MBA-3rd Sem.

Unit-2 International Financial Management (IFM)

Unit-2
Lecture No: -9

INTERNATIONAL FINANCING-CONCEPT

What is International Financing?

International finance is a section of financial economics that deals with the macro-
economic relation between two countries and their monetary transactions. The concepts
like interest rate, exchange rate, FDI, FPI, and currency prevailing in the trade come under
this type of finance.
When LPG (Liberalisation, Privatisation And Globalisation) was accepted by the country
in 1991, the aspect of Globalisation broadened the avenues with which businesses can
arrange funds. Prior to this policy, firms were constrained only to the four walls of the
country. But after Globalisation came into the picture, the scope for raising money
expanded widely.

International Financing (also referred to as International macroeconomics) is the

branch of financial economics broadly concerned with monetary relationships at a
global level. It examines the dynamics of foreign direct investment, exchange rates,

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MBA-3rd Sem. Unit-2 International Financial Management (IFM)

balance of payments, allocation of funds at the global level and other aspects of financial
management.
International financing encourages monetary transactions between two or more
countries. There are different sources around the world from which money might be
obtained, and that will be discussed in detail.

FEATURES OF INTERNATIONAL FINANCE: -

1) Expanded Opportunity to Business: - due to globalization in business there is an

expandedopportunity to the business. Business can raise more funds through less cost
of capital.

2) Foreign Exchange Risk: - It Is Financial Risk That Exists When A Financial Transaction
IsDenominates In A Currency Other Than That Of The Base Currency Of The Company.

3) Imperfect Market: - Due to difference in law and customs among the countries,
tax system, cultural difference, business practices, there is distinction between
international business practices, there is distinction between international business
practice, there is distinction between international business practices, there is
distinction between international finance anddomestic finance. so, it is said that there
is always an imperfect market. due to imperfection in market.

4) Political Risk: - International Financial System Affected By Government Policies

And Political Issues. So There Is A Risk Of Political Policies, International Finance Can
Be Affected. Similarly, A Favorable Political Decision Can Increase International
Financial Stability.

SCOPE OF INTERNATIONAL FINANCE

Currently, International Finance Has Become More Comprehensive Pr Broader In
Scope And Is DealingWith Matters Related To Globalization, Fair Trade Multinational
Banking, And Multinational Corporation. International Finance Consist Of Foreign
Exchange Market, Currency Convertibility, BOP, International Finance And
International Monetary System. So There Is A Big Scope International Finance. It Is
Discusses Below:

1) International Monetary System:- For Better Economic Growth And To Do

Trade And Investments Efficiently, A Country Need To Have Its Own Monetary
System And An Authority Who Can Control The System. For Example, RBI Id India

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Controls Over The Monetary System Of India Through Controlling Over Inflation,
Supply Of Money And Maintaining Interest Rate.
2) International Financial System:- The Growth In Word Trade, Liberalization And
Globalization In Business Brought Tremendous Change In International Financial
System. It Organization And Customs Which Enable The International Payments And
Receipts Between The Countries. Comparing To Past, The Volume Of Transaction Has
Increased In International Finance.

3) Foreign Exchange Market: - This Is A Market Where One Country’s Currency

Denominated In That Currency Can Be Purchase Through Sales Of Another Country’s
Currency. International Financial System Provides This Facility.

4) Currency Convertibility: - The Currency Of A Country Is Freely Convertible

When The ResidentOr Nor Resident Of The Country Are Allowed To Convert The Local
Currency In Foreign Currency. But The Governments Of The Country Restricts The
Residents And Non-Residents To Do This. Various Countries Do Not Allow Converting
The Currency Freely. It Makes The International Business Difficult.

5) Balance of Payment: - Balance Of Payment (BOP) Of A Country Is Defined As,

“Systematic Record Of All Economic Transaction With The Residents Of A Reporting
Country And Residents Of Foreign Countries During A Given Period Of Time”-Kindle
Berger. Thus, Balance OfPayments Includes All Visible And Non-Visible Transactions
Of A Country During A Given Period, Usually A Year. It Represents A Summation Of
Country’s Current Demand And Supply Of The Claims On Foreign Currencies And Of
Foreign Claims On Its.

