Q-1 WHAT IS INTERNATIONAL MONETARY FUND (IMF), EXPLAIN ITS OBJECTIVES

AND ACHIEVEMENTS?
ANS:- KEY TAKEAWAYS

 The International Monetary Fund aims to reducing global poverty, encouraging

international trade, and promoting financial stability and economic growth.
 The IMF has three main functions: overseeing economic development, lending, and
capacity development.
 Through economic surveillance, the IMF monitors developments that affect member
economies as well as the global economy as a whole.
 The IMF lends to its member nations with balance of payment problems so they can
strengthen their economies.
 The group also provides assistance, policy advice, and training through its various
technical assistance programs.

What Is the International Monetary Fund (IMF)?

The International Monetary Fund (IMF) is an international organization that aims to accomplish
a number of different goals. These include reducing global poverty, encouraging international
trade, and promoting financial stability and economic growth.

The organization was created in 1945 and is based in Washington, DC. There are a total of 190
member countries, each of which is represented on the group's board. 1 This representation is
based on how important its financial position is in the world, so stronger, more powerful
countries have a greater voice in the organization than nations which are much weaker.

The IMF functions in three main areas:

 Overseeing the economies of member countries

 Lending to countries with balance of payments issues
 Helping member countries modernize their economies

Monitoring Member Country Economies

The International Monetary Fund's primary job is to promote stability in the global monetary
system. So, its first function is to monitor the economies of its 190 member countries. This
activity, known as economic surveillance, happens at both the national and global levels.
Through economic surveillance, the IMF monitors developments that affect member economies
as well as the global economy as a whole.

Member nations must agree to pursue economic policies that coincide with the IMF's objectives.
By monitoring the macroeconomic and financial policies of its member countries, the IMF sees
stability risks and advises on possible adjustments.

Lending

The IMF lends money to nurture the economies of member countries with balance of payments
problems instead of lending to fund individual projects. This assistance can
replenish international reserves, stabilize currencies, and strengthen conditions for economic
growth. The IMF expects the countries to pay back the loans, and the countries must embark on
structural adjustment policies monitored by the IMF.

Lending through the IMF takes two forms. The first is at non-concessional interest rates, while
the other comes with concessional terms. The latter is advanced to countries with low income,
and bears very low or no interest rates at all.

Technical Assistance

The third main function of the IMF is through what it calls capacity development by providing
assistance, policy advice, and training through its various programs. The group provides member
nations with technical assistance in the following areas:

 Fiscal policy
 Monetary and exchange rate policies
 Banking and financial system supervision and regulation
 Statistics

The organization aims to strengthen human and institutional capacity. This is very important for
countries with previous policy failures, weak institutions, or scarce resources. Through capacity
development, member nations can help strengthen and improve growth in their economies and
create jobs.

Objectives of IMF:
i. To promote international monetary co-operation.

ii. To ensure balanced international trade

iii. To ensure exchange rate stability

iv. To eliminate or to minimize exchange restrictions by promoting the system of multilateral

payments.

v. To grant economic assistance to members countries for eliminating the adverse balance of
payment

vi. To minimize the imbalances in quantum and duration of international trade.

Objectives of IMF:
The main objectives of IMF, as noted in the Articles of Agreement, are as follows:
(i) International Monetary Co-Operation:
The most important objective of the Fund is to establish international monetary co-operation
amongst the various member countries through a permanent institution that provides the
machinery for consultation and collaborations in various international monetary problems and
issues.

(ii) Ensure Exchange Stability:

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Another important objective of the Fund is to ensure stability in the foreign exchange rates by
maintaining orderly exchange arrangement among members and also to rule out unnecessary
competitive exchange depreciations.

(iii) Balanced Growth of Trade:

IMF has also another important objective to promote international trade so as to achieve its
required expansion and balanced growth. This would ensure development of production resources
and thereby promote and maintain high levels of income and employment among all its member
countries.

(iv) Eliminate Exchange Control:

Another important objective of the Fund is to eliminate or relax exchange controls imposed by
almost each and every country before Second World War as a device to deliberately fix the
exchange rate at a particular level. Such elimination of exchange controls was made so as to give
encouragement to the flow of international trade.

(v) Multilateral Trade and Payments:

To establish a multilateral trade and payment system in respect to current transactions between
members in place of the old system of bilateral trade agreements was another important objective
of IMF.

(vi) Balanced Growth:

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Another objective of IMF is to help the member countries, especially the backward countries, to
attain balanced economic growth by exchange the level of employment.

(vii) Correction of BOP Maladjustments:

IMF also helps the member countries in eliminating or reducing the disequilibrium or
maladjustments in balance of payments. Accordingly, it gives confidence to members by selling
or lending Fund’s foreign currency resources to the member nations.

(viii) Promote Investment of Capital:

Finally, the IMF also promotes the flow of capital from richer to poorer or backward countries so
as to help the backward countries to develop their own economic resources for attaining higher
standard of living for its people, in general.

Some of the major achievements of the IMF are as follows:

(i) Stability in Exchange Rates:
The IMF started with the determination of par values of the currencies of different countries in
terms of gold or the U.S. dollar. It, however, allowed the variations in exchange rates by ± 1
percent. Subsequently, the band of fluctuation of exchange rate was enlarged to ± 2.5 percent.
The variation in exchange rate beyond these limits could be possible after obtaining permission
from the IMF. The system of exchange rate under the IMF combines the elements of stability
with flexibility.

