Delbl Unlversltv se,111

GBCS
[HonsJ
I
I

INTERNATIONAL
BUSINESS Semester
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Sllllla&Sa.n 1948
www.shivdas.in
Shiv Das
Delhl l■ln- Serles

INTERNATIONAL
BUSINESS

PAST YEARS
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Shiv Das & Sons

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 CONTENTS-
Syllabus ... (iu)

Unit I
1. Introduction to international Business 1
2. lntemationaJ Business Environment 18
Unit 11
3. International Trade 30
4. International and Econo1nic Organizations 45
5. Regional Economic integration ... 55
Unit III
6. International FinanciaJ Environment 60
Unit IV
7. Exchange Rate Determination 77
Unit V
8. Foreign Trade Promotion Measures and
Organizations in India 89

University Question Papers 97

onwards

(ii,)
 SYLLABUS
B.Com. (Hons.) CBCS
INTERNATIONAL BUSINESS
Duration: 3 ltours Maximum Marks: 100
Lech1res: 75
Objective: The objective of the course is to expose students to the concept, importance
and dynamics of international business and lndia's involvement with global business
operations.

UNIT I
1. Introd11ction to International B11.siness. Globalization and its growing
importance in world economy; Impact of globalization; International business
contrasted with domestic business-complexities of international business;
lntemati.onalization Stages and Orientations. Modes of entry into international
business.
2. Intemational Brl.siness Em,ironinent. National and foreign environments and
their components-Physical, ecooomic, demographic, cultural and poLitical-legaJ
environments; Global trading environment -recent trends in world trade in
goods and services; Trends in 111dia's foreign tmd<'.

UNIT II
3. Intemational Trade. Theories of lnt<'.mlltionaJ Trade, tariff and non-tariff
measures; Balance of Payment account and its components.
4. J,,tcmational & Economic Org111tizntio11s. WTO, UNCTAD, World Bank & IMF.
5. Regional Eco11omic Integration. Fonns of regional integration; Integration
efforts among countries in Europe, North America and Asia. Cost and benefit of
regional economic Integration.

UNIT III
6. l11tem11tio11al Fina11ci11/ f.11vironm1mt. International financial system and
inslitulions; Foreign exchange markets, Spot market, spot rate quotations, bid­
ask spreads, Trading in spot markets, Cross exchange rates; Forward Market
forward rate, Jong and short forward positions, forward premium and discount
Arbitrage, hedging and speculations. Foreign investments-types and flows;
Foreign investment in Indian perspective.

UNITIV
7. ExcJuuige Rate Ddermination. Factors affecting exchange rate-Relative
inflation rates, relative interest rates, relative income levels, govenunent
controls, expectations, etc. Government intervention and government influence
on exchange rares. Theories of exchange rate-Purchasing Power Parity, Interest
Rate Parity and Fisher's effect.

UNITV
8. Foreign Trade promotio11 measmes and organizations in India. Special economic
zones (SEZs) and 100% export oriented units (EOUs); Measures for promoting
foreign investments into and from India; Indian joint ventures and acquisitions
abroad.
❖ ;) ❖ ❖ ❖
(iv)
1. Introduction to lnternadonal Business: Globalization and its
growing importance In world economy; Impact of globalization;
International business contrasted with domestic buslness­
complexJtles of International business; Internationalization
Stages and Orientations. Modes of ency into international
business.
Q. 1. What is globalization? Wlat are the driving forces of Globalization?
Ans. Globaliz.ation refers to the shift toward a more integrated and
interdependent world economy. Globalization is a process of interaction and
integration among the people, companies and governments of different nations.
11\.is process has effects on the en.vironment, culture, political system, economic
development and prosperity and on human physical well-being in societies
around the world.
Globalization 1,as two components:
(r) Globalization of Markets. It implies that national markets are merging
into one huge marketplace. Firms such as Citigroup, Coca-Cola,
McDonalds, Starbucks, Sony seU their products internationally in almost
all the countries. Many companies need to vary aspects of their product
mix and operations from country to country depending on local tastes
and preferences. Globalization of markets includes the markets for
commodities, for industrial products, market for computer software,
markets for financial assets and even markets for commercial jets/
aircrafts.
(ir) The Globaliz.ation of Producti00- It refers to the sourcing of goods and
services from locations around the world to take advantage of regional
and national differences in the cost and quality of factors of production.
For example, take the case of IBM ThinkPad X31 laptop computer. 'flus
product is designed in US. The case, keyboard and hard drive were made
in Thailand; display screen and memory were made in South Korea;
built-in wireless card in Malaysia etc. Firms try to achieve optimal effects
of their productive activities to locations arow1d the globe.
The factors tlult influence the trend of Globalization are:
• formal and informal barriers to trade between countries;
• barriers to Foreign direct investment;
• transportation costs; and
• issues related to political risk and economic risk.
1
 2 smvA DELm UNNERSITY SERIES

Driving forces of globalization are:

(1) Tecltnology. Faster and cheaper technology in the digital global eco­
nomy of the Jnternet era has broken the national barrier of time and
space, thus, integration of national markets have been facilitated with
ease.
(ii) Liberalization. Strong wave of liberaliz.ation induced by the World
Trade Organisation (WTO) as well as unilateral negotiations and
decisions undertaken by the countries world over.
(iii) Trade Flows. Removal of trade barriers time and again has facilitated a
rising growth rate of the world trade over the years. New technology
under IT revolution has created distribution channel, which is difficult to
be blocked under the protectionist trade policy. For example, French
government's restriction on American films tends to be futile when these
are shown through satellite or Internet (Economist, 1999).
(iv) Capital Flows. In the Intern.et Age, capital has become internationally
more mobile.
(v) Factor Mobility. Mobility of individuals, information and knowledge, as
agents of production and countries has smoothened the growth process
of globalization.
Several complex and sensitive issues are inherent in the process and
proliferation of globalization including the role of culture and political/
social acceptance and alternation of the required attitudes towards the
change and involvement of the people at large in the global arena.
Q. 2. Is globalization desirable? Also state its limitations.
Ans. Yes, Globalization is desirable. Removing barriers to international trade
and investment are the twin engines driving the global economy towards greater
prosperity. Globalization has increased international trade and cross-border
investm.ent. It will result in lower prices for goods and services. Globalization
stimulates economic growth, raises the incomes of consumers and helps to create
jobs in participating countries. The economic principle of comparative advantage
is crucial in understanding the benefits of free trade and globalization. The
concept of comparative advantage states that even if country A can produce two
goods more efficiently than country B and if country B can produce only one
good more efficiently than country A, then it benefits both countries to specialize
and produce the good that they have the comparative advantage in producing.
Limitations of Globalization. Anti Globalist movements and protests are
increasing rapidly. People are protesting against a wide range of issues such as
job losses in industries, downward pressure on the wage rates of unskilled
workers, environmental degradation and cultural imperialism of global
corporations and MNCs. Jntemational inequality has increased by globalization.
It has shown several negative effects on undeveloped countries. For e..Tample, per
capita gross domestic product has not risen in Africa. Significant number of
undeveloped countries have been affected by detrimental effects on their
currencies and enormous levels of debt There have been big intervals among
qualified and unqualified workers both in temis of salaries and amounts of
 1. INTRODUCTION TO INTERNATIONAL BUSINESS 3

unemployment. The consequence of globalization will have a great impact on

world politics, income inequality and environment.
The benefits and costs of Globalization are being strongly debated among
businessmen, economists and politicians. The debate focuses on the impact of
globalization on jobs, wages, environment, working conditions and national
sovereignty.
Q. 3. Why companies globalise? Explain with suitable examples.
Ans. Globalisation is the process of interaction and integration among the
people, companies and governments of different nations. Globalisation refers to
the shift towards a more integrated and interdependent world economy.
Globalisation has increased international trade and cross border investment. It
results in lower pri.ces for goods and services. It stimulates economic growth,
raises the incomes of consumers and helps to create employment in different
nations. Many companies need to vary aspects of their product-mix and
operations from country to country depending on local tastes and preferences.
Globalisation facilitates sourcing of goods and services from locations around the
world to take advantage of regional and national boundaries in the cost and
quality of factors of production.
For exRmple: IBM (International Business Machines Corporation) is an
American m.ultinational technology company headquartered in Annonk, New
York, United States, with operations in over 170 countries. It man.ufactures
computer hardware and software. One of its products is IBM Think Pad X31
laptop computer which is designed in U.S., the case, keyboard and hard drive are
made in Thailand; display screen and memory are made in South Korea; built-in
wireless card is produced from Malaysia etc. In this way the firm tries to achieve
optimal effects of the productive activities of different locations around the globe.
Ar1U1Zon is an online retail company that sells products such as books, e-books,
electronics, Kindle e-book readers and tablets. It is conside.red the largest online
retailer in the world. Amazon owes most of its success to its immense selection of
products at competitive prices. Amazon's success is also due in part to the
success of the Amazon Kindle, which is the leading e-book reader. In addition to
the United States, Amazon also has retail websites specifically for the UK,
Canada, Japan, China, France, India and several other countries.
A VRriety of fRctors l111ve contributed to the process of globRlisRtion. Some of
the most importRnt globRlisRtiott drivers Rre:
(1) Containerization. The costs of ocean shipping have come down, due to
containerization, bulk shipping, and other efficiencies. The lower unit
cost of shipping products around the global economy helps to bring
prices in the country of manufacture closer to those in export markets,
and it makes markets more contestable globally.
(i1) Technological changes. Rapid and sustained technological changes have
reduced the cost of transmitting and communicating information­
known as "the death of distance" -a key factor behind trade in
knowledge, products using web technology.
(iit) Ec.-onomies of scale. Due to globalisation there has been an increase in
the minimum efficient scale (MES) associated with some industries. If the
4 SHIVA DELID UNIVERSITY SERIES

MES is rising, a domestic market may be regarded as too small to satisfy

the selling needs of these industries. Many emerging countries have their
own transnational corporations.
(iv) Differences in tax systems. The desire of businesses to benefit from
lower unit labour costs and other favourable production factors abroad
has encouraged countries to adjust their tax systems to attract foreign
direct investment (FDI). Many countries have become engaged in tax
competition between each other in a bid to win lucrative foreign
investment projects.
(v) Less protectionism. Old forms of non-tariff protection such as import
licensing and foreign exchange controls have gradually been dismantled.
National Borders have opened and average import tariff levels have
fallen. There has been a rise in non-tariff barriers such as import quotas
as countries have struggled to achieve real economic growth and as a
response to persistent trade and current account deficits.
(vi) Growth Strategies of Transna.tional and Multinational Companies. In
their pursuit of revenue and profit growth, global businesses and brands
have invested significantly in expanding internationally. This is
particularly the case for businesses owning brands that have proved they
have the potential to be successful globally, particularly in faster­
growing economies fuelled by growing numbers of middle-class
consumers.
Benefits of globtdisation are:
(1) Encourages producers and consumers to benefit from deeper division of
labour and economies of scale.
(ii) Competitive markets reduce monopoly profits and incentive which
compels the businesses to seek cost-reducing innovations.
(ii) Enhanced growth has led to higher per capita income-and helped many
of the poorest countries to achieve faster economic growth and reduce
extreme poverty.
(iv) Gains from sharing of ideas , skills, technologies across national borders.
(v) Opening up of capital markets allows developing countries to borrow
money to cover a domestic savings gap.
(vi) Increased awareness among consumers of challenges from climate
change and wealth/income inequality.
(vii) Competitive pressures of globalisation may prompt improved
governance and better labour protection.
Q. 4. What do you mean by International business? List and explain the
factors responsible for the growth of International Business in the recent past
Ans. International Business is a process in which a firm conducts business
transactions all over the world. These transactions include the transfer of goods,
services, technology, managerial knowledge and capital to other countries.
International business engages in international trade or investment It involves
export or import from other countries.
Feah,res of International lmsiness
(1) Large Scale operations. In International Business, all the business
 I. INTRODUCTION TO INTERNATIONAL BUSINESS 5

transactions are conducted on a very huge scale. Production and

marketing activities are conducted on a large scale.
(i1) Integration of Economies. International Business integrates the
economies of many countries. It uses finance, labour, infrastructure of
one country in another country.
(iii) Dominated by developed countries and MNCs. International business
is majorly dominated by developed countries and their lvfNCs. For
example, USA, Europe and Japan.
(iv) Keen competition. International Business has to face huge competition
in the world market. The competition is between developed countries
and developing countrys' MNCs.
(v) Role of Science &: Technology. International business gives a lot of
importance to the use of Science & Technology. International Business
helps Global Companies to transfer top high-end technologies to the
developing countries.
(v1) Intematioral restrictions. lntemational Business also faces many
restrictions on the inflow and outflow of capital, technology and goods.
Many governments regulate International Business through trade blocks,
tariff barriers, foreign exchange restrictions etc.
(vii) Se.nsitive nature. International Business is very sensitive in nature. Any
change in economic policies, technology, political environment of a
country has a huge impact on it. Marketin.g research should be
conducted to find out and study these changes.
Factors responsible for the growth of International Business are as follows:
• Technology. Technology has been a very important facilitating factor of
International Business. It is a universal factor that crosses national and
cultural boundaries. Once a technology is developed, it soon becomes
available everywhere in the world. For exmrrpl�, technology revolution
Like possession of patented technology encourages internationalization.
International business has facilitated globalization of medical and
healthcare sector. Technology makes it imperative for the business firms
to capture markets in various countries and share the rising costs and
risks.
• Transportation and communication revolution. The International
Technology revolution has made an immense contribution to the
emergence of international trade. The Internet and the World Wide Web
have revolutionized the speed of information search and its
dissemination for global business. The developments in the field of
transportation such as air cargo, containerization and refrigeration. and
supertonnage cargo ships have enabled quick and safe transportation of
goods worldwide.
• Competition. Another important force driving International Business is
increasing competition. Competition compels £inns to explore new ways
of increasing their efficiency, extending their international markets and
by shifting certain production activities to reduce costs.
• Global marketing and R&D. Global marketing is marketing on a
 6 SHIVA DELHI UNIVERSITY SERIES

worldwide scale by taking commercial advantage of global operational

differences, similarities and opportunities in order to .meet global
objectives. MNCs have invested in research and development areas in
order to explore trading techniques, standards and practices.
• Regional Integration. The proliferation of regional integration schemes,
like European Union (EU), North America Free Trade Agreement
(NAFrA), etc. have created a borderless world between the member
countries by reducing trade blocs and fostering the globalization trend.
This has increased the cross-bo.rder investments and financial flows
among natio.ns.
• Emergen.ce of Global Institutions. These institutions include The
General Agreement on Tariffs and Trade (the GATT), the World Trade
Organizations (WTO); the International Monetary Agreement between
nations and their functions are enshrined in international treaties.
Q. 5. How do you define International business? Compare and contrast
International business with domestic business.
Ans. International business, as the term suggests, includes any type of business
activity that crosses national boundaries. No simple or universally accepb!d
definition exists for the tenn international business. At one end of the definitional
spectrum, it is also defined as an organization that buys and/or sells goods and
services across two or more national boundaries, even if the management is
located in a single country. At the other end of the spectrum, it is equated only
with those big enterprises which have operating units outside their own country.
In the middle are institutional arrangements that provide for some managerial
direction of economic activity taking place abroad but stop short of controlling
ownership of the business carrying on the activity, far example, Joint Ventures
with locally owned businesses or with foreign governments.
Difference between International Trade and Domestic Trade. The scope of
international trade is much wider than domestic trade, it involves the study of
trade beyond the political boundaries of the country:
• Mobility of Labour and Capital. The mobility of labour and capital is
more within a country than in case of different countries. It is so mainly
because of the same social, economic and political system within a country
whereas in case of international trade there are restrictive immigration/
financial laws which prevent free mobility of labour and capital.
Community attachment and patriotism also act as an impediment in the
mobility of labour from one country to another.
According to classical economists, free flow of labour and capital from one
country to another leads to difference in the cost of production of an item
thereby making international trade possible.
• Different monetary Set-up. Within a country there is a single currency
which acts as a medium of exchange and facilitates the internal trade of
goods and services whereas in case of international trade one needs to
acquire the currency before importing goods from that country. The
exchange rate has a tremendous influence on the trade between the
countries.
 J. INTRODUCTION TO INTERNATIONAL BUSINESS 7
• Different fiscal policies. Different countries have different modes of
public spending and taxation policies whereas within a country generally
the same tax structure is followed, which can lead to inflow or outflow of
capital from a particular country.
• Production Cost. The cost of production of an item within a country is
nearly the same whereas it differs considerably between two countries. It
is mainly because the social security laws, wage rates, taxes etc. are same
within a country whereas these may differ in two countries. The minimum
wage rate in developed countries is much higher than the wage rates in
underdeveloped countries because of higher cost of living. Hence a labour
intensive item produced in a developed country may cost much more
than in a developing economy.
• Product Immobility. A well-developed system of transport can help the
easy movement of goods and services within a country at a minimal cost.
In case of international trade we not only have to take distance into
consideration but also the interest of the country cannot be ignored.
• Nationalistic Feelings. In case of domestic trade there are no nationalistic
feelings involved. Any organization working within the boundaries of a
country is least suspected whereas in case of international trade, business
organizations working in another country are looked down upon by the
host country. Their business is termed as a drain on the economy.
Sometimes certain organiz.ed groups hinder their entry into the market,
and slogans such as SWAD£SHI can be termed as a case in point
• Different Political set-ups. There are uniform laws concerning trade ,
commerce and taxation within a country whereas they differ in case of
international trade. Every government tries to protect its domestic
business and industry from foreign intervention. Very often the direct or
indirect state intervention influences th.e international trade whereas no
such steps are taken in domestic trade.
• Different Commercial Policies. Any country can impose a variety of
restrictions on international transactions while the same are not imposed
on domestic transactions. The restrictions may be in the form of (r) Tariffs,
(i1) Import quotas, (iit) Voluntill)' export restraint, (iv) Export Subsidies, (v)
International Commodity Agreements, and (v1) Exchange control
Different Market Considerations. Difference in the demand pattern, sales
techniques, market requirements and the like affect international transactions.
Every country has its own policies regarding inflation, economic growth and
employment while these policies widely differ when we take different countries
into consideration.
Q. 6. Distinguish between Domestic and International Business. [2012
Ans. International bnsiness is the outgrowth of Domestic business. Most of the
multinational enterprises (MNEs) started their operations in the domestic market.
Domestic business occurs within the boundaries of a single nation, whereas
international business transactions cross national borders. Cultural, political,
legal, trade and technological environments overseas are Likely to be different
from country to country and region to region within one country.
 8 SHIVA DELHI UNIVERSITY SERIES

Main distinguislring fetltures between International business and Domestic

b11siness:
(1) Scope. Scope of international business is quite wide. It includes not only
merchandise exports, but also trade in services, li.censing and franchising
as well as foreign investments. Domestic business pertains to a limited
territory.
(ii) Benefits. lruemational business benefits both the nations and firms.
Domestic business has lesser benefits when compared to International
business.
(ii,) Market Flu.ctuations. Firms conducting trade internationally can
withstand market fluctuations and huge losses as their operations are
widespread. Though they face losses in one area they may get profits in
other areas. This provides for stabilizing effect during seasonal market
fluctuations. Domestic business has to face this situation which results in
low profits and in some cases losses too.
(iv) Modes of Entry. International business ranges from exporting/importing
to contract manufacturing abroad, licensing and franchising, joint
ventures and setting up wholly owned subsidiaries abroad. Fi:rms
involved in domestic trade do have options but not as many as the the
firms with international business.
(v) Sharing of Technology. International business provides for sharing of
the latest technology that is innovated in various firms across the globe
which in consequence will improve the mode and quality of their
production.
(v1) Political relations. International business obviously improves the
political climate among the nations which gives rise to Cross-national
cooperation and agreement. Nations co-operate more on transactional
issues.
Q. 7. What a.re the complexities involved in international business?
Compare and contrast it with domestic business. (2014
Ans. Complexities in International Business:
(1) There are different types of entry modes. Each type has its own merits
and demerits. A company has to make significant analysis of different
entry modes. It is determined by a number of factors, such as
transportation costs, I.Tade barriers, political risks, business risks.
(ii) Different countries have different labour-mixes. This means that while in
one country, more skilled workers are available, the others may not have
sufficient availability of skilled personnel. If cheap labour is available in
one country, the others may have costly labour resources.
(iii) Countries differ in their cultures, political system, economic system, legal
system and levels of economic development Managers need to recognize
them and must also adopt the appropriate policies and sttategies for
coping \'\rith them.
(iu) International business involves cross-border trade and investments and
managers must find ways to work within the limits imposed by specific
governmental interventions.
 1. INTRODUCTION TO INTERNATIONAL BUS.INESS 9

(v) International transactions involve converting money into different

currencies. Managers must develop policies for dealing with exchange
rate movements. A finn that adopts a wrong policy in this respect may
lose large amounts of money, whereas the right policy can increase the
profitability of the company.
Managing an internation11l business is different from managing a domestic
business. TTw reasons are:
(r) Countries are different.
(ii) TI,e range of problems faced by a manager in an international business is
much wider and more complex than those confronted by a manager in a
domestic business.
(iii) International bwiness operates in international trade and investment
environment.
(iv) International business focuses on the nature of th.e foreign exchange
market and the emerging global monetary system.
Q. 8. "En.try into International business is an incremental process in whkh a
firm gradually increases its foreign market presence." Do you agree? Explain
giving reasons.
Ans. Entry into International business is an incremental process. There are
various reasons in support of this statement
(1) Firms first gain. experience from the domestic market before they move in.
to the foreign markets.
(ii) Firms start their foreign operations from culturally and geographical.ly
close countries and move gradually to geographicaUy more distant
countries.
(iii) Firms start their foreign operations by using traditional export items and
gradually move to catering to more intensive and demanding operation
modes both at the company and target country level.
(iv) Firm's expansion in the sales, objects/products, operations and market
strategy concerns help in expansion to new foreign markets.
(v) Finally, the firm will not commit higher levels of resources to the market
until it has acquired increasing levels of experience and knowledge and
therefore the internationalization evolves step wise at a relatively slow
pace because of local market regulations and organisational learning.
TTiere a.re some basic entry decisions tllken '1y any Jinn wltile stepping into
international markets:
(a) Which markets to enter
• Long run profit potential
• Size of the market
• Growth rate
• Cost and risks involved
• Domestic competition
• Availability of resources
• Political and legal environment
(b) \Vhe.n to enter those markets or timmg of the industry
 10 SHIVA DELHI UNIVERSITY SERIES
• First mover advantage-capture demand, establish strong brand name,
build sales volume, pre-empt rivals, cost advantage etc.
• First mover disadvantage-pioneering costs, chance of failure due to
ignorance of the foreign environment.
• Late entrants-observe and learn from mistakes made by early entrants,
no pioneering costs.
(c) On what scale to enter
• Small scale entry-learn. and gather information, less risk but difficult to
build market share or to capture early mover advantage.
• Large scale entry-strategic commitment, easier to attract customers,
affects competition but reduces resources available to support other
expansions. Large scale entry reduces competition because it can prevent
competitors to enter the market.
Q. 9. Explain the various stages of internationalisation of business.
Or
Discuss the process of internationalisation of business.
Ans. Most of the companies go through different stages of internationalisation.
Some companies start their business at the international level havin.g 100 per cent
exports. Even in the case of the hundred per cent export oriented companies, the
development of their international business passes through different stages of
evolution. A company having domesti.c operations goes through dilierent stagl>s
before it becomes true.ly global.. Following are the important stages in the
internationalisation of any bus.mess.
1. Domestic company. Most of the international companies have their
origin as domestic companies. A purely domestic company operates
domestically because it never considers the option of going international.
The growing stage of the company ends when it reaches growth linuts in
its primary markets. The company diversifies into new markets, products
and technologies instead of focusing on international markets. Domestic
market constraints, foreign market prospects, increasing competition etc.
make the company reorient its strategies and may encourage it to enter
into foreign markets. A domestic company can extend its products and
services to foreign markets by exporting, licensing and franchising. The
company can develop a more serious approach towards international
business and move to the next stage of development i.e., international
company.
2. Multinational company. In this stage the international company
becomes multinational. In other words when a company decides to
respond to market differences, it evolves into the stage three of
internationalisation process. The company adopts a multidemensional
marketing strategy to operate in different countries under multinational
companies. Each foreign subsidiary is managed as if it were an
independent city state. The subsidiaries are part of an area structure in
which each country is part of a regional organisation that reports to
world headquarter.
3. Global company. The global company may have either a global
 1. INTRODUCTJON TO INTERNATIONAL BUSINESS 11

marketing strategy or global sourcing strategy. lt will either focus on

global markets and source from the home or a single country to supply
these markets or it will focus on the domestic market and source from the
world to supply its domestic network.
Production marketing etc., however, can be global in respect of global
companies. Such companies are integrated world enterprises that link
global resources with global markets at a profit.
Q. 10. Write a brief note on orientation in th.e context of international business.
Or
Explain the various stages/approaches of orientation in international business.
Or
Discuss the EPRG framework in the context of international business.
Ans. 11,e degree and nature of involvement in international business or the
international orientations vary widely. The EPRG (Ethnocentric, PolycenlTic,
RegiocenlTic and Geocentric) framework is helpful in understanding the levels of
involvement of firms in international business. The EPRG scheme identifies four
types of attitudes or orientations towards internationalisation. These are
associated with successive stages in the evolution of international operations.
1. Ethnocentric approach (Home country orientation)
2. Polycentric approach (Host coWltry orientation)
3. Geocenrric approach (World orientation)
The above mentioned stages are assumed to reflect the goals and philosophies
of the company followed by it in different stages of internationalisation. Under
d.lfJerent stages a firm adopts different strategies, approaches and policies.
1.. Ethnocentric approach. Under this approach, foreign operations are
viewed as secondary to domestic operations. 11,e management of the
company views domestic techniques and personnel as far more superior
to foreign markel'S. Plans for overseas markets are developed in the home
office, utilising policies and procedures identical to those employed in
the domestic market. Foreign marketing is usually administered by an
ex-port department or international division and the marketing personnel
include people primarily from the home country. Foreign market
operations are conducted from a home country base and there is likely to
be a strong dependence on export agents.
2. Polycenbic approach. In this stage a company starts realising the
importance of overseas markets. The company starts believing that local
personnel and techniques are best suitable to deal with local market
conditions. Subsidiaries are established in overseas markets and each
subsidiary operates independently of the others. It establishes its own
marketing objectives and plans. While formulating the marketing
strategy the environment of each market is taken into consideration. In
this stage the company prepares its business strategies as per the local
conditions.
3. Regiocentric approach. A regiocentric company views diffe.rent regions
as different markets. A particular region with certain important common
marketing features is considered as a single market irrespective of
 12 SHIVA DELHI UNIVERSITY SERIES