IMPORTANCE OF INTERNATIONAL FINANCE: -

International Finance Plays A Critical Role In International Trade And Inter-Economy
Exchange Of Goods And Services. It Is Important For A Number Of Reasons; The Most
Notable Ones Are Listed Here:

1) International finance helps keep international issues in a disciplined state.

2) International finance is an important tool to find the exchange rates, compare

inflation rates, get an idea about investing in international debt securities,
ascertain the economic status of other countries and judge the foreign markets.

3) International finance helps in calculating exchange rates which are very

important in international finance, as they let us determine the relative values of
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currencies.

4) Various economic factors help in making international investments decisions.

Economic factors of economics help in determining whether or not investors
money is safe with foreign debt securities.

5) Utilizing IFRS is an import factor for any stages of international finance. financial
factor for many stages of international finance . financial statements made by
the countries that have adopted ifrs are similar. it helps many countries to
follow similar reporting systems.

6) IRFS system’ which is a part of international finance’ also helps in saving money
by following the rules of reporting on a single accounting standard.

ADVANTAGES OF INTERNATIONAL FINANCE: -

1) Promotion: - International Finance Helps to Promote Domestic Investments

and Growth Through Capital Market.

2) Better Banking System: - International Finance Helps to Healthy

Competition Due to Which It Provides Better Banking System.

3) More Equality: - It Helps to Integrate the Economy of Two Countries and Asy
Flow of Capital. Due To Free Flow of Capital Results into More Equality Between
the Countries.

4) Effective Capital Allocation: - It Helps to Allocate the Country’s Capital

Effectively by Providing Information Related to Different Areas.

5) Capital In need: - It Helps to Access the Capital Market Around the Word
Which Enables the Country to Lend Money in Good Times and Borrow Capital
in Need.

6) Corrective Measures: - Due to Worldwide Cash Flows International Finance

Helps to TakeCorrective Measures to Bad Government Policies.

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References: -
• Gandolfo, Giancarlo (2002). International Finance and Open-Economy
Macroeconomics. Berlin, Germany: Springer. ISBN 978-3-540-43459-7.

• Pilbeam, Keith (2006). International Finance, 3rd Edition. New York, NY: Palgrave
Macmillan. ISBN 978-1-4039-4837-3.

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Unit-2
Lecture No: - 10

INTERNATIONAL FINANCING SOURCES

SOURCES OF INTERNATIONAL FINANCING

Mainly these are classified into three categories which are as follows: -

A. Commercial Banks
Commercial banks not only fund businesses and firms in the home country rather it
extends to the global level. Commercial banks provide foreign currency loans and
advances all over the world.

B. International Agencies and Developmental Banks

These are named Developmental banks because these were introduced by the
government for developmental purposes only. International Agencies and
Developmental banks have emerged throughout the years with the goal to fund finance
internationally.

C. International Capital Market

International Capital Market exists with the aim of enhancing efficiencies in economies
and generating economies of scale.

1. Global Depository Receipts (GDRs)

• Earlier in a country, generally finances were raised domestically, but now it can be
raised from foreign as well. This can happen by issuing securities and shares in
foreign countries. To make this process convenient, there exist a financial
instrument called GDR. The shares are first issued in the currency of the domestic
country. These shares are forwarded to a depository bank, and this depository bank
is then responsible for issuing depository receipts in exchange of these shares.
2. American Depository Receipts (ADRs)
• The American Depository Receipts are quite similar to the Global Depository
Receipts.
• The process of issuing shares in local currency and then sending the shares to the
depository bank to convert them into depository receipts remains as it is.
• The prime difference between both of the depository lies in the fact that ADRs can
only be issued in the USA.

