Fiscal Policy

Fiscal policy, measures employed by governments to stabilize the economy, specifically by

manipulating the levels and allocations of taxes and government expenditures. Fiscal measures
are frequently used in tandem with monetary policy to achieve certain goals.

Fiscal policy in India: Fiscal policy is the guiding force that helps the government decide how
much money it should spend to support the economic activity, and how much revenue it must
earn from the system, to keep the wheels of the economy running smoothly.

Fiscal policy in India: Fiscal policy in India is the guiding force that helps the government
decide how much money it should spend to support the economic activity, and how much
revenue it must earn from the system, to keep the wheels of the economy running smoothly. In
recent times, the importance of fiscal policy has been increasing to achieve economic growth
swiftly, both in India and across the world. Attaining rapid economic growth is one of the key
goals of fiscal policy formulated by the Government of India. Fiscal policy, along with monetary
policy, plays a crucial role in managing a country’s economy.

Through the fiscal policy, the government of a country controls the flow of tax revenues and
public expenditure to navigate the economy. If the government receives more revenue than it
spends, it runs a surplus, while if it spends more than the tax and non-tax receipts, it runs a
deficit. To meet additional expenditures, the government needs to borrow domestically or from
overseas. Alternatively, the government may also choose to draw upon its foreign exchange
reserves or print additional money.

Main objectives of Fiscal Policy in India:

Economic growth: Fiscal policy helps maintain the economy’s growth rate so that certain
economic goals can be achieved.

Price stability: It controls the price level of the country so that when the inflation is too high,
prices can be regulated.

Full employment: It aims to achieve full employment, or near full employment, as a tool to
recover from low economic activity.

Other Objectives

1. Full Employment:

The first and foremost objective of fiscal policy in a developing economy is to achieve and
maintain full employment in an economy. In such countries, even if full employment is not
achieved, the main motto is to avoid unemployment and to achieve a state of near full
employment. Therefore, to reduce unemployment and under-employment, the state should spend
sufficiently on social and economic overheads. These expenditures would help to create more
employment opportunities and increase the productive efficiency of the economy.

2. Price Stability:

There is a general agreement that economic growth and stability are joint objectives for
underdeveloped countries. In a developing country, economic instability is manifested in the
form of inflation. Prof. Nurkse believed that “inflationary pressures are inherent in the process of
investment but the way to stop them is not to stop investment. They can be controlled by various
other ways of which the chief is the powerful method of fiscal policy.”

Therefore, in developing economies, inflation is a permanent phenomena where there is a

tendency to the rise in prices due to expanding trend of public expenditure. As a result of rise in
income, aggregate demand exceeds aggregate supply. Capital goods and consumer goods fail to
keep pace with rising income.

3. To Accelerate the Rate of Economic Growth:

Primarily, fiscal policy in a developing economy, should aim at achieving an accelerated rate of
economic growth. But a high rate of economic growth cannot be achieved and maintained
without stability in the economy. Therefore, fiscal measures such as taxation, public borrowing
and deficit financing etc. should be used properly so that production, consumption and
distribution may not adversely affect. It should promote the economy as a whole which in turn
helps to raise national income and per capita income

4. Optimum Allocation of Resources:

Fiscal measures like taxation and public expenditure programmes, can greatly affect the
allocation of resources in various occupations and sectors. As it is true, the national income and
per capita income of underdeveloped countries is very low. In order to gear the economy, the
government can push the growth of social infrastructure through fiscal measures. Public
expenditure, subsidies and incentives can favorably influence the allocation of resources in the
desired channels.

5. Equitable Distribution of Income and Wealth:

It is needless to emphasize the significance of equitable distribution of income and wealth in a

growing economy. Generally, inequality in wealth persists in such countries as in the early stages
of growth, it concentrates in few hands. It is also because private ownership dominates the entire
structure of the economy. Besides, extreme inequalities create political and social discontentment
which further generate economic instability. For this, suitable fiscal policy of the government
can be devised to bridge the gap between the incomes of the different sections of the society.

6. Economic Stability:
Fiscal measures, to a larger extent, promote economic stability in the face of short-run
international cyclical fluctuations. These fluctuations cause variations in terms of trade, making
the most favourable to the developed and unfavorable to the developing economies. So, for the
purpose of bringing economic stability, fiscal methods should incorporate built-in-flexibility in
the budgetary system so that income and expenditure of the government may automatically
provide compensatory effect on the rise or fall of the nation’s income.

7. Capital Formation and Growth:

Capital assumes a central place in any development activity in a country and fiscal policy can be
adopted as a crucial tool for the promotion of the highest possible rate of capital formation. A
newly developing economy is encompassed by a ‘vicious circle of poverty’. Therefore, a
balanced growth is needed to breakdown the vicious circle which is only feasible with higher
rate of capital formation. Once a country comes out of the clutches of backwardness, it
stimulates investment and encourage capital formation.

8. To Encourage Investment:

Fiscal policy aims at the acceleration of the rate of investment in the public as well as in private
sectors of the economy. Fiscal policy, in the first instance, should encourage investment in public
sector which in turn effect to increase the volume of investment in private sector. In other words,
fiscal policy should aim at rapid economic development and must encourage investment in those
channels which are considered most desirable from the point of view of society

How does a Fiscal Policy work?

Fiscal policy is based on Keynesian economics, a theory by economist John Maynard Keynes.
This theory states that the governments of nations can play a major role in influencing the
productivity levels of the economy of the nation by changing (increasing or decreasing) the tax
levels for the public and thus by modifying public spending.

This influence exerted by the policy helps in curbing inflation, increasing employment and most
importantly it helps in maintaining a healthy value of the currency. Fiscal policy has a major role
in managing the economy. An incompetent policy may lead to huge setbacks for the economy
and may also lead to a recession.

Importance of Fiscal Policy in India:

Along similar lines, a tax slab may affect only the middle-level income group. To summarize, the
existence of a sustainable fiscal policy is imperative to create a vibrant and productive economy.
In a country like India, fiscal policy plays a key role in elevating the rate of capital formation
both in the public and private sectors.
Through taxation, the fiscal policy helps mobilise considerable amount of resources for financing
its numerous projects. Fiscal policy also helps in providing stimulus to elevate the savings rate.
The fiscal policy gives adequate incentives to the private sector to expand its activities. Fiscal
policy aims to minimise the imbalance in the dispersal of income and wealth.

The purpose to define such a policy is to balance the effect of modified tax rates and public
spending. For instance, the government may try and simulate a slow-growing economy by
increased spending. This increased spending is a result of lowered taxes by the government.
However, this lowering of tax rates may cause inflation to rise. This is due to the fact that the
inflow of money in the system is high along with an increased consumer demand. These facts
coupled together lead to a decrease in the value of money.

This implies that more money is required to buy the same thing which was available for a lower
price earlier. With more inflow of money in the economy due to a lesser amount of taxes, the
demands of consumers for goods as well as services increases. This leads to growth in the
businesses and turns the nation economy slow growing to active.

However, this too needs to be controlled. A steady decrease in taxes and increased consumer
spending may lead to too much money inflow into the system. This can lead to an increase in
inflation and thus the cost of production rises. This implies that in effect the purchasing power of
the consumer decreases. The fiscal policy needs to be closely monitored to ensure that the
economy is productive and not infected by uncontrolled inflation.

The importance of Fiscal policy also includes

To Mobilize Resources:

The foremost aim of fiscal policy in developing countries is to mobilize resources in the private
and public sectors. Generally, the national income and per capita income is very low due to low
rate of savings. Therefore, the governments of such countries through forced savings pushes the
rate of investment and capital formation which in turn accelerates the rate of economic
development.

To Accelerate the Rate of Growth

Fiscal policy helps to accelerate the rate of economic growth by raising the rate of investment in
public as well as private sectors. Therefore, various tools of fiscal policy as taxation, public
borrowing, deficit financing and surpluses of public enterprises should be used in a combined
manner so that they may not adversely affect the consumption, production and distribution of
wealth.

To Encourage Socially Optimal Investment:

In underdeveloped countries, fiscal policy encourages the investment into those productive
channels which are considered socially and economically desirable. This means optimal
investment which promotes economic development and avoids wasteful and unproductive
investment.

In short, aim of the fiscal policy should be to make investment on social and economic overheads
such as transportation, communication, technical training, education, health and soil
conservation.

Inducement to Investment and Capital Formation:

Fiscal policy plays crucial role in underdeveloped countries by making investment in strategic
industries and services of public utility on one side and induces investment in private sector by
giving assistance to new industries and introduces modern techniques of production. Thus,
investment on social and economic overheads are helpful in increasing the social marginal
productivity and thereby raising the marginal productivity of private investment and capital
formation. Here, optimum pattern of investment can also go a long way to yield fruitful results of
economic development.

To Provide more Employment Opportunities

Since in less developed countries, population grows at a very fast rate, the aim of fiscal policy in
such countries is to make high doses of expenditures which are helpful to raise employment
opportunities. Generally under developed economies suffer from unemployment.

Who Does Fiscal Policy Affect?

The policy may not affect all the people in the same way. The effect depends on the goals of the
policy-making authorities. For instance, increased spending on research may only increase the
income of a select few people. Whereas construction of dams may lead to increased employment
for a larger group of people.

Instruments of Fiscal Policy:

Taxation Policy: The government tries to keep the taxes progressive in nature and with the help
of direct and indirect taxes controls the Price stability, control of Inflation and distribution of
income. Higher the tax; lower is the purchasing power of people and lower is the tax; higher is
the purchasing power of the people.

Expenditure Policy: Expenditure policy of the government deals with revenue and capital
expenditures. Capital Expenditures of the government include acquisition of long-term assets,
such as facilities or manufacturing equipment etc, which will generate business or additional
profits to government.
Revenue Expenditures are those expenditures which don’t create any productive assets such as
interest paid by the Government of India on all the internal and external loans or pension and
salaries of government employees.

Investment and Disinvestment Policy: Investment and Disinvestment Policy refers to investment
in the form of FDI or FII in an economy from outside the country or disinvestment of
government holding to public or private shares.

Debt / Surplus Management: If the government received more than it spends, it is called surplus.
If government spends more than income, then it is called deficit. To fund the deficit, the
government has to borrow from domestic or foreign sources. It can also print money for deficit
financing.

Sources of Public Revenue

Meaning of Public Revenue

Public revenue generally refers to government revenue. Some important sources or concepts that
are included in public revenue consist of taxes, fees, sale of public goods and services, fines,
donations, etc.

The main sources of public revenue are: Tax and Non-tax revenue

Sources of Public Revenue

A) Tax Revenue:

The chief source of public revenue is Tax. To define tax, it is said that tax is a mandatory
imposition of duty on public authority by government organizations to meet requirements
of general public as a whole.

