UNIT 1

INTRODUCTION
Concept Of International Trade
International trade is an exchange involving a good or service conducted between at least
two different countries. The exchanges can be imports or exports. An import refers to a good
or service brought into the domestic country. An export refers to a good or service sold to a
foreign country.This kind of trade contributes and increases the world economy. The most
commonly traded commodities are television sets, clothes,machinery, capital goods, food,
raw material, etc.International trade and the accompanying financial transactions are
generally conducted for the purpose of providing a nation with commodities it lacks in
exchange for those that it produces in abundance; such transactions, functioning with other
economic policies, tend to improve a nation’s standard of living.
International trade allows countries to expand their markets and access goods and services
that otherwise may not have been available domestically. As a result of international trade,
the market is more competitive. This ultimately results in more competitive pricing and
brings a cheaper product home to the consumer.
Importance of international trade
1. Utilization of resources: Through the establishment of international trade, several
countries use their locally available resources and raw materials by exporting it to other
countries that need them. For instance, countries in the Middle East export oil – which has a
high demand in countries like India.
2. More variety for customers: Apart from comparative advantage and relative input costs,
one of the key benefits to customers from international trade is a range of products. For
instance, Indian ethnic wear is sold in marketplaces across the world, like Gucci from Italy is
available in India. This allows customers to choose from a large variety depending on their
tastes and preferences.
3. Competitive pricing: As a result of international trade, the global market has become
more competitive. This competition encourages countries to produce high quality goods to
grow their exports. As more producers market their goods, individuals get the advantage of
competitive pricing.
4. Economy growth: As more countries engage in international trade, foreign investment
increases. When producers invest money or resources in producing goods outside of their
country of origin, it is termed as Foreign Direct Investment (FDI). A country may realize that
labour is cheaper in another country and choose to build a manufacturing plant there to
produce its goods to cut production costs.
5. Service sector trade: Trade tends to conjure images of physical goods import bananas,
export cars. But increasingly the service sector economy means more trade is of invisibles –
services, such as insurance, IT services and banking.
International business
International business involves transactions and exchanges of goods, services, or resources
between individuals, organizations, or governments in different countries. It encompasses
various activities, including international trade, investment, finance, marketing, and
management. Companies engage in international business to expand their customer base,
increase revenue, access new markets, acquire resources, or gain a competitive advantage.
Various factors shape international business, including government policies, cultural
differences, economic conditions, legal systems, and technological advancements. To
succeed in international business, companies must navigate these complex and dynamic
factors and adapt their strategies to meet the needs of diverse markets and
stakeholders.
International finance
International finance is a section of financial economics that deals with the macro-economic
relation between two countries and their monetary transactions. The concepts like interest
rate, exchange rate, FDI, FPI, and currency prevailing in the trade come under this type of
finance.
Theories of international finance
1. Mercantilism
The Mercantilism theory is the first classical country-based theory, which was
propoundedaround the 17-18th century. This theory has been one of the most talked about
and debated theories. The country focused on the motto that, on a priority basis, it must
look after its own welfare and therefore, expand exports and discourage imports.
It stated that an attempt should be made to ensure that only the necessary raw materials
are imported and nothing else. The theory also propounded the view that the first thing a
nation must focus on is the accumulation of wealth in the form of gold and silver, thus,
strengthening the treasure of the nation.
To put it simply, it can be stated that the classical economists behind the theory of
Mercantilism firmly believed that a country’s wealth and financial standing are largely
demonstrated by the amount of gold and silver it holds. Hence, economists believe that it is
best to increase the reserve of precious metals to maintain a wealthy status.
2. Absolute advantage
Smith’s theory proposes that governments should not try to regulate trade between
countries, nor should they restrict global trade. His theory also encapsulated the
consequences of the involvement and restraint of the government in free trade. Also, he
firmly believed that it is the standard of living of the residents of a country that should
determine the country’s wealth and the amount of gold and silver that a country’s treasure
has. He states that trading should depend on market factors and not the government’s will.