(ii) Promotion of International Trade:

The IMF has contributed in several ways to the enlargement of global trade. It has created
facilities for the member countries for financing and adjusting the balance of payments deficits.
As the multilateral assistance can enable the member countries to correct their temporary or
fundamental payments disequilibrium, they need not take recourse to tariffs, import quotas,
exchange controls and other restrictive practices. Thus, it has attempted to create conditions for
unrestrained expansion of international trade.

(iii) Check on Multiple Exchange Rates:

The IMF has not approved countries adopting the complex, cumbersome and restrictive system of
multiple exchange rates. It has brought about a simplification and rationalisation of exchange
system. The countries seeking the multilateral assistance are discouraged from resorting to the
multiple exchange rates.

(iv) Broadening of the Credit Structure:

In the earlier decades after its inception, the IMF confined its lending operations only for the
purpose of correcting short-term BOP deficits. During the recent decades, there has been a
marked change in the lending operations of the IMF.

Although it continues to provide credit to the member countries for short-term adjustments in
BOP disequilibrium, yet it has undertaken the loan operations for correcting fundamental
disequilibrium or for facilitating structural adjustments in the economies of the member countries.
The IMF has started providing loans also for specific development projects.

During 1950’s and 1960’s, the repayments of IMF loan had to be made within 3 to 5 years
periods. During 1970’s and 1980’s, different types of credit facilities were created. The
repayments are extended over a longer period. For instance, under the Extended Fund Facility
(EFF), the repayments are to be made over a period of 4 to 10 years in the case of loans from
IMF’s own resources and 3-1/2 to 7 years, if the loan is made out of Fund’s borrowed financial
resources.

The IMF provides concessional assistance extended over a period of more than 10 years out of
the Trust Fund. It is thus clear that IMF has in recent years adopted a more liberal attitude in the
extension of credit and has brought about substantial broadening of the structure of international
credit.

(v) Multilateral Payments System:

The IMF has achieved some success in the establishment of a multilateral system of international
payment particularly in respect of current transactions. However, the operations of certain
agencies or organisations which are out of the purview of the Fund have created some hurdles in
this direction.

(vi) Compromise between Gold Standard and Managed Paper Standard:

The system of exchange rate evolved by IMF has been a compromise between the gold standard
and managed paper standard. It has secured the advantages of the both. On the one hand, it has
ensured the benefits of managed paper standard such as maximisation of employment and
acceleration of development. On the other hand, it has helped in the maintenance of international
exchange stability. Moreover, the IMF system has carefully avoided the disadvantages of both
gold and managed paper standard.

(vii) Institution for Consultation and Guidance:

The International Monetary Fund has created a consciousness among the member countries that
their economic problems are the matters of concern not only exclusively for them but for the
whole international community. The IMF provides an excellent forum for discussions on various
monetary, fiscal, financial, trade and exchange problems in general and international payments
problems in particular. The Fund is a specialised institution to undertake research about various
economic problems through its numerous missions and provides an expert guidance to the
member nations for efficiently dealing with them.

(viii) Convertibility of Currencies:

The IMF visualizes the achievement of full global convertibility of currencies in the next decade.
One – quarter to one-third of all the developing countries have already achieved full currency
convertibility. The industrialised countries have abandoned foreign exchange controls with regard
to trade transactions. India too has permitted currency convertibility except in the capital account.
It is on move to bring about full convertibility of Rupee in a phased manner.

A key challenge for the IMF today is to promote capital account convertibility which is generally
difficult to enforce and inefficient in operation. However, among industrial countries and
increasingly among developing countries, capital account restrictions apply to the level of
investment flows rather than to foreign exchange transactions.

Article VIII of the IMF requires that member countries move towards current account
convertibility—that is refraining from placing direct restrictions on the use of foreign exchange in
transactions with nonresidents and avoiding, through taxes or subsidies, the promotion of multiple
exchange rates. 104 countries out of the IMF members had already accepted the obligation of
Article VIII on convertibility of currency by 1995.

However the Mexican collapse of 1994, The East Asian Crisis in 1997-98 and global economic
recession in 2008 and 2009 set the process of economic rethinking about the implications of free
flow of short-term foreign capital and full convertibility of currencies. All the countries had to
readopt appropriate exchange controls to support their depreciating currencies and to check the
flight of capital.
(ix) IMF and Developing Countries:
The IMF has rendered assistance to the less developed countries in several ways. The IMF in the
beginning confined its activities to the adjustment of member nation’s balance of payments
deficits of essentially short-term character and the stabilisation of exchange rate. However, in
recent years, the IMF has started rendering more positive assistance to the poor countries in their
economic transformation.

Firstly, it has undertaken to provide financial assistance for offsetting the fundamental
disequilibrium in the BOP.

Secondly, the IMF has started providing concessional long-term liquidity to the member countries
for not only adjusting the balance of payments but also for furthering development through
increased imports of development goods and services from other countries.

Thirdly, the IMF suggests structural reforms to the less developed countries for removing the
constraints from the development process.

Fourthly, the IMF has rendered assistance to the member countries in the formulation of growth-
oriented monetary, fiscal, exchange and trade policies.

Fifthly, the IMF has organised the Central Banking Advisory Service for providing technical
advice to the less developed countries in the improvement of the working of their central banks.

Sixthly, the IMF has created since 1964, an institute for training the officials of the member
countries in various fields.

