the current account transactions, more and more sectors opened up for foreign direct investments and portfolio investments facilitating entry of foreign investors intelecom, roads, ports, airports, insurance and other major sectors.
Liberalisation, privatisation and globalisation in the form of increased integration of India with the global economy through trade and investment since early nineties are some of the major reasons for the high level of economic growth in recent years. Despite this progress, unemployment, poverty, inequality and low level of human development still remains to be the most serious development challenges to be reckoned with.
Foreign investment plays a very important role in the new economic policy (NEP) launched in India to encounter the economic crisis of ninety.
The main objective of NEP has been to achieve a higher level of economic growth. The strategies that were adopted as the measures for the development of the economy were devaluation, restrictive monetary target, minimization of the physical deficit, trade liberalization, privatization of industrial sectors and opening of the economy for foreign investment and competition.
Among them foreign investment plays a most vital role. The inflow of foreign investment was encouraged to bridge the investment gap particularly in the industrial sector. Foreign investment was supposed to bring technology, marketing enterprise, managerial techniques and new possibilities of import promotion.
For promoting foreign investment in high priority industries and advanced technology, it was decided to provide approval for direct foreign investment upto 51% of foreign equity (earlier 40% in such industries). This change was expected to make Indian policy on foreign investment more transparent. Such a framework would make it easy for foreign companies to invest in India.
The NEP 1991 can be regarded as minor revolution as far as decisions concerning foreign investment and foreign technology agreements are concerned. The various changes in the foreign investment policy can be broadly classified into four categories.
1) Choice of Product: The number of products in which foreign investment is freely permitted has been significantly increased.
2) Choice of Market: The foreign investors are free now to compete with the domestic producers in the Indian market.
3) Choice of Ownership Structure: In most cases, the foreign investor is free to own a majority share in equity.
4) Simplification of Procedures: Foreign direct investment (FDI) flows through three different routes.
The first is with automatic approval by the Reserve Bank of India. The second route for foreign direct investment is from multinational companies on their Indian partners who want to invest in an industry outside these 35 sub-sectors or when an FDI holding or more than 51% is sought, permission has to be taken from the Secretariat of Industrial approvals (SIA) or the Foreign Investment Promotion Board. (FIPB). The third route is investment by non-resident Indians.
Transfer of Technology
Technology is an important ingredient of the development mix. Developing countries are generally characterized by technological backwardness and a slow pace of technological progress. Transfer of technology from the developed to the developing countries is a necessary measure to speed up the pace of the economic development and modernization process. The new economic policy has sown a seed for the
free flow of technology transfer through liberalization and globalization.
Technology transfer has been taking place on a large scale through licensing agreements and joint ventures. The methods of technology transfer are as follows.
1. Training or Employment of Technical Export
2. Contracts for supply of machinery and equipment and
3. Licensing agreements.
The appropriateness of the foreign technology to the physical, economic and social conditions of the developing countries is an important aspect to be considered in technology transfer.
Trade and Economic Development
Evolution of Trade from barter system to money economy
Trade is one of the key determinants of economic development. Development of trade can improve a country’s development. Trade is simply the exchange of commodities which takes place at different levels. The earliest form of trade was probably barter in which one type of good was exchanged for another good. In the beginning of human existence, needs were simple and every individual produced what he wanted. In course of time, people settled down in different occupations. When specialization emerged, trade came into existence. Initially direct exchange of goods for goods known as barter system of trade prevailed. For instance, in a barter economy a person who had plenty of food but no clothes exchanged a part of his food with the person who had plenty of clothes but no food. In this method of direct exchange or barter, there were many difficulties and inconveniences.
The main inconvenience of barter was the necessity for double coincidence of wants. For example, a person has a cow and he wants to exchange cow for rice. Another person who has rice does not want a cow but he wants a horse. In this case, the transaction cannot take place, because there is no double coincidence of wants. The simple process of barter might have worked well when transactions were few and simple. As the system of exchange progressed, and with the advent of industrialization, the domestic
system of production gave place to factory system. At this juncture, absence of double coincidence of wants posed a major problem in the transaction of goods. Further there were other difficulties of barter system, which hinder the trade practices. These are problems of store of value, standard of value and measure of value. Because of the nconvenient system of exchange under barter system, man had to give up barter and had to invent an intermediate
commodity which makes the buying and selling of goods very easy. This intermediate commodity would have to be familiar, easily recognizable and generally acceptable to all people, since it had to serve as the medium of exchange. This medium of exchange was known as money.