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• The sale and purchase of ADRs can only happen in the capital market of America.
These depository receipts are listed only on the stock exchange of the USA and
nowhere else.
• American Depository Receipts like GDRs are negotiable certificates issued by a U.S.
depository bank.
3. Indian Depository Receipts (IDRs)
• As the name implies, Indian Depository Receipts are exclusively available in the
Indian markets.
• Just like for GDRs, here also the shares are forwarded to the depository banks to get
depository receipts in exchange for those respective shares. But it is slightly
different from the GDRs because the depository here is of Indian origin. The
depository receipts are denominated in Indian rupees. Hence it allows any foreign
investors to raise funds from India’s capital market in the form of IDRs as a
replacement for shares/securities.
• An Indian Depository Receipt is a negotiable financial instrument.
• IDRs are nothing, but an Indian version of Global Depository Receipts.
• The depository in India is none other than the Securities and Exchange Board of
India, which is the watchdog of all the securities listed on the stock board.
4. Foreign Currency Convertible Bonds (FCCBs)
• Foreign Currency Convertible Bonds are a combination of debt and equity
instruments.
• Just like any other convertible securities, these bonds are also convertible meaning
thereby that on a nearby future date after a passage of a stipulated time these
bonds can be changed to any depository receipt or some equity shares.
• The bearer of the bond can exchange their FCCBs with some equity shares for
whom the price is already decided or for any exchange rate.
• The bearer can also opt for holding back their FCCBs with them.
• FCCBs are always bought and sold in foreign financial markets.
• The fixed rate of interest over foreign currency convertible bonds is generally
lesser as compared to any other debt instruments, which are non-convertible in
nature.

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References: -

• Feenstra, Robert C.; Taylor, Alan M. (2008). International Macroeconomics. New York,
NY: Worth Publishers. ISBN 978-1-4292-0691-4.
• Madura, Jeff (2007). International Financial Management: Abridged 8th Edition.
Mason, OH: Thomson South-Western. ISBN 978-0-324-36563-4.

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Unit-2
Lecture No: -11

COST OF FOREIGN BORROWINGS

Borrowing costs are interest and other costs incurred by an enterprise in connection with
the borrowing of funds.
Borrowing costs may include:
(a) interest and commitment charges on bank borrowings and other short-term and long-
term borrowings;
(b) amortisation of discounts or premiums relating to borrowings;
(c) amortisation of ancillary costs incurred in connection with the arrangement of
borrowings;
(d) finance charges in respect of assets acquired under finance leases or under other
similar arrangements; and
(e) exchange differences arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs

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References: -

• Eun, Cheol S.; Resnick, Bruce G. (2011). International Financial Management, 6th
Edition. New York, NY: McGraw-Hill/Irwin. ISBN 978-0-07-803465-7.
• Eun, Cheol S.; Resnick, Bruce G. (2015). International Financial Management, 7th
Edition. New York, NY: McGraw-Hill/Irwin. ISBN 978-0-07-786160-5.

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Unit-2
Lecture No: -12

CROSS CURRENCY MANAGEMENT

What is a Cross Currency Transaction?

A cross currency transaction involves the use of more than one currency. For example,
you may be involved in a cross-currency transaction in order to convert one currency into
another currency. Previously, an individual who wanted to exchange one currency into
another currency would need to convert their money into U.S. dollars before the
transaction could take place.

What is Exchange Control?

Exchange controls are government-imposed controls and restrictions on private

transactions conducted in foreign currency. The government’s major aim of exchange
control is to manage or prevent an adverse balance of payments position on national

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accounts. It involves ordering all or part of foreign exchange received by a country into a
common pool controlled by authorities, typically the central bank.

Objectives of Foreign Exchange Control: -

1. Restore the balance of payments equilibrium

The main objective of introducing exchange control regulations is to correct the balance
of payments equilibrium. The BOP needs realignment when it is sliding to the deficit side
due to greater imports than exports. Hence, controls are put in place to manage the
dwindling foreign exchange reserves by limiting imports to essentials items and
encouraging exports through currency devaluation.