international boundaries. Strategy integration, organisational approach

and product policy tend to be implemented at regional headquarters on
the one hand between regional headquarters and individual subsidiaries
on the other.
4. Geocentric approach. Under this approach, a company views the entire
world as a single market lt develops standarised marketing mix,
projecting a uniform image of the company and its products for the
global market. The business of a company following this approach is
usually characterised by sufficiently distinctive national :markets where
the ethnocentric approach is unworkable. Thus this approach views the
entire globe as a single market. National environmental constraints can
restrict multinational operations and can make this approach unfeasible
for certain companies.
Q. 11. What are the different modes of entry into international business?
Give their advantages and disadvantages.
Or
Discuss the contractual entry modes used by firms to enter international
business.
Ans. Contractual entry modes are used in case of intangible products such as
technology, patents, etc. When a company develops a particular technology
through its own research and development programme, it likes to recover the
cost of research and development Therefore, it sells the technology either to a
domestic firm or to a foreign firm.
But in this case, the privacy of technology is not secured and the firm's
ownership advantage is always at stake. Thus, in order to maintain the
ownership advantage, the £inn passes on the technology only to its own
subsidiary located abroad. 1n case, the host country's government does not
permit any foreign investment, the subsidiary of the firm in that host country
cannot exist and therefore transfer of technology through contractual deals is the
only way out.
Different types of Entry modes in international 811siness. Foreign market entry
modes differ in terms of risk, control and commitment of resources they require
and the return on investment.
There are two major types of entry modes. Equity and Non-equity modes.
(1) Equity mode includes Joint Ventures and W1rolly owned s11bsidiaries.
(ii) Non-equity mode includes E:,;porl and Contractual agreements.
E:>:port. It refers to selling of goods produced in one's own country for use or
resale in other countries. It may be in the fomi of merchandise export. For
exnmple, export of clothing, raw materials, computers, etc., Or
Export of services, F11r example, tourism, banking, insurance, engineering,
management sen,ices, etc. Exports may be direct or indirect.
Advantages of Export:
• It avoids substantial costs of establishing manufacturing operations in
the host country.
• It is less risky and less costl y.
 1. INTRODUCTION TO INTERNATIONAL BUSINESS 13
• It gives flexibility to enter in a large number of markets outside the
producer's country.
Disadvantages of Export:
• Fluctuations in exchange rate may cause losses to the Exporting £inn.
• Less control over marketing and sale of product.
• Transportation cost is an important factor. If it is very high, it may wipe
out profits.
Contractual agreements. Licensing, Franchising, Turnkey projects.
1. Lice11si11g. A lice11sing agreeme11t allows foreign firms, either exclusively or
non-exclusively, to manufacture a proprietor's (Exporter's) product for a fixed
term in a specific market.
Advantages of Licensing:
• Obtain extra income for technical know-how and services.
• Quickly expand without much risk and large capital investment.
• Pave the way for future investments in the market.
• Political risk is minimized as the Licensee is usually 100% local.
• ls highly attractive for companies that are new in International Business.
Disadvantages of Licensing:
• Lower income than in other entry modes.
• Loss of control over the licensee manufacturer and his marketing
operations and practices leading to loss of quality.
• Risk of having trademark and reputation rained by an incompetent
partner.
2. Franclrising. A firm in one country (the franchiser) authorizes a firm in a
another country (the franchisee) to utilize its operating system as well as its
brand names, trademarks and logos etc. The franchi�or receives royalty
payments which amounts to some percentage of the franchisee's revenues.
Advantages of Franchising:
• Low political risk
• Low cost
• Simultaneous expansion into different regions of the world.
• Well selected partners bring financial investment as well as managerial
capabilities to the operation.
Disadvantages of Franchising:
• Franchisees may tum into future competitors.
• A wrong franchisee may ruin the company's name and reputation in the
market.
3. Tiimkey prujects. A turnkey project refers to a project when clients pay
contractors to design and construct new facilities and train personnel. It is a way
for a foreign company to export its process and technology.
Advantages of Turnkey projects:
Possibility for a company to establish a plant and earn profits in a foreign
country where FDI opportunities are limited and lack of expertise in a specific
area.
 14 SHIVA DELID UNIVERSITY SERIES

Disadvantages of Turnkey projects:

• Risk of revealing company's secrets to rivals.
• Take over of the plant by the host country.
4. Wholly Owned S11bsidia·ries. A wl,olly owned subsidiary includes two types
of strategies: Greenfield investment and Acquisitions. To decide which entry
mode to use depends on the ground situation. The firm can either set up a new
operation in a foreign country, known as Greenfield venture, or it can aquire an
established firm in that host nation and use that firm to promote its products
(acquisitions).
Advantages of Wholly Owned Subsidiaries:
• Wholly owned subsidiary gives the firm tight control over operations in
different countries.
• It may be beneficial if a firm is trying to realize location and experience
curve economies.
Disadvantages of Wh.oUy Owned Subsidiaries:
• It is a costly method of serving a foreign market from Capital investm.ent
point of view.
• By applying acquisitions, some companies significantly increase their
levels of debt which can have negative effects on the firm because high
debt may cause bankruptcy.
5. Joint Ventures. A JV refers to establishing a firm that is jointly owned by two
or more independent firms. There are five common objectives in a Joint venture:
market entry, risk/reward sharing, technology sharing and joint product
development, and conforming to government regulations. Other benefits include
political coMections and distribution channel access.
Disadvantages Joint Venture:
• Conflict over asymmetric new investments.
• Mistrust over proprietary knowledge.
Q. 12. Identify the mode of entry in the following cases and explain ibi
advantages and disadvantages: [2015
(1) Airtel has pl.ll'Chued Zain TelecommunicatiOJlli in South Africa.
(2) There are a large no. of Pizza-hut restauranbi in India but none of them
is owned by Pizza-hut.
(b) (1) Mode of entry-Acquisition. International acquisition is one in which a
firm acquires an existing host country. By acquiring a current business, the
purchaser gains control over the acquired .firm's assets, employees, technology,
brand names and distribution. It is faster than any other mode.
Advantages ofAcquisition:
• Speed. It provides the ability to speedily acquire resources and
competencies not held in house. It allows entry into new products and
new markets. Risks and costs of new product development decrease.
• Market power. It builds market presence. Market share increases.
Competition decreases. Excessive competition can be avoided by shut
down of capacity. Diversification is aggrieved and synergistic benefits
are gained.
 1. INTRODUCTION TO INTERNATIONAL BUSINESS 15

• Overcomes entiy barrier. It overcomes market entry barrier by acquiring

an existing organization. The risk of competitive reaction decreases.
• Financial gain. Organization with low share value or low price earning
ratio can be acquired to take short-term gains through as.sets stripping.
• Resources and competencies. Acquisition of resources and competencies
n.ot available in-house can be a motive for merger and acquisition.
• Stakeholder expectations. Stakeholders may expect growth through
acquisitions.
Dis11dvantages of A cq11isition:
• Integration problems. The activities of new and old organizations may
be difficult to integrate. Cultural fit can be problematic. All organizations
will involve some conflict and turbulence during the process of
acculturation. Employees may resist it.
• High cost. The acquirer may pay high cost, especially in cases of hostile
takeover bids. Value may not be added for the acquirer.
• Firancial consequences. 1be returns from acquisitions may not be
attractive. Executed cost saving may not materialize.
• Unrelated diversification. This may create problem of managing
resources and competencies.
• Too much focus. Too much managerial focus on acquisition can be
detrimental to internal development.
(2) Model of Entry-francl1ising. It is a contractual agreement of goods,
services and business model for specified fees usually a signing fee and
percentage of the franchisee's revenue or profits. The franchiser provides I.Tade
mark, operating system, well-known products as well as service support such as
advertising, quality assurance, specialized training to the franchisee.
Advantages of Franclrising:
• association with a well established brand, reputation and product or
service;
• assistance with site selection, lease negotiation, site development,
builders and shop fitters;
• assistance with outlet design and equipment purchasing;
• initial management training and continuing management assistance;
• access to group/national market research, along with advertising and
merchandising assistance;
• access to established standard procedures, operating manuals and stock
control systems;
• assistance in securing finance and sometimes financial assistance in
establishing tl1e business;
• access to financing packages which may be more attractive and easier to
access than for non-franchised businesses; and
• access to established financial systems and checks which can provide
early warning signals to highlight trouble spots.
Disadvantages of Franchising:
• inconsistent product quality may affect product image negatively.
16 SHIVA DELm UNIVERSITY SERIES

• the agreement generally prohibits the originating firm from exploiting

the assets in particular .foreign markets.
• does not give firm tight control over manufacturing, marketing and
strategy to realize experience curve and economies of scale.
• firm can lose control over the competitive advantage of their
technological know-how.
Q. 13. \Vhat is a Transnational Corporation (TNC)? Explain its characteristic
features.
Ans. A Transnational Corporation is an enterprise that manages production or
delivers services in more than one country. A 1NC is a corporation that has its
headquarters in one country, known as the home country and operates in several
other countries, known as host countries.
Examples ofTNCs. Royal Dutch Shell Group (Netherlands/United Kingdom);
Daimler Ouysler AG (Germany/USA), Unilever (Netherlands/United
Kingdom); Rio Tinto Pk (Australia/United Kingdom). The growth in the number
and size of transnational corporations since the 1950s has generated controversy
because of their economic and political power and the mobility and complexity of
their operations.
Feature�Characteristics of Transnation11l corporations:
(t) Transnational compa.nies operate in two or more countries, including in
its country of origin. Its business, such as sales, extraction or
manufacturing and spans multiple countries. Its management system
focuses on a global or regional outlook.
(i1) Transnational companies tend to adapt their services or goods to the
local preferences of the host countries.
(iii) 11,ey also strive to craft a business model that suits the particular regions
in which they operate by blending their strategies wiili the development
policies of the host countries.
(iv) There is often an emphasis on green and sustainable development in ilie
local region as a result of studying and responding to the local ecological
envirorunent' s needs.
(v) Transnational companies emphasize their own global strategies that
ensure ilieir continued thriving in ilie international scene and ilieir long­
term development and expansion.
The main advantag es of Transnational corporations:
(1) 11le investment level, employment level, and income level of the host
country increases due to the operation of TNCs.
(i1) The industries of the host country get latest technology from foreign
countries through TNCs.
(iit) The host country's business also gets management expertise from 1NCs.
(iv) The domestic traders and market intermediaries of the host country get
inc�sed business from the operation of 1NCs.
(v) 1NCs break protectionism, curb local monopolies, create competition
among domestic companies and thus enhance their competitiveness.
(m) Domestic ind.ustries can rnake use of R and D outcomes of TNCs.
(vit) 11le host country can reduce imports and increase exports due to goods
 1. INTRODUCTION TO INTERNATIONAL BUSJNESS 17
produced by TNCs in the host country. This helps to improve balance of
payment
(uiir) Level of industrial and economic development increases due to the
growth of TNCs in the host country.
The limitations of Transnational Corporations. Some critics argue that trans­
national corporations exhibit no loyalty to the countries in which they are
incorporated but act solely in their own best interests.
Transnational corporations with headquarters in the United States have played
an increasingly dominant role in the world economy. This dominance is most
pronounced in the developing countries that rely primarily on a narrow range of
exports, usually primary goods. A transnationals corporation has the ability to
disrupt traditional economies, impose monopolistic pra.ctices, and assert a
political and economic agenda on a country.
The basic difference between a m11lti11ational and a transnational lies in the
fact that transnational company is borderless, as it does not consider any
particular country as its base, home or headquarters. Multinationals have
branches in other countries, whereas transnational have subsidiaries.

7177
2. International Business Environment:
National and foreign
environments and their components -Physical, Economic,
Demographic, cultural and political-legal environments; Global trading
environment; Recent Trends in World Trade in goods and Services;
Trends in India's foreign trade.
Q. 1. \'Vhat do you understand by Busin.ess Environment?
Ans. The business environment is the set of forces surrouncling an organisation
that has the potential to affect the way it operates and has access to resources. It
may be visualiz.ed in temlS of three layers surrouncling the organisation from the
General environment to Specific environment and to Domain, beginning with the
immediate internal environment of the organisation, to the general environment.
The environment influences the organisation, i.e., its strategy, structure and
operations.
T11e General environment. It includes those sectors that might not have direct
impact on the daily operations of the firm but will influence it. It is less overt and
indirect but creates major opportunities and threats to all industries and to all
organisations in a given industry, but in different ways which may be favourable
or unfavourable in varying degrees. It consists of several sectors or dimensions
such as - economic, political legal, technological, cultural and social. Each sector
has its own structural, regulatory and ethical practices.
T11e Specific e11viron111ent. lt consist of forces of stakeholde.r groups that directly
affect an organisation's capacity to attract resoun:es. lt entails suppliers,
customers, shareholders, unions and distributors, etc. with whom the
organisation interacts on regular basis and on whose support depends its
survival and growth. An organisation's strategy and achievement of goals largely
depend on how much it satisfies them. Govemmtnt and intm111tiona/ forces prevail
both in general as we.II as specific environment.
Tl1e Organisational Do,nain. It refers to the particular range of goods and
services that the organisation produces, the customets and other stakeholders
and market it serves. Earlier these environmental forces were seen as centred on
the home country of the business, but the environmental horizon of business has
now widened and grown to many countries requiring consideration of internal
forces along with global forces.

I ,I I- I
r
Soclcl and
Cullurol forcos 1--,�-11- l::a6:c"e.

ICustomM DislJ1butOB I

I Govemm&nl I 1- 0to-"°"I I Unions I

I SUopicf, I I Competitors f--'
I
economic
loro� I
.-1
l� 1T�k:c�1
□ G<me<ot envronment □ Sped',c enYf'onment
'Th� ekmatts of org1U1isatiott's emriron11tent
18
 2. INTERNATIONAL BUSINESS ENVJRONMENT 19
Q. 2. "A global business firm operates in an environment which is complex
and multidimensional." Explain the statement with relevant contemporary
examples. (2011
Or
"A global business firm operates in an environment which is complex and
multidimensional" Explain the statement with relevant contemporary.
Ans. 11,e environment of international business firm is complex and
multidimensional because political, economic and legal systems of countries
vary. TI,e potential risks, benefits and costs of doing business in a country are
detennit,ed by its political, economic, legal and cultural systems.
Political system means the system of government prevalent in a country. It can
be assessed according to two dimensions:
(1) Collectivism vs. individualism. Collectivism stresses of the primacy on
the collective goals of the society over individual goals. Individualism
stresses the primacy of individual's freedom over the interests of the
society.
(ii) Democracy vs. Totalitarianism. Democracy refe.rs to the form of
government in which government is by the people, and political freedom
is guaranteed by the constitution. In a totalitarian state, political power is
monopolized by a party or an individual.
These dimensions are interrelated. System that emphasizes on collectivism
tends towards totalitarianism, while systems that focus on individualism tend to
be democratic. It is possible to have democratic societies that emphasize a mix of
collectivism and individualism. For example, China e,mphasizes on individual
freedom ln the economic sphere but it is still ruled by a totalitarian system where
political freedom is constrained.
Economic System. TI1ere are three main types of economic systems: Market
economy, Command economy and Mixed economy.
(I) In a Market economy prices are free of control and private ownership is
predominant. In countries where individual goals are given primacy
over collective goals, free market economy exists.
(iii) In a Command economy prices are set by governed authorities,
productive assets are owned by the state, and private ownership is
forbidden. In countries where collective goals are given importance, such
economy exists.
i
(iiz) A M xed economy has elements of both, a market economy and a
command economy.
Legal system. Differences in the structure of law between countries have
important implications for the practice of International Business. The government
of a country defines the legal framework within which firms do business.
Different types of legal systems are as follows:
(1) Property rights. The degree to which property rights are protected can
vary from country to country. It can be violated in two ways -through
private action and through public action.
(ii) Protection of intellectual property. Patents, copyrights and trademarks
establish ownership rights over intellectual property. It differs from
 20 SHIVA DELHI UNIVERSITY SERIES
country to country. For example, many countries have stringent
regulations on the intellectual property rights but China and Thailand
allow the manufacturing selling of pirated computer softwares.
(iii) Product safety and product liability. Product liability can be much
greater if a product does not conform to required safety standards. Both
civil and criminal liability laws are more stringent in the US than in any
other country. Liability laws are typically less extensive in less developed
countries.
C11lh1ral system. The cultural system has important implications on
International Business due to different components of Culture such as­
Education level, Social structure, Language, Religious and Ethical beliefs, etc. A
global business firm should be well informed about the culture of various
nations. To develop cross cultural literacy, international businesses need to
employ host<ountry nationals, build a staff of cosmopolitan executives and
guard against the dangers of ethnocentric be.haviour. The value system and
norms of a country can affect the costs of doing business in that country.
Q. 3. Write a brief note on physical component of international business
environment.
Or
Explain the physical climension of intemationaJ business environment with
suitable examples.
Ans. Physical environment can affect the success of international business. A
bus.iness must take into consideration the physical dimension of business
environment. The physical compo.nent of international business includes various
physical aspects of a nation. These may include country's territorial size,
geographical location, natural resources, climate, rivers, lakes and forests. Tiw
physical environment influences political and economic activities, shapes cultural
characteristics like language, religion and determines land usage, transportation
and commercial flows. When planning international business activities, the
possible impact of physical environment should be taken into consideration.
Following are some important examples of how physical compon,ent of
international business e11vironment can inffoe11ce business.
(r) Population distribution of a country is affected by the topography of the
nation. People tend to settle where the climate is temperate and where
tl1ere is adequate supply of water. Businesses also concentrate in those
areas which are densely populated.
(iQ Certain climatic conditions can force business to produce certain types of
products only. For ex11mple, business will sell woolen clothes,
moisturisers, certain types of oils etc. in areas where the weather is too
cold. On the other hand in very hot areas business will prefer to sell
cotton clothes, deodorants, cold drinks etc.
(iii) Climate can also influence the packaging strategy of the business. The
main role of packaging is to protect the product in storage. Care need to
be taken by the busi.n.ess in packing those goods which are particularly
are particularly vulnerable to climatic conditions. For example, fruits
being transported to hot climates or across the equator.
 2. INTERNATIONAL BUSINESS ENVIRONMENT 2.1
(il7} Abnormal weather conditions can act as obstruction in the process of
transportation. Unforeseen changes in the weather can threaten
companies that export seasonal goods. For example, typhoon season in
Asia.
(v) Topography of a nation also influences the routing of goods and the
choice of transport mode. This also influences the cost and hence impact
the price offered by the business to the buyer.
Q. 4. What is Economic Environment? What are the different kinds of
economic systems that influence international business?
Ans. Economic Environment constitutes the economic factors that have an
effect on the working of the business. It includes economic system, policies and
nature of an economy, its trade cycles, economic resources, levels of income and
distribution of income and wealth, financial and fiscal sectors, removal of
regional imbalances, economic reforms, human resource.
111ere are three types of economic systems prevalent in today's world:
1. Muket Economy. In a pure market economy, all productive activities are
privately owned. Prices are free of any control and private ownership is
predominanL ln this economy, supply is not restricted. A supply restriction takes
place when a single firm monopolizes the market. In such circumstances, a
monopolist might restrict output and let the prices rise. It is good for the
monopolist but bad for consumers who have to pay higher prices.
In the absence of competition, there is no incentive lo look for ways to lower
production costs. As a result, the monopolist is likely to become inefficient
producin g. high-priced, low-quality goods with the result that the society suffers.
Given the consequences of monopoly, the role of government in a market
economy is to encourage free and fair competition between private producers. It
ensures that entrepreneurs have a right to the profit generated by their own
efforts.
2. Comnwtd Economy. In a pure command economy, the goods and services
that a country produces, the quantity in which they are produced and the prices
at which they are sold are all planned and controlled by the government. The
objective of a command economy is for the government to allocate resources for
the welfare of society. In this economy, all businesses are state-owned. The
government directs them to make investment in the best interests of the nation.
But this system failed in India and France. In this economy the state-owned
enterprises have little incentive to control costs and be efficient. In the absence of
private ownership there is no incentive for better ways to serve the consumer
needs. There is lack of dynamism and innovation. Such economies tend to
stagnate.
3. Mixed Economy. A mixed economy has elements of both a market economy
and a command economy. In a mixed economy, certain sectors of the economy
are privately owned and follow free market mechanism while 0th.er sectors have
significant state ownership and government planning.
In this economic system, government tends to take into state ownership the
troubled firms whose operation is considered to be vital. to national interests. For
example, the French government took over Renault to save it from bankruptcy.
 22 smvA DELHI UNIVERSITY SERIES
Q. 5. \Vrite a brief note on demographic component of international business
environment.
Or
Explain the demographic dimension of international business environment
with suitable examples.
Ans. Demographic dimension of international business environm.ent includes
various demographic factors like size of population, its growth rate, age
composition, family size, nature of the family, income levels etc. The size of the
population is an important determinant of demand for various products. Poo.r
countries with small siz.e of population are not very attractive for global business.
On the other hand, advanced countries having large population are usually very
attractive for business. Major proportion of international trade and foreign
investment takes place between these nations. When the population is very large
even if the country is poor there could be a sizeable market for those goods and
senrices which are regarded luxuries in such countries. High population growth
rate also implies that there is sufficient labour supply in the country which is
always on the rise. When weste.rn nations witnessed industrial revolution, the
population growth was relatively low. This resulted in labour shortage and
increase in wage rates. This further forced businesses to opt for labour intensive
techniques of production. Capital intensive techniques are opposed by many
sociologists, politicians and economists in developing countries. Massive
population size, cheap labour and growing market size encouraged investors to
invest their rnoney in developing countries like OilNA and lNDIA. Tiw
problems of such countries due to the population explosion also indkate the
enormous scope for several Industries.
The impact of Demographic environment on business can be understood with
the help of a simple example. Markets with growing population and income are
growth markets. But decline in birth rate in countries like United States has
negatively influenced the demand for baby products. Johnson and Johnson have
overcome this problem by repositioning their products like baby shampoo and
baby soap, promoting them also to the adult segment particularly to the females.
The occupational mobilities of population have implications for business. U
labour is easily mobile between different occupations and regions, its supply will
be relatively smooth and this will affect the wage rate. On the other hand if
labour is highly heterogeneous in respect of language, caste and religion etc.
personnel management becomes a very difficult task for the business.
Thus it can be conc1"ded that the demographic environment of intentational
b1lSiness includes tl,e following:
Age structure
Gender
income distribution
Family size
Education
- Social class
- Family life cycle
- Overall population size
 2. INTERNATIONAL BUSINESS ENVIRONMENT 23
Q. 6. What is cultural environment in the context of International Business
O perations?
Ans. lnternational Business in a variety of countries requires cross-cultural
literacy. It means understanding of how cultural differences across and within
nations can affect the way in which business is practiced Culture is a complex
whole that includes knowledge, beliefs, art, morals, laws, customs and other
capabilities acquired by people as members of a Society.
The central components of a culture are values and norms. Values a.re abstract
ideals about what a society believes to be good, right and desirable. Norms are
social rules and guidelines that prescribe appropriate behaviour in a particular
situation.
Elements of Culture:
(r) Social Structure. The social structure of a society refers to its basic social
organization. The three main dimensions of social structure a.re the
individualism, group dimension and the stratification dimension.
• Tndivid11alism. The individual is the basic building block of a social
organization in many western societies. These societies emphasize
individual achievements above all else. It has both beneficial and
harmful aspects. Its benefits are-high level of entrepreneurial activity,
new products and new ways of doing things that have been created in
such societies. On the other hand, it increases high degree of
managerial mobility between companies and this is not always a good
thing. Individualism may also make it difficult to build teams within
an organization to perform collective tasks.
• The Group. [n some societies, the group is the basic building block of
social organization. These societies emphasize group membership and
group achievements above all else. This creates pressure for mutual
self-help and collective action. Some argue that such societies a.re
characterized by lack of dynamism and entrepreneurship.
• Social Stratification. All the societies are stratified into different classes
on the basis of characteristics such as family background, occupation
and income. Cass-conscious societies are characterized by low social
mobility and a high degree of stratification. Less class-conscious
societies a.re characterized by high social mobility and a low degree of
stratification.
(i1) Religion. Religion may be defined as a system of shared beliefs and
rituals that is concerned with the realm of the sacred. Ethical system
refers to a set of moral principles or values that are used to guide and
shape behaviour. Most of world's ethical systems a.re the products of
religion. The world's major religions are: Christianity, Islam, Hinduism
and Buddhism. Not only religion, Confucianism also has an impact on
behaviour that is as profound as that of many religions.
• Orristianity. The main branches of Christianity are-Catholic, Orthodox
and Protestant. It emphasizes on the importance of hard work and
wealth creation and frugality. This kind of value system has supported
and facilitated the development of Capitalism.
24 SBJVA DELHI UNIVERSITY SERIES