‘Money is one of the most fundamental of all man’s inventions. In the whole of man’s social existence, money is the essential invention. Money acts a medium of exchange, a measure of value, a store of value and a standard of deferred payments. Thus barter economy has given place to money economy.
With the introduction of money, the process of direct exchange of goods for goods was given up. A new system of exchange was introduced. Under the new system, a person who has an article to exchange, sells it for money and with the money he can purchase the commodities he wants.
The problem of expressing the value of each article in terms of all other is solved and the value was expressed in terms of a single commodity, money. The problem arising from the absence of double coincidence of wants is also solved. It is enough if a person is able to find a purchaser for his goods. It is not necessary that person should possess what he requires. Money can be conveniently stored and a person can save a part of his income for future use. Thus money overcomes all the disadvantages of barter system of exchange.
Before the introduction of paper money, any commodity that was generally demanded was chosen by common consent as a medium of exchange. For example, people living by sea-shore chose shells as medium of exchange, in cold countries people used skins of animals and fur; in tropical countries, elephant tusks, plumage of birds and tiger teeth were used as medium of exchange. With the progress of civilization and economic development, metals like gold, silver, and copper came to be used as money.
It was found inconvenient as well as dangerous to carry gold and silver coins from place to place. In the 15th and 16th centuries, European merchants adopted the practice of carrying proper receipts showing their title to metallic money, which they had kept with well-known goldsmiths for safe custody.
In this way, paper money was introduced as a substitute for metallic money. Then the system of monopoly of note issue by the central bank of the respective country was introduced. At present legal tender money consists mainly of currency notes or paper money issued by the central bank.
Therefore, banking practices facilitate trade and development within the country as well as among countries through employment of monetary weapons like exchange rate.
It would be right to say that the present day trade dimensions would not have been possible without money.
Need for International Trade The type of trade with which most people are familiar is retail trade, in which shopkeepers sell goods to individual consumers for money. If it is done on a large scale it is called wholesale trade, in which factories or producers sell the goods to wholesalers, who in turn sell them to shopkeepers or retailers. The exchange of goods and services between different regions within a country is referred to as internal trade. Thus, international trade refers to the trade or exchange of goods and services between two or more countries.
No country can be completely self sufficient, and trade between countries is therefore essential to ensure a supply of a country’s needs.
Moreover, it enables the people to enjoy those goods and services which they cannot produce themselves or which they can produce at a relatively high cost.
There is unequal distribution of productive resources by the nature on the surface of the earth. Countries differ in respect of climatic conditions, availability of cultivable land, forests, mines, mineral products, labour, capital technology and entrepreneurial skills etc. Given their diversities, no country has the potential to produce all the commodities at the least cost.
Just as there is division of labour in the case of individuals, the countries also adopt this principle at the international level. Each one of them specializes in the production of only such commodities, which they can produce at comparatively lower cost than the others. They export such products to others and in return import those products in the production, of which they have comparative cost disadvantage. The existence of cost differences create
price differential among the various countries.
Theory of Comparative Advantage
The theory of comparative advantage just explains such advantages of free trade. David Ricardo (The Principles of Political Economy and Taxation 1817) shown that trade without barriers can be beneficial for two countries if one is more efficient at producing goods or services needed by the other. What matters is not the absolute cost of production, but rather the ratio between how easily the two countries can produce different goods.
Thus, according to the theory of comparative advantage, if countries specialize in producing what they are most efficient, then they can trade these goods for those produced most efficiently by other country.
The concept of comparative advantage can be illustrated with at least two goods and two countries where each good could be produced with scarce resources in each country. Suppose the two goods are food and clothing, and that the price of food within country ‘A’is 0.50 units of clothing and the price of clothing is 2 units of food. The price of food in country ‘B’ is 1.67 units of clothing and the price of clothing is 0.60 units of food. Then we can say that country ‘A’ has a comparative advantage in producing food and country ‘B’ has a comparative advantage in producing clothing. It follows that in a trading relationship the country ‘A’ should allocate at least some of its scarce resources to producing food and country ‘B’ should allocate at least some of its scarce resources to producing clothing, because this is the most efficient allocation of the scarce resources and allows the price of food and clothing to be as low as possible.