2. Protect the value of the national currency

Governments may defend their currency’s value at a certain desired level through
participating in the foreign exchange market. The control of foreign exchange trading is
the government’s way to manage the exchange rate at the desired level, which can be at
an overvalued or undervalued rate.

3. Prevent capital flight

The government may observe increased trends of capital flight as residents and non-
residents start making amplified foreign currency transfers out of the country. It can be
due to changes in economic and political policies in the country, such as high taxes, low
interest rates, increased political risk, pandemics, and so on.

4. Protect local industry

The government may resort to exchange control to protect the domestic industry from
competition by foreign players that may be more efficient in terms of cost and production.
It is usually done by encouraging exports from the local industry, import substitution, and
restricting imports from foreign companies through import quotas and tariff duties.

5. Build foreign exchange reserves

The government may intend to increase foreign exchange reserves to meet several
objectives, such as stabilize local currency whenever needed, paying off foreign liabilities,
and providing import cover.

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Objectives of FEMA (Foreign Exchange Management Act):-

• FEMA was developed to aid in the orderly growth and upkeep of the Indian forex
market.
• The processes and procedures for all foreign exchange transactions in India are
outlined by FEMA. Both capital account transactions and current account
transactions have been included in the classification of these foreign exchange
transactions.
• The balance of payment is a record of transactions involving commodities,
services, and assets between citizens of several nations as defined by the FEMA
Act. The Capital Account and Current Account are the two main divisions.

➢ Capital Account: All capital transactions are included in the capital account. The
capital account recognizes both domestic and foreign investment in domestic
assets.
➢ Current Account: Trade of goods is included in current account. Current Account
transactions are those that involve money moving into and out of a country or
countries over the course of a year as a result of trading or providing goods,
services, and income. An economy’s health is shown by the current account.

Important FEMA Guidelines and Features: -

Most significantly, FEMA regarded all forex-related offences as civil offences,

whereas FERA regarded them as criminal offences. Additionally, there were other
important guidelines such as:

• FEMA will not apply to Indian citizens who resided outside India. This criterion was
checked by calculating the number of days a person resided in India during the
previous financial year (182 days or more to be a resident). It was noted that even
an office, a branch, or an agency could be a ‘person’ for the purpose of checking
residency.
• FEMA authorized the central government to impose restrictions on and supervise
three things – payments made to any person outside India or receipts from them,
forex, and foreign security deals.
• It specifies the areas around acquisition/holding of forex that requires specific
permission of the Reserve Bank of India (RBI) or the government.
• FEMA put foreign exchange transactions into two categories – capital account and
current account. A capital account transaction altered the assets and liabilities
outside India or inside India but of a person resident outside India. Thus, any
transaction that changed overseas assets and liabilities for an Indian resident in a

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foreign country, or vice versa, was classified as a capital account transaction. Any
other transaction fell into the current account category.

FEMA Applicability: -

The Foreign Exchange Management Act (FEMA) is applicable to all of India as well as
to organizations and offices abroad (which are owned or managed by an Indian
Citizen). The Enforcement Directorate is the name of FEMA’s headquarters, which is
located in New Delhi. FEMA is relevant to:

• Foreign currency exchange.

• Exporting goods or services from India to a nation outside of India.
• Any foreign security.
• Importation of goods and/or services from countries other than India.
• Securities as outlined in the 1994 Public Debt Act.
• Any form of purchase, sell, or exchange (i.e. Transfer).
• Services in banking, finance, and insurance.
• Any foreign corporation when at least 60% of the ownership is held by an NRI (Non-
Resident Indian).
• Any Indian national living inside or outside the country.

References: -

• "Fiat Money". Corporate Finance Institute. Retrieved 2021-11-30.

• "Fiat Money - Meaning, Characteristics and Working". MBA Knowledge Base.
2012-10-05. Retrieved 2021-11-30.

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Unit-2
Lecture No: -13

CONCEPT OF BALANCE OF PAYMENTS (BOP)

The balance of payment is the statement that files all the transactions between the
entities, government anatomies, or individuals of one country to another for a given
period of time. All the transaction details are mentioned in the statement, giving the
authority a clear vision of the flow of funds.