Seventhly, the IMF has made a revolutionary innovation in the form of Special Drawing Rights
(SDR’s) to tackle the problem of international liquidity. Thus the IMF operations have really
achieved much significance from the point of view of the less developed member nations.

Shortcomings of the IMF:

No doubt the IMF has marked achievements to its credit but its working has exposed several
deficiencies or shortcomings because of which it has been subjected to criticism.

The main objections against it are as follows:

(i) Lack of Flexibility:
The IMF is generally a conservative organisation. It lacks flexibility in its approach. It has been
found incapable of making required rapid changes in its operations in the rapidly changing
international economic conditions.

(ii) Determination of Par Values:

Originally the IMF determined the par values of different currencies in terms of gold or the
United States dollar. This choice by IMF was ill-advised. The par values were fixed by the
original members at a time when the over-valuation of currencies was the most common practice.

(iii) Weak and Passive Policy in Respect of Fixation of Exchange Rates:

Some provisions of the IMF related to variations in exchange rate are not constructive. They have
rather destructive effect. For example, the IMF justifies devaluation when the fundamental
disequilibrium is supposed to result from the international inflation. If inflation persists, the
devaluation cannot be effective. It may actually require even subsequent devaluation. The
economy can have appropriate adjustment only through internal economic policy changes.

But the IMF has little authority in this respect except consultation and persuasion. Moreover, the
member countries, in some instances, have changed the par values of their currencies with
impunity. For instance, more than 23 countries devalued their currencies in 1949 in complete
disregard of the IMF rules but the IMF could not prevent that development and remained a silent
spectator.

Such passivity on the part of the IMF raises serious doubt about its effectiveness. It may still be
recognised that the IMF could achieve much greater exchange stability compared with chaos
related to exchange rates during the inter-war period.

(iv) High Interest Rates:

The structure of interest rates on the IMF advances is rather high and that places much burden of
interest payments on the member nations. For instance, since May 1982, an interest rate of 6.6
percent is charged upon the IMF loans out of the ordinary resources of the Fund. However, if the
loans are made out of the borrowed funds, the interest charged is as high as 14.56 percent.

(v) Stiff Conditionality Clauses:

The IMF applies strict conditionality clauses on the borrowing nations. For instance, upto 1970,
the IMF insisted that the member countries borrowing funds would reduce public expenditure for
adjusting the BOP deficit. More stiff conditionality clauses were imposed after 1979. These
clauses include periodic assessment of the performance of the borrowing countries with
adjustment programmes, increase in productivity, improvement in resource allocation, reduction
in trade barriers, strengthening of the collaboration of the borrowing country with the World Bank
etc.

The IMF, while sanctioning a loan of 5.6 billion U.S. dollars to India, imposed stringent
conditionality upon India related to performance criteria in implementing programmes and
policies related to saving, exports and imports.

More recently, India could have access to IMF assistance after consenting to reorganise the
structure of economy, trade and tariffs on the specified lines. The IMF surveillance and
regulations are too strict and negate the declared policy of non-intervention in the domestic
economic matters of the borrowing member nations.

(vi) Secondary Role:

The IMF is sometimes criticised on the ground that it plays only a secondary role rather than a
primary role in international monetary relations. This organisation does not provide short-term
credit facilities. This made the central banks of the Group of Ten (Group of 10 leading
industrialised countries) to enter into Swap Arrangements.
Under this arrangement, countries exchange each-others’ currencies and also provide short-term
credit to tide over temporary disequilibrium in balance of payments. The Swap arrangement made
way to the growth of Euro-Currency Market. As a consequence, the importance of IMF as the
central international monetary institution got reduced.

(vii) Failure to Achieve Exchange Stability:

The key objective of the IMF was to create a system of stable exchange rates. The original system
of adjustable peg permitted only ± 1 percent variations in the par values of the currencies.
However, after the collapse of Bretton Woods’s system in August 1971 consequent upon the
United States refusal of convertibility of dollars into gold, the member countries have been
following diverse exchange policies such as managed float, joint float or pegged exchange rates.
It clearly shows that IMF has failed to maintain a stable uniform international exchange system.
This failure can be attributed essentially to an absence of adequate adjustment mechanism.

(viii) Failure in the Removal of Exchange Restrictions:

One of the principal objectives of the IMF was to achieve the removal of exchange restrictions by
the member countries. The Fund has not been successful in this regard. The member countries
still continue to practise exchange controls and multiple exchange rates in one form or the other.

(ix) Absence of Timely Action:

The international monetary crisis before the breakdown of the Bretton Woods System could
perhaps have been averted, had IMF taken timely remedial action. For a long period, IMF
witnessed passively the intensifying dollar shortage in the sterling area countries and failed to
declare dollar as a scarce currency.

It did not ask the United States to devalue dollar until dollar was eventually devalued in 1972.
Another instance of its indecisiveness was prolonged floatation of the German Mark and the
Japanese Yen. Thus the blame for worsening international monetary situation in 1970’s and in
even subsequent period must be largely borne by the IMF itself.

(x) Pre-Occupation with the U.S. Interests:

The IMF has failed to inspire much confidence among the member nations on account of the fact
that this institution has been found to be excessively pre-occupied with serving the economic
interest of the United States. The constitution of its Executive and veto power to the United States
reflects that the Fund’s policies and operations are dictated by the U.S.A. Most of the
international monetary reforms undertaken by the IMF are meant essentially to relieve the U.S.A.
from its balance of payments difficulties.