Hence, the theory argued that free trade will benefit all due to comparative advantage.
Contribution of foreign trade to economic development
Foreign trade has worked as an ‘engine of growth’ in the past. Recently the “outward-oriented growth strategy” adopted by the Newly Industrializing Economies of Asia, has enabled many countries to overcome the constraints of small resource-poor under-developed economies. Foreign trade contributes to economic development in a number of ways as follows.
i) It explores means of procuring imports of capital goods, which initiates the development process.
ii) It provides for flow of technology, it allows an increase in factor productivity.
iii) It generates pressure for dynamic change through (i) competitive pressure from imports, (ii) pressure of competition for export markets, and (iii) a better allocation of resources.
iv) Exports allow fuller utilization of capacity, increased exploitation of economies of scale, separation of production patterns from domestic demand, and increasing familiarity with absorption of new technologies. These, in turn, help increase the profitability of the domestic business without any corresponding increases in price.
v) Foreign trade increases worker’s welfare. It does so at least in four ways:
(i) larger exports translate into higher wages;
(ii) because workers are also consumers, trade brings them immediate gains through cheaper imports;
(iii) It enables most workers to become more productive as the goods they produce increase in value;
(iv) trade increases technology transfers from industrial nations to UDCs and the transferred technology is biased in favour of skilled labour;
vi) Increased openness to trade has been strongly associated with the reduction of poverty in most developing countries.
In the twenty-first century, we can easily identify the conditions that are favourable for developing economies to the conditions to employ foreign trade as a factor in economic growth. They are as follows:
i) Increasing spread to globalization translates into larger movement of goods and services across the nations.
ii) Continuing reallocation of manufacturing activities from industrial economies to developing economies offers ample opportunities to expand trade not only in goods, but also in services, which are becoming increasingly tradable.
iii) Trade is intertwined with another element of globalization: the spread of international production networks.
iv) Growth of trade is firmly buttressed by international institutions of long standing. The WTO, built on the legacy of the GATT, aims to create a commercial environment more conducive to the multilateral exchange of goods and services.
v) In recent years there have been substantial reductions in trade policy and other barriers inhibiting developing country participation in world trade. Lower barriers have contributed to a dramatic shift in the pattern of developing country trade-away from dependence on commodity exports to much greater reliance on manufactures and services.
In addition, exports to other developing countries have become much more important.
International Monetary Fund (IMF)
A landmark in the history of world economic co-operation is the creation of the International Monetary Fund (IMF). The decision to start IMF was taken at Bretton woods conference and it commenced its operation in March 1947. According to the Articles of Agreement of IMF, the objectives of IMF are:
1) To promote international monetary cooperation
2) To promote stability in foreign exchange rates;
3) To eliminate exchange control
4) To establish a system of multilateral trade and payments
5) To set right the disequilibria in the balance of payments.
The following are the major functions of the IMF
1) Functions as a short term credit institution.
2) Provides machinery for the orderly adjustments of exchange rates.
3) Acts as a reservoir of the currencies of all the member countries from which a borrower nation can borrow the currency of other nations.
4) Functions as a sort of lending institution in foreign exchange. It grants loans for financing current transactions only and not capital transactions.
5) It also provides machinery for altering sometimes the par value of the currency of a member country.
6) It also provides machinery for international consultations.
7) Provides technical experts to member countries having BOP difficulties and other problems.
8) Conducts research studies and publishes them in IMF Staff papers, Finance and development etc.
The structure of IMF
The highest authority of the fund is the Board of Governors. It consists of Executive Board, a Managing Director, a council and staff with its headquarters in Washington, U.S.A. There are ad hoc and standing committees appointed by the Board of Governors and Executive Board. The Board of Governors and the Executive Board are decision-making organs of the fund. The decisions are binding on the fund and its members.
Working of the Fund
The capital of the Fund included quotas of member countries, amount received from the sale of gold and loans from member countries. When a country joins the fund it is assigned a quota that governs the size of its subscription, its voting power and its drawing rights. At the time of formation of the fund each member has to pay 25% of its quota in gold. The remaining 75% was to be furnished in the country’s own currency.
The bulk of its financial resources comes from quota subscriptions, besides, selling gold, borrowing from central banks or private institutions of industrialized countries.
The fund gives loans to members to rectify the temporary disequilibria in BOP on current account. If a member has less currency with the Fund than its quota the difference is called reserve trench. It can draw up to 25% on its reserve trench interest free but payable within a period of 3 to 5 years.