What is Balance of Payment?

The balance of payment (BOP) is a term used in international finance for the statement
of all transactions between one country and all the other countries in the world. It
monitors all international monetary transactions within a specified time, usually per
quarter. When a country pays money, this is called a credit, and when a country receives
or has been given money, the transaction is called a debit.

The BOP theoretically will equal zero because it is constructed according to double-entry
bookkeeping. Under this system, any transaction is represented in the BOP by two entries
in the accounting ledgers. These two entries have equal values on opposite sides: the
debit and the credit.

• CREDIT: Outflow of goods, services, or assets. In terms of assets and liabilities, credit
may also be differentiated as an increase in liabilities and a decrease in assets/goods.
• DEBIT: Inflow of goods, services, and assets. In terms of assets and liabilities, debit
may also be differentiated as a decrease in liabilities and an increase in assets/goods.

By convention, every credit entry has a plus (+) sign, and every debit entry has a minus (-
) sign before the amounts.

An example of a transaction recorded in the BOP could be in a case where Country A

purchases $10 million worth of goods from Country B. The $10 million worth of goods in
INFLOW to Country A is a debit and will be recorded as -$10 million. The payment of
Country A to Country B, which is a $10 million check, will be recorded as a $10 million
credit (+ $10 million). The amounts offset each other, so the overall BOP is zero.

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OUTFLOW INFLOW

Money Goods

+$10 million (credit) -$ 10 million (debit)

Balance of Payment Formula

The formula for the balance of payment is the total of the current account and the
financial/capital account balances. That is:

BALANCE OF PAYMENT = Current Account + Financial/Capital Account

The following examples show how transactions are classified and the effect of such on the
accounts.

Example 1
A French resident is buying a German car worth the equivalent of $20,000.
In this example, the inflow is the car, which is a good or an asset. The outflow is the money
that the French resident sends to Germany as his form of payment. This payment is a
credit of $20,000 under the financial account. This will give the financial account a balance
of +$20,000. The purchased car will be placed in a merchandise account under the current
account. This will be recorded as a debit transaction of -$20,000, giving the current
account a balance of -$20,000. All this information may be organized as follows:

OUTFLOW INFLOW

Money Car

Financial Account Current Account

Credit Debit

+$20,000 -$20,000

FA Balance: +$20,000 CA Balance: -$25,000

Balance of Payment = -$25,000 (Current Account) + $25,000 (Financial Account) = 0

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Reference: -

• "What Is Fiat Money?". Investopedia. Retrieved 2021-11-30.

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MBA-3rd Sem. Unit-2 International Financial Management (IFM)

Unit-2
Lecture No: -14

ITEMS INCLUDED IN BALANCE OF PAYMENTS

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Reference: -

• (Blume, Lawrence; Steven N. Durlauf, eds. (2008). The new Palgrave dictionary of
economics (2nd ed.). Basingstoke, Hampshire: Palgrave Macmillan. pp. 544–546).

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Unit-2
Lecture No: -15

TYPES OF BALANCE OF PAYMENT AND SIGNIFICANCE OF BOP

The balance of payment is divided into three types:

Current account: This account scans all the incoming and outgoing of goods and services
between countries. All the payments made for raw materials and constructed goods are
covered under this account. Few other deliveries that are included in this category are
from tourism, engineering, stocks, business services, transportation, and royalties from
licenses and copyrights. All these combine together to make a BOP of a country.

Capital account: Capital transactions like purchase and sale of assets (non-financial) like
lands and properties are monitored under this account. This account also records the flow
of taxes, acquisition, and sale of fixed assets by immigrants moving into the different
country. The shortage or excess in the current account is governed by the finance from
the capital account and vice versa.