• Islam. Islam is the second largest religion of the world's major religions.
Islam requires the unconditional acceptance of the uniqueness, power
and authority of God and according to Islam the objective of life is to
fulfill the dictates of His will in the hope of paradise. This religion is
characterized by free enterprise and earning huge profits through trade
and commerce.
• Hinduism. Hindu values emphasize that individuals should not be
judged by their material achievements but by their spiritual
achievements.
• Buddhism. Buddhism emphasizes on right seeing, right thinking, right
speech. right action, right living, right effort, right mindfulness and
right meditation. It does not support caste system.
• Confucinnism. Confucian ideology has become deeply inserted in the
culture of China, Korea and Japan. It teaches the importance of
attaining personal salvation through right action. High moral, Joyal
and ethical conduct towards others are central principles to
Confucianism.
(iir) Political Philosophy. The political philosophy is characterized by
concepts of respect, acknowledgement of Inferiority or Superiority,
Authority and Homogeneity in society. The political ideology determines
set of discourses and symbolic practices by means of which both
individuals and groups articulate their relationships to power and
elaborate their political demands and put them at stake.
(iv) Economic Philosophy. The economic philosophy also determines the
foundation of culture in a society. It consists of three main regards. It
raises different questions on welfare, justice and freedom. This is
concerned with the nature of rationality. It also raises moral questions
concerning the character and possibility of knowledge of social
phenomena.
Language is one of the defining characteristics of a culture. It has both
spoken and unspoken dimensions. In countries with more than one
spoken language, we tend to find more than one cultures.
• Spoken lnngunge. The most widely spoken language in the world is
English, followed by French. Spanish and Chinese. English is
increasingly becoming the language of International business. When a
Japanese and a German businessmen get together to do business, it is
almost certain that they will communicate in English. International
businesses which do not understand the local language can make
major blunders through improper translation. For example, General
Motors was troubled for its new Oievrolet Nova, when literally
translated into Spanish, Nova meant Star. However, when spoken it
sounded like "nova", which in Spanish means "it doesn't go n.
• Unspoken language. It means non-verbal communication. A failure to
understand non verbal clues of another culture can lead to
communication failure. For example, Americans and Europeans use the
 2. INTERNATIONAL BUSINESS ENVIRONMENT 25

thuml:>-up gesture to indicate that "it's all right", in Greece the same
gesture is considered obscene.
(v) Education. Formal Education is the medium through which individuals
learn skills and are socialized in to the values and norms of a society. It
plays an important role in the determination of national competitive
advantage. It is also an important factor guiding the location choices of
International Business. The education level also determines the kind of
products that might sell in a country and of the type of promotional
exercises that should be used.
Q. 7. What is PoliticaJ Environment in the context of IntemationaJ Business?
Ans. Politictd Environment In the political dynamics of every society, both
internal and external factors come into play. Internal systems reflect the conflicts
inherent in any society and how they get resolved by a collective political process
as enshrined in its Constitution to promote the good of the society. Regional and
global forces outside its borders also shape its political climate as every country
seeks long-term security of required resources, food and energy apart from its
territory. People everywhere desire maintenance of law and order, improvement
in health and education and infrastructure.
Basic philosophy and attitudes of the political party or individuals in power
also shape the political climate of any country. A country's Constitution decides
the legal fram.ework through which conflicts arnongst individuals, businesses or
with government itself can be settled.
Countries can have a democratic set up with presidential, two party
government or multi-party system apart from dictatorship of various kinds.
Governments are not only regulators, they are also the biggest customer, supplier
of resources and taxing authority deciding duties and levies and even fixing
prices and approving mergers and acquisitions.
Areas in which political factors influence multinational oper.itions include:
(r) The nature of regulatory framework.
(ii) The degree of control over MNCs activities.
(iii) The extent to which it is necessary to take insurance against possible
losses like expropriation of assets.
(iv) Incidence of strikes and terrorism, etc.
Political environment and events are important because they directly influence
economic, social and legal factors and thus business activity in any country.
Areas of political decision making, which make an impact on business:
(a) Extent of welfare state and how it is financed.
(b) Regional development policies and priority accorded in funding.
(c) Environmental policies and how they are implemented.
(d') Division of power between central, regional and local authorities.
(e) Importance given to agriculture and food.
(f) Defence policies and international relations.
(g) Immigration..
Q. 8. Give a brief account of differences in the economic and cultural
environment of business between nations and their implications for business.
[2015
 Ui SHIVA DELHI UNIVERSITY SERIES
Ans. Economic Environment. Economic environment constitutes the economic
factors that have an effect on the working of the bu.siness. It includes economic
system, policies and nature of an economy, its trade cycles, inflation, economic
resources, levels of income and distribution of income and wealth, financial and
fiscal sectors, removal of regional imbalances, economic reforms, hwnan
resources.
E.conomic environment or force is most significant of all the environmental
forces. During the time of inflation, company should pay more price for
resources. It rises the cost of production and price of th.e output. Inflation badly
affects the teclmological environment and other environment of the
organizations. When interest rates are high, company should pay more when it
borrows. It also raises the cost of production and price of the output. So it also
badly affects the teclmological as well as other environmental forces. Business
organization can be benefited from low inflation and interest rate.
In a developing country, the low income may be the reason for the very low
demand for a product But a firm is unable to increase the purchasing power of
the people to generate a higher demand for its product. Hence, it may have to
reduce the price of the product to increase the sales. It may even be necessary to
invent or develop a new low-cost product to suit the low-income market Thus
Colgate designed a simple, hand-driven, inexpensive ($10) washing machine for
low-income bu.yers in less developed countries.
The economic policy of the government, has a very great impact on business.
For example, a restrictive import po.licy, or a policy of protectin g . the home
industries, may greatly help the import-competing industries. Similarly, an
industry that falls within the priority sector in tenns of the government policy
may get a number of incentives and other positive support from the government,
whereas those industries which are regarded as inessential may have the odds
against them.
In India, the government's concern about the concentration of economic power
restricted the role of the large industrial houses and foreign concerns to the core
sector, the heavy investment sector, the export sector and backward regions.
An industrial undertaking may be able to take advantage of external economies
by locating itself in a large city; but the Government of India's policy was to
discourage industrial location in such places and persuade industries to set up
units in backward locations. A backward area location may have many
disadvantages, however, the incentives available for u.nits located in these
backward areas may compensate them for these disadvantages, at least to some
extent.
Cultural Environment The socio-cultural fabric is an important environmental
factor that should be analysed while fom,ulating business strategies. The cost of
ignoring the customs, traditions, taboos, tastes and preferences, etc., of people
could be very high. The buying and consumption habits of the people, their
language, beliefs and values, customs and traditions, tastes and preferences,
education are all factors that affect business.
Every country has a set of different variables which can be new for an offshore
company e.g. rules and regulations, taxation, different currency, different holiday
 2. INTERNATIONAL BUSINESS ENV1RONMENT

periods, etc. The different components of cultural environment are-norms,

values, language, religion, education.
Culture influences many aspects of international business through differences
in communication, transactions, negotiation and behavioUI. Characteristics of
cu.ltUies, such as style of communication (direct or indirect), negotiation
strategies and perception of business partners as friends or merely partners
influence the compatibility or incompatibility of businesses with others in the
international business arena
For a business to be successful, its strategy should be the one that is
appropriate in the socio<ultural environment. The marketing mix will have to be
so designed as best to suit the environmental characteristics of the market. In
1bailand, Helene CUitis switched to black shampoo because Tiuu women felt that
it made their hair look glossier. Nestle, a Swiss multinational company, today
brews more than forty varieties of instant coffee to satisfy different national
tastes. Even when people of different cultures use the same basic product, the
mode of consumption, conditions of use, purpose of use or the perceptions of tl,e
product attributes may vary so much so that the product attributes method of
presentation, positioning, or method of promoting the product may have to be
varied to suit the characteristics of different markets.
For example, the two most important foreign markets for Indian shrimp are the
U.S. and Japan. The product attributes for the success of tl,e product in these two
markets differ. ln the U.S. market, correct weight and bacteriological factors are
more important rather than eye appeal, colour, uniformity of size and
arrangement of the shrimp which are very important in Japan. A very interesting
example is that of the Vicks Vaporub, the popular pain balm, which is used as a
mosquito repellant in some of the tropical areas.
The differences in languages sometimes pose a serious problem, even leading
to a change in the brand name. Preett was, perhaps, a good brand name in India,
but it did not suit in the overseas market; and hence it was appropriate to adopt
Prestige' for the overseas markets. In some languages, Pepsi-Cola's slogan "come
alive" translates as "come out of the grave".
The values and beliefs associated with colour vary significantly between
different cultures. Green is a favowite colour in the Muslim world; but in
Malaysia, it is associated with illness. White indicates death and mourning in
China and Korea; but in some countries, it expresses happiness and is the colour
of the wedding dress of the bride.
There are also a number of demographic factors, such as the age, and sex
composition of population, family size, habitat, religion, etc., which influence the
business.
Q. 9. Explain the concept of Environntental Degradation.
Ans. Enviromnental degradation refers to the depletion of natural resources
(air, water, soil, elements, compounds, etc.) which eventually will lead to the
deterioration of tlle environment. Global climate change leads to an increased
number of weather-related disasters such as floods and droughts, which cause
food shortages and famine. Environmental degradation can be attributed to
various human activities, as well as some natural processes, with the latter
 28 smvA DELHI UNIVERSITY SEUES
having an insignificant share. Exploitation of the fossil fuels is the best example
of this phenomenon. Large scaJe exploitation has depleted the fossil fuel reserves
across the world. Other human activities which have been contributing to
environmental degradation include Urbanization, Overpopulation,
Deforestation, Pollution and Hunting, etc. Industries contribute significantly to
global economic growth and development but also add to increase in pollution
which results in degradation of environment.
Effects of Intcmational . trade on Environment. International trade may affect
sustainable agricultural and rural development and the environment in a number
of ways.
• Trade may encourage production a.ctivities to shift from places where the
environment is less sustainable lo places where it is more sustainable or
vice versa.
• Increased trade liberalization changes the pattern and level of world
consumption, production and income and these changes can affect the
environment in ways that go beyond Uw shifting of consumption and
production among countries.
• Trade influences the process of economic development, creating fresh
opportunities for the profitable use of productive resources. For instance,
international trade in agricultural products is large and an important
source of foreign exchange earnings for many countries.
Q. 10. Comment on the trendt in India's foreign trade in the last decade.
Ans. Trends in India's foreign tnide in tlie last decade. Foreign trade includes
all the imports and exports to and from India. At the level of Central Government
lt .is administered by the Ministry of Commerce and Industry.
Trendt in India's Foreign Trade:
(1) India's mercl1andise exports reached a level of US$304.62 billion during
2011-12 showing a growth of 21.30 per cent as compared to a growth of
40.49 per cent during the previous year. Despite the recent setback faced
by India's export sector due to global slowdown, merchandise exports
still recorded a Compound Annual Growth Rate (CAGR) of 20.3 per cent
from 2004-05 to 2011-12.
(U) As per WTO's International Trade Statistics 2012, in merchandise trade,
India is the 19th Largest exporter in the world with a share of 1.7 per cent
and the 12th largest importer with a share of 2.5 per cent in 2011.
(iii) Exports recorded a growth of 21.30 per cent during Apr-Mar 2011-12.
The Government has set an export target of US$360 billion for 2012-13.
The merchandise exports have reached US$265.95 billion in 2012-13.
(iv) Value of imports during 2012-13 was US$ 448.04 billion as against US$
446.94 billion during the previous year showing a growth of 0.25 per cent
in$ terms. Oil imports were valued at US$155.57 billion during 2012-13
which was 11.92 per cent higller than oil imports valued US $ 139.00
billion in the previous year.
(v) The trade deficit in 2012-13 (Apr-Feb) was estimated at US $ 182.09
billion which was higller than the deficit of US $ 169.81 billion during
2011-12.
 2. INTERNATIONAL 8USINESS ENV1RONMENT 29

(tn) Exports of the top five commodities during the period 2012-13 (April­
January) registered a share of 50.8 per cent in US$ tetms mainly due to
significant contribution in the exports of Petroleum (Crude & Products),
Gems & Jewellery, Transport F.quipments, Machinery and Instruments
and Drugs, Pharmaceuticals & Fine O,emicals.
(l1i1) India's Gems and Jewellery exports declin.ed by 9.3 per cent to US$ 39
billion in 2012-13 because of lower demand from global markets,
especially in the US and Europe.
(viir) The share of Asia comprising of East Asia, ASEAN, West Asia, Other
West Asia, North East Asia and South Asia accounted for 50.78 per cent
of India's total exports in US $ terms. The share of Europe and America
in India's exports stood at 18.88 per cent and 18.77 per cent respectively.
USA has been the most important country of export destination followed
by UAE (12.20 per cent), Singapore (4.79 percent), China (4.59 per cent)
and Hong Kong (3.95 per cent).

1177
3. InternationalTrade: Theories of International Trade, tariff and
non-tarlff measures; Balance of Payment account and Its
components.
Q. L What is the conbibation of the theory of Absolute Advantage in
International Business?
Ans. Adam smith in 1776 introduced the doctrin.e of Laissez-faire to
international trade. Laissez-faire means freedom of enterprise and freedom of
commerce. He argued that all nations would benefit from unregulated free trade
that would permit individual countries to specialize in goods they were best
suited to produce because of natural and acquired advantages. Smith's theory of
trade has come to be known as the 'Theory of Absolute Advantage'. It states that
a nation's imports should consist of goods made more efficiently abroad while
exports should only consist of goods made more efficiently at home. A country
has an absolute advantage in tl,e produ.ction of goods and services when it is
more efficient (in terms of labour productivity per unit) than any other country in
producing it. Countries should specialize in the production of goods in which
they have an absolute advantage and then trade these for goods produced by
other countries. Therefore, a country should never produce goods at home that it
can buy at a lower cost from other countries.
The absolute advantage theory argues that the market would reach an efficient
end by itself. Government intervention in the economic llie of a nation and in
trade relations among nations (in the form of tariffs) is counterproductive. A
nation would benefit &om free trade simply because imports would cost less
than domestic products it otherwise would have to produce. Unlike the
mercantilist doctrine, which stated that a nation could only gain from trade if the
trading partner lost (Zero-sum game), the absolute advantage theory argued that
both countries would gain from the efficimt allocation of "5011rces globally. This can
explained by an example of two countries and two commodities.
Example: Given Number of countries-Two: Ghana and Korea
Quantum of Resources: Both countries have 200 units
Items to be produced with the available resources: Rice or Cocoa
Ghana. 10 units of resources required to produce one ton of cocoa and 20 units
of resources required to produce one ton of rice. Production Possibility is (1) 20
tons of Cocoa and no Rice, (ii) 10 tons of Rice and no Cocoa, (iii) a combination of
both.
South Korea. 40 units of resources required to produce one ton of cocoa and 10
 3. JNTERNATIONAL TRADE 31
units of resources required to produce one ton of rice. Prod11ctio11 Possibility is
(1) 5 tons of Cocoa and no Rice (i1) 20 tons of Rice and no Cocoa, (iii) a
combination of both.
Theory of Absolute Advantage
Details Cocoa Rice
Resources required to produce ONE ton of Cocoa and Rice
Ghana 10 20
South Korea 40 10
Production and Consumption without
trade with 200 units of resources ead1
Using 100 Units for Rice and 100 Units for Cocoa Cocoa Rice
Ghana 10 5
South Korea 2.5 10
Total 125 15
Production with Specialisation
Using All 200 units Cocoa Rice
Ghana (for Cocoa only) 20 0
South Korea (for Rice only) 0 20
Total Global Output 20 20
Additional Production due to Specialization 7.5 5
From the above figures it is obvious that Ghana has an absolute advantage in
the production of Cocoa, and South Korea has an absolute advantage in the
production of Rice. If each country is to specialize in producing the goods which
it produces more efficiently, then Ghana should produce 20 tons of Cocoa and
South Korea 20 tons of Rice. With the given 200 units of Resources. Thus by
specialising the production of both the goods could be maximised. By engaging
in trade and swapping 1 ton of Cocoa for 1 ton of Rice, the producers in both the
countries would get more of both Cocoa and Rice. Thus, absolute advantage
trade theory is seen as a positive-sum game i.e., it produces net gains for all
involved.
Q. 2. What is the contribution of the theory of Comparative Advantage in
International Business?
Ans. Theory of Comparative Advantage. (What happens if One Country has
absolute advantage in the production of ALL the goods?)
Adam Smith's theory of absolute advantage suggests that such a country might
drive no benefit from international trade. However, David Ricardo tried to
answer the above question. It makes se'llse for II country to specialize in tire production
of those goods thnt it produces more e:ffi..-ienlly a11d to buy the goods that it produces less
efficiently from other countries, euen if this me1ms buyingfrom other co1mtries tli11t it can
produce more efficiently by itself
Example: Given Number of countries-Two: Ghana and :Korea
Quantum of Resources: Both countries have 200 units
Items to be produced with the available resources: Rice or Cocoa
Ghana. 10 units of resources required to produce one ton oi Cocoa and
 32 SHIVA DELID UNIVERSITY SERIES

13 }(�) units of resoutces required to produce one ton of Rice. Production

Possibility is (1) 20 tons of Cocoa and no Rice (ii) 15 tons of Rice and no Cocoa,
(iii) or a combination of both.
South Korea. 40 units of resources required to produce one ton of Cocoa and
20 units of resources required to produce one ton of Rice. Production Possibility
is (t) 5 tons of Cocoa and no Rice, (i1) 10 tons of Rice and no Cocoa, (iii) or a
combination of both.
From the above figures it is obvious that Ghana has an absolute advantage in
the production of Cocoa and South Korea has an absolute advantage in the
production of Rice. If each country is to specialize in producing the goods which
it produces more efficiently, then Ghana should produce 20 tons of Cocoa and
South Korea 20 tons of Rice. Thus by specialising the production of both the
goods could be increased.
Theory of Compari,Hve Advi,nti,ge
Details Cocoa Rice
Resources required to produce ONE ton of Cocon and Rice
Ghana 10 units/ton 40/3 units/ton
South Korea 40 units/ton 20 units/ton
Production and Consumption without trade
with 200 units of resources ead1. Using 100
units far Rice and 100 Units for Cocoa Cocoa Rice
Ghana 10 7.5
South Korea 2.5 5.0
Total 12.5 125
Production with Specialisation Cocoa Rice
Ghana (for Cocoa 15-0 units + for Rice 5-0 units) 15 3.75
South Korea (for Rice only) 0 10
Total Output of cocoa and rlce by
two countries with Specialisation 15 13.75
Additional Production due to Specialisation 2.5 (15-125) 1.25 (13.75-12.5)
Thus, 2.5 tons of Cocoa and 1 ton of Rice are additionally produced by engaging in
glol,al trade with countries producing and trading with their specialisation only.
Assumptions of the Above Two Tlieories:
(t) All units of Jabour are homogeneous.
(i1) Labour is perfectly mobile with in the country but it is perfectly
i.nunobile between different countries.
(iii) Tiwre is full employment in countries engaged in international trade.
(iv) There is no transport cost involved in foreign trade.
(v) International trade is free from all government controls like tariffs.
(m) There is perfect competition both i.n the goods market and factor market.
(vi1) Trade takes place between two countries and in two commodities
produced by labour.
(vii1) Production of goods takes place under constant cost conditions.
 3.. INTERNATIONAL TRADE 33
(ix) Ricardo assumes that labour is the only factor of production and cost of
production is measured in teuns of labour units.
(x) Each country has a fixed quantity of resources and free trade does not
change the efficiency with which a country uses its resources.
(x1) There is no effect of trade on income distribution within a country.
Despite the limitations of Ricardian mod.el, research suggests that the countries
will export the goods they are most efficient in and that free trade is beneficial to
trading countries.
Q. 3. E,c pwn Porter's theory of National Competitive Advantage as a theo ry
of international trade. (2014
Ans. The theory of National Competitive Advantage was developed by
Michael Porter in 1990. This theory explained why some nations succeed and
others fail in international competition.
According to Porter, "11,ere are four attributes of n nation (diamond) whid,
contribute to the creation of competitive advantage".
(1) Factor endowm.ents. There are two types of factor endowments. Basic
factors include natural resources, climate, location and demographics.
Advanced factors include communication, infrastructure, sophisticated
and skilled labour, research facilities and technological know-how.
Advanced factors are the most significant for competitive advantage. For
example, Japan has a pool of engineers but it Jacks arable land and
mint.-ral deposits.
(i,) Demand Conditions. Demand conditions play an important role in
creating pressures for innovation and quality if consumers are
sophisticated and demanding.
(iii) Related and Supporting Industries. The third attribute is the presence of
suppliers or related industries that are internationally competitive. It
tends to be grouped into clusters of related industries. Such clusters are
important so that valuable information can flow between the firms and
benefiting all within that cluster.
(iv) Firm Strategy, Structure and Rivalry. Porter makes two important
points here. Firs!, nations are characterized by different management
ideologies. Secondly, there is a strong association between domestic
rivalry and the creation of competitive advantage in an industry.
Domestic rivalry induces firms to find ways to improve efficiency. It
creates pressures to innovate, to improve quality, reduce costs and invest
in upgrading advanced factors. All this helps to create world-class
competitors.
Eval11ating Porter' theory:
• The degree to achieve international success in a certain industry is a
function of the combined impact of four attributes.
• TI1e presence of all four components of diamond is usually required to
boost competitive performance.
• Government can influence each of the four components of the
diamond-either positively or negatively.
 34 SHIVA DELHI UNIVERSITY SERIES
• Factor endowments can. be affected by subsidies, capital market reforms,
level of education, etc.
• Domestic demand can be affected through local product standards,
strictness of regulations.
• Supporting and related industries can be influenced through capital
market regulation, tax policy, antitrust laws.
Q, 4. What is the contribution of the Heclcshcher-Ohlin theory in
International Business?
Ans. Ricardo's theory stresses that Comparative advantage arises from
differences in productivity. Thus, whether Ghana is more efficient than South Korea
in the production of cocoa depends on how productively it uses its resources.
Ricardo stressed labour productivity and argued that differences in labour
productivity between nations underline the notions of comparative advantage.
Swedish &onomists Eli Heckscher and Berti! Ohlin put forward a different
explanation of comparative advantage. They argued that d({ferences in national
factor endowmrnts are the cause for comparative advantage. Factor endowments
are the extent to which a country is endowed with such resources as land, labour
and capital. Nations have varying factor endowments which explain differences
in cost The more abundant a factor is, the lower is the cost. This theory predicts
that countries will import those goods that make intensive use of factors that are
locally scarce. Thus, this theory has tried to explain the pattern of international
trade that we observe in the world economy. Like Ricardo's theory, this theory
argues that free trade is beneficial. Unlike theory of Ricardo, this one argues that
the pattern of int:emational trade is determined by difference in factor
endowments rather than the differences in productivity.
Assumptions:
(1) lt assumes a two-by-two model, 'i.e., there are two countries, two
commodities and two factors of production (Capital and labour).
(ii) There is perfect competition in product as well as factor markets.
(iii) There is full employment of resources.
(iv) The quantity of factor endowments in two countries is different.
(v) There are no transportation costs.
(111) There is free and unrestricted trade between the two countries.
(vii) Returns to scale in production in each commodity are constant.
(viii) Preference of consumers and their demand pattern are identical in both
the countries.
(ix) There is no change in technological knowledge.
(x) There is perfect mobility of factors of production within each region but
they are immobile between different countries.
(xr) The production function of the two countries is different; one
commodity is produced by labour intensive technique and the other by
capital intensive technique.
Implications of H-0 theorem
(t) Trade as well as trade-gains should be the greatest between the
countries, with the greatest differences in economic structure.
 3. INTERNATIONAL TRADE 35
(i1) Trade should cause countries to specialise more in producing and
exporting goods that are distinctly different from their imports.
(iii) Trade policy should take the form of trade restrictions rather than trade
stimulation.
(iv) Cow,tries should export goods that make intensive use of their relatively
abundant resources.
(v) Free trade should equalize factor prices between countries with similar
fairly relative factor endowments, but not between countries with
marked differences in endowments.
(vr) International investment should be stim.ulated by differences in factor
endowments, and international trade and investment should be
negatively correlated.
Q. 5. Explain the Leontief's Paradox.
Ans. Wassily Leontief attempted in 1953 to test the proposition of H-0 theory
with respect to U.S. Using input-Output tables, covering 200 industries and 1947
data, he found that U.S exports were more labour-intensive and its imports
capital-intensive. Since this result contradicted H-0 theorem, it is known as
Leontief' s Paradox. This study stimulated further empirical research. The
empirical evidence accumulated since then shows many paradoxical results and
contains serious challenges to the general applicability of the factor endowments
explanation in other countries such as Germany, India, Canada and Japan.
T11e Leontiefs Paradox stim11lated II se11rcl1 for explanations of t11e following
factors:
(1) Existence of Trade Barriers. U.S. labour-intensive imports were reduced
by trade barriers imposed to protect and save American Jobs.
(ii) Importance of Natural Resources. Leontief considered only labour and
capital inputs, leaving out natural resource inputs. As natural resources
and capital are often used together in production, a country that imports
capital-intensive goods may be actually importing natural-resource
intensive goods. As an example, U.S. imports crude oil which is capital­
intensive.
(iii) Prevalence of factor-Intensity reversals. A factor-intensity reversal
occurs when the relative prices of labour and capital change over time,
which changes the relative mix of capital and labour in the production
process of a commodity from being capital intensive to labour intensive
or vice-versa.
Q. 6. Explain the New Trade Theory.
Ans. 1n 1970s the new trade theory emerged. It explained the diminishing
returns from specialization used in international theory. It argues that the variety
of goods that a country can produce and the scale of production are limited by
the size of the market. The size of the domestic market may not allow producers to
realize economies of scale for certain products which require high cost of
development and very high capital costs. Thus, these products may not be
produced at all. When nations trade with each other and form a single big
market, individual firms in a country may be able to attain economies of scale to
produce them.
 36 SHIVA DELHI UNIVERSITY SERIES
New trade theory implies that each nation can. specialize in producing a
narrower range of products and can buy those goods that it does not produce,
from other countries. So each nation can increase the variety of goods available
for its consumers. Thus, global trade offers an opportunity for mutual gain for
countries.
Let us suppose that there are two countries with annual market for one million
automobiles. By trading with each other these countries can create a combined
market of two million cars. It also argues that because of scale, there are
increasing returns from specialization in many industries. World market may
support only limited number of firms producing a particular product. Those
firms that enter the market first may be the first gainers and it may be difficult for
other firms to catch up with them. 1nis theory argues that countries do not
necessarily specialize and trade solely in order to take advantage of their
differences. They also trade because of increasing returns which makes
specialization advantageous per se. Secondly, it suggests that inter-industry trade
between different countries continues to be determined by H-0 theory while,
intra-industry trade is largely driven by increasing returns resulting from
specialization within the industry. 1nis means that both factor endowments anti
increasing returns aspect can co-exist. Finally, this theory realizes the importance of
'extemallty' in international spec.ialization and trade. Finns that cause
environmental pollution would have an adveise impact on residents.
Externalities include government policies, political relations between countries,
history, culture, environment, accident and luck.
1nis theory also explained Leontiefs paradox; inter-industry and intra-firm
trade which takes place between subsidiaries of the same MNC. Driven by the
prospect of increasing returns, .MNCs see intra-firm trade as a facilitator of global
integration of upstream and downstream activities.
Q. 7. Analyse the Product Life Cycle theory of International Trade in detail.
\Vhat criticisms a.re levelled against it?
Ans. This theory was proposed by Raymond Vernon. The Product-Life Cycle
theory suggests that trade patterns are influenced by where a new product is
introduced. Vernon argued that the wealth and size of the US market gave the
US firms an incentive to develop new products such as televisions, automobiles,
instant cameras, photocopiers, personal computers and semiconductor chips. The
firms believed that it was better to keep production facilities close to the market
and to the center of decision making. The demand of new products tends to be
based on non-price factors. Firms can charge relatively high prices for the new
products. As the product becomes more standardized, the price becomes the
main competitive weapon. When the demand increases, firms set up the
production facilities in other developing countries to get the advantage of lower
cost of production.
For example, Xerox introduced the photocopier in the US and then set up
production facilities in Japan and Great Britain. It began to switch production to
developing countries such as Singapore and Thailand. Product Life Cycle theory
considers to be an accurate explanation of international trade patterns.
With increased globalization and integration of the world economy, a number
 3.JNTERNATIONAL TRADE 37

of new products are introduced where the mix of factor costs and skills is most
favourable.
Criticism of Product Life Cycle theory. While the Product life cycle theory is
widely accepted, some critics say that the theory has so many exceptions. Some of
them are:
• There is no set amount of time that a product must stay in any stage;
each product is different and moves through the stages at different time­
spans.
• The theory can lead to an over-emphasis on new product releases at the
expense of mature products, but in fact the greater profits could possibly
be derived from a mature product if a little work was done on
revamping the product.
• The theory emphasizes on individual products instead of taking larger
brands into account.
• The theory does not adequately account for product redesign and/ or
reinvention.
Q. 8. What are barriers to trade? What are the tariff and non-tariff barriers to
international trade? (2014
Ans. B11rriers to tr11de. A trade barri.er is a government imposed restriction on
the free international exchange of goods or services. The most common barrier to
trade is a tariff-tax on imports. A tariff is a tax on imports which is collected by
the government and which raises the prices of the good to the consumer. Other
barriers include quotas and non-tariffs.
A tariff is a tax imposed in international trade. It adds to the cost of imported
goods and one of the several trade policies that a country can enact. Tariffs are
often created to protect infant industries and developing economies. Tariff is
divided into two categories:
• Specific tariffs are levied as a fixed charge for each unit of a good
imported.
• Ad valorem tariffs are levied as a proportion of the value of the
imported good.
Non-Tariff B11rriers (NTB) refer to the restrictions that arise from different
measures taken by the Government and authorities in the form of Government
laws, regulations, policies, conditions, prohibitions and specific market
requirements in order to make import and export of products difficult and costly.
Some examples of NTB. Import bans, Product-specific quotas, Unjustified
sanitary and phyto-sanitary condition, Complex regulatory environment,
Product classification, Export subsidies, Bi-national product policy, Over-valued
currency, Import licences etc.
A fall in tariff barriers in the recent decades has been accompanied by a rise in
non-tariff barriers, such as subsidies, quotas, voluntary export restraints and local
content requirements.
• Subsidies. A subsidy is a government payment to a domestic producer in
the form of cash grants, low-interest loans, tax breaks and government
equity- participation in domestic firms. They also tend to be captured by
special interests that use them to protect the inefficient.
 38 SHIVA DELHI UNIVERSITY SERIES