A member can further draw annually from the balance quota in 4 instalments up to 100% of its quota from credit trenches
Other credit facilities
1) Buffer stock Financing Facility (BSFF)
2) Extended Fund Facility (EFF)
3) Supplementary Financing Facility (SFF)
4) Structural Adjustment Facility (SAF)
5) Enhanced Structural Adjustment Facility (ESAF)
6) Compensatory and contingency Financing Facility (CCFF)
7) Systematic Transformation Facility (STF)
8) Emergency structural Adjustment Loans (ESAL)
9) Contingency credit Line (CCL)
IMF has shown sufficient flexibility to mould itself in keeping with the changing international economic conditions. The usefulness and success of the fund lies in its membership, which has increased from 44 in 1947 to 182 in 2000.
Trends in Foreign Trade
Foreign trade of a country is gaining importance with the goal of achieving economic development and survival of the fittest with the globalization of the market. Foreign trade becomes more and more important for developing countries. Trends in foreign trade will indicate a country’s development ratio. A proper analysis of a country’s foreign trade can be studied through the following components: 1. Volume of trade 2. Composition of trade and 3. Direction of trade.
Volume of trade
It refers to size of international transactions. Large numbers of commodities are involved in international transactions. Volume of trade can be measured by adding the money value of all commodities and hence it is also called value of trade. The trends in the value of trade will identify the basic forces at operation in the economy. However, it is necessary to find the changes in the value of trade in relation to i) share of exports and imports in Gross Domestic Product ii) Share of exports and imports in world trade.
The share of exports and imports in GDP reflects the nature of trade strategies adopted in the country. The ratio of exports to GDP means supply capability of the economy in regard to exports. It can be called an average propensity to export. The ratio of imports to GDP gives the average propensity of imports.
The share of exports in the world trade indicates the importance of the country as a nation in the world economy. It reflects the market thrust areas to be realized in the midst of competitors in the world market. The changes in the value of exports may be compared to the changes in the value of imports. The relationship between the two variables is known as the terms of trade (TT) i.e. the terms at which exports exchange for imports. If the export value in terms of imports value shows an increase, the TT is said to be favourable. It implies that for a given value of exports, the country can import more. The unfavourable TT implies for a given value of imports, the country has to export more.
Volume of India’s foreign trade
The volume of India’s trade has been multiplied. The trade to GDP ratio has gone up from 13 percent in 1980 to 20 percent at present. The increase has been shared both by exports and imports.
The trends of exports
India’s total exports have increased by more than 300 times during the last five decades, from Rs.606 crores in 1950-51 to over Rs.2, 91,582 crores in 2003-04. However the increase has not been uniform over the years. Before 1965-66, India’s exports were slow. The total exports was 6.8 percent of the NNP in 1950-51, fell to 3.9 percent in 1965-66 indicating that growth in the exports sector lagged behind the growth in other sector of the economy. India’s share in the total world exports was 2.2 per cent in 1950-51, touched the low share to 1.1 percent in 1965. After 1965-66, in
order to bring domestic prices into alignment with external prices, the Indian rupee was devalued. After devaluation, exports slowly picked up. In 1972- 73 a breakthrough change in exports occurred mainly due to substantial growth in the exports of sugar, iron and steel, fruits and vegetables and food products. A welcoming trend appeared in 1986-87 due to liberal import policy. Due to this, exports increased at an annual average rate of more than 25% in
rupee terms. The rising trend in exports turned down in 1996-97. Exports witnessed a sharp upward trend in 1999-2000. In the year 2000-2001,
there was a 21% growth in exports. But a marked decline in world output, and trade and slackening of global demand, pushed the growth rate of exports downwards. Again exports recorded 20.34% during 2002-03 mainly due to rise in international commodity prices, recovery of the domestic manufacturing sector, depreciation of the rupee and the introduction of various export promotion measures. The upward trend maintained itself in 2003- 04.
In short, India’s exports during the last three and a half decades have shown a mixed trend whereas the rate of growth as measured in terms of past performance or in terms of its share of national income shows an appreciable rise. But it presents a picture of poor performance when measured in terms of the share in world exports.