Therefore, with the above defined term, some points are highlighted as below:

i) A Tax is a compulsory duty levied by the government. If any individual refuses to

comply with tax payments, he can be punished or penalized

ii) Tax basically involves some understanding and sacrifice on the basis of a tax payer

iii) Tax is a duty and not a penalty

(iv) Most part of revenue income is generated from tax by the central government.

Broad classification of taxes is: Direct and Indirect Taxes

Direct taxes:

 Direct taxes are levied on wealth and income of individuals or organizations.

These taxes are personal income tax, corporate tax, and gift or wealth tax. The
impact of direct taxes is on the same person.
 Direct taxes are developing in nature and the tax rate increases along with the tax
base.
 Progressive direct taxes are involved in falling income discrimination especially
in rising countries.

Following major direct taxes are stated:

1. Personal Income Tax:

Personal income tax is duty imposed on an individual or group of individuals after

specific permissible deductions

2. Corporate Tax:

 Corporate tax is a duty that has to be paid on the profits registered corporate
firms. Corporate tax is direct tax because the company is given legal entity.

3. Other Direct Taxes:

 List of other direct taxes include, Wealth tax, Interest tax, gift tax, Expenditure
tax, etc
 The share of these taxes is unimportant.

Indirect taxes

 Indirect taxes are imposed on goods & commodities.

 These taxes include sales tax, excise duty, service tax, customs duty, VAT, etc.
 The impact of indirect taxes may be implied on different people.
 In direct taxes are not progressive but regressive in nature. Here, the burden to
pay duties is indirectly or directly bearded by the consumer irrespective of their
income level.
 Indirect taxes are of utmost importance for countries that are developing and face
low income levels.

Major Indirect Taxes:

a) Excise Duty :

 These taxes are levied on manufactured goods and consumable goods in India
 Excise duty is the chief and single largest source to generate revenue income
  Rates of excise duty faces a declining trend

b) Customs Duty:

 This duty is imposed on exports of selective range and imports

 With revenue point of view, Custom duty has less importance
 Peak rate of custom levy is 10%

c) Service Tax:

 This tax is imposed by specific category of firms, agencies or persons

 Rate of service taxes have been increased progressively

d) Goods and Service Tax

 Goods and service tax includes range of all taxes like excise duty, service tax,
goods tax, VAT, etc.It covers goods and service charges in mostly all sectors.It
generally simplifies the complexity of charges on good and services

B) Non tax revenues

Non Tax Revenue comprises all revenues apart from taxes accumulated to the Government.

Non tax revenues are funds that are generated from internal sources

The sources of revenue are:

Administrative revenues

Commercial revenues

Grants and gifts

Important sources of Non tax revenues include

a) Special Assessment:

 This can be called as betterment charge

 This tax is imposed to a certain category of members of a community who are generally
benefited from governmental activities or public functions like constructions of road,
railways, parks, etc
 Therefore, government imposes special charges on such properties

b) Surplus of Public Enterprises

  The government has arranged public sector enterprises that are concerned in commercial
activities.
 The surpluses generated of these enterprises are a significant source of non-tax revenue.
 These incomes are in the form of profits that are known as commercial revenues.

c) Fees:

 A fee is a significant source of managerial non-tax revenue charged by Government

authorities for depiction services to the members of the public.
 There is no compulsion to pay fees. All those utilize services may pay fees.
 Fees may be charged for getting licenses, passports or registrations, filing of court cases,
etc.

d) Fine and Penalties

 These are general sources of administrative non tax revenues

 These may be applied on public for non compliance with certain rules and regulations.
 These are not considered as the major source of revenue for the government

e) Grants and Gifts

 Grants are financial support

 These are provided to public authority to perform certain social activities
 These are generated by higher public authority to lower ones
 e.g. World bank gives grants to State bank
 There is no repayment compulsion
 Gifts and donations are voluntarily made by individuals, organizations or foreign
governments to the Central Government.
 These gifts are made by natural feeling in case of disasters or natural calamities
 Gifts are not considered as a source of income
 Therefore, tax plays an important part in generating government revenue. Non tax is
important in developing revenue.
 Public Debt

Definition: Public debt receipts and public debt disbursals are borrowings and repayments
during the year, respectively, by the government.

Description: The difference between receipts and disbursals is the net accretion to the public
debt. Public debt can be split into internal (money borrowed within the country) and external
(funds borrowed from non-Indian sources).

In India, public debt refers to a part of the total borrowings by the Union Government which
includes such items as market loans, special bearer bonds, treasury bills and special loans and
securities issued by the Reserve Bank. It also includes the outstanding external debt.

The aggregate borrowings by the Union Government—comprising the public debt and these
other borrowings — are generally known as ‘net liabilities of the Government’.

Objectives:

In India, most government debt is held in long-term interest bearing securities such as
national savings certificates, rural development bonds, capital development bonds, etc. In
industrially advanced countries like the U.S.A., the term government or public debt refers to
the accumulated amount of what government has borrowed to finance past deficits.

The State generally borrows from the people to meet three kinds of expenditure:

(a) Public Debt to Meet Budget Deficit:

It is not always proper to effect a change in the tax system whenever the public expenditure
exceeds the public revenue. It is to be seen whether the transaction is casual or regular. If the
budget deficit is casual, then it is proper to raise loans to meet the deficit. But if the deficit
happens to be a regular feature every year, then the proper course for the State would be to
raise further revenue by taxation or reduce its expenditure.

(b) Public Debt to Meet Emergencies like War:

In many countries, the existing public debt is, to a great extent, on account of war expenses.
Especially after World War II, this type of public debt had considerably increased. A large
portion of public debt in India has been incurred to defray the expenses of the last war.

(c) Public Debt for Development Purposes:

During British rule in India public debt had to be raised to construct railways, irrigation
projects and other works. In the post-independence era, the government borrows from the
public to meet the costs of development work under the Five Year Plans and other projects.
As a resmult the volume of public debt is increasing day by day.

Classification of Public Debt:

The structure of public debt is not uniform in any country on account of factors such as
categories of markets in which loans are floated, the conditions for repayment, the rate of
interest offered on bonds, purposes of borrowing, etc.

In view of these differences in criteria, public debt is classified into various categories:

i. Internal and External Debt:

Sums owed to the citizens and institutions are called internal debt and sums owed to
foreigners comprise the external debt. Internal debt refers to the government loans floated in
the capital markets within the country. Such debt is subscribed by individuals and institutions
of the country.

On the other hand, if a public loan is floated in the foreign capital markets, i.e., outside the
country, by the government from foreign nationals, foreign governments, international
financial institutions, it is called external debt.

ii. Short term and Long Term Loans:

Loans are classified according to the duration of loans taken. Most government debt is held
in short term interest-bearing securities, such as Treasury Bills or Ways and Means Advances
(WMA). Maturity period of Treasury bill is usually 90 days.

Government borrows money for such period from the central bank of the country to cover
temporary deficits in the budget. Only for long term loans, government comes to the public.
For development purposes, long period loans are raised by the government usually for a
period exceeding five years or more.

iii. Funded and Unfunded or Floating Debt:

Funded debt is the loan repayable after a long period of time, usually more than a year. Thus,
funded debt is long term debt. Further, since for the repayment of such debt government
maintains a separate fund, the debt is called funded debt. Floating or unfunded loans are
those which are repayable within a short period, usually less than a year.

It is unfunded because no separate fund is maintained by the government for the debt
repayment. Since repayment of unfunded debt is made out of public revenue, it is referred to
as a floating debt. Thus, unfunded debt is a short term debt.

iv. Voluntary and Compulsory Loans:

A democratic government raises loans for the nationals on a voluntary basis. Thus, loans
given to the government by the people on their own will and ability are called voluntary
loans. Normally, public debt, by nature, is voluntary. But during emergencies (e.g., war,
natural calamities, etc.,) government may force the nationals to lend it. Such loans are called
forced or compulsory loans.

v. Redeemable and Irredeemable Debt:

Redeemable public debt refers to that debt which the government promises to pay off at some
future date. After the maturity period, the government pays the amount to the lenders. Thus,
redeemable loans are called terminable loans.

In the case of irredeemable debt, government does not make any promise about the payment
of the principal amount, although interest is paid regularly to the lenders. For the most
obvious reasons, redeemable public debt is preferred. If irredeemable loans are taken by the
government, the society will have to face the consequence of burden of perpetual debt.

vi. Productive (or Reproductive) and Unproductive (or Deadweight) Debt:

On the criteria of purposes of loans, public debt may be classified as productive or

reproductive and unproductive or deadweight debt. Public debt is productive when it is used
in income-earning enterprises. Or productive debt refers to that loan which is raised by the
government for increasing the productive power of the economy.

A productive debt creates sufficient assets by which it is eventually repaid. If loans taken by
the government are spent on the building of railways, development of mines and industries,
irrigation works, education, etc., income of the government will increase ultimately.

Productive loans thus add to the total productive capacity of the country.
 Deficit Financing

Deficit financing is the budgetary situation where expenditure is higher than the revenue. It is a
practice adopted for financing the excess expenditure with outside resources. The expenditure
revenue gap is financed by either printing of currency or through borrowing.

Nowadays most governments both in the developed and developing world are having deficit
budgets and these deficits are often financed through borrowing. Hence the fiscal deficit is the
ideal indicator of deficit financing.

Purposes of Deficit Financing;

1. To overcome the problem of lack of funds for speeding up the country's development.

2. Promote additional investment in the country to side away the adverse impacts of depression
period of the country.

3. To arrange fund for ensuring the holistic development of the country.

4. To arrange fund for the unforeseen events and arrange resources for wartime expenditure.

5. To upgrade the infrastructure of the country so that the taxpayers of the country are convinced
that the tax paid by them is spent on the right things.

Advantages of Deficit Financing:

When the Government resorts to deficit financing, it usually borrows from the Reserve Bank.
The interest paid to the Reserve Bank actually comes back to the Government in the form of
profits.

Through deficit financing, resources are used much earlier than they can be otherwise. The
development is accelerated. This technique enables the Government to get resources without
much opposition.

Sources of Deficit Financing

The deficit financing is done in three ways;

1. Printing new currency notes

2. Borrowing from internal sources (RBI, General Public, Ad-hoc Treasury Bills & government
bonds etc.)
3. Borrowing from External Sources (like borrowing from developed countries and International
institutions like World Bank, IMF, etc.)

Deficit Financing in India

In India, when the total income of the government (revenue account + capital account) falls
below its total expenditure, then;

1. Government withdraws money from its cash deposited in the Reserve Bank or

2. Borrows loan from the central bank and commercial banks and even state governments
through Ad-hoc Treasury Bills.

3. Borrows from the general public in the form of Bonds and other securities or

4. Orders the RBI to print new currency notes

Keep in mind that the above 4 measures increase the supply of money in the market which leads
to increase the rate of inflation in the country. That is the reason that deficit financing is known
as “Idea of Money Supply. also”

It is worth to mention that deficit financing is equal to fiscal deficit of the country.