3. Comparative advantage
The theory of comparative advantage flourished in the 19th century and was propounded by
David Ricardo. This theory strengthened the understanding of the nature of trade and
acknowledges its benefits. The theory suggests that it is better if a country exports goods in
which its relative cost advantage is greater than its absolute cost advantage when compared
with other countries. For instance, let’s take the examples of Malaysia and Indonesia. Let’s
say Indonesia can produce both electrical appliances and rubber products more efficiently
than Malaysia. The production of electrical appliances is twice as much as that of Malaysia,
and for rubber products, it is five times more than that of Malaysia. In such a condition,
Indonesia has an absolute productive advantage in both goods but a relative advantage in
the case of rubber products. In such a case, it would be more mutually beneficial if Indonesia
exported rubber products to Malaysia and imported electrical appliances from them, even if
Indonesia could efficiently produce electrical appliances too. this theory basically
encourages trade that is mutually beneficial.
4. Heckscher-Ohlin theory (Factor Proportions theory)
The theories founded by Smith and Ricardo were not efficient enough for the countries, as
they could not help the countries determine which of the products would benefit the
country. The theory of Absolute Advantage and Comparative Advantage supported the idea
of how a free and open market would help countries determine which products could be
efficiently produced by the country. However, the theory proposed by Heckscher and Ohlin
dealt with the concept of comparative advantage that a country can gain by producing
products that make use of the factors that are present in abundance in the country. The
main basis of their theory is on a country’s production factors like land, labour, capital, etc.
They proposed that the approximate cost of any factor of resource is directly related to its
demand and supply. Factors which are present in abundance as compared to demand will be
available at a cheaper cost, and factors which are in great demand and less availability will
be expensive. They proposed that countries produce goods and export the ones for which
the resources required in their production are available in a much greater quantity. Contrary
to this, countries will import goods whose raw materials are in shorter supply in their own
country as compared to the one from which they are importing.
For example, India has a large number of labourers, so foreign countries establish industries
that are labour-intensive in India. Examples of such industries are the garment and textile
industries.
What Is International Trade Finance?
International trade finance refers to the financial aid provided by banks or financial
institutions to companies who aspire to expand their business on a global scale. It plays a
key role in simplifying trade between importers and exporters who work collaboratively from
different corners of the world.A key benefit of trade finance is that it reduces the payment
and supply risks between exporters and importers by introducing a third party such as banks
or NBFCs. Exporters receive payments as per the contract, whereas importers can extend
credit to complete the delivery of goods.
TYPES OF INTERNATIONAL TRADE FINANCE
1. Letter of Credit:
A letter of credit is issued by a bank on the behalf of the buyers. It guarantees that the seller
will receive payment in exchange for the goods and services delivered to the buyers.
2. Bank Guarantee:As the name suggests, this guarantee is also issued by a bank. The bank
serves the role of a third-party guarantor in case the importer or exporter fails to make the
payments as per the contract.
3. Payment in Advance:This is a type of pre-export trade finance wherein the supplier
receives an advance payment amount or the full payment from the buyer before the
delivery of the goods. This gives more leeway to suppliers in terms of maintaining a
consistent cash flow. However, it can be risky for the buyers in case of delayed or failed
delivery.
4. Insurance: You can use for shipping and the delivery of goods as well as to protect the
exporter from non-payment by the buyer.

BALANCE OF PAYMENT
Balance Of Payment (BOP) is a statement that records all the monetary transactions made
between residents of a country and the rest of the world during any given period. This
statement includes all the transactions made by/to individuals, corporates and the
government and helps in monitoring the flow of funds to develop the economy.