(xi) Failure to Tackle East Asian Currency Crisis:

A serious currency crisis engulfed the East Asian countries including Thailand, Malaysia,
Philippines, South Korea, Singapore, Hong Kong and Indonesia in early July, 1997. Depreciation
of their currencies, coupled with speculation, led to sharp decline in equity prices in the stock
markets of these countries, collapse of financial institutions and large scale flight of foreign
capital. IMF advice to these countries was to enforce high interest rates, tight money and cut on
public spending. These remedies aggravated the recessionary condition in the whole region.
The conditions of recession, unemployment and low growth rates persisted in this entire region
during the whole of 1998. The IMF should have come forward with a debt rescheduling plan
which was unfortunately given up at the instance of the United States and other advanced
countries. The IMF must partly bear the blame for worsened economic situation in the East Asian
region during 1997 and 1998. The role of IMF was woefully inadequate to assist the member
countries during world economic recession in 2008 and 2009 owing to lack of resources.

(xii) Discrimination against the Developing Countries:

Although the majority of the members of the Fund are the less developed countries of Asia,
Africa and South America, yet it is dominated by the rich countries, more particularly the United
States. The policies and operations of the IMF are generally in favour of the developed and
against the poor countries. That is why, the IMF is sometimes derisively called as “Rich
Countries Club”.

The rich countries have often adopted uncompromising attitude towards the issues concerning the
less developed countries such as expansion in the Fund’s resources, settlement of international
debt problem, unconditional and concessional development assistance etc.

(xiii) Inconsistency:
IMF has always supported huge state-funded bank bailouts in the rich world, while demanding at
the same time an end to all state funding in the poor world. This has been the heart-rending story
of IMF inconsistency from El Salvadore to Ethiopia, to East Asian countries. They have
invariably forced the poor member countries to drastically slash public expenditure on food aid,
public health services and free or subsidized elementary education.

(xiv) Support to Financial Speculators:

The IMF has been found to be supporting the big banks or financial speculators even when a
country or region was confronted with economic crisis. It happened at the time of the East Asian
Crisis in 1997-98 and world-wide recession in 2008-09. After 2008 crash, originality Hungarian
government’s step to slash public services was lauded by the IMF. It led to great public
resentment and the government was kicked out.

The new government introduced a 0-7 percent levy on the banks. This made the IMF crazy and it
shrieked that it was, unlike bailouts, distortive of banking activity. They shut down their entire
programme in Hungary. The Nobel Prize winning economist Joseph Stieglitz lamented such an
attitude of the IMF in these words, “When the IMF arrives in a country, they are interested in
only one thing. How do we make sure the banks and financial institutions are paid? ……….. It is
the IMF that keeps the (financial) speculators in business.”

It is true that there are some serious shortcomings in the operation of the IMF. But it is not proper
to overlook the part played by the IMF in the post-war period in tackling to a large extent, the
short-term balance of payments problems both of the developed and the less developed countries.
It must be fully acknowledged that the IMF has adopted a flexible approach and has attempted to
move with the changing international economic environment.
The original IMF Articles of Agreement were amended in 1978 to legalize the exchange rate
flexibility, to raise member countries’ quotas for augmenting the resources of the Fund and to
delink the international exchange system from gold. The IMF has created the system of Special
Drawing Rights (SDR’s) to relieve the shortage of international liquidity.

It has created new lending facilities such as Compensatory Financing Facilities (CFF), Buffer
Stock Facility (BSF), Extended Fund Facility (EEF) and Supplementary Financing Facility (SFF)
etc. for providing larger flow of aid to the developing countries in tackling the balance of
payments difficulties. The IMF has also started making provision for long-term financial
assistance at low rates of interest. The broadening of credit structure by IMF signifies that the less
developed countries should not abandon faith and hope in the efficacy of this vital international
monetary institution.

Q-2 DISCUSS THE OBJECTIVES AND FUNCTIONS OF 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.

Currently, the World Bank has two stated goals that it aims to achieve by 2030. The first is to
end extreme poverty by decreasing the number of people living on less than $1.90 a day to below
3% of the world population. The second is to increase overall prosperity by increasing income
growth in the bottom 40% of every country in the world.

KEY TAKEAWAYS

 The World Bank is an international organization that provides financing, advice, and
research to developing nations to help advance their economies.
 The World Bank and International Monetary Fund (IMF)—founded simultaneously under
the Bretton Woods Agreement—both seek to serve international governments.
 The World Bank has expanded to become known as the World Bank Group with five
cooperative organizations, sometimes known as the World Banks.
 The World Bank Group offers a multitude of proprietary financial assistance, products,
and solutions for international governments, as well as a range of research-based thought
leadership for the global economy at large.
 The World Bank's Human Capital Project seeks to help nations invest in and develop their
human capital to produce a better society and economy.

Understanding the World Bank

The World Bank is a provider of financial and technical assistance to individual countries around
the globe. The bank considers itself a unique financial institution that sets up partnerships to
reduce poverty and support economic development.

The World Bank supplies qualifying governments with low-interest loans, zero-interest credits,
and grants, all to support the development of individual economies. Debt borrowings and cash
infusions help with global education, healthcare, public administration, infrastructure, and
private-sector development. The World Bank also shares information with various entities
through policy advice, research and analysis, and technical assistance. It offers advice and
training for both the public and private sectors.

Functions of the World Bank

 It helps the war-devasted countries by granting them loans for reconstruction.