• Import Q11otas. It is a direct restriction imposed by an. importing country

on the quantity of a particular good that may be imported.
• Voluntary Export Restraint(V£R). It is a quota on trade imposed from
the exporting country's side.
• Local content ru,uirement. It is a requirement that some specific fraction
of a good be produced domestically. The requirement can be expressed
either in physical terms or in value terms. It benefits producers by
limiting foreign competition.
Difference between tariff and non-tariff bamers. The purpose of both tariff and
non-tariff barriers is the same, that is, to impose restrictions on imports but they
differ in approach and manner.
Tariff barriers ensure revenue for a government but non-tariff barriers do not
bring any revenue. Import licence and Import quota are non-tariff barriers. NTBs
are country specific and are often based on flimsy grounds that can result into
economic loss. On other hand, Tariff barri.ers are more transparent in nature.
Q. 9. "Economic integration is achieved after passing through dlfferent
stages." Analyse the statem.ent giving suitable examples. [2012
Or
"The customs unions, common market, economic anion are various stages in
the growth of regiona.1 economic integration." Explain.
Ans. Economic integration is the unification of economic policies between
different states through the partial or full abolition of tariff and non-tariff
restrictions on trade taking place among them prior to their integration. The
objective of economic integration is to lead to lower prices for distributors and
consumers with the goal of increasing the combined economic productivity of the
states. Regional economic integration is an attempt to achieve economic gains
from the f.ree flow of trade and invesbnent between neighbouring countries.
Stages of Economic Integratio11. Th.ere are several levels of economic
integration -
(1) Free Trade Area
(ii) Custom Union
(iii) Common Market
(iv) Economic Union
(v) Political Union
(1) Free Trade Area.. In a free trade area, barriers to trade between member
countries are removed but each country determines its own external
trade policy.
For example, European Free Trade Association (EFTA) established in
1960. It joins four countries-Norway, Iceland, Liechtenstein and
Switzerland. Its emphasis has been on &ee trade in industrial goods.
Each member is allowed to determine its own level of protection.
(ii) Custom Union. A custom union eliminates trade barriers between
member countries and adopts a common external trade policy. TI1e
establishment of external trade policy requires significant administrative
machinery to oversee trade relations with non-members.
For example., the Andean Pact was established between member
 3. INTERNATIONAL TRADE 39

countries and imposes a common tariff of 5 to 20 per cent on the

products imported &om outside_
(iii) Common Market. The next level of economic integration is common
market. It is similar to a custom union except that a common market also
allows factors of production to move freely between countries. Labour
and capital are n:ee to move because there are no restrictions on
immigration, emigration, or cross-border flows of capital beh<1Teen
m.ember countries. A Common market demands a significant degree of
harmony and cooperation on fiscal, monetary and employment policies.
For example, Ml:RCOSUR (South American Countries) established itself
as a Southern common market.
(iv) Economic Union. An economic union requires even dose economic
integration and cooperation than a common market. ln addition to free
flow of products and factors of production and the adoption of common
external trade policy, it also requires a common currency and the
harmonization of tax rates. lt demands a coordinating bureaucracy and
the sacrifice of significant amounts of national sovereignty to that
bureaucracy.
For cx11111plc, single market of the European Union.
(v) Political Union. Political union is the logical culmination of attempts in
which a central political structure coordinates the economic, social, and
foreign policy of the member coun.tries. The United States provides a
suitable example of political union. In United States, independent states
are effectively combined into a single nation.
Q. 10. "The Balance of Payments account is a cash flow statement that
records the flow of foreign exchange from all international transactions over a
period of time". Discuss. [2014
Ans. Bal11nce of Payments is a macro-level cash flow statement showing
inflows and outflows of foreign exchange. It is based on the concept of double
entry book keeping. The credit side shows the receipts of foreign exchange from
abroad and the debit side shows payments in foreign exchange to foreign
residents.
Again, receipts and payments are divided under two heads:
(1) Current Account. It is part of BOP Statement showing flows of foreign
exchange transactions on account of trade of goods and invisibles.
(ii) Capital Account. It is a part of BOP Statement showing flows of foreign
loans/investments and banking funds.
When credit side of the Current Account along with the credit side of the (long­
term) Capital Account transactions is compared with the transactions on the
debit side of the Current Account and the long-term Capital Account, the
difference is known as the basic balance which may be negative or positive.
Bala.nee of Payments:
• Balance of Trade = Export of goods - Import of goods
• Balance of Current Account = Balance of trade + Net earnings on
invisibles
• Balance of Capital Account = Foreign exchange inflows - Foreign
 40 smvA DEl.HI UNIVERSITY SERIES
exchange outflows, on account of
foreign investment, foreign Joans,
banking transactions and other capital
flows.
• Overall Balance of Payments = Balance of Current Account + Balance of
Capital Account + Statistical
discrepancy
After the statistical discrepancy is found, the overall balance is arrived at. If the
overall BOP is in swplus, the surplus amount is used for repaying the
borrowings from the IMF and then the rest is transferred to the Official Reserve
Account. Whereas, if the overall balance is in deficit, the monetary authorities
arrange for Capital flows to cover up the deficiL
From this point of vi.ew, the capital inflows are divided into two types:
• Accommodating Capital flows. If the inflow of funds on the Capital Account
is for meeting the overall Balance of Payments deficit.
• Autonomo11s Capital flow. It refers to flow of loans/investment in normal
course of a business. For e:ra.mple, if foreigner is paying back the Joan or
the inflow of foreign direct investment.
Q. 11. What is the impact of imposition of tariff barriers on price of goods? Is
it beneficial for the consumer? (2016
Ans. The most common barriers to trade are tariffs, quotas and non-tariff
barriers. A tariff is a tax on imports, which is collected by the government and
which raises the price of the good to the consumer. Tariffs usually aim first to
limit imports and second to raise revenue. A tariff raises the price of the foreign
good beyond the market equilibrium price, which decreases the demand for and,
eventually, the supply of the foreign good.
Benefits and cost of tariff:
(1) Tariffs lnaease the prices of importtd goods. Because of this, domestic
producers are not forced to reduce their prices from increased
competition, and domestic consumers are left paying higher prices as a
result. Tariffs also reduce efficiencies by allowing companies that would
not exist in a more competitive market to remain open.
(U) Tariffs inaease the cost of imports, leading to a decline in consumer
swplus. Example, UK consumers have lost out from EU (European
Union) wide tariffs on agricultural products. Many agricultural goods
are more expensive because of the high tariffs placed to protect EU
farmers.
It is hard to think of any benefits from tariffs for consumers. Maybe in the
long run consumers benefit from the protection of domestic industries if
these industries use the tariffs to improve domestic producers, who
produce the good. will benefit from the introduction of tariff. This is
because it makes their domesti.c production relatively more attractive
compared to the imports.
T11ere are folwwing otlt.er benefits of using tariffs:
1. Imposition of tarrifs helps in protecting Domestic Employment. Th.e
possibility of increased competition from imported goods can threaten domestic
 3. JNTERNATIONAL TRADE 41

industries. These domestic companies may fire workers or shift production

abroad to cut costs, which means higher unemployment .
2. Protecting Consumers. A government may levy a tariff on products that it
feels could endanger its population. For example, South Korea may place a tariff
on imported beef from the United States if it thinks that the goods could be
tainted with disease.
3. Infant Industries. The use of tariffs to protect infant industries can be seen
by the Import Substitution lndustrwization (ISi) strategy employed by many
developing nations. The government of a developing economy will levy tariffs on
imported goods in industries in which it wants to fasten the growth. This
increases the prices of imported goods and creates a domestic market for
domestically produced goods, while protecting those industries from being
forced out by more competitive pricing. It decreases unemployment and allows
developing countries to shift from agricultural products to finished goods.
4. National SecW"ity. Barriers are also employed by developed countries to
protect certain industries that are deemed strategically important for supporting
national security. For exnmple, while both Western Europe and the United States
are industrialized, both are very protective of defense-oriented companies.
5. Ret.tl.iation. Countries may also set tariffs as a retaliation technique if they
think that a trading partner goes against the government's foreign policy
objectives. For example, if France believes that the United States has allowed its
wine producers to call its domestically produced sparkling wines "Champagne"
for too Jong, it may levy a tariff on imported meat from the United States.
Q. 12. ExpWn various commercial policy instruments used by different
nations to regulate Foreign Trade. [2015
Ans. Commercial policy instruments used by different nations to regulate
Foreig,1 Trade:
1. A �riff is a tax imposed in international trade. It adds to the cost of
imported goods and one of the several trade policies that a country can enact.
Tariffs are often created to protect infant industries and developing economies.
Tariff is divided into two categories:
• Specific tariffs are levied as a fixed charge for each unit of a good
imported.
• Ad valorem tariffs are levied as a proportion of the value of the
imported good.
2. Non-Tariff Barriers (NTB) refer to the restrictions that arise from different
measures taken by the Government and authorities in the form of Government
Jaws, regulations, policies, conditions, prohibitions and specific matl<et require­
ments in order to make import and export of products difficult and costly.
Some examples of NTB - Import bans, Product-specific quotas, Unjustified
sanitary and phyto-sanitary condition, Complex regulatory environment,
Product classification, Export subsidies, Bi-national product policy, Over-valued
currency, Import licences, etc.
A fall in tariff barriers in the recent decades has been accompanied by a rise in
non-tariff barriers, such as subsidies, quotas, voluntary export restraints and local
content requirements-
42 smvA DELHI UNIVERSITY SERIES
• Subsidies. A subsidy is a government payment to a domestic producer in
the fonn of cash grants, low-interest loans, tax breaks and government
equity participation in. domestic firms. They also tend to be captured by
special interests that use them to protect the inefficient.
• Import Quotas. It is a direct restriction imposed by an importing country
on the quantity of a particular good that may be imported.
• Voluntary Export Restraint(VER). It is a quota on trade imposed from
the exporting country's side.
• Local content requirement. It is a requirement that some specific fraction
of a good be produced domestically. The requirement can be expressed
either in physical terms or in value terms. It benefits producers by
limiting foreign competition.
Q. 13. What is the Balance of Payment Account? What are its different
components?
Ans. Balance of Payment Account is a statement listing receipts and paym.ents
in the international transactions of a country. It records the inflows and the
outflows of foreign exchange. The system of recording is based on double entry
book-keeping, where the credit side shows the receipts of foreign exchange from
abroad and the debit side shows payments in foreign exchange to foreign residents.
Components of BOP are as follows:
(I) Current Account Transactions. The Current account records the receipts
and payments of foreign exchange in the following ways. They are:
Current account receipts winch include:
(1) Export of goods
(ir) Invisibles:
• Services
• Unilateral transfers
• Investment income (outgoing)
(iir) Non-monetary movement of Gold
Current account payments include:
(i) Import of goods
(i,) Invisibles:
• Services
• Unilateral transfers
• Investment income
(iir) Non-monetary movement of Gold
Export of goods affects the inflow of foreign exchange into the country, while
import of goods causes outflow of foreign exchange from the country. The
difference between the two is known as the balance of trade. If exports exceed
imports, balance of trade is in surplus. Excess of import over export means deficit
balance of trade. There is another item in the Current account, known as non­
monetary movement of Gold. This is for industrial purposes and is shown in the
Cunent account, either separately from. or along with, the Trade in merchandise.
(D) Capital Account Transa.cti.ons. Capital account shows flow of foreign
loans/investment and banking funds. Its transactions take place in the following
ways:
 3. JNTERNATIONAL TRADE 43

(1) Capital account Receipts that include:

• Long-term inflows of funds
• Short-term inflows of funds
(ii) Capital account Payments include:
• Long-term outflows of funds
• Short-term outflows of funds
The debit side of Capital account includes disinvestment of capital, country's
investment abroad, loans given to foreign governments or a party and the bank
balances held abroad. The credit side includes official and private Borrowings
from abroad net of repayments, Direct and portfolio investments and Short-term
investments into the country.
(III) Official Reserve Account. Official Reserves are held by the monetary
authorities of a country. They comprise of monetary gold, SOR allocations by the
IMF and foreign currency assets. U the overall balance of payments is in surplus,
the surplus amount adds to the official reserve account. But if the overall BOP is
in deficit then official Reserves account is debited by the amount of deficit
Q. 14. \Vhat is free trade? Give arguments in its favour.
Ans. Free trade is a policy formed between two or more nations that permits
the unlimited import or export of goods or services between partner nations. Free
trade means that countries can import and export goods without any tariff
barriers or other non-tariff barriers to trade.
When nations do not have free trade agreements, which are treaties that outline
the parameters of trade between trade partners, tariffs are imposed on goods and
services. Tariffs are taxes that nations impose on imports. Tariffs increase the cost
of goods, which is passed on to the consumers.
Free trade eliminates tariffs and makes corporations more competitive in
foreign markets. Essentially, free trade enables lower prices for consumers,
increased exports, benefits from economies of scale and a greater choice of goods.
There are many benefits offree trade, 9Uch as:
(1) Facilitates comparative advantage to corporations. According to Adam
Smith's theory of absolute advantage, when the countries in a free trade
agreement made products and provided those products for the other
country at a cheaper rate than the receiving country could produce it,
both countries benefited. David Ricardo expanded on Smith's ideas
arguing that countries should do what they do better and cheaper than
other countries. This is called comparative advantage. Ricardo further
noted that concentrating on core competencies gave nations a compara­
tive advantage.
(it) Generating currency. Free trade also helps countries generate foreign
currency that they can use to purchase the things that they need. For
instance, Japan exports cars and computers to China and the United
States which helps in generating foreign currency. Japan takes the
revenue it earned from exporting and uses it to import needed products,
such as food or mineral fuels.
(iii) Opening up markets. Free trade opens foreign markets and lowers
barriers for corporations that otherwise might not be able to compete
44 SHIVA DELm UNIVERSITY SERIES

against local competitors. Without free trade agreements, foreign

cotporations must pay tariffs that increase their cost and decrease
competitiveness.
(iv) Increased competition. With more trade, domestic 6nns will face more
competition from abroad. Therefore, there will be more incentives to cut
costs and increase efficiency. It may prevent domestic monopolies from
charging too high prices.
(v) Economies of scale. H countries can specialise in certain goods they can
benefit from economies of scale and lower average costs; this is especially
true in industries with high fixed costs or that require high levels of
investment The benefits of economies of scale will ultimately lead to
lower prices for consumers and greater efficiency for exporting firms.

7777
4. International and EconomJc Organlzatk>ns: wro, UNCTAD,
World Bank and IMF.
Q. 1. Explain the working of the wro, its objectives, principles, structure
and functiorung.
Or
Discuss the organizational structure, principles and functions of the wro as
a regulator of global trade.
Ans. The World Trade Organization was established on January 1, 1995. The
'Manakesh Declaration' of lsth April, 1994 affirmed that the results of the
Uruguay Round would 'strengthen the world economy and lead to more trade,
investm.ent, employment and income growth throughout the world'. The WTO is
the embodiment of the Uruguay Round results and the successor to the General
Agreement on Tariffs and Trade (GATI).
Objectives of WTO
The WTO reiterates the objectives of GAIT, which are as follows:
(1) Raising standard of living and incomes, promoting full employment,
expanding production and trade and optimum utilisation of world's
resources.
(i1) InlToduce sustainable development-a concept which envisages that
development and environment can go together.
(iir) Taking positive steps to ensure that developing countries, especially the
least developed ones, secure a better share of growth in the world lTade.
Functions of WTO
The WTO is based in Geneva, Switznlond. Its functions are enumerated as
under.
(1) Administering and implementing the multilateral and plurilateral lTade
agreements, which together make up the WTO.
(i1) Acting as a forum for multilateral trade negotiations.
(lit) Seeking to resolve trade disputes.
(iv) Overseeing trade policies.
(v) Cooperating with other international institutions involved in global
economic policy making.
(m) Maintaining trade related database. Members are required to notify in
detail various trade measures and statistics.
(vit) Acting as a watchdog of international trade, constantly examining the
lTade regimes of individual members.
(viii) Acting as a management consultant for world trade. Experts on the panel
of WTO scan the world economic environment, and make observations
on contemporary issues.
(ix) Technical assistance and training for developing countries.
Having gone through the functions of the WTO one can conclude that the WTO
does not aim at economic or political integration, but seeks to promote free lTade
among member countries.
The WTO Agreement contains 29 individual legal texts covering everything
from agriculture to textiles and clothing, and from services to government

45
 46 SHIVA DELHI 1.JNNERSITY SERIES

procurement, rules of origin and intellectual property. Added to these are 25

additional ministerial declarations, d4!Cisio.ns and understandings, which spell
out further obligations and commibnents for wro members.
GAIT AND WTO:
The wro is not a simple extension of GATI. It completely replaces its
predecessor and has a very different dlaracter.
The major differences between the two bodies are as under:
(r) TI\e GATI was a set of rules, a multilateral agreement with no
institutional foundation, only a small associated secretariat which had its
origin in the atteinpt to establish an International Trade Organisation in
the 1940s. The WTO is a permanent institution with its own Secretariat.
(ir) The GATI was applied on a 'provisional basis' even if after more than
four decades, Governments chose to treat it as a permanent commitment.
The wro commitments are full and permanent.
(iil) Tile GA TI rules applied to trade in merchandise goods. In addition to
goods, the WTO covers trade in services and trade-related aspects of
intellectual property rights.
(iv) While GATI was a multilateral instrument, by the 1980s many new
agreements had been added of plurilateral, and therefore selective
nature. The agreements which constitute the WTO, are almost all
multilateral and thus, involve commitments for the entire membership.
(v) TI\e wro dispute settle.ment system is faster, more automatic, and thus
much less susceptible to blockages, than the old GATI system. The
implementation of wro dispute findings will also be more easily
assured.
'GATI 1947 continued to exist until the end of 1995, thereby allowing time for
all GATI members to accede to the WTO and permitting an overlap of activity in
areas like dispute settlement. Moreover, GATI lives on as 'GATI 1994', the
amended and updated version of GATI 1947, which is an integral part of the
wro Agreement and which continues to provide the key disciplines affecting
international trade in goods.
Q. 2. What is WTO? Explain its principles and functions in detail. Also
distinguish WTO from GAIT. (2012
Ans. The wro was established on 1 Jan., 1995. WTO acts as an umbrella
organization that encompasses the GATI along with two sister bodies:
• General Agreement on Trade in Services (GATS)
• Trade Related aspects of Intellectual Property Rights (fRIPS)
wro has taken over the resporu.ibility for resolving trade disputes and
monitoring the trade policies of member countries. All the major decisions are
taken by the members as a whole on the basis of consensus.
Objectives of WTO:
• To promote trade flows by encouraging nations to adopt non­
discriminatory and predictable trade policies.
• Achieve further liberalization gradually through multilateral
negotiations.
 A
4. INTERNATIONL AND ECONOMIC ORGANIZATIONS 47
• Establish impartial procedures for resolving trade disputes among
themselves.
WTO Tradi ng Systein Principles:
1. Most-Favoured-Nation (MFN) treating other people equally. Under the
WTO agreements, COWi.tries cannot nonnally discriminate between their trading
partners. This principle is known as the most-favoured-nation (MFN) treatment.
A country should not discriminate between i.ts own products and foreign
products but some exceptions are allowed in limited circumstances. MFN means
that every time a country lowers a trade barrier or opens up a market, it has to do
so for the same goods or servi.ces for all its trading partners-whether rich or
poor, weak or strong.
2. National Treatment-treating foreigners and locals equally. Imported and
locally-produced goods should be treated equally-at least after the foreign
goods have entered the domestic market. National treatment only applies once a
product, service or item of intellectual property has entered the market.
Therefore, charging customs duty on an import is not a violation of national
treatment even if locally-produced products are not charged an equivalent tax.
3. Free trade. Lowering trade barri.ers is one of the most obvious means of
encouraging trade. The barriers include customs duties (or tariffs) and measures such
as import baM or quotas that restrict quantities selectively. Opening up of the
markets can be benefic:ial, but it also requires adjusbnents. The wro agreements
allow countries to in.traduce changes gradually through " progr essive liberalization".
Developing countries a.re usually given longer time to fulfil their obligations.
4. Predictability. With stability and predictability, investment is encouraged,
jobs are created and consumers can fully enjoy the benefits of competition­
choice and lower prices. The multilateral trading system is an attempt by the
governments to make the business environment stable and predictable. When
countries agree to open their markets for goods or services, they are bound by
their commitments. This ensures higher degree of security for traders and
investors.
5. Promoting fair competition. The system of WTO is described not as just
"free trade", it is "free and fair trade". The system allows tariffs and protection in
limited circumstances. More accurately, it is a system of rules dedicated to open,
fair and undistorted competition. This system discourages "WI.fair practices"
such as export subsidies and dumping products at below cost to gain market
share.
6. Encouraging development and economic reforms. The WTO system
contributes to development. Developing countries need flexibility and special
privileges to implement the system's agreements. The agreements include the
provisions of GATI that allow for special assistance and trade concessions for
developing countries. Almost 3/4th of WTO members are developing countries
and transition economies. Better-off coW1tries should accelerate implementing
market access commitments on goods exported by least developed countries
(LDCs).
Functions of WTO. The five core functions that the WTO system serves are:
• a negotiation forum;
48 SHIVA DELHI UNIVERSITY SERIES

• a forum for settling disputes;

• transparency of trade policies through sun,eillance;
• technical assistance and training; and
• research and analysis.
In its day-to-day work, the WTO Secretariat has an influence on
implementation, through:
• the Trade Policy Reviews,
• the work of the Councils (such as the TRIPS Coun.ci.1)
• the training and technical assistance,
• the public communication function, and
• the research.
Differ=e between GAIT and WTO:
GAIT wro
(1) General Agreement on Tariffs (1) World Trade Organization
and Trade.
(ir) GATT was a multilateral (ii) WTO was formed as a
agreement regulatil1g replacement for GATT in 1995
international trade. It was with the purpose of supervisin.g
created in 1948. and liberalizing international
trade.