Finance account: The funds that flow to and from the other countries through
investments like real estate, foreign direct investments, business enterprises, etc., is
recorded in this account. This account calculates the foreign proprietor of domestic assets
and domestic proprietor of foreign assets, and analyses if it is acquiring or selling more
assets like stocks, gold, equity, etc.

Importance of Balance of Payment

A balance of payment is an essential document or transaction in the finance
department as it gives the status of a country and its economy. The importance of the
balance of payment can be calculated from the following points:

• It examines the transaction of all the exports and imports of goods and services for a
given period.
• It helps the government to analyse the potential of a particular industry export
growth and formulate policy to support that growth.
• It gives the government a broad perspective on a different range of import and export
tariffs. The government then takes measures to increase and decrease the tax to
discourage import and encourage export, respectively, and be self-sufficient.

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• If the economy urges support in the mode of import, the government plans according
to the BOP, and divert the cash flow and technology to the unfavourable sector of the
economy, and seek future growth.
• The balance of payment also indicates the government to detect the state of the
economy, and plan expansion. Monetary and fiscal policy are established on the basis
of balance of payment status of the country.

References: -

• "Worldwide export trade value 1950-2020". Statista. Retrieved 2021-11-22.

• "Creation of the Bretton Woods System | Federal Reserve
History". www.federalreservehistory.org. Retrieved 2021-11-22.

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Unit-2
Lecture No: -16

DISEQUILIBRIUM IN BOPS: ITS TYPES

Causes of Disequilibrium in Balance of Payments

However, the following are the important causes of producing a disequilibrium in the
Balance of payments (BOP) of a country:

1. Unfavorable Balance of Trade

Import exceeding Exports- huge development and investment programs in the developing
economies are the root causes of the disequilibrium in the BOP of these countries.

2. Cyclical Fluctuations, their Phases, and Amplitudes

Business or cyclical fluctuations induced by the operations of the trade cycle, their phases
and amplitudes differ in different countries, which generally produce cyclical
disequilibrium in a country’s BOP.
For example, if there occurs a Business Recession in foreign countries it may easily cause
a fall in the exports and exchange earnings of the country concerned resulting
in disequilibrium in the BOP.
3. Burden of Payment of Foreign Debt

One important reason for a surplus or deficit in Balance of payments may arise out of
international borrowing and investment.
4. Speedy Economic Development

Due to rapid economic development, the resulting income and price effects will adversely
affect the balance of payments position of a developing country.

5. Inadequate Promotion of Exports

A vast increase in the domestic production of foodstuff, raw material, substitute goods,
etc.

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In advanced countries has decreased their need for import from the agrarian
underdeveloped Nations.

6. Inflationary Spiral at Home

An inflationary rise in prices within the country may also produce disequilibrium in the
Balance of payments.

7. Capital Movements

The capital movements can also cause disequilibrium in the balance of payments of a
country. A massive inflow of foreign capital into a country is followed by an unfavorable
Balance of payments.

8. Natural Factor

Natural calamities, such as the failures of rains coming from floods may easily
cause disequilibrium in the Balance of payments by adversely affecting agricultural and
industrial production in the country.

The Exports decline while the imports maybe go up, causing a discrepancy and the
country’s Balance of payments.

9. High Population Growth

A huge population and its high rate of growth in poor countries also have adversely
affected their BOP position.

It is easy to see that an increase in population increases the need for these countries for
imports and decrease the capacity to export.

10. Political Factors

The political factors may also produce serious disequilibrium in the country’s BOP.

For example – The existence of political instability may result in disrupting the productive
apparatus within the country, causing a decline in exports and an increase in imports.

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11. Miscellaneous Factors

Unfavourable exchange rates, increasing internal prices, increasing

defence expenditure specialization, Higher cost of democracy, etc.

The changes in the tastes, habits, fashions of the people.

References: -

• "August 15, 1971". HuffPost. 2013-11-19. Retrieved 2021-11-22.