Composition of Trade and Direction of Trade
Composition of trade means a study of the goods and services of imports and exports of a country. In other words, it tells about the commodities of imports and the commodities of exports of a country. Therefore it indicates the structure and level of economic development of a country. Developing countries export raw materials, agricultural products and intermediate goods; developed countries export finished goods, machines, equipments and
technique. Direction of trade means a study of the countries to whom the exports are made and from whom the imports are made.
Composition of Imports of India
Imports of India may be divided into three parts namely capital goods, raw materials and consumer goods.
Imports of capital goods
Capital goods include metals, machines and equipments, appliances and transport equipments, and means of communications. These goods are essential for industrial development of the country. Imports of these goods amounted to Rs.356 crore in 1960-61 which increased to Rs.26, 532 crore
Imports of raw materials and intermediate goods
It includes the imports of cotton, jute, fertilizer, chemicals, crude oil etc. A number of raw materials and intermediate goods have to be imported during the process of economic development. If amounted to Rs.527 crore in 1960-61 which increased to Rs.13, 966 crore in 1985-86. Petroleum
products include crude oil, petrol and lubricating oil. Imports of these products have ever been increasing. In 1960-61, imports of these products amounted to Rs.69 crore which increased to Rs.30, 538 crore in 1997-98. Import of petroleum products constitutes about 23 percent of our total imports.
Fertilizers are an important input for agriculture. Chemical products are an important input for industrial development. The import of these products is continuously increasing in India. In 1960-61 import of these items amounted to Rs.88 crore only which increased to Rs.3755 crore in 1997-98.
Imports of consumer goods
It includes the import of food grains, electrical goods, medicines, paper etc., India faced an acute shortage of food grains till the end of Third Five Year Plan. As a result, India had to import food grains in large quantities. Import of food grains in 1960-61 was 3748 thousand tonnes (Rs.181 crore).
In 1997-98 it was 1399 thousand tones. Now India has achieved self-reliance in food production.
Direction or sources of imports of India
Sources of imports of India have undergone several important changes during the planning period. Some important facts are as follows:
At the beginning of economic planning, we were importing from selected countries only. Now the picture has changed. We import different goods and services from different countries of the world. At present we get our imports from almost all the countries of the world. For the purchase of machines and equipments, we depend mainly on OECD (Organization for Economic Cooperation and Development) countries and East European countries. For the supply of food grains and petroleum products, we depend on OPEC (Oil Producing and Exporting Countries) countries. The OECD countries supply largest part of our imports. In 1997-98 out of the total imports of Rs.1,51,553 crore, the imports of Rs.75,593 crore were made (49.9%) from these countries. Other important suppliers of our imports are USA, Belgium, Germany, Japan and Britain.
Composition of exports of India
Exports of India may be divided into two parts I) Exports of traditional items and ii) Exports of non-traditional items.
Exports of traditional items
It includes the exports of tea, coffee, jute, jute products, iron ore, species, animal skin, cotton, fish, fish products, mineral products etc. At the beginning of the planning era, their items contributed about 80 percent of out total exports. Gradually, the contribution of these items is declining and that of non-traditional items is increasing. At present the contribution of traditional items is about 18.8% in our total exports.
It includes the export of sugar, engineering goods, chemicals, iron and steel electrical goods, leather products, gems and jewellery. There is a significant change in the pattern of exports of India during recent years. India has started to export a number of non-traditional items to a number of countries of the world. Contribution of these items is gradually increasing in total exports of India and shows a declining trend during some years also. Some facts to illustrate the changes are given below:
i) Agriculture and allied products which constituted 20.4 percent of total exports in 1996-97, decreased to 18.8 percent in 1999-2000. ii) Ores and minerals which constituted 3.5 percent of total exports in 1996-97, decreased to 3 percent in 1999-2000. iii) Manufactured good which contributed 73.4 percent of total exports in 1996-97, increased to 75.7 percent in 1999-2000. iv) Crude and petroleum products constituted 1.4 percent of total exports in 1996-97 but decreased to 1.0 percent in 1999- 2000. v) With regard to other items of exports which constituted 1.2 percent
in 1996-97 increased to 1.3 percent in 1999-2000.
Direction of exports of India
During the planning era, several important charges have taken place in the destination of exports of India. At present, we deal with about countries including many developed countries. Our major exports are directed towards the following countries:
1. OECD countries (Belgium, France Germany, U.K. North America, Canada, USA, Australia and Japan). Our exports which constituted 53.5 percent of the total exports in 1990-91 increased to 55.7 percent in 1999-2000.