(iii) The main objective of GATT was (iii) Its objective is to govern GATT
to strengthen international trade. and international trade practices.
(iv) There was no permanent (iv) It has a permanent structure
structure or framework. with a permanent framework.
(v) It included rules and regulations (v) WTO includes trade in goods;
for trade in goods. trade in services and trade­
related aspects of intellectual
property rights.
(v1) It had a permanent appellate (vi) Disputes are resolved faster as
body to review findings and settlement system has a select
settle disputes. time frame.
Q. 3. Discuss the salient features of \Vorld trade and analyse recent trends in
World trade. [2015
Ans. The establishment of the World Trade Organizations (WTO) as the
successor to, the GATT on pt January, 1995 under the Marrakesh Agreement
places the global trading system on a firm constitutional footing with the
evolution of international economic legislation resulted through the Uruguay
Round of GAIT negotiations. A remarkable feature of the Uruguay Round was
that it paved the way for further liberalisation of intemational trade with the
fundamental shift from the negotiation approach to the institutional framework
envisaged through transition from GAIT to WTO Agreement.
Features of World Trade: Some of the most important salient features of world
trade organisation are as follows:
 4. INTERNATIONAL AND ECONOMIC ORGANIZATIONS 49

l. Non-Discrimination. 1hls is the most important principle on which

WTO has been founded. The principle of non-discrimmation means two
things. (1) All rrading partners will be granted the most favoured nation
(MFN) status, that is, each member state of WTO will rreat every other
member state equally as the most favoured nation doing rrade.
No discrimination will be done by a member of state between different
rrading states who are also members of WTO. However, some exceptions
have been provided in this regard, far example, in case regional trade
agree-ments exist. (i1) Forei gn goods, services, trademarks, patents and
copyrights shall be given the same treabnent as is given to nationals of a
country.
2. Free Trade. The objective of WfO, as in case of GAIT, is to promote free
trade among nations through negotiations. For this purpose WTO has to
work for progressive liberalisation of trade through reduction in tariffs
and removal of quantitative restrictions on imports by member countries.
3. Stability in the Trading System. Under WTO agreements member states
are committed not to raise tariff and non-tariff trade barriers arbitrarily.
This provides stability and predictability to the trading system.
4. Promotion o.f Fair Competition. WTO system of multilateral trading
system provides for transparent, fair and undistorted competition among
the various countries. Rules such as Most Favoured Nation (MFN)
treatment to all trading parties, equal treatment to foreign goods, patents
and copyrights as with nationals ensure fair competition among trading
countries. Besides, wro agreement provides for discouraging unfair
competitive practices such as export subsidies and dumping (that is,
selling products abroad below domestic prices to gain market access).
5. Special Concern for Developing Countries. WTO has shown special
concern for the developing countries as it has given them more time to
adjust to agreements under it and also some special privileges. An
important feature of WTO is that it would deal with not only the
disputes in the area of trade in goods but a whole range of issues such as
services and intellectual property rights.
6. Market Access Commitment. wro agreements which seek to establish
multilateral trading system require the member countries to undertake
market access commibnent on reciprocity basis. ln fact, market access is
ensured by abolishing non-tariff barriers as well as by reducing tariffs.
7. Decision at the Ministerial Level Meeting. Another feature of WTO
agreement is that it has upgraded decision-making at the ministerial
level. Important decisions regarding trade related matters are to be taken
at the Ministerial level meetings. Ministerial level meetings have now
been incorporated in the legal structure of wro.
8. Wider Range of Issues. Another important featw-e of WTO is that it will
deal with not only issues and disputes relating to trade in goods but also
the whole range of issues concerning trade in services and intellectual
property rights.
50 SHIVA DELHI UNIVERSTIY SERIES

9. Multilateral Trading System. The most important features of WTO is

that it seeks to establish just and fair multilateral system of international
trade wherein the developed countries, the developing countries, and the
least developing countries all have equal opportunities for market access
of their products in foreign countries and wherein discriminatory trade
barriers and unjust Government support to exports by different countries
have to be eliminated.
Recent Trends in World Trade:
1. United Nations' projection for India's exports to do well in coming times
is quite encouraging for the coWltry. According to Asia-Pacific Trade and
Invesbnent Report 2015 recently released by United Nations Economic
and Social Commission for Asia and th.e Pacific (UNESCAP), exports
from lndia are expected to relatively do well in 2016 as their shipments
are largely directed to advanced economies in Europe and North
America that are expected to expand in the corning year.
2. Presently, lndia's exports have registered a negative growth at(-) 24.3%
for a consecutive 1 O'h month. ln light of the major challenges being faced
by Indian exporters in the backdrop of the global economic slowdown,
Ministry of Commerce and Industry recently announced increased
support for export of various products and included some additional
items under the Merchandise Exports from lndia Scheme (MEIS).
3. Pertaining to global trade growth, WTO lowered forecast for world trade
growth to 2.8% in 2015 from 3.3% in April. These revisions reflect a
nwnber of factors that we.ighed on the global economy in the first half of
2015, including falling import demand in China, BrazU and other
emerging economies; (alling prices for oil and other primary
commodities and significant exchange rate fluctuations.
4. However, World Trade Organisation (WTO) in its recent flagship report,
World Trade Report 2015, highlighted that full implementation of the
Trade Facilitation Agreement (IFA) reached in December 2013 has the
potential to increase global merchandise exports by U5$1 trillion per
annum, with developing countries expected to capture more than half of
these gains.
5. In the direction of strengthening international economic relations, India
has signed 18 MOUs/ Agreements with Germany during the visit of
Chancellor of Federal Republic of Germany to India in the month of
October.
6. Signing of Trans-Pacific Partnership(TPP) Agreement by Ministers of the
12 Trans-Pacific Partnership (IPP) countries, Australia, Brunei
Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand,
Peru, Singapore, United States, and Vietnam is also a major development
at the international level.
Q. 4. Give an overview of UNCTAD.
Ans. The United Nations Conference on Trade and Development (UNCTAD)
was established in 1964 as a permanent intergovernmental body.
UNCTAD is the principal organ of the United Nations General Assembly
 4. INTERNATIONAL AND ECONOMIC ORGANIZATIONS 51

dealing with trade, investment, and development issues. The organization's goals
are to: "maximize the trade, investment and development opportunities of developing
countries and assist them in their efforts to integrate into tile world economy on an
equitable basis."
Objective. The primary objective of UNCTAD is to formulate policies relating
to all aspects of development including trade, aid, transport, finance and
technology. The conference ordinarily meets once in four years; the permanent
secretariat is in Geneva.
Creati.on. The creation of UNCTAD in 1964 was based on concerns of
developing countries over the international market, multi-national corporations,
and great disparity between developed nations and developing nations. The
United Nations Conference on Trade and Development was established to
provide a forum where the developing countries could discuss the problems
relating to their economic development. The organisation grew from the view
that existing institutions Like GATT (now replaced by the World Trade
Organization, WTO), the international Monetary Fund (lMF), and World Bank
were not properly organized to handle the particular problems of developing
countries. Later, in the 1970s and 1980s, UNCfAD was closely associated with
the idea of a New International Economic Order (NlEO).
Acl,ievements. One of the principal achievements of UNCTAD has been to
conceive and implement the Generalised System of Preferences(GSP). It was
argued in UNCTAD that to promote exports of manufactured goods from
developing countries, it would be necessary to offer special tariff concessions to
such exports. Accepting this argument, the developed countries formulated the
CSP scheme under which manufacturers' exports and some agricultural goods
from the developing countries enter duty-free or at reduced rates in the
developed countries. Since imports of such items from other developed countries
are subject to the normal rates of duties, imports of the same items from
developing countries would enjoy a competitive advantage.
Members. Currently, UNCTAD has 194 member states and is headquartered in
Geneva, Switzerland. UNCTAD has 400 staff members and a bi-annual (2010-
2011) regular budget of $138 million in core expenditures and $72 million in
extra-budgetary technical assistance funds.
Q. 5. Give the principles, objectives and functions of the World Bank.
Ans. The World Bank originated in 1944 as a result of the Bretton Woods
Conference. It is one of the world's largest sources of development assistance to
developing countries. It has extended assistance to more than 100 developing
colU'ltries. The world bank works with the government agencies, non­
governmental organizations and the private sector to formulate assistance
strategies.
Objectives of World Bank. The World Bank was established to prom.ote long­
term foreign investment loans on reasonable terms. The, purposes of th.e Bank, as
set forth in the 'Articles of Agreement' are as follows:
(1) To assist in the reconstruction and development of territories of members
by facilitating the invest-ment of capital for productive purpose
including;
 52 SHIVA DELHI UNIVERSITY SERIES

(a) the restoration of economies destroyed or disrupted by war;

(b) the reconversion of productive facilities to peaceful needs; and
(c) the encouragement of the development of productive facilities and
resources in less developing countries;
(ii) To promote private investment by means of guarantee or participation in
loans and other investments made by private investors.
(iii) When private capital is not available on reasonable terms, to supplement
private investment by providing on suitable conditions finance for
productive purpose out of its own capital funds raised by it and its other
resources.
(iv) To promote the long-range balanced growth of international trade and
the maintenance of equilibrium in balances of payments by encouraging
international investment for the development of the productive resources
of m.embers, thereby assisting in raising productivity, the standard of
living, and conditions of labour in their territories.
(v) To arrange the loans made or guaranteed by it in relation to international
loans through other channels so that the more useful and urgent projects,
large and smaU alike, will be dealt with first.
(vi) To conduct its operations with due regard to the effect of international
invesbnent on business conditions in the territories of members and in
the immediate postwar years, to assist in bringing about a smooth
transition from a wartime to peacetime economy.
World Ba11k performs tire followingfunctions:
(t) Granting reconstruction Joans to war devastated countries.
(it) Granting developmental loans to underdeveloped countries.
(iii) Provicting loans to governments for agriculture, irrigation, power,
transport, water supply, education, health, etc.
('iv) Providing loans to private concerns for specified projects.
(v) Promoting foreign investment by guaranteeing loans provided by other
organisations.
(ri.) Providing technical, economic and monetary advice to member countries
for specific projects.
(vii) Encouraging industrial development of underdeveloped countries by
promoting eco-nomic reforms.
Q. 6. Explain the objectives, functions and achievements of the IMF.
Ans. The International Monetary Fund (IMF) came into official existence on
December 27, 1945, when 29 countries signed its Articles of Agreement (its
Charter) agiwd at a conference held in Bretton Woods, New Hampshire, USA,
from July 1-22, 1944. The IMF commenced financial operations on March 1, 1947.
Its current membership is 182 countries.
IMF lends money to members having trouble meeting financial obligations to
other members, but only on the conditi.on that they undertake economic reforms
to eliminate these difficulties for their own good and that of the entire
membership. Contrary to widespread perception, the IMF has no effective
authority over the domestic economic policies of its members.
 4. INTERNATIONAL AND ECONOMIC ORGANIZATIONS 53

I11ere are several major achievements to tl1e credit of tl1e International

Monetary System. For example, it
• sustained a rapidly increasing volume of trade and investment;
• displayed flexibility in adapting to changes in international commerce;
• proved to be efficient (even when there were decreasing percentages of
reserves to trade);
• proved to be hardy (it survived a number of pre-lm crises, speculative
and otherwise, and the down-and-up swings of several business cycles);
• allowed for a growing degree or international cooperation;
• established a capacity to accommodate reforms and improvements.
11,e objectives of tlze International Monetary F11nd are:
• To promote international monetary cooperation through a permanent
institution that provides the machinery for consultation and
collaboration on international monetary problems.
• To facilitate the expansion and balanced growth of international trade
and to contribute, thereby, to the promotion and maintenance of high
levels of employment and real income and to the development of the
productive resources of all members as primary objectives of economic
policy.
• To promote exchange stability, to maintain orderly exchange
arrangements among members and to avoid competitive exchange
depreciation.
• To assist in the establishment of a multilateral system of payments in
respect of current transactions between members and in the elimination
of foreign exchange restrictions which hamper the growth of world
trade.
• To give confidence to members by making the general resources of the
Fund temporarily available to them under adequate safeguards, thus
providing them with opportunity to correct maladjustment in their
balance of payments without resorting to measures destructive to
national or international prosperity.
• In accordance with the above, to shorten the duration and lessen the
degree of disequilibrium in the international balances of payments of
members.
Q. 7. Explain the evolution of the IMF from the Bretton Woods era till the
present.
Ans. The United Nations Monetary and Financial Conference was held at
Mount Washington Hotel, Bretton Woods, USA in july 1944 in which 730
delegates from 44 Allied nations participated to design the international
monetary system. lt proposed the establishment of two core institutions
• International Monetary Fund (IMF), to achieve exchange rate stability
and to finance short term balance of payments deficits;
• International Bank for Reconstruction and Development (IBRD) to assist
in reconstruction and development of the member countries.
Under this system. each member nation established a par value in relation to
US dollar and maintained the market value of its currency within ±1 per cent of
 54 SHIVA DELHI UNIVERSITY SERIES

the defined value. The US dollar was pegged to gold at $ 35 per ounce. The US
dollar was the only cunency that was fully co:n,vertible to gold. Other cun:e:ncies
were not directly convertible to gold. Thus, countries held in US dollars as well as
gold for use as an international means of payment. This system can be described
as a dollar-based gold-exchange standard. Jt was observed that US dollar was
better than gold because dollars earned interest and facilitated liquidity.
Therefore, other countries accumulated dollars as official reserves and used it as
a:n intervention currency to stabilize exchange rates in the market.
Merits of this system
(r) Tius system economize on gold because countries could use not only
gold but also foreign exchange as a:n international means of payment.
(ii) Each member country could also earn interest on their foreign exchange
reserves.
(iit) Countries could save transaction costs associated with transporting gold
under international exchange system.
Demerits of t1ris system
(Q Under this system, the reserve-currency country would run balance of
payments deficits to supply reserves, but if such deficits were large, they
could lead to a crisis of confidence in the reserve currency itself.
(ii) Tius system turned out to be in.effective in the expansionary monetary
policy a:nd rising inflation.
(iir) TI1e Bretton Woods system evolved into a fixed-rate dollar standard. The
system eventually collpased, due lo diverging monetary and fiscal
policies, differe:ntial rates of inflation and various external shocks.
(iv) TI1e US$ was the main reserve currency held by central banks. Persistent
deficits in the US balance of payments had to be financed by heavy
capital outflows of dollars. Foreigners, having accumulated huge
reserves of US $, eventually lost confidence in the ability of the US to
convert dollars to gold.
(v) TI1e dollar was devalued a first time in 1971, a second time in 1973 till
eventually it started floating. Since 1973, the world has experienced more
volatile exchange rates.
Jn order to save the Bretton Woods system, 10 major countries met and
proposed the Smitliscmian Agreement in December 1971. According to this
Agreement.
• TI,e price of gold was raised to $ 38 per ounce,
• Each of the other countries revalued its currency against the U.S dollar
by up to 10 per cent.
• The band within which the exchange rates were allowed to move was
expanded from 1 per cent to 2.25 per cent in either direction.
• An international reserve, SOR. (Special Drawing Rights) was created by
11\,{F. SOR is a portfolio of major individual currencies and allocated to
the members of the 11\,{F. Countries could use the SOR in addition to gold
and foreign exchange to make international payments.

J J .J .J
5. Reg1onal Economic Integration: Forms of regional integration;
Integration efforts among, countries in Europe, North America
and Asia. Cost and benefit of regional economic Integration.
Q. 1. What is regional economic integration? What are the different forms of
regional economic organizations?
Ans. Eco11omic integration is the unification of economic policies between
different states through the partial or full abolition of tariff and non-tariff
restrictions on trade taking place among them prior to their integration. Th.e
objective of economic integration is to lead to lower prices for distributors and
coru,wners with the goaJ of increasing the combined economic productivity of
the states. Regiomll economic integration is an attempt to achieve economic
gains from the free flow of trade and investment between neighbouring
countries.
StRges of Economic Integration. Th.ere are several levels of economic
integration -
(i) Free Trade Area
(ii) Custom Union
(iii) Common Market
(it1) Economic Union
(v) Political Union
(i) Free Trade Area. In a free trade area, barriers to trade between member
countries are removed but each country determines its own external
trade policy.
For example, European Free Trade Association (EFTA) established in
1960. It joins four countries-Norway, Iceland, Liechtenstein and
Switzerland. Its emphasis has been on free trade in industrial goods.
Each member is allowed to determine its own level of protection.
(ii) Custom Union. A custom union eliminates trade barriers between
member cow1tries and adopts a common external trade policy. The
establishment of external trade policy requires significant administrative
machinery to oversee trade relations with non-members.
For t:c11mple., the Andean Pact was established between member
countries and imposes a common tariff of 5 to 20 per cent on the
products imported from outside.
(iii) Common Market. The next level of economic integration is common
market. It is similar to a custom union except that a common market also
aJJows factors of production to move freely between countries. Labotu
and capital are free to move because there are no restrictions on
immigration, emigration, or cross-border flows of capital between
member countries. A Common market demands a significant degree of
harmony and cooperation on fiscal, monetary and employment policies.
For example, MERCOSUR (South American Countries) established itself
as a Southern common market.
(iv) Economic Union. An economic union requires even close economic
integration and cooperation than a common market. In addition to free

ss
 56 SHIVA DELHI UNIVERSITY SERIES

flow of products and factors of production and the ad.option of common

external trade policy, it also requires a common currency and the
harmonization of tax rates. It demands a coordinating bureaucracy and
the sacrifice of significant amounts of national sovereignty to that
bureaucracy.
For example, single market of the European Union.
(v) Political Union. Political union is the logical culmination of attempts in
which a central political structure coordinates the economic, social, and
foreign policy of the member countries. The United States provides a
suitable example of political union. In United States, independent states
are effectively combined into a single nation.
Q. 2. \Vrite short notes on the following:
(a) NAFTA
(b) ASEAN
(c) European Union
(d) SAARC
Ans. (a) NAFTA. The North American Pree Trade Agreement (NAFTA) was
signed between the United States of America, Canada and Mexico. The
Agreement came into force on l 51 January, 1994. NAPTA seeks to eliminate all
tariffs on products and end other barriers to services and investment capital
within North America. It covers the following areas:
( i) Muket access. This covers tariff and non-tariff barriers, rules of origin,
governmental procurement.
(ii) Trade rules. Which look after safeguards, subsidies, countervailing and
anti-dumping duties, health and safety standards.
(iii) Services. Provides safeguards for b:ade in services (consulting,
engineering software etc.).
(iv) Investment. Investment rules governing minority interest, portfolio
investment, real estate and majority-ovn1ed or controlled investments
from the NAFTA countries.
(v) Intellectual property. Provides adequate and efficient protection and
enforcement of intellectual property rights.
(vi) Dispute settlement. Provides a dispute settlement process that is to be
followed instead of taking unilateral action against an offending party.
The significant provisions of NAFTA include trade liberalization, labour
standards and envirorunemtal standards. There have been very different views
on the potential benefits and harmful effects of NAFTA among its members. For
exn111ple, many Mexicans feared that high competition from the U.S firms would
damage the Mexican industry and economy, while many others believed that
liberalization and competition will increase the competitiveness of the Mexican
industry. Foreign. investment in Mexico has risen su.bstantially since the
agreement. NAFTA could also cause difficulties for exports from the developing
countries to the US and Canada because developing nation like Mexico would
get a considerable edge over other nations.
(b) AS£AN. The Association of South East Asian Nations (ASEAN) was
formed by the Bangkok Declaration in 1967 by five countries viz., Indonesia,
 S. REGIONAL ECONOMIC INTEGRATION 57

Malaysia, Philippines, Singapore and Thailand with a view to accelerate

economic progress. ASEAN expanded its membership to include other nations.
The agreement leads to cr-eation of ASEAN -China free trade zone within ten
years and eliminate tariff and non tariff barriers on trade. Its fundamental
principles include:
(1) Respect for the independence, sovereignty, equality, integrity and
national identity of all ASEAN Member States;
(ir) Shared commitment and collective responsibility in enhancing regional
peace, security ru,d prosperity;
(ir) Renunciation of aggression and of the threat or use of force or other
actions inconsistent with international law;
(iv) Peaceful settlement of disputes;
(v) Non-.interference in the internal affairs of ASEAN Membe.r States;
(111) Enhanced consultations on matters which affect the common interest of
ASEAN countries;
(vir) Adherence to the rule of law, good governance, the principles of
democracy and constitutional government;
(viii) Respect for fundamental freedom, the promotion and protection of
human rights, and the promotion of social justice.
(c) E11ropean Union. The EU is a unique economic and political partnership
between 28 European countries that together cover much of the continent.
The EU was created in the aftermath of the Second World War. The first steps
were to foster economic cooperation. The idea being that the countries who
trade with one another become economically interdependent and so more likely
to avoid conflicts. The reNlt was the European Economic Community (EEC),
created in 1958 initially increasing economic cooperation between six countries:
Belgium, Germany, Fran.ce, Italy, Luxemburg and Netherlands. Since then, a
huge single market has been created and continues to develop towards its full
potential.
The Single European Act was established to create a true single market by
abolishing administrative barriers to the free flow of trade and investment
between EU countries. The Act provided for the restructuring of substantial
sections of European industry. Twelve EU members now use a common
cunency, the Euro. The economic gains from a common currency come from
reduced exchange costs, reduced risk associated with currency fluctuations and
increased price competition within the EU. By adopting the Euro, the EU has
become the second largest currency zone in the world after that of the US dollar.
To qualify for EU membership the countries had to privatize state assets,
deregulate markets, restrictive industries and inflation. The European
Commission restricts mergers and acquisitions in order to reduce competition
with in th.e EU.
(d) SAARC. The South Asian Association for Regional Co-operation (SA.ARC)
is an economic and political organization of eight countries in Southern Asia.
The eight members are-Afghanistan, Bangladesh, Bhutan, India, Maldives,
Nepal, Pakistan and Sri Lanka. These South Asian countries agreed on fiTJe areas
of cooperation:
 58 smvA DELHI UNIVERSITY SERIES
• Agriculture and Rural Development
• Telecommunications, Science, Technology and Meteorology
• Health and Population Activities
• Transport
• Hu.man Resource Developmetn
The members of SAARC signed a framework agreement on SAFTA (South
Asia Free Trade Area) to reduce customs duties of all traded goods to zero by
the year 2016. '111e objectfoe of t1,e Agreement is to promote competition in the
area and to provide equitable benefits to the countries involved. It aims to
benefit the people of the SAARC Countries by bringing transparency and
integrity among the nations. SAFfA was also formed in order to increase th.e
level of trade and economic cooperation among the SAARC nations by reducing
the tariffs and barriers and also to provide special preference to the Least
Developed Countries (LDCs) among the SAARC nations.
The instruments involved in SAFTA are:
• Trade Liberalisation Programme
• Rules of Origin
• Institutional Arrangements
• Consultations and Dispute Settlement Procedures
• Safeguard Measures
Q. 3. How successfully ASEAN has promoted integration among various
countries of Asia? (2015
Ans. ASEAN. The ASEAN Declaration states that tlw aims and purposes of tile
Association are:
(1) To accelerate the economic growth, social progress and cultural
development in the region through joint endeavours in tile spirit of
equality and partnership in order to strengthen tll.e foundation for a
prosperous and peaceful community of Soutlleast Asian nations, and
(ir) To promote regional peace and stability through abiding respect for
justice and the rule of law in the relationship among countries in the
region and adherence to the principles of the United Nations Charter.
Founded in 1967, ASEAN today encompasses Brunei, Cambodia, Indonesia,
Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam -
economies at vastly different stages of development but all sharing immense
growth potential. ASEAN is a major global huh of manufacturing and trade, as
well as one of the fastest-growing consumer markets in the world. As the region
seeks to deepen its ties and capture an even greater share of global trade, its
economic profile is rising-and it is crucial for tllose outside the region to
understand its complexities and contradictions. The seven insights below offer a
snapshot of one of the world's roost diverse, fast-moving, and competitive
regions.
Labour-force e:x-pansion and producti,'ity improvements drive GDP growth­
and ASEAN is making impressive strides in both areas. Home to more tllan 600
million people, it has a larger population than the European Union or North
America. ASEAN has tile tllird-largest labour force in tile world, behind China
and India; its youthful population is producing a demographic dividend.
 5. REGIONAL ECONOMIC INTEGRATION 59

Perhaps most important, almost 60 per cent of total growth since 1990 has come
from productivity gains, as sectors such as manufacturing, retail,
telecommunications, and transportation grow more efficient. ASEAN has
dramatically outpaced the rest of the world on growth in GDP per capita since
the late 1970s. Income growth has remained strong since 2000, with average
ann.ual real gains of more than 5 per cenL Some member nations have grown at a
torrid pace: Vietnam, for example, took just 11 years (from 1995 to 2006) to
double its per capita GDP from $1,300 to $2,600. Extreme poverty is rapidly
receding. In 2000, 14 per cent of the region's population was below the
international poverty line of $1.25 a day (calculated in purchasing-power-parity
ten11s), but by, that share had fallen to just 3 per cent. Already some 67 million
households in ASEAN states are part of the "consuming class," with incomes
exceeding the level at which they can begin to make significant discretionary
purchases.
There 11ave been a 1111m.ber of noteworthy achievements by ASEAN member
states on t11e rond to ASEAN Economic Comm.unity 2015:
(1) Tariffs. This is a success story of political com.r:nitme.nt for ASEAN
member states. Following the implementation of the ASEAN Free Trade
Area, common effective preferential tariff rates are virtually zero for
ASEAN-6. More than 70% of intra-ASBAN trade is conducted at zero
most-favoured nation tariff rates, and less than 5% are subject to tariffs
above 10% (WTO 2011).
(i1) Trade facilitation. The five originaJ mem.ber states of ASEAN have live
implementation of national single windows already with planned full
roll out to all significant ports and airports by 2015.
(iii) Investment liberalisation and facilitation. The original ASEAN member
states are near achieving international best practices while the newer
members have to catch-up.
(iv) Services liberalisation. Mutual recognition agreements or their
equivalent have been agreed for three types of goods and seven
professions, and a "framework agreement'' has been concluded.