 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.
 Also, it helps the underdeveloped countries by granting development loans.
 So, it also provides loans to various governments for irrigation, agriculture, water supply,
health, education, etc.
 It promotes foreign investments to other organizations by guaranteeing the loans.
 Also, the world bank provides economic, monetary, and technical advice to the member
countries for any of their projects.
 Thus, it encourages the development of of-industries in underdeveloped countries by
introducing the various economic reforms.

Objectives of the World Bank

 This includes providing long term capital to its member nations for economic
development and reconstruction.
 Thus, it helps in inducing long term capital for improving the balance of payments and
thereby balancing international trade.
 Also, it helps by providing guarantees against loads granted to large and small units and
other projects for the member nations.
 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.
 Also, it promotes the capital investment for member nations by providing a guarantee for
capital investment and loans.
 So, if the capital investment is not available than it provides the guarantee and then IBRD
provides loans for promotional activities on specific conditions.

Purposes of the World Bank

 It wants to create an environment that is a pro-investment.

 Also, it wants to improve the omic stability by reducing poverty.
 So, it is working towards achieving sustainable growth.
  Increasing the opportunities for jobs and business in member nations which are
underdeveloped.
 Through investment, it plans to promote the socio-economic status of the society.
 Also, it wants to ensure that the judicial and legal systems are developed and individual
rights are protected.
 Strengthing the government of its member nations by promoting education.
 Combating corruption and to ensure that there are adequate training opportunities and
research facilities.
 It wants to provide loans with low-interest rates and interest-free credits.

Q-3 EXPLAIN VARIOUS FORMS OF REGIONAL ECONOMIC GROUPING. ALSO

DISCUSS MERITS AND DEMERITS OF REGIONAL ECONOMIC GROUPING?

Regional economic integration has enabled countries to focus on issues that are relevant to their
stage of development as well as encourage trade between neighbors.

There are four main types of regional economic integration.

1. Free trade area. This is the most basic form of economic cooperation. Member countries
remove all barriers to trade between themselves but are free to independently determine
trade policies with nonmember nations. An example is the North American Free Trade
Agreement (NAFTA).
2. Customs union. This type provides for economic cooperation as in a free-trade zone.
Barriers to trade are removed between member countries. The primary difference from the
free trade area is that members agree to treat trade with nonmember countries in a similar
manner.1
3. Common market. This type allows for the creation of economically integrated markets
between member countries. Trade barriers are removed, as are any restrictions on the
movement of labor and capital between member countries. Like customs unions, there is a
common trade policy for trade with nonmember nations. The primary advantage to workers
is that they no longer need a visa or work permit to work in another member country of a
common market. An example is the Common Market for Eastern and Southern Africa
(COMESA).2
4. Economic union. This type is created when countries enter into an economic agreement to
remove barriers to trade and adopt common economic policies. An example is the
European Union (EU).3

In the past decade, there has been an increase in these trading blocs with more than one hundred
agreements in place and more in discussion. A trade bloc is basically a free-trade zone, or near-
free-trade zone, formed by one or more tax, tariff, and trade agreements between two or more
countries. Some trading blocs have resulted in agreements that have been more substantive than
others in creating economic cooperation. Of course, there are pros and cons for creating regional
agreements.

Pros
The pros of creating regional agreements include the following:

 Trade creation. These agreements create more opportunities for countries to trade with
one another by removing the barriers to trade and investment. Due to a reduction or
removal of tariffs, cooperation results in cheaper prices for consumers in the bloc countries.
Studies indicate that regional economic integration significantly contributes to the
relatively high growth rates in the less-developed countries.
 Employment opportunities. By removing restrictions on labor movement, economic
integration can help expand job opportunities.
 Consensus and cooperation. Member nations may find it easier to agree with smaller
numbers of countries. Regional understanding and similarities may also facilitate closer
political cooperation.

Cons

The cons involved in creating regional agreements include the following:

 Trade diversion. The flip side to trade creation is trade diversion. Member countries may
trade more with each other than with nonmember nations. This may mean increased trade
with a less efficient or more expensive producer because it is in a member country. In this
sense, weaker companies can be protected inadvertently with the bloc agreement acting as
a trade barrier. In essence, regional agreements have formed new trade barriers with
countries outside of the trading bloc.
 Employment shifts and reductions. Countries may move production to cheaper labor
markets in member countries. Similarly, workers may move to gain access to better jobs
and wages. Sudden shifts in employment can tax the resources of member countries.
 Loss of national sovereignty. With each new round of discussions and agreements within
a regional bloc, nations may find that they have to give up more of their political and
economic rights. In the opening case study, you learned how the economic crisis in Greece
is threatening not only the EU in general but also the rights of Greece and other member
nations to determine their own domestic economic policies.

Q-4 WHAT IS SAARC? DISCUSS ITS OBJECTIVES AND PRINCIPLES?