• N. Gregory Mankiw (2014). Principles of Economics. p. 220. ISBN 978-1-285-16592-9.
fiat money: money without intrinsic value that is used as money because of
government decree

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Unit-2
Lecture No: -17

TYPES OF DISEQUILIBRIUM OF BOP

The disequilibrium of BOP can be classified into various types.

a. Cyclical Disequilibrium: -

The disequilibrium, which arises because of changes in the trade cycle, is referred as
Cyclical Disequilibrium. Changes in the economic conditions either in domestic economy
or in international economy will result into Cyclical Disequilibrium.
Eg. : In case of recovery & prosperity, the economic activities are rising as such the prices
in domestic economy will also rise. In turn, it will result into unfavorable BOP. On the other
hand in case of recession & depression there will be fall down of prices which may result
into favorable equilibrium.

b. Structural Disequilibrium: -

The disequilibrium that arises on account of structural changes relating to imports &
exports is known as structural disequilibrium.
Eg. : The exports of commodity on account of synthetic substitutes for the same. As such
it has resulted into structural disequilibrium.

c. Short run Disequilibrium: -

It refers to the disequilibrium which exist into the economy on account of some temporary
problems like natural calamity, political instability etc. Such Disequilibrium is also called
as temporary disequilibrium & the government need not take special measures to deal
with these problems.

d. Long Run Disequilibrium: -

It refers to disequilibrium, which persists in the economy over long period. Such
disequilibrium exists on account of imbalance between exports and imports. This
disequilibrium is also called as fundamental disequilibrium or secular disequilibrium. It
shall be noted that government is required to take adequate steps to solve this problem.

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e. Exchange Rate Disequilibrium: -

The Disequilibrium which arises on account of imbalance in the rate of exchange shall be
referred as rate of exchange disequilibrium. Such disequilibrium exist through out the
world & it occurs because of over valuation & under valuation of the currency.

Reference: -
• Gandolfo, Giancarlo (2002). International Finance and Open-Economy
Macroeconomics. Berlin, Germany: Springer. ISBN 978-3-540-43459-7.

Dr. Pramod Gupta, Professor- MBA Department-MITRC 54

MBA-3rd Sem. Unit-2 International Financial Management (IFM)

Unit-2
Lecture No: -18

CURRENT ACCOUNT DEFICIT

If an economy is running a current account deficit, it is absorbing (absorption = domestic

consumption + investment + government spending) more than that it is producing. This
can only happen if some other economies are lending their savings to it (in the form of
debt to or direct/ portfolio investment in the economy) or the economy is running down
its foreign assets such as official foreign currency reserve.

India’s current account deficit in the January-March 2021 quarter stood at $8.1 billion
compared to a surplus of $0.6 billion in the same quarter a year ago.

Dr. Pramod Gupta, Professor- MBA Department-MITRC 55

MBA-3rd Sem. Unit-2 International Financial Management (IFM)

What is Current Account Deficit?

The current account measures the flow of goods, services and investments into and out
of the country. The country runs into a deficit if the value of goods and services we import
exceeds the value of those we export. The current account includes net income, including
interest and dividends, and transfers, like foreign aid.

A nation’s current account maintains a record of the country’s transactions with other
nations, it comprises of following components:

• Trade of goods,
• Services, and
• Net earnings on overseas investments and net transfer of payments over a period of
time, such as remittances

What is the formula to calculate Current Account Deficit (CAD)?

The formula to calculate CAD is:

Current Account = Trade gap + Net current transfers + Net income abroad
(Trade gap = Exports – Imports)

Dr. Pramod Gupta, Professor- MBA Department-MITRC 56

MBA-3rd Sem. Unit-2 International Financial Management (IFM)

References: -

• Eun, Cheol S.; Resnick, Bruce G. (2011). International Financial Management, 6th
Edition. New York, NY: McGraw-Hill/Irwin. ISBN 978-0-07-803465-7.
• Eun, Cheol S.; Resnick, Bruce G. (2015). International Financial Management, 7th
Edition. New York, NY: McGraw-Hill/Irwin. ISBN 978-0-07-786160-5.

Dr. Pramod Gupta, Professor- MBA Department-MITRC 57