7177
6. International FJnandal Envlronment: International financial
system and Institutions; Foreign exchange markets, Spot market,
spot rate quotations, bid-ask spreads, Trading In spot markets,
Cross exchange rates; Forward Market: forward rate, long and
short forward positions, forward premium and discount.
Arbitrage, hedging and speculations. Foreign Investments­
types and flows; Foreign Investment In lndl.an perspective.
Q. 1. Explain the functioning of the various international financial systems
and institutions glven below:
(a) IFC
(b) Asian Development Bank (ADB)
(c) Multilateral Investment Guamttt Agency (MIGA)
(d) International Development Association
(e) IBRD
Ans. (a) IFC. The IFC was established in 1956. There are 133 countries that are
tnembers of the IFC and it is legally and financially separate from the IBRD,
although IBRD provides some administrative and other services to the IFC. The
IFC's main responsibilities are (1) To provide risk capital in the form of equity
and long-term loans for productive private enterprises in association with
private investors and management; (ir) To encourage the development of local
capital markets by carrying out standby and underwriting arrangements; and
(iii) To stimulate the international flow of capital by providing financial and
technical assistance to privately controlled finance companies. Loans are made
to private firms in the developing member countries and are usually for a period
of seven to twelve years. The key feature of the IFC is that its loans are made to
private
enterprises and its investments are made in conjunction with private business.
ln addition to funds contributed by IFC. funds are also contributed to the same
projects by local and foreign investors.
(b) Asum Development Bank (ADB). The Asian Development Bank is a
multilateral developmental finance institution founded in 1966 by 31 member
governments to promote social and economic progress of Asian and the Pacific
reglon. The Bank gives special attention to the needs of smaller or less
developed countries and gives priority to regional/ non-regional national
programmes. The inaugural meeting was held in Tokyo and the newly named
bank was installed in Manila (Philippines). The first President was Mr.
Wanatanade and during his initial years the bank conducted regional surveys to

60
 6. INTERNATIONAL FINANCIAL ENVIRONMENT 61
develop a fuller understanding of the social and economic conditions of the
Developing Member Countries (DMq.
The Bank's principal functions are:
• To extend loans and equity investments for the economic and social
development of its Developing Member Countries (DMCs);
• To provide technical assistance for the preparation and execution of
development projects and programmes and for advisory services;
• To promote and facilitate investment of public and private capital for
development purposes; and
• To respond to requests for assistance in coordinating development
policies and plans of its DMCs.
(c) MulHiatertd Investment G1U1r1111tee Agency (MIGA). The MIGA was
established in 1988 to encourage equity investment and othe.r direct investment
flows to developing countries by offering investors a variety of different
services. It offers guarantees against noncommercial risks; advises developing
member governments on the design and implementation of policies,
programmes and procedures related to foreign investments; and sponsors a
dialogue between the international business community and host governments
on investment issues.
(d) lntemaHonal Development Association. The IDA was formed in 1960 as a
part of the World Bank Group to provide financial support to Least Developed
Countries (LDCs) on a more liberal basis than could be offered by the IBRD. The
IDA has 137 member countries, although all members of the IBRD are free to
join the IDA. IDA's funds come from subscriptions from its developed members
and from the earnings of the lBRD. Credit terms usually are extended to 40 to 50
years with no interest. Repayment begins after a ten-year grace period and can
be paid in the local currency, as long as it is convertible. Loans are made only to
the poorest countries in the world, those with an annual per capita gross
national product of $480 or less. More than 40 countries are eligible for IDA
financing.
(e) IBRD. The IBRD was set up in 1945 along with the IMF to aid in rebuilding
the world economy. It was owned by the governments of 151 countries and its
capital is subscribed by those governments; it provides funds to borrowers by
borrowing funds in the world capital markets, from the proceeds of loan
repayments as well as retained earnings. At its funding, the bank's major
objective was to serve as an international financing facility to function in
reconstruction and development. The IBRD lends money to a government for
the purpose of developing that country's economic infrastructure such as roads
and power generating facilities. Funds are directed towards developing
countries at more advanced stages of economic and social growth. Also, funds
are lent only to members of the IMF, usually when private capital is unavailable
at reasonable terms. Loans generally have a grace period of five years and are
repayable over a period of fifteen or fewer years.
Q. 2. What d.o you understand by foreign exchange market? Give the
different functions performed by the foreign exchange market.
Ans. The Foreign exchange market is a global centralized market for the
 62 SHIVA DELm UNIVERSITY SERIES

exchange of one currency for another. It is not restricted to any given country or
geographical area. Foreign exchange markets are .made up of banks, commercial
companies, central banks, investment management firms, hedge funds and retail
forex brokers and investors.
The foreign exch4nge market performs tl,e following important functions:
(1) Transfer function. The basic function of the Foreign Exchange Market is
to facilitate the conversion of one currency into another, i.e., to
accomplish transfers of purchasing power between two countries. This
transfer of purchasing power is effected through a variety of credit
insttuments, such as telegraphic transfers, bank drafts and foreign bills.
(ii) Credit function. Another function of the Foreign Exchange Market is to
provide credit, botl1 national and international, to promote foreign
trade.
(ii,) Hedging function. A third function of the Foreign Exchange Market is
to hedge foreign exchange risks. Exchange risks should be avoided or
reduced. For this, the exchange market provides facilities for hedging
anticipated or actual claims or liabilities through forward contracts in
foreign exchange. A forward contract which is normally for three
months, is a contract to buy or sell foreign exchange against another
currency at some fixed date in the future at a price agreed upon now.
Q. 3. Write short notes on. the followin g:
(a) Foreign Excha.nge Risk
(b) Foreign Exchange Exposure
(c) Euro Cu.rrenc:y Market
Ans. (a) Foreign Exchange Risk. The risk of investment value changing due to
changes in the currency's exchange rate is known as foreign exchange risk. The
risk that an investor will have to close out a long or short position in a foreign
currency due to adverse movement of exchange rate is also known as currency
risk or exchange rate risk
This risk usually affects businesses that are involved in export or import but it
can also affect investors making international investments. For example, if money
must be converted to anther currency to make a certain investment, then any
future changes in the currency exchange rate will cause that investment value to
either increase or decrease when the investment is sold and converted back into
original currency.
(b) Foreign Exc11a11ge. Exposure- Foreign exchange exposure is the sensitivity of
the real domestic currency value of assests, liabilities, or operating incomes to
unanticipated changes in exchange rates. It is the risk associated with the
activities of the global firm dealing in currencies other than its home currency.
Essentially it is the risk that a foreign currency may move in a direction which
is financially detrimental to the global firm. For example, in 2010 the weak Euro,
British Pound and Australian dollar had a negative impact upon reported US
dollar result (2000}.
(c) E11ro-currency Market. The Euro-currency market is the money market for
borrowing and lending currencies that are held in the form of deposits in banks
located outside the countries where the currencies are issued as legal tender.
 6. INTERNATIONAL FINANCIAL ENVIRONMENT 63

Clraracteristics of Euro-c11rrency (off-sl1ore) market:

(i) Ti:ansactions in each currency take place outside the country of origin of
that currency.
(i1) Even though the transactions are recorded outside the country of is.sue, it
continues to be held in the country of issue. This is because a currency
cannot be used for settlement of commercial liability outside its dom.estic
area.
(iiz) Euro-Currency deposits and loans fall outside the regulatory and
supervisory control of the monitoring authority in the country of origin.
(iv) Euro-Currency market is distinct from the foreign exchange market. It is
a market for deposits and for loans between banks and between banks
and theii: customers. It is a market in which foreign currencies are lent
and borrowed whereas in the foreign exchange market, foreign
currencies are bought and sold. 1his market therefore converts short
term deposit resources into short and medium term loans for financing
projects. While the Euro-Currency market operates on interest rates, the
foreign exchange market operates on exchange rates.
(v) Due to absence of regulation, deposits in this market are u.nsecured. Due
to this, deposits are received only on short-term basis (mnxinium: one year)
whereas loans are demanded on medium to long-term basis. This creates
an asset-liability mismatch which results in Euro-banks being exposed to
both liquidity and interest rate risks.
(v1) To eliminate interest rate risk, Euro-banks developed the credit roll-over
concept which Involves resetting the interest rates on loans at fixed pre­
decided intervals. To achieve thls loans/credits are provided on 'floating
rates of interest'. To ensure that the Interest rates are reset on a fai:r and
equitable basis, the concept of reference rates called UBOR (London
Inter Bank Offered Rate) was developed.
(viJ) Each Euro-Currency credit (loan) specifies the periodicity of the roll-over
and the LIBOR to which it is referenced. To provide a uniform profit
margin for the lender a 'MARKUP' is specified over and above the
UBOR The interest cost to the borrower is therefore the applicable
UBOR + Mark-up. The mark-up normally remains constant through the
life-span of the loan.
Q. 4. Discuss the concept of Foreign Exchange Market.
Ans. Foreign exchange market is the market in which participants are able to
buy, sell exchange and speculate on currencies. Foreign exchange markets are
made up of banks, companies, central banks, investment management firms,
hedge funds and retail foreign exchange brokers and investors. The forex market
is considered to be the largest financial market in the world.
Since the currency markets are large and liquid they are considered to be the
most effective financial markets. The foreign exchange market includes a global
network of computers that connects participants from all parts of the world.
Hence, it is a global decentralized market for the trading of currencies.
The foreign exchange market works through financial institutions and it
operates on several levels. Banks turn to a smaller number of financial firms
 64 SHJVA DELID UNIVERSITY SERIES

known as dealers. These dealers are actively involved in large quantities of

foreign exchange trading. Most forex dealers are banks, insurance companies and
other financial firms. Trade between foreign exchange dealers can be very large,
involving hundreds of millions of dollars.
The forex market assists international trade and investments by enabling
currency conversion.
Following are the maill features/cl111Tacteristics of foreign excl,ange marker.
(1) Forex market is the only market i.e., open 24 hours a day except
weekends.
(ir) Volume of transactions which are executed in foreign exclumge market is
extremely huge because of many big players in the market.
(ii,) llley are more liquid than any other market.
(iv) They are present in every country and hence are geographically every
where in the world.
(v) 111.ese markets are difficult to trade in as the exchange rates of counbies
are affected by so many factors like liquidity, interest rates, geo political
factors etc.
(tn) 13ig banks and governments are major players in foreign exchange
market.
Q. 5. State the functions performed by the Foreign Exchange Market.
Ans. Following are the main /11nctio11s of foreig11 exchange market
(1) Tra.nsfer function. The basic function of the foreign exchange market is
to facilitate the conversion of one currency into another. It accomplishes
the transfer of purchasing power between two countries. This transfer of
purchasing power is effected through various instruments like bank
drafts, foreign bills and telegraphic transfers. In performing the transfer
function, the foreign exchange market carries out payments
internationally by clearing debts in both directions simultaneously,
analogous to domestic clearings.
(ir) Credit function. Another function of the foreign exchange market is to
provide credit both national and international, to promote foreign trade.
When foreign biJJs of exchange a.re used in international payments, a
credit for about 3 months, till their maturity is required.
(iir) Hedging function. The third function of foreign exchange market is to
hedge foreign exchange risks. In a free exchange market when exchange
rates (price of one currency in terms of another currency) change, there
may be a ga.in or loss to the party concerned. Under this conclition, a
person or a firm undertakes a great exchange risk if there are huge
amounts of net claims or net liabilities which are to be met in foreign
money. Exchange risks as such should be avoided or reduced. For this
the exchange market provides facilities for hedging anticipated or actual
claims or liabilities through forward contracts in exchange. A forward
contract which is normally for three months, is a contract to buy or sell
foreign exchange against another currency at some fixed date in the
future at a price agreed upon now. No money passes at the time of the
contract, but the contract makes it possible to ignore any likely changes
 6. INTERNATIONAL FJNANCI.AL ENVIRONMENT 65

in exchange rate. The existence of a forward market, hence makes it

possible to hedge an exchange position.
Q. 6. Discuss the concept of Spot Market.
Or
What do you understand by spot market? Explain.
Ans. Spot market is one of the foreign exchange markets in which the
commodity is bought or sold for an immediate delivery or delivery in the very
near future. The trades in the spot markets are settled on the spot. This market is
of daily nature and deals only in spot transactions of foreign exchange and not in
future transactions. ln simple words, spot market refers to the market in which
the receipts and payments are made immediately. Usually, a time of two business
days is allowed to settle the transaction. The exchange rate that prevails in the
spot market is termed as Spot Rate or Current Rate.
Working of Foreign Exchange Spot Market:
A spot deal in foreign exchange market comprises of a bilateral contract
between two parties in which a party transfers a set amount of a particular given
currency against the receipt of a specified amount of another currency from the
counter party, based on an agreed exchange rate, within two business days of the
date when the deal gets finalised. The price is based on the ongoing exchange
rate, i.e, the current value of one country's currency relative to another. Porex
currency transactions which require delivery on the same day are cash
transactions. The most traded currency in the spot market is US dollar. The other
major common currencies traded in spot markets are the Euro, Yen, Pound and
Swiss Francs.
Tl,ere are many benefits to trading in the spot market wlricl1 include:
Lower capital requirement
Easy to operate
Lower transaction costs
An ever-changing market
Access to large trading volumes.
Q. 7. What is meant by Spot Rate?
Or
Define spot rate quotation.
Ans. The price quoted for immediate settlement on a commodity, a security or
a currency. The spot rate also called 'Spot price' is based on the value of an asset
at the moment of the quote. This value is in turn based on how much buyers are
willing to pay and how 1nuch sellers are willing lo accept. TI1i.s depends on
factors like current market value and expected future market value. Hence spot
rates change frequently. In case of currency transactions, the spot rate is
influenced by the demands of individuals and business willing to transact in
foreign currency as well as by the forex traders. TI1e spot rate from a foreign
exchange perspective is also called 'Benchmark Rate' or 'Straight Forward Rate'.
Spot settlement, i.e., the transfer of funds that completes a spot transaction,
normally occurs one or two business days from the trade date. The spot date is
the day when settlement occurs. Regardless of what happens in the markets
between the date the transaction is initiated and the date it settles, the transaction
will be completed on the agreed upon spot rate.
 66 SHIV
A DELHI UNIVERSITY SERIES

Q. 8. What is meant by 'Bid-ask Spread'? Discuss.

Or
Explain the concept of 'Bid-ask Spread.
AM. 'Bid-ask Spread' is the amount by which the ask price exceeds the bid.
This is essentially the difference in price between the highest price that a buyer is
willing to pay for an asset and the lowest price for which a seller is willing to sell
it. For example, if the bid price is $20 and the ask price is $22, then the 'Bid-ask
spread' is $2. The size of the spread from one asset to another will differ mainly
because of the difference in liquidity of each asset. For exnmple, currency is
considered the most liquid asset in the world and the bid-ask spread in the
currency market is one of the smallest. On the contrary, less liquid assets such as
a small capital stock may have relatively higher spread.
(Bid-uk Spread • Ask-price - Bid price)
Q. 9. Define Cross Exchange Rate.
Or
What do you understand by cross exchange rate? Explain.
Ans. Cross exchange rate is the currency exchange rate between two
currencies, both of which are not the official currencies of the country in which
the exchange rate quote is given. In other words, the cross rate is the exchange
rate between currency A and currency C derived from actual exchange rate
between currency A and between currency B and currency C. Often cross rate is
referred to an exchange rate between two currencies not involving the US dollar.
Currency vendor provides quotes for only the most liquid currencies, like U.S.
dollar, Euro, Pound etc. Exchange rate between other currencies is normally
calculated as the cross rates using the quotes for major currencies.
...where A = Uni!s of currency A per unit of currency C
A = -><-
A B
C
-
C B C B = UnJta of currency A per unit of currency B
= UnJIS of currency B per W\it of currency C
C
Q. 10. Define Forward Market.
Or
Discuss the concept of forward market.
Ans. The forward market refers to the market in which sale and purchase of
foreign currency is settled on a specified future date at a rate agreed upon today.
The quoted exchange rate in this market is called, 'Forward Rate'. Many of the
international transactions are signed on one date and completed on a later date.
Forward contracts a.re made to minimise the risk of loss due to adverse changes
in the exchange rate through hedging and for the purpose of making profit. The
nature of forward types of foreign exchange markets is decentralised with
participants from all over the world entering into different types of forex deals
either on a one-to-one basis or through brokers. The forward markets have no
set terms with regard to the settlement dates and this may range from 3 days to
3 years. Any date post the spot date can be considered as a fonvard settlement.
 6. INTERNATIONAL FJNANCIAL ENVIRONMENT 67

Q. 11. Explain the concept of forward rate.

Ans. A rate applicable to a financial transaction that will take place in the
future. Forward rates are based on the spot rate, adjusted for the cost of carry
and refer to the rate that will be used to deliver a currency at some future time.
bl forex, the forward rate specified in an agreement is a contractual obligation
that must be honoured by th.e parties involved. For example, an American
exporter has a large export order pending for Europe, and undertakes to sell 5
million euros in exchange for dollars at a rate of 1.35 euros per U.S. dollar in six
month time. The exporter is obligated to deliver 5 million euros at the specified
date, regardless of status of export order or the exchange rate prevailing in the
spot market at that time.
Q. 12. Distinguish between Long and Short Forwazd Positions in forwazd
markets.
Ans. The differences between long and short forward positions are as follows:
(I) The long position holder is the buyer of the contract and the short
position holder is the seller of the contract
(ii) The long position will take the delivery of the asset and pay the selJer of
the asset the contract value, while the seller is obligated to deliver the
asset versus the cash value of the contract at the origination date of this
transaction.
(iii') Both the parties are at risk of default as typically no cash is exchanged at
the beginning of the transactio.n. However certain transactions do need
that one or both sides put up some form of colJateral to protect them
from the defaulted party.
Q. 13. State the procedure for settling a forwazd contract at expiration.
Ans. A forward co11.tract at expiration can be settled in one of th� following
two ways:
(i) Physical delivery. It refers to an option or forward contract that requires
the actual underlying asset to be delivered on the specified delivery
date, rather than being traded out with offsetting contracts. Most
derivatives are not actually exercised but are traded before their
delivery dates. When trade of commodities occur physical delivery is
essential. Physical delivery is also carried with financial instruments.
Traders, who hold a short position in a physically settled security,
futures contract to expiration are required to make delivery of the
underlying asset. Traders, who do not own assets, are obligated to
purchase them at the current price.
(ii) Cash settlement. It refers to an option or futures contract that requires
the counter parties to the contract to net out the cash difference in the
value of their positions. The appropriate party receives the cash
difference. In such type of settlement no actual assets are delivered at
the expiration of futures contract Instead traders must settle any open
position by making or receiving cash payment based on the difference
between the final settlement price and the previous day's settlement
price. Usually the final settlement price for a cash settled contract will
 68 SHIVA DELID UNIVERSITY SERIES

reflect the opening price for the underlying asset. Once this payment is
made the buyers and sellers have no further obligation on the contract.
Q. 14. What is meant by Forward Premium and Forward Discount?
Ans. Excess or deficit resulting from a forward delivery contract in currency
trading is called 'Forward Premium' or 'Forward Discount' respectively.

[Annualised forward pmmum • Forwud rate - Spot nte x 360

Olarount Spot rate No. ol days in a conlrad >'lOO
. ].
A positive percentage value means a forward premium and a negative
percentage value means a forward discount.
If the forward exchange rate for a currency is higher than the spot rate, there is
a premium on that currency. A discount exists when the forward exchange rate is
lower than the spot rate. A negative premium is equivalent to a discount.
Forward currency exchange rates often differ from the spot exchange rate.
For example, if the ninety day¥/$ forward exchange rate is 109.50 and spot rate
is ¥/$ = 109.38, the dollar is considered to be strong relative to the yen, as the
dollar's forward value, ex.ceeds the spot value. The dollar has a premium of 0.12
Yen per dollar. The yen would trade at a discount because its forward value in
terms of dollars is less than its spot rate.
Q. 15. Discuss the concept of arbitrage in the foreign exchange market. Give
a suitable example.
Ans. Currency arbitrage is a forex strategy in which a currency trader takes
advantage of different spreads offered by brokers for a particular currency pair
by making trades. Different spreads for a currency pair imply disparities between
the bid and ask prices. Currency arbitrage involves buying and selling currency
pairs from different brokers to take advantage of this disparity. For example, two
different ban.ks (Bank A and Bank B) offer/ quote for the US/EUR currency pair.
Bank A sets the rate at 3/2 dollars per euro and Bank B sets its rate at 4/3 dollars
per euro. In currency arbitrage, the trader would take one euro, convert that into
dollars with Bank A and then back into euros with Bank B. The end result is that
the trader who started with one euro now has 9/8 euros. The trader has made a
1/8 euro profit, if trading fee is not taken into consideration. Currency arbitrage
involves the exploitation of the differences in quotes rather than movements in
the exchange rates of the currencies in the currency pair. Forex traders typically
practice tw0<111Tency arbitrage in which the differences between the spreads of
two cun:ericies are exploited. Traders can also practice three currency arbitrage,
also known as triangular arbitrage. Due to the use of computers and high speed
trading systems, large traders often catch differences in currency pair quotes and
close the gap quickly.
Q. 16. Write a brief note on cwrency speculation in the foreign exchange
market.
Ans. Currency speculation involves buying, selling and holding currencies in
order to make a profit from favourable fluctuations in exchange rates. In other
words, it is the act of trading in an asset or conducting a financial transaction that
has a significant risk of losing most or all of the initial outlay, in expectation of a
substantial gain. In the context of foreign exchange, currency speculation means
 6. INTERNATIONAL FINANCIAL ENVIRONMENT 69

buying and selling of currencies for the purposes of profiting on the changes in
exchange rates. Speculation i.n currencies is most often referred to as 'currency
trading'. Currencies have the largest and most liquid speculative market place in
the world. The large majority of cunency speculation is done by traders who
have no other purpose for buying and selling currencies than profiting on price
changes. The currency market is unique as it operates through a global market
place with major exchanges throughout the world connected through a global
interbank. With large scale and frequent fluctuation currency traders have great
access to trade and perpetual opportunities to gain. Currency speculation
involves high degree of .risk since predicting what events will influence exchange
rates during a specific period of tim.e as well as the magnitude of influence, is
very difficult. For example, if a trader believes that euro will appreciate against the
US dollar, then the trader will buy euros with US dollars. lf the exchange rate
rises and th.e investor thinks that the appreciation will taper off, the investor can
buy US dollars with the euros that were purchased. The profit is made by the use
of arbitrage (diffe.rence between the currency exchange rates). If the trader buys
euros with US dollars with belief of appreciation of euros and euros do not
appreciate, the trader could lose money as the euros are not worth as much as
before.
Q, 17. Write a brief note on Foreign Exchange Hedge.
Or
What do you understand by hedging?
Arul. A foreign exchange hedge is a method used by companies to eliminate or
hedge their foreign exchange risk resulting from transactions in foreign
currencies. Hedging transfers the foreign exchange risk from the trading or
investing company to a business that carries the risk such as a bank. There is cost
to the company for setting up a hedge. By setting up a hedge, the company also
forgoes any profit if the movement in the exchange rate would be favourable to
it.
When a currency trader enters into a trade with the intent of protecting an.
existing or anticipated position from an unwanted move in the foreign currency
exchange rates, they can be said to have entered into a forex hedge. By utilising a
forex hedge properly, a trader that is long'" 1 a foreign currency pair can protect
themselves from downside risk, while the trader that is short..2 a foreign currency
pair can protect again.st upside risk.
Currency hedging is the act of entering into a financial contract in order to
protect against unexpected, expected or anticipated changes in currency
exchange rates. Currency hedging is used by financial investors and businesses to
eliminate risks they encounter. When conducting business at a global level,
hedging can be associated with an insurance policy that limits the impact of
foreign exchange risk.
Tlte primary metliods of liedging an RS follows:
(1) Spot contracts. Spot contracts are the regular type of trade that is made
by a retail forex trader. Since spot contracts have a very short-term
70 SHIVA DELHI UNIVERSITY SERIES