South Asian Association for Regional Cooperation

(SAARC)
History
The South Asian Association for Regional Cooperation (SAARC) is an economic and political
organization of eight countries in South Asia. It was established in 1985 when the Heads of State
of Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka formally adopted the
charter. Afghanistan joined as the 8th member of SAARC in 2007. To date, 18th Summits have
been held and Nepal’s former Foreign Secretary is the current Secretary General of SAARC. The
19th Summit will be hosted by Pakistan in 2016. SAARC aims to promote the wealfare of the
people of South Asia and improve the quality of their life through economic growth, social
progress and cultural development in region. The areas of cooperation under the SAARC include
trade, investment, industrial development, agriculture and rural development, health, youth and
children, environment and forestry, science and technology, transport and human resource
development.
Objectives
SAARC aims to promote economic growth, social progress and cultural development within the
South Asia region. The objectives of SAARC, as defined in its charter, are as follows:

 Promote the welfare of the peoples of South Asia and improve their quality of life
 Accelerate economic growth, social progress and cultural development in the
region by providing all individuals the opportunity to live in dignity and realise
their full potential
 Promote and strengthen collective self-reliance among the countries of South
Asia
 Contribute to mutual trust, understanding and appreciation of one another’s
problems
 Promote active collaboration and mutual assistance in the economic, social,
cultural, technical and scientific fields
 Strengthen co-operation with other developing countries
 Strengthen co-operation among themselves in international forms on matters of
common interest; and
 Cooperate with international and regional organisation with similar aims and
purposes.
Principles of SAARC

 To respect the principle of mutual benefit and not to interfere in the internal affairs of
other countries, and to respect the political independence, sovereignty, equality and
regional integrity of the nations
 To increase mutual cooperation and to extend cooperation to other countries of the region
 Regional cooperation is seen as addition to bilateral and multilateral relations of SAARC
member nations
 Bilateral and contentious issues ( issues causing a lot of disagreements) are excluded from
the deliberations of SAARC.

Q-5 WHAT IS FOREIGN EXCHANGE MARKET? WHAT FACTORS DETERMINE THE

FOREIGN EXCHANGE RATES?

The foreign exchange market (also known as forex, FX, or the currencies market) is an over-the-
counter (OTC) global marketplace that determines the exchange rate for currencies around the
world. Participants in these markets can buy, sell, exchange, and speculate on the relative
exchange rates of various currency pairs.

Foreign exchange markets are made up of banks, forex dealers, commercial companies, central
banks, investment management firms, hedge funds, retail forex dealers, and investors.

KEY TAKEAWAYS
  The foreign exchange market is an over-the-counter (OTC) marketplace that determines
the exchange rate for global currencies.
 It is, by far, the largest financial market in the world and is comprised of a global network
of financial centers that transact 24 hours a day, closing only on the weekends.
 Currencies are always traded in pairs, so the "value" of one of the currencies in that pair is
relative to the value of the other.

Understanding the Foreign Exchange Market

The foreign exchange market—also called forex, FX, or currency market—was one of the
original financial markets formed to bring structure to the burgeoning global economy. In terms
of trading volume, it is, by far, the largest financial market in the world. Aside from providing a
venue for the buying, selling, exchanging, and speculation of currencies, the forex market also
enables currency conversion for international trade settlements and investments.

According to the Bank for International Settlements (BIS), which is owned by central banks,
trading in foreign exchange markets averaged $6.6 trillion per day in April 2019. 1

Currencies are always traded in pairs, so the "value" of one of the currencies in that pair is
relative to the value of the other. This determines how much of country A's currency country B
can buy, and vice versa. Establishing this relationship (price) for the global markets is the main
function of the foreign exchange market. This also greatly enhances liquidity in all other
financial markets, which is key to overall stability.

The value of a country's currency depends on whether it is a "free float" or "fixed float." Free-
floating currencies are those whose relative value is determined by free-market forces, such as
supply-demand relationships. A fixed float is where a country's governing body sets its
currency's relative value to other currencies, often by pegging it to some standard. Free-floating
currencies include the U.S. dollar, Japanese yen, and British pound, while examples of fixed
floating currencies include the Chinese Yuan and the Indian Rupee.

One of the most unique features of the forex market is that it is comprised of a global network of
financial centers that transact 24 hours a day, closing only on the weekends. As one major forex
hub closes, another hub in a different part of the world remains open for business. This increases
the liquidity available in currency markets, which adds to its appeal as the largest asset
class available to investors

Foreign Exchange rate (ForEx rate) is one of the most important means through which a country’s
relative level of economic health is determined. A country's foreign exchange rate provides a
window to its economic stability, which is why it is constantly watched and analyzed. If you are
thinking of sending or receiving money from overseas, you need to keep a keen eye on the
currency exchange rates.
The exchange rate is defined as "the rate at which one country's currency may be converted into
another." It may fluctuate daily with the changing market forces of supply and demand of
currencies from one country to another. For these reasons; when sending or receiving money
internationally, it is important to understand what determines exchange rates.
1. Inflation Rates
Changes in market inflation cause changes in currency exchange rates. A country with a lower
inflation rate than another's will see an appreciation in the value of its currency. The prices of
goods and services increase at a slower rate where the inflation is low. A country with a
consistently lower inflation rate exhibits a rising currency value while a country with higher
inflation typically sees depreciation in its currency and is usually accompanied by higher interest
rates

2. Interest Rates
Changes in interest rate affect currency value and dollar exchange rate. Forex rates, interest rates,
and inflation are all correlated. Increases in interest rates cause a country's currency to appreciate
because higher interest rates provide higher rates to lenders, thereby attracting more foreign
capital, which causes a rise in exchange rates

3. Country’s Current Account / Balance of Payments

A country’s current account reflects balance of trade and earnings on foreign investment. It
consists of total number of transactions including its exports, imports, debt, etc. A deficit in
current account due to spending more of its currency on importing products than it is earning
through sale of exports causes depreciation. Balance of payments fluctuates exchange rate of its
domestic currency.