2. OPEC countries (Iran, Iraq, Kuwait, Saudi Arabia etc.). Our exports which constituted 5.6 percent of the total exports in 1990- 91 increased to 10.0 percent in 1999-2000.
3. Eastern Europe (GDR, Romania, Russia etc.). Our exports which constituted 17.9 percent in 1990-91 decreased to 3.1 percent in
4. Other LDC’s (Africa, Asia, Latin America). Our exports constitute 16.8 per cent in 1990-91, increased to 28.2 percent in 1999-2000.
To sum up, during the last five decades, significant changes have been observed in the volume, composition and direction of India’s trade. Most of these changes have been in consonance with the development needs of the economy.
Balance of Trade and Balance of Payment
Meaning and definition of Balance of Payments
Balance of payments means a systematic record of all the economic transactions of a country with the rest of the world during a given period, say one year. It throws light on the international economic position of a country. The international economic performance of a country is reflected in its balance of payments. Each country enters into economic transactions with other countries of the world. As a result of such transactions, it receives and makes
payments to other counties. So balance of payments is a statement of accounts of these receipts and payments.
Benham defined Balance of payments as follows: “Balance of Payments of a country is a record of its monetary transactions over a period with the rest of the world”
In the words of Kindleberger, “the balance of payments of a country is a systematic record of all economic transactions between its residents and residents of foreign countries”.
Composition of Balance of Payments
Balance of payments is a statement or an account, which records all the foreign receipts and payments of a country. It records all the visible and invisible items. Visible items mean the imports and exports of commodities. Invisible items mean the imports and exports of services and other foreign transfers and transactions. BOPs is classified as balance of payments on current account and capital account. The BOPs on current account records the current position of the country in the transfer of goods, services and merchandise as well as invisible items such as donations, unilateral transfers etc.
Balance of payments on capital account shows the country’s financial position in the international scenario, the extent of accumulated foreign exchange reserves, foreign assets and liabilities and the impact of current transactions on international financial positions.
Balance of Trade
Balance of trade confines to trade in visible items only. Visible itemsare those, which are physically exported and imported like merchandise, gold, silver and other commodities. The invisible items are the services mutually rendered by shipping, insurance and banking companies, payment of interest and dividend, tourist spending and so on. The balance of trade refers to the difference between physical imports and exports of visible items only for a given period, say, a year.
During a given period, exports and imports may be exactly equal. Then, the balance of trade is said to be balanced. If the value of exports is in excess of the value of imports, the balance of trade is said to be favourable. If the value of imports is greater than the value of exports, the balance of trade is said to be unfavourable.
Accommodating and Autonomous Capital
If a country has a deficit in its current account balance, there will be always offsetting transactions on the capital account to bring the balance of payments into equilibrium. This may be possible either through autonomous capital flows or through accommodating capital flows.
The Role of the General Agreement on Tariffs and Trade (GATT)
The General Agreement on Tariffs and Trade (GATT) was a multilateral trade treaty between countries to regulate international trade and tariffs in accordance with specific rules, norms or code of conduct. GATT was set up in 1948 in Geneva to follow the objectives of free trade in order to encourage growth and development of all member countries. There are 117 member nations in GATT. The principal purpose of GATT was to ensure competition in commodity trade through the removal of or reduction in trade barriers.
GATT served as an important international forum for carrying on negotiations on tariffs. Under GATT, member nations met at regular intervals to negotiate agreements to reduce quotas, tariffs and such other restrictions on international trade. GATT became a permanent international trade institution for the multilateral expansion of trade until it was replaced by World Trade Organisation (W.T.O) in 1995.
Objectives of GATT
1) Expansion of international trade;
2) Increase of world production by ensuring full employment in the participating nations.
3) Development and full utilization of world resources; and
4) Revising standard of living of the world community as a whole.
The rules adopted by GATT are based on the following fundamental principles:
1) Trade should be conducted in a non-discriminatory way;
2) The use of quantitative restrictions should be condemned; and
3) Disagreements should be resolved through consultations.
Methods of achieving the objectives
The GATT proposed to achieve the objectives through the following methods:
1) Most favoured Nation clause
The clause is also known as elimination of discrimination clause. This clause is to be adopted to avoid discrimination in international trade. The clause implies that each country shall be treated as the most favoured nation. Any particular trade concession offered by a member country to her trading partner should also be available to all the members of the GATT at the same time.