delivery date (two days) they are not the most effective currency hedging
method.
(ii) Foreign CW'l'ency options. This is the most popular method of currency
hedging. The foreign currency option gives the plll'Chaser the right, but
not the obligation to buy or sell the currency pair at a particular exchange
rate at some time in the future. Regular options strategies can be
employed such as bull or bear spreads to limit the loss potentiaJ of
currency trade.
Long Position: The buying of a security such as a stock, commodity or
currency, with the expectation that th.e asset will rise in vaJue.
Short Position: A short position is the saJe of a borrowed security,
commodity or currency with the expectation that the asset will fall in
value.
Q. 18. Write s.hort note on:
(a) Measures for Promoting Foreign Investments
(b) Types of FOi
(c) Trends in Foreign Direct Investment in India
(d) Greenfield and Brownfield Investment
Ans. (a) Measures to promote Foreign Direct Investment into India by tl1e
Indian Govemment. A investment made by foreign business entity into a
business entity in another country is called Foreign Direct Investment. Foreign
investment is the investment originating from other countries. Foreign Direct
Jnvestment plays an important role in the development of an economy. It helps
in achieving a certain degree of linanclaJ stability development and growth. In
order to attract Foreign Direct Investment FD!. The Government has put in place
a policy framework on FOi which is transparent, predictable and easily
comprehensible. The Indian government has announced a number of reforms
and has implemented several industrial policies:
• The FD( is aJlowed in India through collaborations such as Joint Venture
collaborations, preferential allotments and investment through EURO
issues.
• It has opened an FOi route by setting up of 100% EOUs /EHTPs/ STPs,
etc. and entering into Foreign technology agreement.
• FDI is encouraged in almost all the economic activities under the
automatic route.
• Huge amounts of FDI is coming into India through non-resident
Indians, internationaJ companies and various other foreign investors.
• FOi Approval in India is also done by the Foreign Investment Promotion
Board. The time taken by Foreign Investment Promotion Board for
approving the proposaJs for foreign direct investment in India is
between four to six weeks.
Major advantages of FDI in India have been in terms of:
• Increased capital inflows.
• Improved technology.
• Management expertise.
• Access to internationaJ markets
 6. INTERNATIONAL FINANCIAL ENVIRONMENT 71
The major sectors tl,at l1at1e benefited from Foreign Direct Investment are:
• Financial sector
• Insurance
• Telecommunications
• Hospitality and Tourism
• Pharmaceuticals
• Software and Information technology
(b) Types of FDI. Foreign direct investment (FDI) is a direct investment into
production or bW1iness in a cowitry by an individual or company of another
cow,try, either by buying a company in the target country or by expanding
operations of an existing business in that country. FDis require a business
relationship betweell a parent company and its foreign subsidiary. Foreign
direct business relationships give rise to multinational corporations.
FDls can be broadly classified into two types-Outward FDls and Inward
FDls, depending on the direction of flow of money.
Inward FDI occurs when foreign capital is invested in local resources. The
factors responsible for the growth of inward FDI include tax breaks, low interest
rates and grants.
Outward POI, also referred to as "direct investment abroad", is backed by the
government against all associated risks.
Other types of PDI are based on the necessities of differential performance and
limitations related with ownership patterns. These are:
(/) Vertical Foreign Direct Investment. Vertical Foreign Direct Investment
takes place when a multinational corporation owns some shares of a
foreign enterprise, which supplies inputs for it or uses the output
produced by the MNC. Vertical FDI takes two forms:
• Backward vertical FDI. It is an investment in a foreign country's
industry that provides inputs for a firm's domestic production
processes. Such type of FDI is mainly found in extractive industries
(e.g., oil extraction, bauxite mining, tin mining and copper mining). Its
objective is to provide inputs into firm's downstream operations (e.g.,
oil refining, aluminium smelting).
• Forward vertical FDI. In this type of FDI, an industry abroad sells the
outputs of a firm's domestic production processes. It is less common
than backward vertical FDI. For example, Volkswagen entered the US
market and acquired a large number of dealers rather than distribute
its cars through independent US dealers.
(ii) Horizontal Foreign Direct Investment. Horizontal Foreign Direct
Investment is an investment in the same industry abroad as a firm
operates in at home. It takes place when a multinational company
carries out a similar business operation in different nations. Firms
apparently prefer horizontal FDI over either Licensing or Exporting.
This may be due to number of factors such as -transportation costs,
market imperfections, competition, strategic behaviour and location
advantages.
 71. SHIVA DELHI UNIVERSITY SERIES
(c) Trends in Foreign Direct I11vestmetrt in India. Foreign Direct Investment
helps in accelerating the rate of economic growth. FDI provides Capital. Foreign
Direct Investment is expected to bring needed capital to developing countries.
The developing countries need higher investment to achieve increased targets of
growth in national income.
The Salient Features of Foreign Direct Investment Policy in India are RS
follows:
1. FDI up to 100 per cent is allowed under the automati.c route in all activities/
sectors except the following, which will require approval of the Government:
(1) Activities/items that require an Industrial licence.
(i,) Proposals in which the foreign collaborator has a previous/existing
venture/ tie-up in India in the same or allied field.
(iir) All proposals relating to acquisition of shares in an existing Indian
company by a foreign/NRl investor.
(iv) All proposals falling outside notified sectoral policy/caps or under
sectors in which FOi is not permitted.
2. FDI in areas of special economic activity:
(1) Special Economic Zones (SEZs). 100 per cent FDI is permitted under
automatic route for setting up of Special Economic Zone. Units in SEZ
qualify for approval through automatic route subject to sectoral norms.
Details about the type of activities pennitted are available in the Foreign
Trade Policy issu.ed by the Department of Commerce. Proposals not
covered under the automatic route require approval by FIPB.
(ii) Export Oriented Units (EOUs). 100 per cent FDI is permitted under
automatic route for setting up 100 per cent EOU, subject to sectoral
norms. Proposals, which are not covered under the automatic route
would be considered and approved by FIPB.
(iir) Industrial Pllrlcs. 100 per cent FDI is pennitted under automatic route for
setting up of Industrial Parks.
Electronic Hardware Technology Parle (EHTP). All proposals for FDI/NRI
investment in EHTP Units are eligible for approval under the automatic
route subject to the parameters listed. For proposals not covered under
automatic route, the applicant should seek separate approval of the FIPB,
as per the procedure outlined in the policy.
(iv) Sofrware Technology Park Units. All proposals for FDI/NRI investment in
SfP units are eligible for approval under automatic route subject to
parameters listed. The applicant should seek separate approval of the
FlPB for proposal not covered under automatic route.
(d) Greenfield and Bruw,rfield Investment.
Greenfield Investment. A greenfield investment is a form of foreign direct
investment where a parent company builds its operations in a foreign country
from the ground up. Tiris form includes investment in construction of new
production facilities, the building of new distribution hubs, offices and living
quarters. In addition to building new facilities, most parent companies also create
new long-term jobs in the foreign country by hiring new employees. Developing
 6. INTERNATIONAL FJNANCIAL ENVIRONMENT 73
countries often offer prospective companies tax breaks, subsidies and other type
of incentives to set up Greenfield investments. Coca Cola, McDonald's and
Starbucks are great examples of US firms that have invested in Greenfield
projects around the world.
The advantages of a Greenfield l1tvestment are:
(1) It will achieve economies of scale and scope in production, marketing,
finance, research and development, transportation and purchasing.
(ii) It will have greater control of all aspects of the business.
(iii) It will be able to implement the best long-term strategy.
(iv) C.ommitment to the market will be solid.
(v) Vendor financing is often available.
(111) lhis form will have control over the brand.
(vir) It will have control over the staff.
(vii1) There will be press opportunities.
Disadvantages of Greenfield approacl,:
(1) It is likely to cost more.
(ii) C.ompetition will be difficult to overcome.
(iir) The entry process may take years.
(iv) The barriers to entry can be costly.
(v) Govemmental regulations may put multinational enterprises at a
disadvantage in the short term.
Brownfield Investment&. Brownfield Invesbnent is when a company or
government entity purchases or leases existing production facilities to launch a
new production activity. This is one strategy used in foreign direct investment.
Brownfield investing covers both the purchase and the lease of existing facilities.
At ti.mes, this approach may be preferable, as the structure already stands. It
results in cost savings for the investing business, it can also avoid certain steps
that are required in order to build new facilities on empty lots, such as building
permits and coMecting utilities. Brownfield investing involves the use of
previously constructed facilities that were once in use for another purpose
whereas Greenfield investing covers any situation in which new facilities are
added to previously vacant land.
Q. 19. Discuss the contribution of Foreign Investment in India's economic
growth. (2015
Ans. As per the International Monetary Fund (IMF), Foreign Direct Invest­
ment, commonly referred to as FDI is an investment made to acquire lasting or
long-term interest in enterprises operating outside of the economy of the
investor. Inorganically or organically done investment in another country is not
FOi.
Ever since coming to power, the NDA govern.roent has taken a nwnber of steps
to bolster the FDI scenario in India. It has enabled international entities like
Carrefour and Walmart to come and invest in the multi-brand retail market in
India. The retail market in India has been growing at a substantial rate and at
present, it is worth somewhere around 28 billion dollars. It is expected that in
2020, this value will reach approximately 260 billion dollars.
Foreign Direct lnvesbnent (FDI) and Economic Growth:
 74 SHIVA DELm UNIVERSITY SERIES
The economic development witnessed during the past two decades in India
rests to a great extent on Forei gn Direct Investment (FOi). FOi has been a vital
non-debt financial force behind the economic upsurge in India. Special
investment vantages like cheap cost wages and tax exemptions on the amount
being invested attract foreign companies to invest in India. FOi in India is done
across a wide range of industries and its relentless influx reflects the tremendous
scope, faitl1 and trust that foreign investors have in the Indian economy.
To ensure an uninterrupted inflow of FOi in India, the Indian government has
created conducive trade abnosphere and elfeclive business policy measures in
place. This strategy is reflected in the steps taken by the government, such as
easing out the restrictions levied on sectors like stock exchanges, power
exchanges, defence, telecommunications and PSU oil refineries to name a few.
The Indian Market for FDI:
The last fiscal (2014-15) year saw a considerable increase in the PDI made in
India. India's pro-growth business policies have contributed a great deal in
making this possible. The first five months of the 2014-15 fiscal year noticed a net
inflow of US$ 14.1 million FOi in India, amounting to a good 33.5 per cent rise in
the FDI influx.
Advat1tages of FDI i11 lt1dia:
There are several benefits of increasing foreign direct investment in India. First
of all, with more FDI, consume.rs will be able to save 5 to 10 per cent on their
expenses because products will be available at much less rates and to top it all,
the quality will be better as well. It is also expected that the farmers who face a
lot of economic problems will also get better payment for their produce. It is
expected that their earnings will increase by 10 to 30 per cenl
FOi is also supposed to have a positive effect on the employment scenario by
generating approxirnately 4 million job opportunities. Areas like logistics will be
benefited as well because of FOi and it is assumed that 6 million _jobs will be
created. The governrnents-botl1 central and state-will be benefited because of
FOi. An addition of 25-30 billion dollars to the national treasury is also expected.
Steps tRken by Govemrnet1t to Promote FDI:
The Indian Government has taken a number of steps to show its willingness to
allow more foreign direct invesbnent in the country. In the infrastructure
development sector, it has relaxed the norms pertaining to area restriction, the
laws regarding gaming a comfortable exit from a particular project and the
requirements relating to minimum capitalization. If companies are ready to
commit 30 per cent of their investments for affordable housing, then the rules for
minimum capitalization and area restriction will be waived off. The Indian
Ministry of Finance has also proposed that 100 per cent FOI will be allowed in
railways-related infrastructure.
Investments in IndiR during 2015-16:
The Indian government, during the 2014-15 .fiscal year, announced that it
would allow FDI worth US$ 14.65 billion into the railways infrastructure. Some
of the most expensive and largest railway projects will be carried out under these
investments. Hundred per cent FDI into the health sector will be allowed by the
 6. INTERNATIONAL FJNANCIAL ENVIRONMENT 75
Department of Industrial Policy and Promotion (DIPP) to enable indigenous
manufacturing and reduce imports of medical devices. By the next fiscal year, the
value of medical devices in the world market will be worth US$ 400 billion. The
equity investment in the real estate is expected to go two-fold as the Indian
government has allowed 100 per cent FOi into the construction sector.
Q. 20. Enumerate the various sources of global business finance.
Ans. An InternationaJ Business chooses sources of funding based on its capital
structure to find the best debt-to-equity ratio that maximizes its value. TI1e
optimal capital structure for a company is the one which offers a baJance between
the ideal debt-to-equity ratio and minimizes the firm's cost of capital.
Different so11rces of global finance art as follows:
• Export-Import Banlc. It provides two types of loans: direct loans to
exports and intermediary loans to responsible parties, such as foreign
government-lending agencies which re-lend to foreign buyers of capital
goods and related services (for txnmple, a maintenance contract for a jet
passenger plane). Programs of the US EXIM bank cover upto 85 per cent
of the value of the exported goods and services, with repayment tenns of
one year or more.
• With-in company loans. A new company can raise funds only through
external sources, such as shares, debentures, loans, public deposits, etc.
but an existing firm which needs finance for its future growth and
expansion can generate funds through retained earnings.
• Eurobonds. This is an inte.mational bond that is denominated in a
currency not native to the country where it is issued. For example, a US
£inn making an invesbnent in Denmark may finance the investment by
borrowing through the London-based Euro-market rather the Danish
capital market.
• International equity markets. An International business can issue new
shares in its foreign markets. Shares are the most common form of raising
long-term funds from the market. Every company, except a company
limited by guarantee, has a statutory right to issue shares.
• International Finance Corpontion. A globaJ business can also get
finance through loans from specialized financial institutions and
development banks.
• Local debt financing. The firm may wish to consider local debt financing
for invesbnents in countries where the locaJ currency is expected to
depreciate on the foreign exchange market Debt financing generally
offers the lowest cost of capital due to its tax deductibility. However, it is
rarely the optimal structure since a company's risk generally increases as
debt increases.
Q. 21. Distinguish between International Leasing and International
Licensing.
Ans. International Leasing. The lease is the agreement between the lessor and
the lessee; wherein the lessor grants permission to the lessee to use his property
in return for periodical rental payments. IntemationaJ lease refers to the type of
lease agreement where one or more parties to the lease agreement reside or are
 76 SHIVA DELm UNIVERSITY SERIES

domiciled in different countries. There are two types of international lease-the

lmport Lease and the Cross Border Lease. In the foo:ner type of lease, both the lessor
and the lessee belong to the same country, but the equipment supplier stays in
some other country. In the case of a cross-border lease, both the lessor and the
lessee stay in different countries, irrespective of where the equipment supplier
stays.
International Licensing. It allows foreign firms to manufacture a proprietor's
product for a fixed term in a specific market either exclusively or non­
exclusively. In foreign market entry mode, a licenso.r in the home country makes
limited rights or resources available to the licensee in the host country. The rights
or resources may include patents, trademarks, managerial skills, technology, and
others that can make it possible for the licensee to manufacture and sell in the
host country a similar product. Although, the licensor has already been
producing and selling in the home country. The licensor earnings usually take the
form of one time payments, technical fees and royalty payments calculated as a
percentage of sales. As in this mode of entry, the transfe.rence of knowledge
between the parental company and the licensee is strongly present. TI,e decision
making of an international license agreement depends on the respect shown by
the host government for intellectual property and on the ability of the licensor to
choose the right partners and avoid them to compete in each other's m.arket.
Licensing is a relatively flexible work agreement that can be customized to fit the
needs and interests of both, licensor and licensee.
7. Exchange Rate Determination. Factors affecting exchange
rate-Relatlve lnHatlon rates, relative Interest rates, relative
Income levels, government controls, expectations, etc.
Government Intervention and government Influence on
exchange rates. Theories of exchange rate-Purchasing Power
Parity, Interest Rate Parity and Fisher's effect.
Q. 1. Explain how exchange rate is determined in a free market?
Ans. The foreign exchange rate is determined with the forces of demand for
and supply of in the foreign exchange market. In other words, demand supply
theory applies with regard to the determination of exchange rate. As such the
equilibrium rate of exchange will be determined with the help of forces of
demand for and supply of foreign exchange.
11,ere is a functional relation between foreign currency rate and demand for
foreign currency. This relation between the two is inverse. This means when
exchange rate is high, demand for foreign exchange will be low and vice-versa.
As such the demand curve for foreign currency will slope downwards to the
right. 1n the diagram given below DD is the demand curve.
The relation between rate of currency and
supply of foreign currency is direct. This means Y D Excess i5upp ly s
supply of foreign currency will be more when
i •••••••• -4-
exchange rate is more and vice•versa. As such -� .,. R
supply curve (SS) as shown in the diagram will R V�
rise upwards to the right. 1l1e eq1tilibrium !t 'll R ·······:
Excess
Demand

exchange rate is determined at a point where c:,; S : 0

demand for and supply of foreign currency is O'--Am-- u
o .._-t
. n /_O
.....uan-11ty
-.--➔X
equal. lf rate other than this is fixed, either
there will be excess of supply or demand as the case may be. As shown in the
diagram, the equilibrium exchange rate is OR. At 0� rate, there is excess of
supply equal to MN and at 0� rate, there is excess of demand equal to AB.
Q. 2. What do you mean by supply of foreign exchange? What are its sources?
Ans. The supply of foreign currency is the amount of foreign currency in. a
country. It comes from the following sources:
(r) Payments available to domestic suppliers for the good/services they
have exported.
(ii) The amount which foreigners invest in the home country on puxchasing
goods and services.
77
 78 SHIVA DELID UNIVERSITY SERIES
(iir) Foreign currencies flow into the economy due to cun·ency dealers and
speculators.
The relationship between exchange rate and y s
supply of foreign exchange is direct. It implies
that supply of foreign exchange will be more
when exchange rate of a foreign currency is
more and vice-versa. Because of that supply
curve rises upwards to the right as shown in the s
following diagram. ._
_ __ _,___,___�x
a,a
When the price of US dollar increases, supply Demand for US $
of US dollar also increases for now more goods
can be bought from India and vice-versa.
Q. 3. What do you mean by demand for foreign exchange? What are its
determinants?
Ans. TI1e demand for foreign exchange signifies the amount of foreign
currency which is demanded by a home country say India. Hence, it means how
much foreign currency is demanded by a particular country. The demand for
foreign currency is generally made for the following reasons:
(i) For making payments to foreign country against imports.
(ii) For making investments and lending by domestic residents.
(iii) For sending or making payments for unilateral transfers like gifts,
donations etc.
(iv) To speculate on the value of foreign cttrrency.
There is an inverse relationship between the
demand for foreign exchange and its price. lt
implies that demand for foreign exchange will
be more when foreign exchange rate is low and
vice-versa. Therefore, the demand curve for
foreign exd1ange wilJ slope downwards to the
right as shown in the diagram . '-------,!c---,�-�x
In the diagram, it is clear that when price of
a a,
Demand lor US $
US dollar in terms of some other currency falls,
the demand for US dollar will increase. The reverse of it happens when price of
US dollar increases in terms of another currency.
Q. 4. Explain the factors influencing exchange rate determination.
Ans. Foreign exchange rate is one of the most important means through which
a country's relative level of economic health is determined. A country's forex ral'e
provides a window to its economic stability which is why it is constantly
watched.
Following are some of tlie leading factors influencing excl11111ge rate
determination:
1. Relative inflation rates. Usually a country with a lower inflation rate
exhibits a rising currency value as its purchasing power increases relative to
other currencies. Those countries with higher inflation witness depreciation in
the value of their currency in relatiox, to the currencies of their trading partners.
This is usually accompanied by higher interest rates.
 7. EXCHANGE RATI! Dl!TERMJNATION 79
2. Relative interest rates. Differentials in interest rates also influence exchange
rate detenni.nation. By manipulating interest rates, central banks exert influence
over both inflation and exchange. Higher interest rates offer lenders a higher
return as compared to other countries. Therefore, higher interest rates attract
foreign capital and cause the exchange rate to rise. The impact of higher interest
rates is mitigated, however, if a country's inflation is much higher or if additional
factors drive the value of their currency down. The reverse relationship exists for
decreasing interest rates.
3. Current Account Deficits. The current account is the balance of trade
between a country and its trading partners, reflecting all payments between
countries for goods, services, interest and dividends. A deficit in the current
account shows a country is importing goods and services more than it is
exporting them. The country will then borrow capital from foreign sources to
make up the deficit causing its currency to depreciate relative to its trading
partner.
4. Public Debt. Nations with large public deficits and debts are less attractive
to foreign investors. This is bt.'Cause a large debt encourages inflation in the
economy, consequently higher inflation leads to lower value of currency.
5. Terms of trade. Terms of trade refers to ratio of comparing export prices to
import prices. [f the price of a country's exports rises by a greater rate than that of
its imports, Its terms of trade have favorably improved, which tends to indicate
currency appreciation. On the other hand, if the price of a country's imports rises
more than the rate of exports, their currency's value will decrease in relation to
trading partners.
6. Political stability and Economic performance. Foreign investors look for the
stable countries having good economic performance in which they can invest
their capital. Political instability can cause a loss of confidence in a currency and
uJtimately results in movement of capital to the currencies of more stable
countries.
7. Relative income levels. Income levels influence currencies through
consumer spending. When incomes increases, people spend more. Higher
demand for imported goods increases demand for foreign currencies and hence
weakens the local currency. On the other hand, when people are not able to buy
imported items due to low incomes level demand for foreign currencies fall,
strengthening the local/ domestic currency.
8. Govemment intervention and control. Some governments attempt to
influence the value of their currency. Government buys or sells foreign currency
to influence the exchange rate of its own currency. Usually central banks
intervene in foreign exchange markets in order to achieve various economic
objectives like price stability, controlling inflation and deflation etc. Under certain
cirCUIJlstances the government might want to intervene in the foreign exchange
markets to influence the level of the exchange through changes in exchange rates,
reserves and borrowing etc.
For example, China has sought to keep its currency undervalued to make
Chinese exports more competitive.
9. Speculation. If a country's currency value is e,q,ected to rise, investors will
 80 SHIVA DELHI UNIVERSITY SERIES
demand more of that currency in order to make a profit in the near future. As a
result the value of the currency wiU rise due to the increase in demand. With this
increase in currency value comes a rise in the exchange rate as well.
Q. 5. Write a short note on Exchange Rates. (2015
Ans. Exchange Rates. Exchange rate defines the price of a nation's currency in
terms of another currency. An exchange rate has tv.•o components, the domestic
currency and a foreign currency, and can be quoted either directly or indirectly.
In a direct quotation, the price of a unit of foreign currency is expressed in terms
of the domestic currency. In an indirect quotation, the price of a unit of domestic
currency is expressed in tem1S of the foreign currency. An exchange rate that
does not have the domestic currency as one of the two currency components is
known as a cross currency, or cross rate. An exchange rate has a base currency
and a counter currency. In a direct quotation, the foreign currency is the base
currency and the domesti.c currency is the counter currency. In an indirect
quotation, the domestic currency is tl1e base currency and the foreign currency is
the counter currency. Most exchange rates use the US dollar as the base currency
and other currencies as the counter currency. However, there are a few
exceptions to this rule, such as the euro and Commonwealth currencies like the
British pound, Australian dollar and New Zealand dollar.
T11e main exclrange rate systems include:
1. fixed exchange rates. A fixed exchange rate system, or pegged exchange
rate system, is a currency system in which governments try to maintain a
currency value that is constant against a specific currency or good. In a fixed
exchange-rate system, a country's government decides the worth of its currency
in tenns of either a fixed weight of an asset, another currency, or a basket of other
currencies. The central bank of a country remains committed at all times to buy
and sell its currency at a fixed price.
To ensure that a currency will maintain its " pegged" value, the country's
central bank maintain reserves of foreign currencies and gold. They can sell these
reserves in order to intervene in the foreign exchange market to make up excess
demand or take up excess supply of the country's currency. The most famous
fixed rate system is the gold standard, where a unit of currency is pegged to a
specific measure of gold.
2. floating exchange rates. A floating exchange rate, or fluctuating exchange
rate, is a type of exchange rate regime wherein a currency's value is allowed to
fluctuate according to the foreign exchange market. A currency that uses a
floating exchange rate is known as a floating currency. The dollar is an example
of a floating currency. Many economists believe floating exchange rates are the
best possible exchange rate regimes because these regimes automatically adjust
to economic circumstances. These regimes enable a country to dampen the
impact of shocks and foreign business cycles, and to pre-empt the possibility of
having a balance of payments crisis. However, they also give rise to
unpredictability as the result of their dynamism.
A genuine free float would involve leaving exchange rates entirely to the
vagaries of supply and demand on the foreign exchange markets, and neither
 7. EXCHANGE RATE DETERMINATION 81