Impacts of the Deficit Financing on the country

1. Increase in inflation due to the increase in the supply of money in the economy.

2. Decrease in average consumption level due to higher inflation.

3. Increase in income disparities, because rich get more opportunities due to higher supply of
money in the economy.

4. Adverse Impact on Saving:- Deficit financing leads to inflation and inflation affects the habit
of voluntary saving adversely.

In fact it is not possible for the people to maintain the previous rate of saving due to rising prices.

5. Adverse Impact on Investment: - Deficit financing effects investment adversely. When there is
inflation in the economy trade unions/employees demand higher wages to survive.

If their demands are accepted it increases the cost of production which de-motivates the
investors.
Famous economist Keynes was the strong supporter of the deficit financing in the developing
countries so that these countries can be pulled out from the vicious circle of poverty,
unemployment and under production.

In essence it can be said that the deficit in the country is not as bad as it looks like. Perhaps this
is the reason that the deficit finance system is used in every rich country of the world.

Public Expenditure

Meaning of Public Expenditure:

Expenses incurred by the public authorities—central, state and local self- governments—are
called public expenditure. Such expenditures are made for the maintenance of the governments
as well as for the benefit of the society as whole.

Objectives Of Public Expenditure :-

The major objectives of public expenditure are

 Administration of law and order and justice.

 Maintenance of police force.
 Maintenance of army and provision for defence goods.
 Maintenance of diplomats in foreign countries.
 Public Administration.
 Servicing of public debt.
 Development of industries.
 Development of transport and communication.
 Provision for public health.
 Creation of social goods.

Classification of Public Expenditure

Types of Public Expenditure:

Public expenditure may be classified into developmental and non-developmental expenditures.

Former includes the expenditure incurred on social and community services, economic services,
etc. Non-developmental expenditure includes expenditures made for administrative service,
defence service, debt servicing, subsidies, etc.

Public expenditure is classified into revenue expenditure and capital expenditure. Revenue
expenditure includes civil expenditure (e.g., general services, social and community services and
economic services), defence expenditure, etc. On the other hand, capital expenditure comprises
expenditures incurred on social and community development, economic development, defence,
general services, etc.
Public expenditure may also be classified as plan expenditure and non-plan expenditure.

Non-plan expenditure falls under two broad heads, viz., revenue expenditure and capital
expenditure. The former comprises interest payments, defence expenditures, subsidies, pensions,
other general services (like health, education), economic services (like agriculture, energy,
industry, transport and communication, science, technology and environment, etc.)

Expenditures on agriculture, rural development, irrigation and flood control, energy, industry and
mineral resources, etc., are included in plan expenditure.

Role/Importance of Public Expenditure in a Developing Economy

Underdeveloped nations are keen on rapid economic development which requires huge
expenditure to be incurred in the various sectors of the economy.

The private sector is either unable to find and invest these huge amounts or it is unwilling
because the return from such investments may be uncertain or long delayed.

Hence, economic development has to depend almost entirely on public expenditure. Public
expenditure, therefore, plays capital role in economic development of an under-developed
economy.

Public expenditure promotes economic development in the following ways:

Social and Economic Overheads:

Economic development is handicapped kin underdeveloped countries on account of the lack of

the necessary infrastructure. Economic overheads like the roads and railways, irrigation and
power projects are essential for speeding-up economic development. Social overheads like
hospitals, schools, and colleges and technical institutions too are essential. Money for these
things cannot come out of private sources. Public expenditure has to build up the economic and
social overheads.

Balanced Regional Growth:

It is considered desirable to bring about a balanced regional growth. Special attention has to be
paid to the development of backward areas and underdeveloped regions. This requires huge
amounts for which reliance has to be placed on public expenditure.

Development of Agriculture and Industry:

Economic development is regarded synonymous with industrial development but agricultural

development provides the base and has to be given top priority. Government has to incur lot of
expenditure in the agricultural sector, e.g., on irrigation and power, seed farms, fertilizer
factories, warehouses, etc., and in the industrial sector by setting up public enterprises like the
steel plants, heavy electrical, heavy engineering, machine-making factories, etc. All these
enterprises are calculated to promote economic development.

Exploitation and Development of Mineral Resources:

Minerals provide a base for further economic development. The government has to undertake
schemes of exploration and development of essential minerals, e.g., coal and oil. Public
expenditure has to play its role here too.

Subsidies and Grants:

The Central Government gives grants to State governments and the State governments to local
authorities to induce them to incur some desirable expenditure. Subsidies have also to be given to
encourage the production of certain goods especially for export to earn much-needed foreign
exchange.

Plan and Non-Plan Expenditure of Indian Government

(a) Planned Expenditure of Indian Government

Any expenditure that is incurred on programmes which are detailed under the current (Five Year)
Plan of the centre or centre’s advances to state for their plans is called plan expenditure.
Provision of such expenditure in the budget is called Plan Expenditure.

Expressed alternatively, “plan expenditure is that public expenditure which represents current
development and investment outlays (expenditure) that arise due to proposals in the current
plan.” Such expenditure is incurred on financing the Central plan relating to different sectors of
the economy.

Items of plan expenditure are:

(i) expenditure on electricity generation, (ii) irrigation and rural developments, (iii) construction
of roads, bridges, canals and (iv) science, technology, environment, etc. It includes both revenue
expenditure and capital expenditure. Again, the assistance given by the Central Government for
the plans of States and Union Territories (UTs) is also a part of plan expenditure. Plan
expenditure is further sub-classified into Revenue Expenditure and Capital Expenditure which
along with their components are shown in the preceding chart.

(b) Non-Plan Expenditure:

This refers to the estimated expenditure provided in the budget for spending during the year on
routine functioning of the government. Non- Plan expenditure is all expenditure other than plan
expenditure of the govt. Such expenditure is a must for every country, planning or no planning.

For instance, no government can escape from its basic function of protecting the lives and
properties of the people and protecting the country from foreign invasions. For this, the
government has to spend on police, Judiciary, military, etc. Similarly, the government has to
incur expenditure on normal running of government departments and on providing economic and
social services.

Non-plan revenue expenditure is accounted for by interest payments, subsidies (mainly on food
and fertilisers), wage and salary payments to government employees, grants to States and Union
Territories governments, pensions, police, economic services in various sectors, other general
services such as tax collection, social services, and grants to foreign governments.

Non-plan capital expenditure mainly includes defence, loans to public enterprises, loans to
States, Union Territories and foreign governments

Developmental activities undertaken under Public expenditure

In modern economic activities public expenditure has to play an important role. It helps to
accelerate economic growth and ensure economic stability. Public Expenditure can promote
economic development as follows :-

 To promote rapid economic development.

 To promote trade and commerce.
 To promote rural development
 To promote balanced regional growth
 To develop agricultural and industrial sectors
 To build socio-economic overheads eg. roadways, railways, power etc.
 To exploit and develop mineral resources like coal and oil.
 To provide collective wants and maximise social welfare.
 To promote full – employment and maintain price stability.
 To ensure an equitable distribution of income.
 Unit-4

Nature of International Trade

By internal or domestic trade are meant transactions taking place within the geographical
boundaries of a nation or region. It is also known as intra-regional or home trade. International
trade, on the other hand, is trade among different countries or trade across political frontiers.

International trade, thus, refers to the exchange of goods and services between one country or
region and another. It is also sometimes known as “inter-regional” or “foreign” trade. Briefly,
trade between one nation and another is called “international” trade, and trade within the territory
(political boundary) of a nation “internal” trade.

For all practical purposes, trade or exchange of goods between two or more countries is called
“international” or “foreign” trade.

International trade takes place on account of many reasons such as:

1. Human wants and countries’ resources do not totally coincide. Hence, there tends to be
interdependence on a large scale.

2. Factor endowments in different countries differ.

3. Technological advancement of different countries differs. Thus, some countries are better
placed in one kind of production and some others superior in some other kind of production.

4. Labour and entrepreneurial skills differ in different countries.

5. Factors of production are highly immobile between countries.

In short, international trade is the outcome of territorial division of labour and specialisation in
the countries of the world.

Advantages of International Trade:

The following are the major gains claimed to be emerging from international trade:

(1) Optimum Allocation:

International specialisation and geographical division of labour leads to the optimum allocation
of world’s resources, making it possible to make the most efficient use of them.

(2) Gains of Specialisation:

Each trading country gains when the total output increases as a result of division of labour and
specialisation. These gains are in the form of more aggregate production, larger number of
varieties and greater diversity of qualities of goods that become available for consumption in
each country as a result of international trade.

(3) Enhanced Wealth:

Increase in the exchangeable value of possessions, means of enjoyment and wealth of each
trading country.

(4) Larger Output:

Enlargement of world’s aggregate output.

(5) Welfare Contour:

Increase in the world’s prosperity and economic welfare of each trading nation.

(6) Cultural Values:

Cultural exchange and ties among different countries develop when they enter into mutual
trading.

(7) Better International Politics:

International trade relations help in harmonising international political relations.

(8) Dealing with Scarcity:

A country can easily solve its problem of scarcity of raw materials or food through imports.

(9) Advantageous Competition:

Competition from foreign goods in the domestic market tends to induce home producers to
become more efficient to improve and maintain the quality of their products.

(10) Larger size of Market:

Because of foreign trade, when a country’s size of market expands, domestic producers can
operate on a larger scale of production which results in further economies of scale and thus can
promote development. Synchronised application of investment to many industries
simultaneously become possible. This helps industrialisation of the country along with balanced
growth.

Disadvantages of International Trade:

When a country places undue reliance on foreign trade, there is a likelihood of the following
disadvantages:

1. Exhaustion of Resources:

When a country has larger and continuous exports, her essential raw materials and minerals may
get exhausted, unless new resources are tapped or developed (e.g., the near-exhausting oil
resources of the oil-producing countries).

2. Blow to Infant Industry:

Foreign competition may adversely affect new and developing infant industries at home.

3. Dumping:

Dumping tactics resorted to by advanced countries may harm the development of poor countries.

4. Diversification of Savings:

A high propensity to import may cause reduction in the domestic savings of a country. This may
adversely affect her rate of capital formation and the process of growth.

5. Declining Domestic Employment:

Under foreign trade, when a country tends to specialize in a few products, job opportunities
available to people are curtailed.

6. Over Interdependence:

Foreign trade discourages self-sufficiency and self-reliance in an economy. When countries tend
to be interdependent, their economic independence is jeopardised. For instance, for these
reasons, there is no free trade in the world. Each country puts some restrictions on its foreign
trade under its commercial and political policies.
 Regulation of Foreign trade

What are the various legislations which regulate the Foreign Trade in India?