When all the elements are correctly included in the BOP, it should be zero in a perfect
scenario. This means the inflows and outflows of funds should balance out. However, this
does not ideally happen in most cases. A BOP statement of a country indicates whether the
country has a surplus or a deficit of funds, i.e., when a country’s export is more than its
import, its BOP is said to be in surplus. On the other hand, the BOP deficit indicates that its
imports are more than its exports.Tracking the transactions under BOP is similar to the
double-entry accounting system. All transactions will have a debit entry and a corresponding
credit entry.
Why is the Balance of Payment (BOP) vital for a country?
A country’s BOP is vital for the following reasons:
1. The BOP of a country reveals its financial and economic status.
2. A BOP statement can be used to determine whether the country’s currency value is
appreciating or depreciating.
3. The BOP statement helps the government to decide on fiscal and trade policies.
4. It provides important information to analyse and understand the economic dealings with
other countries.
 Elements of a Balance of Payment
There are three components of the balance of payment viz current account, capital account,
and financial account.
1. Current Account: The current account monitors the inflow and outflow of goods and
services between countries. This account covers all the receipts and payments made with
respect to raw materials and manufactured goods.It also includes receipts from engineering,
tourism, transportation, business services, stocks, and royalties from patents and copyrights.
When all the goods and services are combined, they make up a country’s Balance of Trade
(BOT).
2. Capital Account: All capital transactions between the countries are monitored through the
capital account. Capital transactions include purchasing and selling assets (non-financial) like
land and properties.The capital account also includes the flow of taxes, purchase and sale of
fixed assets etc., by migrants moving out/into a different country. The deficit or surplus in
the current account is managed through the finance from the capital account and vice versa.
3. Financial Account: The flow of funds from and to foreign countries through
variousinvestments in real estate, business ventures, foreign direct investments etc., is
monitored through the financial account. This account measures the changes in the foreign
ownership of domestic assets and domestic ownership of foreign assets. Analysing these
changes can be understood if the country is selling or acquiring more assets (like gold,
stocks, equity, etc.).
 UNIT 2
INTERNATIONAL MONETARY SYSTEMS
What Is an Exchange Rate Mechanism (ERM)?
An exchange rate mechanism (ERM) is a set of procedures used to manage a country's
currency exchange rate relative to other currencies. It is part of an economy's monetary
policy and is put to use by central banks.Such a mechanism can be employed if a country
utilizes either a fixed exchange rate or one with a constrained floating exchange rate that is
bounded around its peg (known as an adjustable peg or crawling peg).
Different types of exchange rate systems
1. Fixed Exchange Rate
In a fixed exchange rate system, a country’s currency is linked to a specific reference
currency, such as the U.S. dollar or a group of currencies. The exchange rate doesn’t change
much and usually stays within 1%. The government or central banks has no control over such
exchange rate fluctuations.
2. Floating Exchange Rate
The value of the currency is determined by market forces of supply and demand. It
fluctuates freely based on factors like interest rates, inflation, and market conditions. The
government or central bank doesn’t control these fluctuations.
3. Managed Floating Exchange Rate
The currency’s value is influenced by market forces, but the central bank intervenes to
stabilize it during significant fluctuations. They use foreign exchange reserves to keep the
currency within the desired range. It helps protect importers and exporters from extreme
volatility.
4. Crawling Peg
The exchange rate is adjusted periodically within a specific range. It’s usually based on
money supply, inflation, and trade imbalances. The central bank changes the rate at fixed
intervals to manage economic conditions.
5. Currency Board
The country’s currency is fully backed by a foreign reserve currency, such as the U.S. dollar or
the euro. This mechanism eliminates the central bank’s ability to manage the exchange rate
and money supply independently.
6. Dollarization
The country adopts a foreign currency, often the U.S. dollar, as its official currency. It means
the country stops using its currency and relies entirely on foreign currency. The monetary
policy of the foreign country becomes the de facto policy for the dollarized country.
What Is International Monetary System?
International Monetary System (IMS) is a well-designed system that regulates the valuations
and exchange of money across countries. It is a well-governed system looking after the
cross-border payments, exchange rates, and mobility of capital. This system has rules and
regulations which help in computing the exchange rate and terms of international payments.