2) Quantitative restrictions on Imports
The GATT rules prohibited the use of import quota fixation. But three important exceptions were allowed to this rule:
a) Countries, which are facing balance of payments difficulties, may use the device of input quota fixation.
b) Developing countries may resort to quota fixation but only under procedure accepted by the GATT.
c) Quotas may be applied to agricultural and fishery products if domestic production is subject to equally restrictive controls.
3) Tariff negotiations and Reduction of Tariff
The GATT recognized that tariffs are often an important obstacle to international trade. Hence, the GATT would encourage negotiations for tariff reduction to be conducted on a reciprocal and mutually advantageous basis, taking into consideration the varying needs of individual contracting parties.
The Uruguay Round of talks 1993 was most ambitious and complex. Apart from the traditional tariff and non-tariff measures, new areas such as Trade related Intellectual property Rights (TRIPS), Trade Related Investment Measures (TRIMS) and Trade in services were taken up for discussion.
There were differences among members countries in areas such as agriculture, textiles, TRIPS and anti-dumping. The Uruguay Round has enlarged the scope of GATT to include services and agriculture. The Uruguay Agenda wanted to remove all trade barriers.
World Trade Organization (WTO)
Seven rounds of negotiations occurred under the GATT and the eight round known as ‘Uruguay Round’ started in 1989 and concluded in 1994 with the establishment of the World Trade Organization (WTO) in 1995. The principles and agreements of GATT were adopted for the WTO, along with new ones. There are 150 member countries in WTO which was charged with administering and resolving trade disputes between the members. Unlike the GATT, the WTO has a substantial and effective organizational structure. Pascal Lamy is the Director-General of the WTO since 2005 for a term of four years.
The WTO aims for a trading system free of any discrimination and with more freedom, that is, toward fewer trade barriers (tariffs and nontariff barriers). It also aims for a trading system with greater competition but with more accommodation for less developed countries, giving them more time to adjust, greater flexibility, and more privileges.
Major Functions of WTO
1. Administering WTO trade agreements.
2. Forum for trade negotiations.
3. Handling trade disputes.
4. Monitoring national trade policies.
5. Technical assistance and training for developing countries.
6. Cooperation with other international organizations.
All members of the WTO will meet once in two years in the Ministerial Conference which can make decisions on all matters of the multilateral trade agreements. The Fourth Ministerial Conference held at Doha, Fifth at Cancum (Mexico) and the Sixth at Hong Kong. The Seventh round to discuss the Doha Development Agenda negotiations were suspended due to persisting disagreements between developed and developing countries.
International Bank for Reconstruction and Development (IBRD)
The International Bank for Reconstruction and Development (IBRD) better known as World Bank was set up in 1944. Since IMF was designed to provide temporary assistance in correcting balance of payments difficulties, an institution was needed to assist long-term investment purposes. Thus IBRD was established for promoting long term investment loans on concessional terms.
1) To assist in the reconstruction and development in the member countries by providing capital support.
2) To promote private foreign investment.
3) To promote growth of international trade in the long run and improve Balance of Payments of member countries.
4) To arrange for loans through for small and large projects.
Membership and Organization
All the members of the IMF are members of IBRD. It had 182 members in 2000. Like IMF, IBRD has a three-tier structure with a president, Executive Directors and Board of Governors. The Board of Governors is the supreme body. Every member country appoints one Governor and an alternate Governor for a period of 5 years. The voting power of each Governor is related to the financial contribution of its Government.
It was started with an authorized capital of $10 billion . In July 1992, it has risen to $184.1 billion.
The IBRD seeks to maintain unutilized access to funds in the markets in which it borrows. Its objective is to minimize the effective cost of those funds to its borrowers. It is to provide an appropriate degree of maturity transformation between its borrowing and lending. Maturity transformation refers to the Bank’s capacity to lend at longer maturities than it borrows.
Special Action Programme (SAP)
Special Action Programme (SAP) was started in 1983 to strengthen IBRD’s ability to assist member countries in adjusting to the current economic environment.
Structural Adjustment Facility (SAF)
The Structural Adjustment Facility was introduced in 1985 in order to reduce the balance of payments deficits of its members while maintaining or regaining their economic growth.