Foreign trade in India is governed by the Foreign Trade (Development and regulation), 1992
which is the principal law related to this. This law has been amended significantly in the year
2010 by the Parliament of our country. A Foreign Trade Policy which is regulated every 5 years
by the Central Government contains more detailed explanations and provisions regarding foreign
trade. The current Foreign Trade Policy is [1st April, 2015 – 31st March, 2020].

The terms “Import and Export” are defined in the Section 2(e) of the FTDR Act, 1992 which
means “respectively bringing into, or taking out of, India any goods by land, sea or air;”

Custom duty is governed by the Customs Act, 1962 and Customs Tariff Act, 1975 which defines
various kinds of customs that can be imposed.

The payment and receipt of foreign currency are controlled by the Foreign Exchange
Regulations.

Besides the FTDRA there are some product specific laws also which govern the exports of
certain products such as tea, coffee, tobacco etc. Examples are Tea Act, 1953, Coffee Act, 1942,
Tobacco Board Act, 1975 and Rubber Act, 1947.

What are the requirements that need to be fulfilled before starting the Import-Export
Business?

Director General of Foreign Trade (DGFT) of the Foreign Trade Policy of 2015-2020 confers
power under Paragraph 1.03 to notify Handbook of Procedure and Appendices which lays down
the procedures for the Import-Export trade.

A businessman needs to undergo various requirements and various procedures which can be
defined as follows:

Step 1: Obtain IEC (Importer- Exporter Code) defined as the Code number granted under Section
7

An IEC needs to be obtained from the Director General of Foreign Trade which is necessary for
foreign trade business. To obtain the IEC an Application must be made in the Aayat Niryaat
Form 2A format to the regional authority of the Director General of Foreign Trade (DGFT) as
defined under Section 6.
Step 2: Membership of Export Promotion Council (EPC) or Commodity board (CB) should be
obtained by Exporters

As per the Foreign Trade Policy, exporters need to obtain Registration- cum –Membership
Certificate from the EPC of the concerned sector, be it software, plastic, sports etc. Exporters of
14 specified in the Handbook of Procedures must register themselves with the EPC.

Step 3: Points of entry and exits for India for Imported and Exported goods

These are also called as the Custom Stations. They can be divided into three as follows:

 Custom port (Goods that arrive or depart by ship)

 Customs Airport (Goods that arrive or depart by air transport)
 Land custom station

Locations where custom authorities can keep imported/exported goods before issuing clearance
are known as “custom areas” which also include custom stations.

Step 4: Custom Intermediaries handle last mile deliveries and shipments in the Import-Export
process.

Custom Brokers who are known as the custom intermediaries may be appointed to handle
deliveries and receive shipments. Customer Broker are regulated under the Customer Brokers
Licensing Regulations 2013.

Step 5: Import through post and courier

 In some cases import/export of certain goods can also be carried out through courier.
 There are some restrictions also on the goods which can be imported/ exported by courier
which are as follows:
 Goods which weigh more than 70 kg
 Perishable commodities, maps and precious and semi-precious stones, gold and silver
 Goods which require to comply with the special provisions of the special act
 Only certain courier companies who are given the status of Authorized Couriers are given
permission to undertake international courier business for importer and exporter.
 Determinants of India’s Foreign trade

i. The country’s inflation rate:

If the country has a relatively high rate of inflation, domestic households and firms are likely to
buy a significant number of imports. The country’s firms are also likely to experience some
difficulty in exporting. A fall in inflation, however, would increase the country’s international
competitiveness and would be likely to increase exports and reduce imports.

ii. The country’s exchange rate:

A fall in a country’s exchange rate will lower export prices and raise import prices. This will be
likely to increase the value of its exports and lower the amount spent on imports.

iii. Productivity:

The more productive a country’s workers are, the lower the labour costs per unit and cheaper its
products. A rise in productivity is likely to lead to greater number of households and firms
buying more of the country’s products – so exports should rise and imports fall.

iv. Quality:

A fall in the quality of a country’s products, relative to other countries’ products, would have an
adverse effect on the country’s balance of trade in goods and services.

v. Marketing:

The amount of exports sold is influenced not only by their quality and price but also by the
effectiveness of domestic firms in marketing their products. Similarly, the quantity of imports
purchased is affected by the efficacy of the marketing undertaken by foreign firms.

vi. Domestic GDP:

If incomes rise at home, more imports may be bought. Firms are likely to buy more raw
materials and capital goods, and some of these will come from abroad. Households will buy
more products, and some of these will be imported. The rise in domestic demand may also
encourage some domestic firms to switch from the foreign to the domestic market. If this does
occur, exports will fall.

vii. Foreign GDP:

If incomes abroad rise, foreigners will buy more products. This may enable the country to export
more.

viii. Trade restrictions:

A relaxation in trade restrictions abroad will make it easier for domestic firms to sell their
products to other countries.

*Magnitude and Direction of Foreign trade-Take directly From running notes*

Problems of India’s Foreign trade

1. Poor Quality Image-

“Made in India” does not enjoy good reputation in the markets abroad. Rather it is considered to
be a sign of poor quality. The products manufactured in Japan, Korea and now even China are
frequently quoted as examples of dependable quality. Carelessness, lack of commitment on part
of exporters and non presence of a proper exporter’s culture in India are to blame.

2. High Costs-

While technological factors and low productivity contribute to high costs of production, It is
estimated that interest rate alone constitutes nearly 5% of the cost of production in India.
Moreover bank charges in India work out to nearly 3% as compared to 1% in countries like
Japan and Korea. Similarly, port charges in India are 3-4 times higher than those in Hong Kong,
Singapore. The traditional export sectors of textiles and jute have already suffered a lot due to
lack of modernisation, whereas many other competing countries have made rapid strides in this
regard.

3. Unreliability-

Besides quality, Indian exporters are regarded as unreliable on certain other factors such as going
back on a contract and refusing to fulfil it on its original terms, inability to provide prompt
aftersales services. While exporters from competing countries like South Korea, Japan and
Taiwan normally replace a defective consignment free of cost and without taking much time.

4. Infrastructural Bottlenecks-

In India, power shortages and breakdowns disrupt production schedules, inadequate and
unreliable transport increase costs and adversely affect timely shipments and lack of
communication facilities hinder growth of exports.
5. Inadequacy of Trade Information System-

With the phenomenal expansion of the internet it has become very easy in the world today to
obtain information. However in India, because of poor facilities of communication, when
compared to developed countries, it is not possible to depend on internet for obtaining latest
trade information. Developed countries mention that they won’t prefer trading with exporters
who are not in a position to complete necessary formalities through the mode of Electronic Data
Interchange.

6. Supply Problems-

The problem is that much of the exporting is the result of residual approach rather than conscious
effort of producing to export. It is a serious drawback of the Indian export sector in its inability
to provide continuous and smooth supply of adequate quantities in respect of several products.
The tendency to export what we produce instead of producing to export still characterise the
export behaviour.

7. Faceless Presence-

Indian exports are sold in foreign markets in the same condition as they are exported but under
foreign brand names. Major items like leather manufactures, seafood and spices, etc, Although,
may go further repacking or processing have a faceless presence in the foreign markets. It holds
true that when a product carries a foreign brand name it fetches a higher price. than the same
product with an Indian name.

8. Uncertainties-

One of the defects of our trade policy regime has been the uncertainty about future policies,
incentive schemes, etc. The import export policy have been given a five year span to bring about
some stability, however, still a very large number of amendments are affected each year. There
have been reports of loss of Crores worth exports due to inter departmental coordination.

9. Procedural Complexities-

With regard to export documentation and formalities, it have been observed that most existing
procedural and documentation formalities prescribed by different authorities have been
developed to suit their own individual requirements without much regard to its repercussions on
total export activity.

10. Institutional Rigidities-

When the export of a country is being intensified, it is necessary that the formalities related to
export activity are also streamlined and simplified so that they do not constitute impediments to
growth of the country’s export trade.
 Export Promotion in India

A number of institutions have been set up by the government of India to promote exports. The
export and import functions are looked after by the Ministry of Commerce. The Government
formulates the export-import policies and programmes that give direction to the exports.

Exim policies aim at export assistance such as export credit, cash assistance, import
replenishment, licensing, free trade zones, development of ports, quality control and pre-
shipment inspection, and guidance to Indian entrepreneurs to set up ventures abroad.

1. International Presence

The Director of Exhibitions makes arrangements for participation in international exhibitions,

holds Indian exhibitions abroad, runs show rooms in foreign countries and, sets up Trade centres
outside India.

2. Export Promotion Council

The Director of Commercial Intelligence is concerned with commercial publicity through

various media, monthly publications, directories of foreign importers of Indian products,
country-wise.

There are 22 export promotion councils for different products, offering services of export
promotion such as price, quality, packing, marketing, transport etc. They conduct market
surveys, publish reports on foreign trade, administer various export promotion schemes, develop
trade contacts, quality control, joint participation in trade fairs and exhibitions.

3. Setting up of Commodity boards to promote exports

Commodity Boards are set up to help export of the traditional items. There are seven Commodity
Boards apart from All India Handloom and Handicraft Board under the Commerce ministry.
They advise the government on its policies, signing trade agreements, fixing quota, etc.

4. Trade reps

There are Trade Representatives abroad who conduct market surveys, furnish information on
exports-imports, settle trade disputes and pass on information about the rules and regulations for
imports.

5. Indian Institute of Foreign Trade

The Indian Institute of Foreign Trade (IIFT) was set up by the Government in co-operation with
trade, industry, universities, educational and research institutions. It is an autonomous body, set
up to train people in international trade, conduct research, survey and organize training
programmes.

6. Participation

To promote, organize and participate in the international trade fairs, Government set up Trade
Fair Authority of India in 1977. It sets up showrooms and shops in India and abroad. It assists in
development of new items for diversification and expansion of India’s exports. They publish
journals namely, Journal of Industry & Trade, Udyog Vyapar Patrika, Indian Export Service
Bulletin and Economic and Commercial news.

7. Trade development Authority

In addition to the above, we have Trade Development Authority to collect information, conduct
research and render export finance and help in securing and implementing export orders.

8. Financing for export

The Export Credit Guarantee Corporation (ECGC) covers both commercial and political risks on
export credit transactions. Its head office is in Mumbai and branches are in Delhi, Calcutta and
Chennai. In 1982, the Government set up EXIM Bank with head office in Mumbai, branch
offices in other major cities in India and abroad.

EXIM Bank finances exports and imports of machinery, finances joint ventures, provides loan,
undertakes merchant banking functions such as underwriting stocks, shares and bonds or
debentures, develops and finance export oriented industries, undertakes techno marketing studies
and, promotes international trade.