4. Government Debt
Government debt is public debt or national debt owned by the central government. A country
with government debt is less likely to acquire foreign capital, leading to inflation. Foreign
investors will sell their bonds in the open market if the market predicts government debt within a
certain country. As a result, a decrease in the value of its exchange rate will follow.

5. Terms of Trade
Related to current accounts and balance of payments, the terms of trade is the ratio of export
prices to import prices. A country's terms of trade improves if its exports prices rise at a greater
rate than its imports prices. This results in higher revenue, which causes a higher demand for the
country's currency and an increase in its currency's value. This results in an appreciation of
exchange rate.

6. Political Stability & Performance

A country's political state and economic performance can affect its currency strength. A country
with less risk for political turmoil is more attractive to foreign investors, as a result, drawing
investment away from other countries with more political and economic stability. Increase in
foreign capital, in turn, leads to an appreciation in the value of its domestic currency. A country
with sound financial and trade policy does not give any room for uncertainty in value of its
currency. But, a country prone to political confusions may see a depreciation in exchange rates.

7. Recession
When a country experiences a recession, its interest rates are likely to fall, decreasing its chances
to acquire foreign capital. As a result, its currency weakens in comparison to that of other
countries, therefore lowering the exchange rate.

8. Speculation
If a country's currency value is expected to rise, investors will demand more of that currency in
order to make a profit in the near future. As a result, the value of the currency will rise due to the
increase in demand. With this increase in currency value comes a rise in the exchange rate as
well.

Conclusion:
All of these factors determine the foreign exchange rate fluctuations. If you send or receive
money frequently, being up-to-date on these factors will help you better evaluate the optimal time
for international money transfer. To avoid any potential falls in currency exchange rates, opt for a
locked-in exchange rate service, which will guarantee that your currency is exchanged at the same
rate despite any factors that influence an unfavorable fluctuation.
Q-6 WHAT IS MEANT BY FOREIGN INVESTMENTS? GIVE ITS CLASSIFICATIONS.
EXPLAIN THE NEED OF FOREIGN CAPITAL FOR UNDER- DEVELOPED NATIONS.

Foreign investment is when a domestic investor decides to purchase ownership of an asset in a

foreign country. It involves cash flows moving from one country to another to execute the
transaction. If the ownership stake is large enough, the foreign investor may be able to influence
the entity’s business strategy.
Summary
Foreign investment is when investors purchase an asset in a foreign country, resulting in the cash
flow consideration transferring from one country to the next.
Foreign direct investments (FDIs) are long-term physical investments, such as plants, toll roads,
and bridges within foreign countries.
Examples of FDIs include financial institutions trading equity stakes of foreign companies on the
stock exchange.
Understanding Foreign Investments
Foreign investments are often made by larger financial institutions hoping to diversify their
portfolio or expand operations for one of their current companies internationally. It is often
considered a move for scaling purposes or a catalyst to spur in economic growth.
For example, some companies may expand their offices worldwide to reach global talent and
connections. Examples would include Goldman Sachs, J.P. Morgan, Morgan Stanley, and other
large corporations. In other cases, some companies may open facilities or operations to capitalize
on cheaper labor or production costs offered in specific countries.
For textile companies in particular, such as retail production, many factories are located in China
and Bangladesh despite sales being focussed on North America – such as H&M or Zara – because
material and labor are significantly cheaper there; thus, outsourcing would result in higher
profitability. In other cases, some large corporations will prefer to conduct business in countries
that have lower tax rates.
Direct vs. Indirect Foreign Investments
Foreign investments are typically defined as either direct or indirect. Foreign direct investments
are when investors purchase a physical asset such as a plant, factory, or machinery in a foreign
country. In contrast, foreign indirect investments are when investors buy stakes in foreign
companies that trade on their respective stock exchanges.
Generally speaking, direct foreign investments are favored by the foreign country over indirect
foreign investments because the assets they purchase are considered long-term. Therefore, they
help boost the foreign country’s economy over time.
Alternatively, indirect foreign investments are typically shorter-term investments that aren’t
always used for the growth and development of another country’s economy over time.
Commercial Foreign Investments and Official Flows
Beyond direct and indirect foreign investments, commercial foreign investments and official
flows are two other types of investing methodologies conducted internationally.
Commercial loans are essentially bank loans issued by a domestic bank to a foreign business or
government. Similarly, official flows are various forms of development assistance that developing
or developed countries receive from a foreign country.
Types of Foreign Investments
Funds from foreign country could be invested in shares, properties, ownership / management or
collaboration. Based on this, Foreign Investments are classified as below.

 Foreign Direct Investment (FDI)

 Foreign Portfolio Investment (FPI)
 Foreign Institutional Investment (FII)

Details on each of the foreign investment type can be found below :

Foreign Direct Investment (FDI)

FDI is an investment made by a company or individual who us an entity in one country, in the
form of controlling ownership in business interests in another country. FDI could be in the form
of either establishing business operations or by entering into joint ventures by mergers and
acquisitions, building new facilities etc.

Foreign Portfolio Investment (FPI)

Foreign Portfolio Investment (FPI) is an investment by foreign entities and non-residents in
Indian securities including shares, government bonds, corporate bonds, convertible securities,
infrastructure securities etc. The intention is to ensure a controlling interest in India at an
investment that is lower than FDI, with flexibility for entry and exit.