In other words, International Monetary System mobilizes the capital from one nation to
another by felicitating trade. There are many participants like MNCs (Multinational
Corporations), Investors, Financial Institutions, etc., in the International Monetary System.
Advantages of Current International Monetary System: -
Following are a few advantages of the International Monetary
Market
1. IMS enhances financial stability and maintains the price level on a global scale. It also
boosts global growth.
2. International Monetary System mobilizes money across countries and determines the
exchange rate.
3. This system encourages the governments of respective countries to manage their Balance
of Payment by reducing the trade deficit.
4. IMS is a well-regulated system that makes the whole process of international trading
smooth.
5. This system relocates the capital from one country to another by enhancing cross-border
investments.
6. International Financial Architecture provides liquidity to the countries of the world.
7. This system tries and avoids any short or long-run disruptions in the world economy.
Gold standards
The gold standard is a monetary system where a country's currency or paper money has a
value directly linked to gold. With the gold standard, countries agreed to convert paper
money into a fixed amount of gold. A country that uses the gold standard sets a fixed price
for gold and buys and sells gold at that price. That fixed price is used to determine the value
of the currency. For example, if the U.S. sets the price of gold at $500 an ounce, the value of
the dollar would be 1/500th of an ounce of gold.
GOLD EXCHANGE STANDARDS
Gold-exchange standard, monetary system under which a nation’s currency may be
converted into bills of exchange drawn on a country whose currency is convertible into gold
at a stable rate of exchange. A nation on the gold-exchange standard is thus able to keep its
currency at parity with gold without having to maintain as large a gold reserve as is required
under the gold standard.The Bretton Woods Agreement and System ExplainedApproximately
730 delegates representing 44 countries met in Bretton Woods in July 1944 with the
principal goals of creating an efficient foreign exchange system, preventing competitive
devaluations of currencies, and promoting international economic growth. The Bretton
Woods Agreement and System were central to these goals. The Bretton Woods Agreement
also created two important organizations—the International Monetary Fund (IMF) and the
World Bank. While the Bretton Woods System was dissolved in the 1970s, both the IMF and
World Bank have remained strong pillars for the exchange of international currencies.
FEATURES OF BRETTON WOOD SYSTEM
Bretton Woods aimed to fix problems of the standardized monetary valuation.
Characteristics of Bretton Woods are as follows:
1. Stabilizing international exchange rates was the primary objective of Bretton Woods.
2. It was an attempt to help nations recover economically post-World War II.
3. Bretton Woods was adopted by 44 countries—they agreed to peg their currencies against
the USD.
4. The US Dollar was pegged against the price of gold—fixed at $35 per ounce of gold.
5. The US Dollar was considered—an international reserve currency.
6. It provided a fixed exchange rate. However, this rate was adjustable.
7. It standardized international monetary payments—by facilitating currency conversion.
8. Post Bretton Woods, allied countries did not have any control over the international
payment and settlement system.
What Was the European Monetary System (EMS)?
The European Monetary System (EMS) was an adjustable exchange rate arrangement set up
in 1979 to foster closer monetary policy cooperation between members of the European
Community (EC). The European Monetary System (EMS) was later succeeded by the
European Economic and Monetary Union (EMU), which established a common currency, the
euro.
What Is the International Monetary Fund (IMF)
The International Monetary Fund (IMF) is an international organization that promotes global
economic growth and financial stability, encourages international trade, and reduces
poverty. When member countries run into trouble, they can turn to the IMF for advice and
financial assistance. Out of the 195 countries in the world, 190countries are members of the
IMF. The International Monetary Fund (IMF) works to achieve sustainable growth and
prosperity for all of its 190 member countries. It does so by supporting economic policies
that promote financial stability and monetary cooperation, which are essential to increase
productivity, job creation, and economic well-being. The IMF is governed by and accountable
to its member countries.