9. Advisory Councils

Some of the State Governments have set up specialized Export Trade Corporations which
undertake export promotion. They are established in Andhra Pradesh, Bihar, Karnataka, Uttar
Pradesh, Madhya Pradesh, Himachal Pradesh. There are also Advisory Councils like Board of
Trade, Export-Import Advisory Council, etc.

10. Technical assistance and Training

The Small Industries Development Organization (SIDO) with 26 small industries service
institutions, provide techno-managerial assistance like motivating entrepreneurs to export,
provide information on export-import and offer consultancy services with respect to export
procedure, documentation and export incentives.
It also provides training programmes to educate entrepreneurs on exports, conduct seminars,
meetings, holds discussions with export promotion agencies and publish small industry export
bulletin, besides liasing with the export promotion organizations for solving the problem of small
scale exporters.

*India’s trade agreements-Take directly from class running notes*

BOP Structure and Components

Balance of Payments

The Balance of Payments or BoP is a statement or record of all monetary and economic
transactions made between a country and the rest of the world within a defined period (every
quarter or year). These records include transactions made by individuals, companies and the
government. Keeping a record of these transactions helps the country to monitor the flow of
money and develop policies that would help in building a strong economy.

Why balance of payment is vital for a country?

A country’s BOP is vital for the following reasons:

 BOP of a country reveals its financial and economic status.

 BOP statement can be used as an indicator to determine whether the country’s currency
value is appreciating or depreciating.
 BOP statement helps the Government to decide on fiscal and trade policies.
 It provides important information to analyze and understand the economic dealings of a
country with other countries.
 By studying its BOP statement and its components closely, one would be able to identify
trends that may be beneficial or harmful to the economy of the county and thus, then take
appropriate measures.

Elements of balance of payment

There are three components of balance of payment viz current account, capital account, and
financial account. The total of the current account must balance with the total of capital and
financial accounts in ideal situations.

Current Account

The current account is used to monitor 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, together they make up to a country’s Balance Of Trade (BOT).
There are various categories of trade and transfers which happen across countries. It could be
visible or invisible trading, unilateral transfers or other payments/receipts. Trading in goods
between countries are referred to as visible items and import/export of services (banking,
information technology etc) are referred to as invisible items. Unilateral transfers refer to money
sent as gifts or donations to residents of foreign countries. This can also be personal transfers like
– money sent by relatives to their family located in another country.

Capital Account

All capital transactions between the countries are monitored through the capital account. Capital
transactions include the purchase and sale of 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/in to a different country. The deficit or surplus in the current account is managed
through the finance from capital account and vice versa.

There are 3 major elements of capital account:

 Loans & borrowings – It includes all types of loans from both the private and public
sectors located in foreign countries.
 Investments – These are funds invested in the corporate stocks by non-residents.
 Foreign exchange reserves – Foreign exchange reserves held by the central bank of a
country to monitor and control the exchange rate does impact the capital account.

Financial Account

The flow of funds from and to foreign countries through various investments in real estates,
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. On analyzing these changes, it can be understood if the country is
selling or acquiring more assets (like gold, stocks, equity etc).
 Disequilibrium in BOP

The BOP deficit or surplus indicate imbalance in the BOP. This imbalance is interpreted as BOP
Disequilibrium. A country's balance of payments is said to be in disequilibrium when its
autonomous receipts (credits) are not equal to its autonomous payments (debits).

Types of BoP Disequilibrium

Main types of disequilibrium in the balance of payments are: i. Cyclical Disequilibrium ii.
Structural Disequilibrium iii. Short-run Disequilibrium iv. Long-run Disequilibrium.

i. Cyclical Disequilibrium:

It occurs on account of trade cycles. Depending upon the different phases of trade cycles like
prosperity and depression, demand and other forces vary, causing changes in the terms of trade
as well as growth of trade and accordingly a surplus or deficit will result in the balance of
payments.

Cyclical disequilibrium in the balance of payments may occur because:

 Trade cycles follow different paths and patterns in different countries. There are no
identical timings and periodicity of occurrence of cycles in different countries.
 No identical stabilisation programmes and measures are adopted by different countries.
 Income elasticities of demand for imports in different countries are not identical.
  Price elasticities of demand for imports differ in different countries.

In short, cyclical fluctuations cause disequilibrium in the balance of payments because of

cyclical changes in income, employment, output and price variables. When prices rise during
prosperity and fall during a depression, a country which has a highly elastic demand for imports
experiences a decline in the value of imports and if it continues its exports further, it will show a
surplus in the balance of payments.

Since deficit and surplus alternatively take place during the depression and prosperity phase of a
cycle, the balance of payments equilibrium is automatically set forth over the complete cycle.

ii. Structural Disequilibrium:

It emerges on account of structural changes occurring in some sectors of the economy at home or
abroad which may alter the demand or supply relations of exports or imports or both. Suppose
the foreign demand for India’s jute products declines because of some substitutes, then the
resources employed by India in the production of jute goods will have to be shifted to some other
commodities of export.

If this is not easily possible, India’s exports may decline whereas with imports remaining the
same, disequilibrium in the balance of payments will arise. Similarly, if the supply condition of
export items is changed, i.e., supply is reduced due to crop failure in prime commodities or
shortage of raw materials or labour strikes, etc. in the case of manufactured goods, then also
exports may decline to that extent and structural disequilibrium in the balance of payments will
arise.

Moreover, a shift in demand occurs with the changes in tastes, fashions, habits, income,
economic progress, etc. Propensity to import may change as a result. Demand for some imported
goods may increase, while that for certain goods may decline leading to a structural change.

Furthermore, structural changes are also produced by variations in the rate of international
capital movements. A rise in the inflow of international capital tends to have a direct impact on a
country’s balance of payments.

iii. Short-run Disequilibrium:

A short-run disequilibrium in a country’s balance of payments will be a temporary one, ‘lasting

for a short period, which may occur once in a while. When a country borrows or lends
internationally, it will have short-run disequilibrium in its balance of payments, as these loans are
usually for a short period or even if they are for a long duration, they are repayable later on;
hence the position will be automatically corrected and poses no serious problem.
As such, a disequilibrium arising from international lending and borrowing activities is perfectly
justified. However, a short-run disequilibrium may also emerge if a country’s imports exceed its
exports in a given year.

This will be a temporary one if it occurs once in a way, because later on, the country will be in a
position to correct it easily by creating the required credit surplus by exporting more to offset the
deficit. But even this type of disequilibrium in the balance of payments is not justified, because it
may pave the way for a long-term disequilibrium.

When such disequilibrium (arising from imports exceeding exports or even vice versa) occurs
year after year over a long period, it becomes chronic and may seriously affect the country’s
economy and its international economic relations. A persistent deficit will tend to deplete its
foreign exchange reserves and the country may not be able to raise any more loans from
foreigners.

iv. Long-run Disequilibrium:

The long-term disequilibrium thus refers to a deep- rooted, persistent deficit or surplus in the
balance of payments of a country. It is secular disequilibrium emerging on account of the
chronologically accumulated short-term disequilibria — deficits or surpluses.

It endangers the exchange stability of the country concerned. Especially, a long-term deficit in
the balance of payments of a country tends to deplete its foreign exchange reserves and the
country may also not be able to raise any more loans from foreigners during such a period of
persistent deficits.

In short, true disequilibrium is a long-term phenomenon. It is caused by persistent deep-rooted

dynamic changes which slowly take place in the economy over a long period of time. It is caused
by changes in dynamic forces/factors such as capital formation, population growth, territorial
expansion, technological advancement, innovations, etc.

A newly developing economy, for instance, in its initial stages of growth needs huge investment
exceeding its savings. In view of its low capital formation, it has also to import a large amount of
its capital requirements from foreign countries and its imports thus tend to exceed its exports.
These become a chronic phenomenon. And in the absence of a sufficient inflow of foreign
capital in such countries, a secular deficit balance of payments may result.

Causes of Disequilibrium in the Balance of Payments

There are several variables which join together to constitute equilibrium in the balance of
payments position of a country, viz., national income at home and abroad, the prices of goods
and factors, the supply of money, the rate of interest, etc., all of which determine the exports,
imports and demand and supply of foreign currency.
The main cause of the disequilibrium in the balance of payments arises from imbalance between
exports and imports of goods and services. When for one reason or another exports of goods and
services of a country are smaller than their imports, disequilibrium in the balance of payments is
the likely result.

Causes of disequilibrium in BOP:

There are several factors which cause disequilibrium in the BOP indicating either surplus or
deficit.

Such causes for disequilibrium in BOP are listed below:

(i) Economic Factors:

(a) Imbalance between exports and imports. (It is the main cause of disequilibrium in BOR), (b)
Large scale development expenditure which causes large imports, (c) High domestic prices
which lead to imports, (d) Cyclical fluctuations (like recession or depression) in general business
activity, (e) New sources of supply and new substitutes.

(ii) Political Factors:

Experience shows that political instability and disturbances cause large capital outflows and
hinder Inflows of foreign capital.

(iii) Social Factors:

(a) Changes in fashions, tastes and preferences of the people bring disequilibrium in BOP by
influencing imports and exports; (b) High population growth in poor countries adversely affects
their BOP because it increases the needs of the countries for imports and decreases their capacity
to export.

Measures to correct disequilibrium in BOP:

Sustained or prolonged deficit has to be settled by short term loans or depletion of capital reserve
of foreign exchange and gold.

Following remedial measures are recommended:

(i) Export promotion:

Exports should be encouraged by granting various bounties to manufacturers and exporters. At

the same time, imports should be discouraged by undertaking import substitution and imposing
reasonable tariffs.

(ii) Import:
Restrictions and Import Substitution are other measures of correcting disequilibrium.

(iii) Reducing inflation:

Inflation (continuous rise in prices) discourages exports and encourages imports. Therefore,
government should check inflation and lower the prices in the country.

(iv) Exchange control:

Government should control foreign exchange by ordering all exporters to surrender their foreign
exchange to the central bank and then ration out among licensed importers.

(v) Devaluation of domestic currency:

It means fall in the external (exchange) value of domestic currency in terms of a unit of foreign
exchange which makes domestic goods cheaper for the foreigners. Devaluation is done by a
government order when a country has adopted a fixed exchange rate system. Care should be
taken that devaluation should not cause rise in internal price level.

(vi) Depreciation:

Like devaluation, depreciation leads to fall in external purchasing power of home currency.
Depreciation occurs in a free market system wherein demand for foreign exchange far exceeds
the supply of foreign exchange in foreign exchange market of a country (Mind, devaluation is
done in fixed exchange rate system.)

CAD and its impact on Indian Economy

What is the Current Account Deficit (CAD)?