Foreign Institutional Investment (FII)

Foreign Portfolio Investment (FPI) is an investment by foreign entities in securities, real
property and other investment assets. Investors include mutual fund companies, hedge fund
companies etc. The intention is not to take controlling interest, but to diversify portfolio ensuring
hedging and to gain high returns with quick entry and exit.

The differences in FPI and FII are mostly in the type of investors and hence the terms FPI and FII
are used interchangeably.

THE IMPORTANT OF FOREIGN CAPITAL IN UNDERDEVELOPED COUNTRIES

CAN BE MAINLY JUDGED FROM THE FOLLOWING REASONS:

1. Solution to the Problem of Capital Deficiency:

The underdeveloped countries are generally designated as ‘capital poor’ or ‘low-saving and low-
investing economies. The rate of domestic savings in these countries is highly inadequate to meet
the requirement of their economic development. Majority of people are living on the subsistence
level. Besides, it is not possible to increase the rate of domestic savings to any significant extent.

It is not possible for these countries to develop rapidly with their domestic resources alone.
Foreign aid can help to bridge the gap between the rate of domestic savings and required rate of
investments if these countries are to developed at a fairly rapid rate. A modest requirement of
development it has been correctly observed, will be to invest at least 10 percent of their national
income in these countries. But domestic saving is inadequate to meet the requirements of capital
formation. Hence foreign aid capital is indispensable for economically backward areas.

2. Technical Knowledge and Specialized Capital Equipment:

These countries are not only ‘capital poor’ but they are also backward in technology for rapid
economic development. They require trained personnel, technical know-how and expert opinion.
They also need modern machines and equipment’s. Foreign capital can help to solve the problem
of technological backwardness of these countries. Therefore, foreign capital is significant not
only as a source of additional savings but also as a supplier of modern technology and specialized
capital equipment to underdeveloped countries.

3. To Correct Adverse Balance of Payments:

Foreign aid is also crucial from the point of its favourable effect on the balance of payments of
the recipient country. These countries are generally involved in unfavorable balance of payments.
Economic development tends to affect the balance of payments adversely as the huge imports of
capital goods, technical know-how and raw materials are required to carry on the development
programmes. On the other side, the exports from these countries are sluggish because of high cost
of production and increased domestic consumption.

In this way underdeveloped countries suffer from a continuous pressure on their balance of
payments. Foreign capital can help to solve the foreign exchange crisis to a greater extent in these
countries. Thus according to Dr. D. Bright Singh, external assistance becomes unavoidable in
mobilization of resources in a country as it gives guarantee of releasing sufficient amount of
foreign exchange to carry on the development programmes.

4. Foreign Capital helps to maintain the Production Level:

Another significance is that aid imports can be of immense help in maintaining the level of
industrial production in less developed countries by providing essential raw materials, semi
manufactured goods, machines, tools and equipment’s. These countries are not in a position to
import their requirements out of their own foreign exchange earnings. As a result they have to
resort to foreign borrowing in order to maintain the level of production in the country.

5. Helpful in the Development of Economic and Social Overheads:

It is a hard fact that underdeveloped countries lack in the necessary infrastructure for
development like rails, roads, canals, power projects and other economic and social overheads.
Since their development requires a huge capital investment and a long gestation period, these
countries are unable to undertake these heavy projects with the aid of domestic resources. Foreign
capital can be very helpful in the pace of economic development. It leads to lay down the
foundations of rapid economic development in these countries.

6. To Break Vicious Circle of Poverty:

Foreign aid capital is useful to break the vicious circle of poverty and market imperfections. In
the opinion of Prof. Nurkse, “The use of foreign resources is one way of breaking the vicious
circle of poverty and low capital formation.

The flow of foreign capital and other resources will provide an increase in productivity fast
enough to out run population growth and thus launch a process of cumulative expansion, and will
acquire a sufficient portion of this capital in foreign exchange to permit importation of raw
materials and equipment needed for development, in addition to essential food stuffs”.

7. Rapid rate of Capital Formation:

As underdeveloped countries have slow rate of capital formation but with the aid of foreign
capital, rate of capital formation can easily be speeded up as this imported capital is employed in
heavy capital intensive industries such as machinery, steel and fertilizer etc.

8. Proper Use of Natural Resources and Risky Projects:

In underdeveloped countries capital is very shy and the private enterprise is reluctant to undertake
risky projects like the exploitation of untapped natural resources. Foreign capital covers up this
deficiency by opening new ventures and new areas of business activity. It goes into pioneering
enterprises involving all risks. Thus the investment of foreign capital results in opening up
inaccessible areas and tapping up of new and exploited natural resources in the country.

9. Helpful in Combating Inflation:

Underdeveloped countries generally suffer from inflationary pressure during the initial stage of
their development. Inflation in these countries is the outcome of the disequilibrium between
demand and supply. Public investment programme on a mass scale generates demand ahead of
the supply of goods. This in turn creates inflationary pressure in the economy. Foreign capital is
helpful to minimize inflationary pressure through import of food and other consumer goods. In
either way, foreign capital keeps inflationary pressures under control.

10. Tends to Increase Productivity, Income and Employment:

With the inflow of capital, the labour in the country is equipped with modern tools which in turn
raise its productivity. A rise in labour productivity results in higher real wages for the workers
and cheaper goods for the consumers. In general in this way foreign capital leads to setting up of
new industries which provide greater income and employment for its growing population.