Conditions for lending
1. An efficient regulating mechanism for ensuring transparent policies
and depoliticised environment.
2. Adequate risk management.
3. Provision for long-term finance.
4. Increase in the share of the private sector in the country’s GDP.
The IBRD is a corporate institution whose capital is subscribed by its members. It finances its lending operations primarily from its own medium and long term borrowing in the international capital markets and currency swap agreement (CSA). The Bank also borrows under the discount note programme. It has enabled two new borrowing instruments. Central Bank Facility (CBF) borrowing inflating rate notes is meant to help IBRD to meet some of the objectives of its funding strategy.
The Bank lends member countries in the following ways. 1) By marketing or participating in loans out of its own funds.
2) By making or participating in direct loans out of funds raised in the market of a member.
3) By guaranteeing loans made by private investors.
4) The Bank also provides facilities to member countries through SAF and SAP.
The Bank is laying greater emphasis on developing human resources such as education, population, health, nutrition and environment.
International Finance Corporation (IFC)
The IFC was set up in July 1956, as an affiliate of the World Bank. It was set up with the objective of assisting the private enterprises in developing
countries by providing them risk capital. The IFC provides debt and equity finance to projects sponsored by the private sector developing countries.
Though IFC is affiliated to World Bank, it is a separate legal entity with a separate fund and functions. Members of IBRD are eligible for its membership.
1) In association with private investors, to invest in productive private enterprises without government guarantee of repayment.
2) It serves as a clearing house, to bring together investment opportunities, private capital and experienced management.
3) To help in stimulating productive investment of private capital both at home and abroad.
Industrial, agricultural, financial, and commercial and other private enterprises are eligible for IFC financing. Their operations are productive and contribute to the development of the economy. It does not follow a policy of uniform interest rate for its investment. It is subject to negotiation.
International Development Association (IDA)
IDA was set up in September 1960, as a subsidiary of the World Bank. The establishment of IDA was another step in the direction of increasing international liquidity in the world. The IDA was set up particularly to provide finance to less developed countries on a soft loan basis ie. on terms imposing lower servicing charge on loans than the conventional bank charges.
1) To promote economic development
2) To increase productivity
3) To raise standard of living in the member countries
4) Furthering the developmental objectives of the World Bank and supplement its activities.
5) To provide finance to the member countries to meet their important development requirements. IDA loans can be utilized to finance both foreign exchange and local currency costs.
The Multinational Investment Guarantee Agency (MIGA)
MIGA is the new affiliate of the World Bank family and was established in 1988. It has an authorized capital of $ 1.08 billion.
1) To encourage the flow of direct foreign investment into developing member countries.
2) It provides insurance cover to investors against political risks.
3) It insures only new investments.
4) Promotional and advising services are provided to increase the attractiveness of the investment climate. MIGA’s guarantee serves as a catalyst for multinational investments.
Choose the correct answer
Question: Globalization means
a. Integration of the economy with world economy
b. Increasing degree of openness in respect of international trade
c. Process of transformation of the world in to a single economic unit.
d. All the above.
Question: Technology transfer has been taking place on a large scale through
a. licensing agreements and joint ventures
b. choice of ownership structure
c. simplification of procedures
Question: The decision to start IMF was taken at
a. Round-table conference
b. Geneva conference
c. Bretton woods conference
Question: IBRD was set up in
Question: The main inconvenience of barter system was
a. transactions were many and complex
b. lack of double coincidence of wants
c. The intermediate commodity need not be familiar
d. prevalence of domestic system
Fill in the blanks
Question: The goal of global economy is
Question: is one of the most fundamental inventions of man
Question: The Saps find their origin in the growth of
Question: Has worked as an “engine of growth” in the past.
Question: The highest authority of the IMF is the
Board of Governors…
Match the following
|1. OPEC Countries||A. Iran, Iraq, Kuwait|
|2. IMF||B. Washignton|
|3. Uruguay Round||C. 1993|
|4. 182 members of IBRD||D. Year 2000|
|5. GATT||E. Geneva|
Answer in one or two words
Question: What is SAF?
Answer: Structural Adjustment facility
Question: Name the record of a country’s monetary transactions.
Answer: Balance of payments
Question: When was SAP started?
Question: Name four exports of India.
Answer: Coffee, Tea, Jute, Iron, Ore, Spices, Cotton, fish etc.
Question: Which is the catalyst for multinational investment?