A CAD is when the total imports of the goods, services, and capital in India exceed the exports.
It is also known by the name, current account imbalance. It is not a negative thing, as long as it is
under control. In layman terms, CAD means, the amount of money, which is going out of the
country through the imports, investments, and services is greater the money coming into the
country. It is generally measured as the percentage of the Gross Domestic Product (GDP).

Why CAD is Important?

CAD helps in measuring or determining the strength and weakness of an economy. A surplus
CAD implies that a country has enough money to lend to the other nations. It basically means
that the country has the resources in large quantities, which it can provide or lend to the other
economies in the world. The country, which is lending, provides an opportunity for the other
countries to enhance their productivity and improve trade deficit.
On the other hand, if there is a current account deficit, then it is not considered as the positive
sign for an economy. A deficit basically implies that a country is in the process of investing more
than saving. Moreover, a country with negative CAD borrows resources from other countries to
meet its domestic consumption and investment related requirements.

Components of CAD

There are three main components that affect the CAD of India, which is as follows:

Trade in Goods and Services: It includes both the export and import of goods and services. Here
the difference between the value of exports and imports is measured. Trade in goods and services
are one of the most important and biggest components of CAD. Any kind of fluctuation in the
trade deficit is one of the prominent causes of increase or decrease in CAD.

Net Income from Foreign Investments: It is used to measure the income payments made to the
foreigners and net income payments received from the foreigners. The deficit on the net income
from foreign investments crops up when the value of the income being made to the foreigners is
greater than the value of income received from the foreigners.

Direct Money Transfers: It means the total amount of money that is being sent back by citizens
working abroad to their home country. Here, the money is being transferred by the citizens
without any goods or services. For example, An Indian citizen working in the United States of
America (U.S.A) sending money to his/her family in India.

If the overall value (credit-debit) of these three prominent components comes to be positive, then
it can be said that the CAD is under control or surplus.

Causes of CAD in India

Just consider a situation that you are a spendthrift individual. You do not have any savings left
with you and there is an urgent requirement of money to meet your requirements. The question
here is will you able to secure a loan from your bank or friend if you are not credit worthy?
Maybe not. Similarly, if a country with a negative CAD means they are not keeping a tab on
their spending and also do not have enough savings left in the financial institutions of the
country. This is where the creditworthiness of a country comes into the picture. If the resources
of a country are limited and also does not have sufficient savings or money left with the banks,
then the other countries may not lend the money unless it improves its CAD. The main causes
CAD rise in India is as follows:

 Rise in the global crude oil prices. India is one of the biggest importers of fuel in the
world.
 A decrease in the value of rupee has made imports expensive.
 The trade war between the United States (U.S) and China also have a negative impact on
India’s exports.
Effects of CAD on Indian Economy

A substantial or considerable CAD is not always considered negative, especially for the
developing economies like India. A widening CAD for a short time period can be good as it can
help the country to increase its local productivity and exports in the future. However, if there a
negative CAD for the longer period of time, then it can spell more trouble for the country as it
can lead to exchange rate depreciation, loss of jobs and investor confidence.

The higher or negative CAD may also put the rupee under pressure, which may ultimately go on
to increase the cost of overseas borrowing. Moreover, foreign investors also do not show a keen
interest in investing in countries with higher CAD. This is because the investors begin to
question the economic growth of a country and its creditworthiness i.e. whether they will get
better returns on their investment or not. Fearing this, the foreign investors start to withdraw
funds from the market, which in turn lowers the value of rupee when compared with other global
currencies.

\
 Unit-5

Nature of International business Environment

The (IBE) International Business Environment is multidimensional including the political risks,
cultural differences, exchange risks, legal & taxation issues. Therefore (IBE) International
Business Environment comprises the political, economic, regulatory, tax, social & cultural, legal,
& technological environments.

An international business environment is the surrounding in which international companies run

their businesses. It brings along it with many differences.

Thus, it is mandatory for the people at the managerial level to work on the factors that make an
International Business Environment.

The Difference – Business Environment and International Business

International business is an exchange of goods and services that conducts its operations across
national borders, between two or more countries. International business is also known as
Globalization whereas, a Business Environment is the surrounding in which the international
companies operate.

Characteristics of International business

Large scale operations

International businesses are conducted on a very large scale. They perform their operations in
different countries globally. Their business activities are very large in size ranging from
production, marketing & selling of their products. These businesses serve the demands of local
markets also where they are present & also demands of different countries globally. That’s why
they produce large amount of goods & services to cater to the large demands.

Earns foreign exchange

International businesses are served as an important source for earning foreign exchange. Foreign
Currencies of different countries are involved in transactions in these businesses. This helps in
getting enough foreign exchange reserve for the country.

Integrates economies

Another important feature of international business is that it integrates the economies of different
countries worldwide. It takes advantage of different economies & aims at providing its services
economically. It takes labour from one country, technology from one country & finance from
another country. Also, it designs, produces, assembles its products not only in one country but in
different-different countries. This help in taking advantage of different economies & becoming
economical.

Large number of middlemen

International businesses are very large in size. Their scale of operations is not limited to one
country but performs in different countries globally. There is a large number of middlemen
involved in international businesses. These all person renders their services properly for the
efficiency of the business. Their services help the business in easy expansion & growth.

High risk

The degree of risk associated with international business is very high. These businesses require a
large amount of resources both in terms of money & manpower for carrying out its operations.
These need to carry out trade in different countries at large distances. It requires huge cost &
time to carry these goods & services. Also, sometimes different economies face unfavourable
conditions which affect the business conditions.

Intense competition

International business faces a large number of risks internationally. These businesses invest large
amount in advertising their products. There are a large number of competitors in international
market. There is tough competition in terms of price, quality, design, packing etc. Business needs
to focus on these things to face the tough competition going on.

International restrictions

International businesses face large restrictions while carrying out there operations in different
countries. Sometimes they are not allowed to inflow & outflow goods, technology & different
resources. There are restricted by the government of different countries to not enter into their
countries. They face several foreign exchange barriers, trade barriers & trade blocks which are
harmful for international business.

Highly sensitive nature

International businesses are highly sensitive in nature. A proper market research is very essential
for carrying out these businesses effectively. Any unfavourable economic conditions in one
country will adversely affect the business. If there is any economic, political or technological
change will directly influence the functioning of the business. Therefore, these businesses should
change their activities from time to time to survive the change.
Elements of International business environment

Political Environment

The political environment refers to the type of the government, the government relationship with
a business, & the political risk in the country. Doing business internationally, therefore, implies
dealing with a different type of government, relationships, & levels of risk.

There are many different types of political systems, for example, multi-party democracies, one-
party states, constitutional monarchies, dictatorships (military & non-military). Therefore, in
analyzing the political-legal environment, an organization may broadly consider the following
aspects:

 The Political system of the business;

 Approaches to the Government towards business i.e. Restrictive or facilitating;
 Facilities & incentives offered by the Government;
 Legal restrictions for instance licensing requirement, reservation to a specific sector like
the public sector, private or small-scale sector;
 The Restrictions on importing technical know-how, capital goods & raw materials;
 The Restrictions on exporting products & services;
 Restrictions on pricing & distribution of goods;
 Procedural formalities required in setting the business

Economic Environment

The economic environment relates to all the factors that contribute to a country’s attractiveness
for foreign businesses. The economic environment can be very different from one nation to
another. Countries are often divided into three main categories: the more developed or
industrialized, the less developed or third world, & the newly industrializing or emerging
economies.

Within each category, there are major variations, but overall the more developed countries are
the rich countries, the less developed the poor ones, & the newly industrializing (those moving
from poorer to richer). These distinctions are generally made on the basis of the gross domestic
product per capita (GDP/capita). Better education, infrastructure, & technology, healthcare, & so
on are also often associated with higher levels of economic development.

Clearly, the level of economic activity combined with education, infrastructure, & so on, as well
as the degree of government control of the economy, affect virtually all facets of doing business,
& a firm needs to recognize this environment if it is to operate successfully internationally.
While analyzing the economic environment, the organization intending to enter a particular
business sector may consider the following aspects:
  An Economic system to enter the business sector.
 Stage of economic growth & the pace of growth.
 Level of national & per capita income.
 Incidents of taxes, both direct & indirect tax.
 Infrastructure facilities available & the difficulties thereof.
 Availability of raw materials & components & the cost thereof.
 Sources of financial resources & their costs.
 Availability of manpower-managerial, technical & workers available & their salary &
wage structures.

Technological Environment

The technological environment comprises factors related to the materials & machines used in
manufacturing goods & services. Receptivity of organizations to new technology & adoption of
new technology by consumers influence decisions made in an organization.

As firms do not have any control over the external environment, their success depends on how
well they adapt to the external environment. An important aspect of the international business
environment is the level, & acceptance, of technological innovation in different countries.

The last decades of the twentieth century saw major advances in technology, & this is continuing
in the twenty-first century. Technology often is seen as giving firms a competitive advantage;
hence, firms compete for access to the newest in technology, & international firms transfer
technology to be globally competitive.

 Level of technological development in the country as a whole & specific business sector.
 The pace of technological changes & technological obsolescence.
 Sources of technology.
 Restrictions & facilities for technology transfer & time taken for the absorption of
technology.

Cultural Environment

The cultural environment is one of the critical components of the international business
environment & one of the most difficult to understand. This is because the cultural environment
is essentially unseen; it has been described as a shared, commonly held body of general beliefs &
values that determine what is right for one group, according to Kluckhohn & Strodtbeck.

National culture is described as the body of general beliefs & the values that are shared by the
nation. Beliefs & the values are generally seen as formed by factors such as the history,
language, religion, geographic location, government, & education; thus firms begin a cultural
analysis by seeking to understand these factors.

While analyzing social & cultural factors, the organization may consider the following aspects:

 Approaches to society towards business in general & in specific areas;

 Influence of social, cultural & religious factors on the acceptability of the product;
 The lifestyle of people & the products used for them;
 Level of acceptance of, or resistance to change;
 Values attached to a particular product i.e. the possessive value or the functional value of
the product;
 Demand for the specific products for specific occasions;
 The propensity to consume & to save.

Competitive Environment

The competitive environment also changes from country to country. This is partly because of the
economic, political, & cultural environments; these environmental factors help determine the
type & degree of competition that exists in a given country. Competition can come from a
variety of sources. It can be a public or a private sector, come from the large or the small
organizations, be domestic or global, & stem from traditional or new competitors, GST
registration. For a domestic firm, the most likely sources of competition might be well
understood. The same isn’t the case when a person moves to compete in the new environment.

Need for International business

(a) Insufficiency of Domestic Demand:

If the domestic demand for the product is not sufficient to consume the production, the firm may
take a decision to enter the foreign market. In this way he can equalize the production and
demand.

(b) To Utilise Installed Capacity:

If the installed capacity of the firm is much more than the level of demand of the product in the
domestic market, it can enter the international market and utilise its un-utilised installed capacity.
In this way it can export the surplus production.