The IMF has three critical missions: furthering international monetary cooperation,
encouraging the expansion of trade and economic growth, and discouraging policies that
would harm prosperity. To fulfil these missions, IMF member countries work collaboratively
with each other and with other international bodies.
 FUNCTIONS OF IMF
1. Advisory and Technical Assistance: IMF helps its member countries through its policy
advice and technical assistance in formulating sound policies and building strong institutions.
2. Support for Low-Income Countries: IMF provided help to its low-income members with
policy advice, technical assistance and loans for poverty reduction and reducing the debt
burden.
3. Stability in Foreign Exchange Rate: IMF helps to achieve stability in foreign exchange rates.
The rates of exchange under the IMF had not fluctuated as much as they used to before the
establishment of the IMF.
4. Setting up of a Multilateral Trade and Payment System: IMF helps to set up multilateral
trade and payment system. Member countries were allowed to impose exchange control on
commercial transactions, but it was hoped that these restrictions on foreign trade would be
eliminated.
5. Establishment of a Monetary Reserve Fund: IMF helps to establish monetary reserve by
accumulating a sizeable stock of the national currencies of different countries. It is out of this
stock that the Fund meets the foreign exchange requirements of the member countries.
OBJECTIVES OF IMF
1. To Ensure Stability in Foreign Exchange Rates:There was a lot of instability in foreign
exchange rates before the Second World War, which produced adverse repercussions on
international trade. So, IMF was established to eliminate this instability of foreign exchange.
2. To Promote International Trade:Another important objective of the IMF was to promote
international trade by removing all the obstacles and hindrances, which had the effect of
restricting it.
3. To Promote Investment of Capital in Backward and Underdeveloped CountriesIMF exports
capital from the richer to the poorer countries so that the poor countries can develop their
economic resources for achieving a higher standard of living.
4. To Eliminate or Reduce the Disequilibrium in the Balance of Payments: IMF helps to
reduce the disequilibrium in the balance of payments by selling or lending foreign currencies
to the member nations.
WORLD BANK
The World Bank is an international organization dedicated to providing financing, advice, and
research to developing nations to aid their economic advancement. The bank predominantly
acts as an organization that attempts to fight poverty by offering developmental assistance
to middle- and low-income countries. The World Bank and International Monetary Fund
(IMF)—founded simultaneously under the Bretton Woods Agreement—both seek to serve
international governments. World Bank, international organization affiliated with the United
Nations (UN) and designed to finance projects that enhance the economic development of
member states. Headquartered in Washington, D.C., the bank is the largest source of
financial assistance to developing countries.
Functions of World bank
1. It helps the war-devasted countries by granting them loans for reconstruction.
2. Thus, they provide extensive experience and the financial resources of the bank help the
poor countries increase their economic growth, reducing poverty and a better standard of
living.
3. Also, it helps the underdeveloped countries by granting development loans.
4. So, it also provides loans to various governments for irrigation, agriculture, water supply,
health, education, etc.
5. It promotes foreign investments to other organizations by guaranteeing the loans.
6. Also, the world bank provides economic, monetary, and technical advice to the member
countries for any of their projects.
7. Thus, it encourages the development of of-industries in underdeveloped countries by
introducing the various economic reforms.
Objectives of world bank
1. This includes providing long term capital to its member nations for economic
development and reconstruction.
2. Thus, it helps in inducing long term capital for improving the balance of payments and
thereby balancing international trade.
3. Also, it helps by providing guarantees against loads granted to large and small units and
other projects for the member nations.
4. So, it ensures that the development projects are implemented. Thus, it brings a sense of
transparency for a nation from war-time to a peaceful economy.
5. Also, it promotes the capital investment for member nations by providing a guarantee for
capital investment and loans.
6. So, if the capital investment is not available than it provides the guarantee and then IBRD
provides loans for promotional activities on specific conditions.