(c) Legal Restrictions:

Sometimes the Government of a country imposes certain restrictions on the growth and
expansion of certain firms or on the production and distribution of certain commodities in the
domestic market in order to achieve certain social objectives.
(d) Relative Profitability:

The export business is more attractive for its higher rate of profitability. The higher profitability
rate also gives extra strength to the firm.

(e) Less Business Risk:

A diversified export business helps the exporting firm in mitigating the risk of sharp fluctuations
in the business activity of the firm.

(f) Increased Productivity:

Due to certain social and technological developments the industrial production has increased to a
great extent. The production will be higher at cheaper rate. The surplus production can be
exported.

(g) Social Responsibility:

In order to meet the social responsibility some business firms take the decision to contribute to
the National Exchequer by exporting their products.

(h) Technological Improvements:

Technological improvements also attract the business firm to enter foreign markets. It introduces
new products with latest technological improvements and faces the competition successfully in
the international markets.

(i) Product Obsolescence:

If a product becomes obsolete in domestic market it may be in demand in International markets.

The firm has to make a survey for introducing the product in those markets.

Significance of International business

International Business is the study that deals with all commercial transactions such as sales,
investments, transportation, logistics, etc., that take place between two or more countries and
nations beyond their political boundaries. It can be described as the financial transactions which
include exchange of goods and services, knowledge and technology that are carried across the
globe to fulfil the goals of individuals and organisations.

Companies that perform International Business activities are generally involved in exports and
imports. This field is crucial to boost the company’s efficiency by using modern management
techniques. Students who want to expand their understanding of global markets and different
regions of the world should consider studying International Business.
Earn foreign exchange

International Business allows the firms to export their products and services to different locations
across the globe. This eventually helps them to earn valuable foreign currency.

Proper utilisation of resources

With the production of goods and services on a huge scale for the global market, International
Business makes relevant and appropriate use of resources.

Expand and diversity

Every country is diverse in terms of culture, legal practices, politics, economics and technology.
This diversity makes International Business riskier as compared with domestic business.
Therefore, it is necessary to identify and understand the conditions in that particular nation with
which trade will take place. International Business helps the companies to expand their activities
and earn a large amount of profits from foreign lands.

Achieve objectives

International Business also helps in accomplishing company’s short and long-term goals as it
utilises the best technologies that support an organisation to generate high-quality of goods.

Increase competitive capacity

International Business assists in producing quality products at competitive prices as it uses better
management techniques and advanced technologies. This helps in increasing the competition
with different foreign companies.

Maintain good political relations

International Business aids in improving the political relations between two countries. Import
and export of business contributes to the national economy and exchequer, and also maintains
international, economical, cultural and political relations between different countries. Nations
have come closer on account of International Business.

International Business programs give scholars an understanding of various business management

practices found across the globe and prepare them for graduation careers in abroad or in
organisations that are involved in business worldwide. It is very important for management and
business scholars to stay updated with such information.
 Forces influencing international business

Various companies are involved in transacting their goods, services and capital across the
national borders and are affected by number of factors. various restrictions are also imposed on
companies that are transacting their business at international level. various internal and external
factors directly impact the working of these business firms. Various external environment factors
directly affecting the working of large MNCs include social conditions of economy, political and
legal factors, etc. However, internal factors can be controlled by the management team of
companies by taking various strategic initiatives.

Political factors:

Various political factors affect the international factors. Political factors such as changes in tax
rates, policies and actions of government, political stability of country, foreign trade regulations
etc. affects the working of an international business firm. Lack of political stability in the country
directly impacts the operations of business firm. Also, various tax policies and government
initiatives sometimes hinders the expansion of business in other countries. Thus, effective
political environment of business influences the growth of business firm (Shaw, 2018).

Economic factors:

Economic factors relates to the economic system of the country where the firm has its operations.
Various econocmi factors such as inflation rate, interest rate, income distribution, employment
level, allocation of government budget, etc., directly impacts the operations of business firm.
Various economic factors such as purchasing power of customers also determines the demand of
various products and services.

Legal factors:

Legal factors relate to the legal environment of the country in which firm operates. Different
laws prevail in different countries and international business firms have to abide by the laws of
each country. Laws relating to age and disability discrimination, wage rates, employment and
environment laws affects the working of business firms. Along with this, various international
lending agencies affects the legal culture and working policies of business firm

Social factors:

Social factors such as education, awareness and trends and status of people in the society affects
the consumer behavior to purchase various goods and services. Also, Social environment and
culture such as customs, lifestyles and values differs from country to country which further
directly impacts the international business.

Environmental factors:
Environment factors such as weather, climate change, temperature etc. affects the business firm
and the demand pattern of various goods and services. increasing environment awareness has
made this external environment factor a significant issue to be considered by business firms.
Move towards environment friendly products and services also has affected the demand pattern
of various goods and services.

Technical factors:

Technological changes in the industry has both positive and negative impacts on the working of
business firms. Technological changes and development of automated work processes helps in
increasing the efficiency of business processes. However, technological changes also threaten the
demand of various products and services in the industry.

Challenges faced by International business

1. Different Trade Patterns:

International business has to deal with the business patterns among the various countries of the
world.

It has to take into account these business policies of various countries which govern their imports
and exports. These policies and practices impose certain constraints and restrictions on
international business.

2. Regulatory Measures:

Every country wants to export its surplus natural resources, agricultural produce and
manufactured goods to the extent, it can and import only these goods and products which are not
produced or manufactured within the country. For this purpose regulatory measures like tariff
barriers (custom duties) non-tariff barriers, quota restrictions, foreign exchange restrictions,
technological and administrative regulations, consulter formalities, state trading and preferential
arrangements, trade agreements and joint commissions etc. Come in the way of free trade and
unfettered flow of foreign business.

3. Lop Sided Development of Developing Countries:

Developed counters are equipped with sophisticated, technologies capable of transforming raw
materials into finished goods on a large scale. While developing countries on the other-hand lack
technological knowledge and latest equipment. It leads to the lop sided development in the
international business.

4. Economic Unions:
There is an increasing tendency among nations to form small groups of Economic Unions which
help them to negotiate terms for the business with other countries.

5. National Policy of Development:

The country desirous of achieving self-sufficiency, follows a strategy of importing capital goods
equipped with latest and sophisticated technology and restricting imports of less important
consumer goods with a view to lowering down its import bill.

6. Procedural Difficulties:

Different countries have evolved different procedures, practices and documents in order to
regulate the export trade. Some of these such as foreign exchange control regulations and others
have been formulated after keeping in view the national objectives and have posed certain
procedural problems to exporters and importers.

7. Other Problems:

Apart from the problems written above there are many other internal difficulties which restrict
our export business and consequently affect the foreign exchange earnings.

(i) Business and industry have not recognised the importance of international business,

(ii) Inflation, high prices and black marketing are starting us in the face. If the situation persists it
may put our price level beyond the means of our customers abroad, no matter how badly they
need our export,

(iii) Our internal economy is being managed very badly in recent years. If it continues we cannot
supply our own essential need. What to say about supply to other nations,

(iv) Poor business ethics is also responsible for our international business.

*Mechanisms/Theories of International business-Refer class running notes*

 GATT And WTO

The General Agreement on Tariffs and Trade was a free trade agreement between 23 countries
that eliminated tariffs and increased international trade. It was the first worldwide multilateral
free trade agreement. It was in effect from January 1, 1948 until January 1, 1995. It ended when
it was replaced by the more robust World Trade Organization.

GATT grew out of the Bretton Woods Agreement. The summit at Bretton Woods also created
the World Bank and the International Monetary Fund to coordinate global growth

Purpose

The purpose of GATT was to eliminate harmful trade protectionism. That had sent global trade
down 65 percent during the Great Depression. GATT restored economic health to the world after
the devastation of the depression and World War II.

Three Provisions

GATT had three main provisions. The most important requirement was that each member must
confer most favored nation status to every other member. All members must be treated equally
when it comes to tariffs. It excluded the special tariffs among members of the British
Commonwealth and customs unions. It permitted tariffs if their removal would cause serious
injury to domestic producers.

Second, GATT prohibited restriction on the number of imports and exports. The exceptions
were:

When a government had a surplus of agricultural products.

If a country needed to protect its balance of payments because its foreign exchange reserves were
low.

Emerging market countries that needed to protect fledgling industries.

In addition, countries could restrict trade for reasons of national security. These included
protecting patents, copyrights, and public morals.

The third provision was added in 1965. That was because more developing countries joined
GATT, and it wished to promote them. Developed countries agreed to eliminate tariffs on
imports of developing countries to boost their economies. It was also in the stronger countries'
best interests in the long run. It would increase the number of middle-class consumers
throughout the world.
Overview of WTO

WTO, which was established in 1995, and its predecessor organization the GATT have helped to
create a strong and prosperous international trading system, thereby contributing to
unprecedented global economic growth. The WTO currently has 164 members, of which 117 are
developing countries or separate customs territories. WTO activities are supported by a
Secretariat of some 700 staff, led by the WTO Director-General. The Secretariat is located in
Geneva, Switzerland.

The WTO provides a forum for negotiating agreements aimed at reducing obstacles to
international trade and ensuring a level playing field for all, thus contributing to economic
growth and development. The WTO also provides a legal and institutional framework for the
implementation and monitoring of these agreements, as well as for settling disputes arising from
their interpretation and application.

Decisions in the WTO are generally taken by consensus of the entire membership. The highest
institutional body is the Ministerial Conference, which meets roughly every two years. A
General Council conducts the organization's business in the intervals between Ministerial
Conferences. Both of these bodies comprise all members. Specialised subsidiary bodies
(Councils, Committees, Sub-committees), also comprising all members, administer and monitor
the implementation by members of the various WTO agreements.

Objectives And Operation

The WTO has six key objectives: (1) to set and enforce rules for international trade, (2) to
provide a forum for negotiating and monitoring further trade liberalization, (3) to resolve trade
disputes, (4) to increase the transparency of decision-making processes, (5) to cooperate with
other major international economic institutions involved in global economic management, and
(6) to help developing countries benefit fully from the global trading system.

WTO's main activities are:

 negotiating the reduction or elimination of obstacles to trade (import tariffs, other barriers
to trade) and agreeing on rules governing the conduct of international trade (e.g.
antidumping, subsidies, product standards, etc.)
 administering and monitoring the application of the WTO's agreed rules for trade in
goods, trade in services, and trade-related intellectual property rights
 monitoring and reviewing the trade policies of our members, as well as ensuring
transparency of regional and bilateral trade agreements
 settling disputes among our members regarding the interpretation and application of the
agreements
 building capacity of developing country government officials in international trade
matters
  assisting the process of accession of some 30 countries who are not yet members of the
organization
 conducting economic research and collecting and disseminating trade data in support of
the WTO's other main activities
 explaining to and educating the public about the WTO, its mission and its activities.

Organizational structure of WTO

Agreements reached in Uruguay round

1) Agreement On Agriculture (AOA)

The main objective is to increase market orientation in agriculture trade. It provides for
commitments in the area of market access, domestic support and export competition. The
members have to transform their non-tariff barriers like quotas into equivalent tariff measures.
The tariffs are to be reduced by 36% within 6 years in case of developed countries and by 24%
within 10 years in case of developed countries. The least developed countries need not make any
commitment for reduction.

2) Agreement On Trade In Textiles And Clothing (Multi – Fiber Arrangement)

This provides for phasing out the import quotas on textiles and clothing in force under the Multi
– Fibre Arrangement since 1974, over a| span of 10 years i.e. by 1st January, 2005. With this
agreement quota on textile and clothing has now been abolished.
3) Agreement On Manufactured Goods

The developed countries agreed to reduce tariffs on manufactured goods other than textiles by
40%. The tariffs would now be brought down to an average of 3.8% from earlier 6.3%.

4) Agreement On TRIMs
An Agreement on Trade Related Investment Measures (TRIMs) calls for introducing national
treatment of foreign investments and removal of quantitative restrictions. It identifies 5
investment measures that are inconsistent with the GATT provisions on national treatment and
on general elimination of qualitative restrictions.

5) Agreement On TRIPs

Trade Related Intellectual Property Rights (TRIPs) pertain to Patents and Copyrights. Whereas
earlier on process patents were granted to food, medicines, drugs and chemical products, the
TRIPs Agreement now provides for granting product patents also in all these areas. Protection
will be available for 20 years for patents and 50 years for copyrights.

6) General Agreement On Trade And Services (GATS)

For the first time, trade in services like banking, insurance, travel, maritime transportation,
mobility of labour etc. has been brought within the ambit of negotiations. The General
Agreement on Trade in Services (GATS) provides a multilateral framework of principles and
services that should govern trade in services under conditions of transparency and progressive
liberalization.

7) Disputes Settlement Body

Settlement of disputes under GATT was a never ending process. The Disputes Settlement Body
(DSB) set up under WTO seeks to plug the loopholes and provide security and predictability to
the multilateral trading system. It has now been made mandatory to settle a dispute within 18
months. The findings of disputes settlement panels will be final and binding on all parties
concerned.

In addition to the above, the Uruguay Round also reached agreements on the understanding and
implications of certain articles of GATT 1947, viz, pre-shipment inspection, rules of origin,
import licensing, anti – dumping measures and countervailing duties, safeguards, subsidies etc.
 Trade Related Aspects of Intellectual Property Rights (TRIPS)

Trade-Related Aspects of Intellectual Property Rights (TRIPS) is arguably the most important
and comprehensive international agreement on intellectual property rights. Member countries of
the WTO are automatically bound by the agreement. The Agreement covers most forms of
intellectual property including patents, copyright, trademarks, geographical indications,
industrial designs, trade secrets, and exclusionary rights over new plant varieties. It came into
force on 1 January 1995 and is binding on all members of the World Trade Organization (WTO).

The Agreement provides for norms and standards in respect of following areas of intellectual
property:

• Patents

• Trade Marks

• Copyrights

• Geographical Indications

• Industrial Designs

The basic obligation in the area of patents is that, invention in all branches of technology
whether products or processes shall be patentable if they meet the three tests of being new
involving an inventive step and being capable of industrial application. In addition to the general
security exemption which applied to the entire TRIPS Agreement, specific exclusions are
permissible from the scope of patentability of inventions, the prevention of whose commercial
exploitation is necessary to protect public order or morality, human, animal, plant life or health
or to avoid serious prejudice to the environment.

Trade Related Investment Measures (TRIMS)

The agreement on the Trade Related Investment measures (TRIMS) calls for introducing
national treatment of foreign investment and removal of quantities restrictions. It identifies five
investment measures which are inconsistent with the General Agreement on Trade and Tariff
(GATT) on according national treatment and on general elimination of quantitative restrictions.
These are measure which are imposed on the foreign investors the obligation to use local inputs,
to produce for export as a condition to obtain imported goods as inputs, to balance foreign
exchange outgo on importing inputs with foreign exchange earnings through export and not to
export more than a specified proportion of the local production.

Trade-Related Investment Measures is the name of one of the four principal legal agreements of
the World Trade Organization (WTO), trade treaty. TRIMs are rules that restrict preference of
domestic firms and thereby enable international firms to operate more easily within foreign
markets. The TRIMs Agreement prohibits certain measures that violate the national treatment
and quantitative restrictions requirements of the General Agreement on Tariffs and Trade
(GATT).

TRIMs may include requirements to:

 Achieve a certain level of local content;

 Produce locally;
 Export a given level/percentage of goods;
 Balance the amount/percentage of imports with the amount/percentage of exports;
 Transfer of technology or proprietary business information to local persons;

These requirements may be mandatory conditions for investment, or can be attached to fiscal or
other incentives. The TRIMs Agreement does not cover services. All WTO member countries
(offsite link) are parties to this Agreement. This Agreement went into effect on January 1, 1995.
It has no expiration date.

The Agreement requires all WTO Members to notify the TRIMs that are inconsistent with the
provisions of the Agreement, and to eliminate them after the expiry of the transition period
provided in the Agreement. Transition periods of two years in the case of developed countries,
five years in the case of developing countries and seven years in the case of LDCs.

Local content Measures requiring the purchase or use by an enterprise of domestic

requirement products, whether specified in terms of particular products, in terms of
volume or value of products, or in terms of a proportion of volume or
value of its local production. (Violation of GATT Article III:4)
Trade balancing Measures requiring that an enterprise's purchases or use of imported
requirements products be limited to an amount related to the volume or value of local
products that it exports. (Violation of GATT Article III:4)
Measures restricting the importation by an enterprise of products used in or
related to its local production, generally or to an amount related to the
volume or value of local production that it exports. (Violation of GATT
Article XI:1)
Foreign exchange Measures restricting the importation by an enterprise of products (parts and
restrictions other goods) used in or related to its local Production by restricting its
access to foreign exchange to an amount related to the foreign exchange
inflows attributable to the enterprise. (Violation of GATT Article XI:1)
Export restrictions Measures restricting the exportation or sale for export by an enterprise of
(Domestic sales products, whether specified in terms of particular products, in terms of
requirements) volume or value of products, or in terms of a proportion of volume or
value of its local production. (Violation of GATT Article XI:1)
 General Agreement on Trade in Service(GATS)

What is GATS?

GATS envisage the objective of establishing a sound multilateral framework or principles

and rules for trade in services. Many countries directly have laws, which restrict entry of foreign
services enterprises in areas like finance, media, communications, transport etc.

The GATT looks upon these regulations relating to investment in the service sector as distorting
factors affecting free trade. Hence these distortions have to be eliminated or minimized. The
GATS Agreement covers all services (there are 161 tradable services under GATS) – financial +

services (banking insurance etc), education, telecommunications, maritime transport etc.

Service trade expansion has big prospects though countries are in general reluctant to liberalise
it. According to the WTO, “while services currently account for over 60 percent of global
production and employment, they represent no more than 20 per cent of total trade (BOP basis).”

The Four Modes of Services Supply

The GATS define services in four ‘modes’ of supply: cross-border trade, consumption abroad,
commercial presence, and presence of natural persons.

Mode 1: Cross Border

Services which themselves cross-frontiers from one country to another e.g. Distance learning,
consultancy, BPO services.

Mode 2: Consumption abroad

Services, which are made available within a country for foreign consumers’, e.g.: tourism,
educational students for students, medical treatment etc.

Mode 3: Commercial Presence

Services supplied by an entity of one country, which is commercially pressed in another e.g.:
banking, hotel etc.

Mode 4: Movements of natural persons

This is a foreign national providing services like that of doctor, nurse, IT engineer etc.
functioning as a consultant, employee, from one country to another.

Services given by governments are exempted from GATS. These are services provided on a non-
market basis (e.g. Social security schemes, health Education etc). Besides, Air Transport
Services are also exempts from coverage that affects traffic rights. GATS divides services
liberalization commitments into two – general obligations and specific obligations.

The GATS is basically a primary step towards service trade that was reached at the Uruguay
Round. Service trade liberalization under it is at the entry level stage. As a Multilateral rule
making and trade liberalization regime, the GATS has to be expanded by making further
discussions.

Dispute Settlement Mechanism of WTO

The dispute settlement mechanism, with its ability to deliver binding decisions, is one of the
central elements of the Uruguay Round Agreement. It provides security and predictability to the
multilateral trading system. WTO members have committed themselves not to take unilateral
actions against perceived violations of the trade rules. In fact, they have pledged to take recourse
to the DSM and abide by its rules and procedures.

Stages in Dispute Settlement

The first stage of settling disputes is the holding of consultations among the members concerned.
Parties to a dispute are obliged to see if they can settle their differences. Such consultations aim
at evolving solution of the dispute in a mutually acceptable manner if no solution is found, in the
second stage, the complainant can ask the DSB to establish a panel..

The panel is set up by the DSB in consultation with the disputing parties. The three-member
panel decides the case in a quasi-judicial manner. The panel examines the complaint. Its report
contains findings and recommendations. The DSB adopts the panel report after its submission.

In the third stage, any party to the dispute can appeal a panel’s decision to the WTO appellate
body. A standing appellate body (SAB) is .set up by the DSB to hear all appeals. Prompt
compliance with recommendations or ruling of the DSB is essential in order to ensure effective
resolution of disputes to the benefit of all members. Members are given time to implement the
recommendations but if a member fails to act, it is obliged to enter into compensation
negotiations with the complainant.

If no satisfactory compensation is agreed, the complainant may request authorisation from the
DSB to suspend concessions or obligation against the other party. The suspension of concession
is thus the last resort, which an aggrieved member can call upon in retaliation.
 Anti dumping in WTO

What is dumping?

Dumping is, in general, a situation of international price discrimination, where the price of a
product when sold in the importing country is less than the price of that product in the market of
the exporting country. Thus, in the simplest of cases, one identifies dumping simply by
comparing prices in two markets.

The Anti-Dumping Committee

The WTO holds two meetings of the Anti-Dumping Committee (AD Committee) each year to
provide a forum for discussing anti-dumping measures. The AD Committee reviews: (i) AD
implementing laws of WTO Members to determine conformity with the WTO Agreement; and
(ii) reports by Members on AD measures.

Anti dumping measures

 High tariff on dumped products

 Decreasing import quotas for such products
 Banning the products
 Review on agreements

In India anti dumping actions are taken by Directorate general pf Anto dumping and allied duties

Anti dumping investigation process

Refer class running notes for detailed information