intervening on the market using official reserves of foreign exchange nor taking
exchange rates into account when making interest rate decisions. The Monetary
Policy Committee of the Bank of England clearly takes account of the external
value of sterling in its decision-making process, so tl1at although the pound is no
longer in a fixed exchange rate system, it would not be correct to argue that it is
on a genuinely free float.
The central bank of countries using a managed float will attempt to keep
currency relationships within a predetermined range of values (not usually
publicly announced), and will often intervene in the foreign exchange markets by
buying or selling their currency to remain within the range.
Q. 6. How do inflation and interest rates influence the value of the currency?
Explain.
Ans. The rate of inflation in a country has a major impact on the value of its
currency and the rates of foreign exchange it has with the currencies of other
nations. lnflation is more likely to have a significant negative impact on a
currency's value and foreign exchange rate. An extremely high rate of inflation is
very likely lo impact the country's exchange rates with other nations. lnflation is
closely related to interest rates, which can influence exchange rates. Higher
interest rates tend to attract foreign investment which is likely to increase the
demand for country's currency. However, higher interest rates often cause
increasing inflation rates, which is a negative influence on the country's currency.
Low interest rates increase consumer spending and economic growth and
usually have a positive impact on currency value but they are not capable of
attracting foreign investment. Hence, interest rate and inflation are the major
factors influencing value of a currency.
Q. 7. Give a brief account of Foreign Exchange risks. How are these risks
managed? [20.15
Ans. Foreign Exclumge Risk. The risk of investment value changing due to
changes in the currency's exchange rate is known as foreign exchange risk. The
risk that an investor will have to close out a long or short position in a foreign
currency due to adverse movement of exchange rate is also known as currency
risk or exchange rate risk. This risk usually affects businesses that are involved in
export or import but it can also affect investors making international investments.
For example, if money must be converted to another currency to make a certain
investment, then any future changes in th.e currency exchange rate will cause that
investment value to either increase or decrease when the investment is sold and
converted back into original currency.
Methods of ma11aging foreig,1 excl,ange risks:
1. Forward contracts. The forward market is where you can buy and sell a
currency, at a fixed future date for a predetermined rate, i.e. the forward rate of
exchange. This effectively fixes the future rate. Forward exchange contracts are
used extensively for hedging currency transaction exposures.
Advantages include. It fixes the future rate, thus eliminating downside risk
exposure flexibility with regard to the amount to be covered. It is relatively
straightforward both to comprehend and to organize.
 82 SBJV
A DELHI UNIVERSITY SERIES
Disadvantages include. Contractual commitment that must be completed on
the due date (option date forward contract can be used if uncertain). It provides
no opportunity to benefit from favourable movements in exchange rates.
2. Money market hedges. The basic idea is to avoid future exchange rate
uncertainty by making the exchange at today's spot rate instead. This is achieved
by depositing/borrowing the foreign currency until the actual commercial
transaction cash flows occur. This effectively fixes the future rate. The money
markets are markets for wholesale (large-scale) lending and borrowing, or
trading in short-term financial instruments. Many companies are able to borrow
or deposit funds through their bank in the money markets. Instead of hedging a
currency exposure with a forward contract, a company could use the money
markets to lend or borrow, and achieve a similar result. Since forward exchange
rates are derived from spot rates and money market interest rates, the end result
from hedging should be roughly the same by either method.
3. Futures contracts. Futures contracts are standard sized, traded hedging
instruments. The aim of a currency futures contract is to fix an exchange rate at
some future date, subject to basis risk.
4. Options. A currency option is a right, but not an obligation, to buy or sell a
currency at an exercise price on a future date. If there is a favourable movement
in rates the company will allow the option to lapse, to take advantage of the
favourable movement. The right will only be exercised to protect against an
adverse movement, i.e., the worst-case scenario. A call option gives the holder the
right to buy the underlying currency. A put option gives the holder the right to
sell the underlying currency. Options are more expensive than the forward
contracts and futures but result in an asymmetric risk exposure.
5. Forex swaps. In a forex swap, the parties agree to swap equivalent amounts
of currency for a period and then re-swap them at the end of the period at an
agreed swap rate. l11e swap rate and amount of currency is agreed between the
parties in advance. Thus it is called a fixed rate/fixed rate swap. The main
objectives of a forex swap are:
• To hedge against forex risk, possibly for a longer period than is possible
on the forward market.
• Acc-ess to capital markets, in which it may be impossible to borrow
directly.
• Forex swaps are especially useful when dealing with countries that have
exchange controls and/or volatile exchange rates.
6. Currency swaps. A currency swap allows tl1e two counter parties to swap
int.eresl rate commitments on borrowings in different currencies. In effect a
currency swap has two elements-
(1) An exchange of principal in different currencies, which are swapped
back at the original spot rate-just like a forex swap.
(ii) An exchange of interest rates-the tirn.ing of these depends on the
individual contract. The swap of interest rates could be fixed for fixed or
fixed for variable.
Q. 8. Briefly explain central bank intervention in foreign exchange markets.
Or
Write a short note on foreign exchange market /currency intervention.
 7. EXCHANGE RATE DETERMINATION 83
Ans. A central bank will buy or scll a currency in the foreign exchange market
in order to increase or decrease the vaJue of its nation's cun:ency. This is known
as cu.rrency intervention or foreign exchange market intervention. When a country's
currency is enduring extreme and unnecessary upward or downward financial
pressure, a government or central bank will use foreign exchange market
intervention to stabilise the situation. Central bank intervention can be used to
boost or decrease a currency's value, most commonly for the purpose of boosting
exports of a nation. It is believed that export dependent countries could spiral
into recession if it becomes too reliant on market intervention. Global trading
partners exchange rates will rise while the prices of their exports increase within
the global market. A decline in value of a nation's currency can lead to an
increase in inflation as prices of imported items will go up.
Subsequently, interest rates will be augmented by the central bank but will
disturb the economic growth and asset market. This may lead to decline in
currency's value. Countries with large budget deficits rely on foreign inflows of
capital. A decline in the value of a currency can cause major financial dilficulty to
countries with high budget deficits. Financing the deficits will be extremely
delayed and will jeoparadize the growth process of a nation. 1n orde.r to maintain
the value of the currency, there will need to be an elevation of interest rates.
Central bank in.tervt'tles in foreign exclumge markets by 11sing t11e following
met/rods:
1. Direct intervention. The most direct way for central banks to intervene and
affect the exchange rate is to enter the private forex market directly by buying or
selling domestic currency. There are two possible transactions.
First, the central bank can sell domestic currency in exchange for a foreign
currency. This transaction will raise the supply of domestic currency causing a
reduction in the value of the domestic currency. Hence, when domestic currency
depreciates the foreign currency in question will appreciate. Since the central
bank is the ultimate source of domestic currency, it can flood the forex market
witl1 domestic currency. Hence, the central bank can depreciate the value of
domestic currency.
The central bank can also raise the value of domestic currency by buying
domestic currency in exchange for foreign currency. It must have a stockpile of
foreign currency known as foreign exchange reserves. These reserves are
accumulated over time and held in case an intervention is desired.
2. Sterilized foreign exchange intervention. Direct forex intervention will
change the domestic money supply. It can have an inflationary pressure on the
economy. Hence sterilized intervention is used to cause a change in the exchange
rate while at the same time leaving the money supply. This does not influence
interest rates and hence does not create inflationary pressure on the economy. A
sterilized foreign exchange intervention occurs when a central bank counters
direct intervention in the forex market with a simultaneous offsetting transaction
in the domestic bond market. For txllmple, in order to lower the value of domestic
cw-rency, the central bank cnay sell domestic currency and buy foreign currency.
Sterilization in this case involves an open market operation in which it sells
treasury bond at the same time and in the same value as the domestic cun:ency in
the forex market.
 84 SHIVA DELm UNIVERSITY SERIES
Q. 9. Write short noes on:
(a) Floating Exchange Rate System
(b) Exchange Rate System of Managed Float
Ans. (a) Floating Exchange Rate System. The Floating Exchange Rate System
is a mechanism where a nation's currency's value is set by the foreign exchange
market through supply and demand for that particular CWTency relative to other
runencies. Thus, floating exchange rates change freely and are determined by
trading in the forex market. This is opposite to a ufixed exchange rate" regime.
For exam.pie, if a currency's value moves in any one direction at a rapid and
sustained rate, the Central Bank intervenes by buying and selling its own
currency reserves (i.e., Federal Reserve in the US) in the foreign exchange
market in order to stabilize the local currency. However, central banks are
reluctant to intervene, unless absolutely necessary, in a floating regime.
The key arguments for flexible exchange rotes:
(i) Easier external adjustments
(ii) National policy autonomy
Suppose a country is experiencing a BOP deficit This means that there is an
excess supply of country's currency at the prevailing exchange rate in the
foreign exchange market. Under a flexible exchange rate system, the external
value of th.e country's currency will simply depreciate to the level at which there
is no excess supply of th.e country's currency. At the new exchange rate level, the
BOP disequilibrium will disappear.
As long as the exchange rate is allowed to be determined by market forces,
external balance will be achieved automatically. The government does not have
to take policy actions to correct the BOP disequilibrium. It can use its monetary
and fiscal policies to pursue its economic goals.
(b) "Excl,onge Rate System of Managed Float. A Managed Float system is an
exchange rate regime in which the country's central bank occasionally intervenes
to change the direction or the pace of change of the country's currency value. In
most instances, the intervention aspect of a dirty float system is meant lo act as a
buffer against an external economic shock before its effects become truly
disruptive to the domestic economy. It's also known as a "Managed Float." From
1946 until 1971, many of the world's major industrialized nations participated in
a fixed exchange rate system known as the Bretton Woods Agreement. This
ended when President Richard Nixon took the United States off the gold
standard on August 15, 1971; Since then, most major industrialized economies
feature floating exchange rates. Many developing nations seek to protect their
domestic industries and trade by using a managed float in which the central bank
intervenes to guide the currency. The frequency of such intervention varies. For
example, the Reserve Bank of India manages the rupee closely in a very narrow
band, while the Monetary Authority of Singapore allows the local dollar to
fluctuate more freely in an undisclosed band.
Q. 10. Briefly explain the Purchasing Power Parity Theory.
Or
\Vhat is meant by purchasing power parity?
Ans. PPP (Purchasing Power Parity) is an economic theory that estimates the
 7. EXCHANGE RATE DIITERMINATION 85
amount of adjustment needed on the exchange rate between countries in order
fo .r the exchange rate to be equivalent to each currency's purchasing power.
PPP is calculated as:
-WMn! S Repre5en!S runency 1 to cun:ency 2
p
5 s .-1. [P1 Repr-nts the C06t of good X in curm,cy 1
l"l P1 Represents the cost of good X in cunency 2
According to this theory the exchange rate adjusts so that an identical good in
two different countries has the same price when expressed in the same currency.
In simple words, PPP is a theory which states that exchange rates between
currencies are in equilibrium when their purchasing power is the same in each of
the two cow1tries. PPP is used world-wide to compare the income levels in
different countries. It makes it easy to understand and interpret the purchasing
power of the countries.
TI1e basis for PPP is the 'law of one price'. ln the absence of transportation and
other transaction costs, competitive markets will equalize the price of an identical
good in two countries when the prices are expressed in the same currency.
TI1e theory aiins to determine the adjustments needed to be made in the
exchange rates of two currencies to make them at par with the purchasing power
of each other. In other words, the expenditure on a similar commod.ity must be
same i.n both currencies when accounted for exchange rate. The purchasing
power of each currency is determined in the process.
For example, suppose a pair of shoes costs f2,400 in India. Then it should cost
$40 in America when the exchange rate is f60 between the dollar and the rupee.
Q. 11. \\That do you understand by price level ratio of PPP (Purchasing Power
parity) conversion factor to market exchange rate?
Ans. Purchasing power parity conversion factor refers to the number of units
of a country's currency required to buy the same amount of goods and services in
the domestic market as a foreign currency would buy in its own country. The
ratio of PPP conversion factor to market exchange rate is the result obta.ined by
d.ividing the PPP conversion factor by the market exchange rate. The ratio also
referred to as the national price level, makes it possible to compare the cost of the
bundle of goods that make up gross domestic product across countries. It tells
how many units of foreign currency are requ.ired to buy foreign currencies' worth
of goods in the country as compared to the un.ited slates.
Q. 12. What is the relevance of PPP?
Ans. The concept of PPP is useful in comparing quality or standard of living in
different countries which may not be possible if one just looked at per capita
income. A lower income may allow a good quality of life in a country of low
prices. For instance, a haircut may cost lot more in London than in New Delhi.
The major shortcoming of PPP exchange rates is that these are difficult to
measure.
Q. 13. What is meant by Interest Rate Parity?
Ans. The economic theory of interest rate parity states that the difference
between the interest rate in h¥o countries is equal to the differential between the
forward rate and the spot rate of those two countries. This equality does not
always exist and thus allows traders to arbitrage options position to earn risk less
 86 SHIVA DELHI UNIVERSITY SERIES
returns. For interest rate parity to exist, there must be easy capital mobility
between countries, along with complete substitutability of assets. For instance, a
deposit in a foreign bank is considered the same as a deposit in a domestic bank.
If the nominal returns were different between the domestic and foreign
deposits, investors would move their money to the bank paying the higher
nominal return. Interest rate parity exists when the expected nominal rates are
the same for both domestic and foreign assets. Any difference is due to expected
appreciation or depreciation in the foreign or domestic currencies. For example, if
the domestic interest rate is 8% and the foreign interest rate is 5%, this means that
the market expects the foreign currency to appreciate by 3 % or the investors
expect th.e domestic currency to depreciate by 3%. 1n this case the investor can
invest in a forei gn deposit and then convert the foreign currency to his domestic
currency or can invest in domestic deposit and then can convert the domestic
currency to the foreign currency. Either option will produce the exact same cash
flow.
Q. 14. Explain with the help of an example, the interest rate parity theory of
exchange rate.
Ans. The Interest Rate Parity condition can be used to develop an exchange
rate detemlination model. Interest rate parity or covered interest parity condition
provides equilibrium to the financial market. According to this theory, the cost of
money (i.e., the cost of borrowing money or the rate of return on financial
instruments), when adjusted for the cost of covering foreign exchange risk, is the
same across different currencies. This theory assumes the total absence of
transaction costs, taxes and capital controls, providing the investors and traders
with an atmosphere of free trade.
The above theory can be explained in detail, with the help of the following
example:
Consider trading of currencies between India and US. ff inte.rest rate parity
holds, then the rate of return cm dollar deposits equals the expected rate of return
of J.ndian rupees.
(RoR,= Ro�)

where-
1, is interest rate prevailing in the US
1, is interest rate prevailing in India
F (E$/') is the forward exchange rate
E$/' is spot exchange rate between the dollar and the rupee
From the data given below we can find the best country for purchasing a one­
year interest-bearing asset.
Consider tirefollowing dRtR on i11terests rRte R11d exc11Rnge. rRtes in t1ie US Rnd
India;
5.45% per year
3.65% per year
 7. EXCHANGE RATI! DETERMINATION 87
F(E$/f) 2012 0.6369 $/�
E$/� 2001 0.6944 $/�
We assume that decision is to be made for the year 2001; therefore, we take
2002 rates as the expected exchange rates and use 2000 rates as the current spot
rates. Thus, the ex-post, (i.e., after the fact) rate of return on India deposits is
given by,
0.6369-0.6944x(l+Q.0365)
R = 0· 365 +
R0·"' 0.6944
A negative rate of return means that the investor would have lost money (in
dollar terms) by purchasing lndian assets.
Since RoRs = 5.45% and Ro� = -4.93%, an investor seeking the highest rate of
return should deposit his money in the US accowit..
Q. 15. Jn what circumstances will the interest rate parity theory not hold?
t
Ans. Cases wl,en Interest Rate Pari y does not 1,old good:
(1) Transaction Cost ·n,e transaction cost involved in the money market
operations is the difference between the investment and borrowing rate.
In other words, the costs incurred while investing in one market and/or
borrowing in another, and converting one currency into another. The
theory of Interest Rate Parity assumes this cost to be NlL since otherwise,
arbitrage opportunities will e)(ist for borrowers and investors. The
presence of these costs will allow deviations to the extent of the costs
involved.
(ii) Political Risks. Political risks arise when an investor invests in deposits
denominated in foreign currency held domestically. For e.,-rample, a French
citizen may hold a dollar deposit wilh a London Bank. This additional
risk forces investors to seek a higher rate of return on investment than
warranted by interest parity. Th.is factor allows deviations from the
parity to take place.
(ii,) Capi.taJ Controls. This is one of the major factors, which casues deviation
from interest parity. Capital controls include restriction on investing or
borrowing abroad, and on repatriation of investments made by foreign
residents. Because of these controls, the interest rate in Euro-markets
(where capital controls do not apply) is more in line with parity, than the
domestic interest rates in different countries.
Q. 16. Write a brief note on Fisher's EffecL
Or
Explain the theory of Fisher's effect.
Ans. 'Fisher's effect' is an economic theory proposed by the economist Irving
Fisher that describes the relationship between inflation and both real and
nominal interest rates. The Fisher's effect states that "the real interest rate equals tire
nominal interest rate minus expected inflation rate. Therefore, real interest rates fall as
injla.tion increases, 11nless nominal rates increase at the same rate as inflation". For
exam.pie. if the nominal interest rate on a savings accowit is 4% and the expected
rate of inflation is 3%, then money in the savings account is actually growing at
1 %. The smaller the real interest rate the longer it will take for savings deposits to
grow substantially.
 88 SHIVA DELHI UNIVERSITY SERIES
The interest rate an investor has in a savings account is actually the nominal
interest rate. Hence the fisher's theory describes the relationship between
inflation and both real and nominal interest rates.
( Real interest rate = The nominal interest tate - Expected inflation rate.)
International Fisher Effect States "that an expected change in the current exchange
rate between any two currencies i.� approximat"tly equivalent to the difference between the
two countrie.� nominal interest rates for tl1at time".
For example, if country A's interest rate is 10% and country B's interest rate is
5%, country B's currency should appreciate roughly 5% compared to country A's
currency. According to Fisher, country with a higher interest rate will also tend to
have a higher inflation rate. The increased amount of inflation should cause the
currency in the country with the high interest rate to depreciate against a country
with lower interest rates.
 -z
1--

8. Foreign Trade Promotion Measures and Organizations In India;

Special Economic Zones (SEZS) and I OOl/o export oriented uruts
(EOUs); Measures for promoting foreign investments into and from
India; India joint ventures and acquisition abroad.
Q. 1. What measures have been undertaken by the Indian Government to
promote Foreign Trade? Mention the various organizations set up for the
same. (2014
Ans. Meas11res undert,dcen by tl,e Indi,m Government to promote Foreign Trade.
1. Enhanced Interaction; Interaction with important trading partners will be
enhanced to act as a catalyst for the private sector to explore and tap full
potential of the CIS region. The Government shall have increased frequency of
inte.raction at the highest level with important trading partners. Bilateral trade
and economic cooperation between India and these countries is regularly
reviewed through the bilateral Joint Commissions/Working Groups and Joint
Busin.ess Councils.
2. Institutional Mechanisms:
(1) Joint Commission Meetings. Institutional arrangements in the form of
Joint Commission/Working Croup already exist with Russian
Federation, Ukraine, Belarus, Uzbekistan, Kazakhstan, Kyrgyzstan,
Armenia, Tajikistan, Turkmenistan. These institutional mechanisms have
been activated. Bilateral Agreement for establishing an Inter­
Governmental Commission with Azerbaijan was signed. Steps will also
be taken for formation of Joint Commission with other countries of the
CJS region, where the same have not yet been instituted.
(i1) Joint Business Councils. FJCO plans to increase interaction with its
counterparts and hold meetings of the Joint Business Councils (JBCs) at
regular intervals. Similarly 01/PHD Chamber of Commerce & Industry/
FIEO also propose to have regular interaction with their counterparts in
CJS region with whom they have signed MoUs. Simul-taneously,
seminars and conferences are proposed to be organised within the
country for creating awareness on emerging markets in the CJS region.
(ii,) Trade Missioruv[>elegations. Trade/Economic Missions result in
creating necessary awareness in the region regarding India's economic
reforms, strength of Indian industry and its export capabilities. These
also provide impetus for businessmen to explore new markets, High­
level trade missions shall be mounted to the OS region.
89
90 SHNA DELHI UNIVERSITY SERIES

(iu) Roles ide.ntified for some important Government Organisations:

India Trade Promotion Organisation (JTPO). The India Trade Promotion
Organisation (ITPO) shall undertake various trade promotion measUJ'es,
which would include:
• Participation in specialised and commodity specific fairs and
as
exhibitions in the countries of the region.
• Special promotion and publicity in the as countries.
• India Promotion in Departmental Stores in respect of consumer products.
• Organising Buyer-Seller Meets.
• Promotion by Indian Mission by organising catalogue/brochure
exhibitions.
• To award top export performers to the CIS countries.
National Centre far Trade Infannation (NCTI):
• Jointly promoted by India Trade Promotion Organisation (ITPO) and
National Informatics Centre (Nlq, this organisation is involved in
assimilation and dissemination of useful trade information.
• Ncn provides contact details of product wise specific buyers through
the World Trade Point Federation Network (www.ncti-india.com)
initiated under the Trade Efficiency programme of UNCTAD.
Currently there are more than 100 Trade Points across the globe two of
which are located in Russia and one in Uzbekistan.
• NCTI also has access to the requisite database and expertise to provide
trade data analysis helpful in country and product specific strategy
formulation.
• NCTI has signed an MoU with National Centre for Marketing and
Price Study, Ministry of Foreign Affairs of the Republic of Belarus for
exchange of trade related information.
Various Organizations tl,at l1aue been set up to promote Foreign Trade:
(r) Export Promotion Councils. These are set up with a view to securing
active cooperation of growers, producers and exporters in order to
increase exports. These councils have been set up as non-profit
organizations under the Companies Act. For example, Cashew Export
Promotion Council, Cochin; Silk Export Promotion Council, Mumbai;
Engineering Export Promotion Council, Kol.kata.
(ii) Commodity Boards. These are set up for the development of certain
commodities £or export purposes. They deal with the entire range of
problems of production, development, marketing etc. Example, the Coffee
Board, the Rubber Board, the Central Silk Board, the Tea Board, etc.
(ii,) The Export Inspection Council (EiC). EIC has been set up with the
objective of exporting goods of good quality and for lending confidence
in foreign buyers in respect of quality. lt has been set up in five zones­
Delhi, Mumbai, Kol.kata, Chennai and Cochin.
(iv) Trade Development Authority. The authority was set up in 1971. lt
assists in product development and helps in raising the technological
level of the selected industrial exports. It works through lnfonnation
Division Research and Analysis Division and Merchandising Division.
 8. FOREIGN TRADE PROMOTION Ml!ASURES &: ORGANIZATIONS IN INDL4. 91
(v) Indian Institute of Foreign Trade (IlFI'). It is an autonomous body
registeted under the Societies Registration Act. The main functions of
IIFT are training of personnel in export trade, research and surveys of
projects in export and collection and dissemination of information.
(v1) Department of Commerce. The Deparbnent of Commerce in the
Ministry of Commerce is the apex body of the institutional infra­
structure created for the promotion of exports. It is responsible for
making and directing India's foreign trade policy and programmes. It is
also responsible for implementing various trade promotional measures
and the development and regulation of export oriented industries.
(vii) Freight Investigation Bureau (FIB). It serves as a link between shippers
and shipping companies to solve shipping and freight problems. It was
set up in 1959 under the Directorate General of Shipping. It collects,
maintains and examines freight rates of Shipping Lines and analyses the
impact of changes in rates of freight.
Q. 2. Write short notes on the foUowing:
(11) SEZs and their importance in the Indian Economy
(b) EOUs
(c) EXIM Bank
Ans. (11) SEZs 11nd tlreir import11nce in the Indian Economy. Special Economic
Zone (SEZ) is a geographical region that has special economic laws different from a
country's typical economic laws. An SEZ is a trade capacity development tool with
the goal to promote rapid economic growth by using tax and business incentives to
attract foreign investment and technology. The functions of the SEZs in lndia are
governed by a three tier administrative body. The Board of Approval is the apex
body and is headed by the Secretary, Department of Commerce.
Tire main objectives of tire SEZ Act, 2005 are:
(1) Generation of additional economic activity;
(ii) Promotion of exports of goods and services;
(iit) Promotion of investment from domestic and foreign sources;
(iv) Creation of employment opportunities; and
(v) Development of infrastructure facilities.
It is expected that this will trigger a large flow of foreign and domestic
investment in SEZs, infrastructure and productive capacity, leading to generation
of additional economic activity and creation of employment opportunities. In
India, SEZs have played an important role in facilitating exports, thereby
enabling the country to be a part of the globalization process. The SEZ sector
contributed 924 per cent of the total exports from the Central Government SEZs
in FY 2011. Over the years the increasing attractiveness of the Indian market has
lured investors from across the world making India a preferred destination for
FDI from Asian, European and North American investors.
Some of the successful Indian SEZs include-
• Nokia Special Economic Zone ([elecom Equipment SEZ}
• Mahendra City SEZ (Apparel and Fashion Accessories, IT/ Hardware,
Auto-ancillary)
• Apache SEZ Development India Private Limited (Footwear SEZ).
 92 SHIVA DELHI UNIVERSITY SERIES
(b) EOU. An Export Oriented Unit (EOU) is one which only produces goods
which are meant for export. 100 per cent of its output has to be exported against
which the company gets many benefits and preferences including tax benefits
and export subsidies. The main objective of the EOU scheme is to increase
exports, earn foreign exchange for the country, and import of latest technologies
to stimulate direct foreign investment and to generate additional employment.
The EOUs are licensed to manufacture goods within the bonded time period for
the purpose of export. As per the Exim Policy, the period of bonding is initially
five years, which is extendable to another five years by the Development
Commissioner. The EOUs are required to achieve the minim.wn NFEP (Net Foreign
Exchange Earning as a Percentage of Exports) and the minimum EP (Export
Performance) as per the provisions of EXIM Policy which vary from sector to sector.
Major Sectors in EOU. Granite, Textiles/Garments, Food Processing,
Chemicals, Computer Software, Coffee, Pharmaceuticals, Gem & Jewellery,
Engineering Goods, Electricals & Electronics, Aqua & Pearl Culture.
In tl,e following sectors, a11 EOU owner needs a special license.
• Anns and ammunition,
• Explosives and allied items or Defense Equipment,
• Defense aircraft and warships,
• Atomic substances,
• Narcotics and psychotropic substances and hazardous chemicals,
• Distillation and brewing of alcoholic drinks,
• Cigarettes/cigars and manufactured tobacco substitutes.
(c) .EXlM Bank. Export-Import Bank of lndia is the premier export finance
institution of the country, set up in 1982 under the Export-Import Bank of India
Act, 1981. Government of India launched the institution with a mandate, not just
to enhance exports from India, but to integrate the country's foreign trade and
investment with the overall economic growth. Since its inception, Exim Bank of
India has been both a catalyst and a key player in U1e promotion of cross border
trade and investment. Commencing operations as a purveyor of export credit,
like other Export Credit Agencies in the world, Exim Bank of India has, over the
period, evolved into an institution that plays a major role in partnering Indian
industries, particularly the Small and Medium Enterprises, in. their globalization
efforts, through a wide range of products and services offered at all stages of the
bm,iness cycle, starting from import of technology and export product
development to export production, export marketing, preshipment and post­
shipment and overseas investment.
Objectives of EXlM Biink. The objectives of EXIM Bank are as follows:
• Provision of financial, technical and administrative assistance in the
import and export sectors.
• Planning, promotion, development and financing of export imported
concerns.
• Undertaking and financing research, surveys and techno-economic
studies in relation with the promotion and development of foreign trade.
• Collection, compilation and dissemination of market and credit
information in respect of international trade.
 8. FOREIGN TRADE PROMOTION MEASURES & ORGANIZATIONS IN INDL� 93
F11nctio11s of Exim Bank
• Provision of .financial support for the export and import of goods and
services, not only of India but also of third world countries.
• Provision of financial help for the exports and imports of machin ery and
equipment on lease basis.
• Provision of financial help for facilitating joint ventures in foreign
countries.
• Undertaking of limited merchant banking activities such as underwriting
of stocks, shares, debentures, etc. of companies engaged in the export­
import sectors;
• Provision of financial, technical and administrative assistance to parties
engaged in the export-import sectors.
The Bank has strong linkages with other stakeholders in agri-sector such as
Ministry of Food Processing industries, GOI, NABARD, APEDA, Small Farmers
Agri-Business Consortiun1 (SPAC), National Horticulture Board, etc. Apart from
financing, the bank also provides a range of advisory services to exporters. Th.e
Bank also publishes a number of Occasional Papers, Working Papers on export
potential of various sub-sectors in agriculture and bi-monthly publication in
different languages on global scenario in agri-business and opportunities therein.
Q. 3. Write a note on lndilln Joint Ventures and acquisitions abroad.
Ans. Indian Joint Venhires Abroad. A Joint Ventw:e Abroad means a foreign
concern formed, registered or incorporated in a foreign country with a foreign
partner in accordance with the laws and regulations of the country in which
investment has been made by an lndian entity. Joint venture undertakings are
established abroad by the Indian entrepieneurs for building up an export
potential for their products manufactured through foreign collaboration in the
developing countries where there is a favourable political climate and a demand
for the Indian products.
Significance of ]Vs abroad:
• Joint Ventures/Wholly Owned Subsidiaries abroad promote economic
co-operation between India and the host countries.
• Joint Ventures abroad result in transfer of technology and skills, sharing
the results of Research and Development, access to the global market,
promotion of the brand image, generation of employment and utilization
of raw materials available in India and the host country,
• Increased exports of plant and machinery and goods and services from
India, foreign exchange earnings through dividend earnings, royalty,
technical know-how fee, etc.
For t1iis purpose, tl,e Government offers t1,e following oppommities:
(1) Opportunities to increase the export potential of the Indian companies;
(i1) Facility of repatriation of capital, dividend and royalty and remuneration
earned outside India from Joint Ventures;
(iir) Incentives under the Income-tax Act
Q. 4. Write a brief note on regional economic integration.
Or, Define regional economic integration. Discuss its advantages and
disadvantages. Also discuss its types.
 94 SHIV
A DELHI UNIVERSTIY SERIES

Or, Discuss the cost and benefit of regional econ.omic integration.

Aru. Regional economic integration refers to the efforts to promote free and
fair trade on a regional basis. It enables countri.es to focus on issues that are
relevant to their stage of development as well as encourage trade between
neighbours. Regional economic integration refers to cooperation between various
countries of a particular region in order to develop that particular area. It
includes eco11omic integration of various trading areas of different countries.
Types of regional economic integration:
(1) Free trade area. This is the most common form of regional economic
integration. Member countries remove all barriers to trade between
themselves but are free to independently determine trade policies with
non-member nations.
Example, North American Free Trade Agreement (NAFTA).
(it) Custom union. It encourages economic cooperation as in a tree trnde
zone. Barriers to trade are removed between member countries in a
sim.ilar manner. Members may agree to treat trade with non-members.
Example, The Gulf Cooperation council (GCq.
(iii) Common market. It allows for the creation of economically integrated
markets between member countries. Trade barriers are removed along
with restrictions on the movement of labour and capital between
member countries. There is a common trade policy regarding trade with
union members.
Example, Common Market For Eastern And Southern Africa (COMFSA).
(iv) Economic union. It is created when countries enter into an economic
agreement to remove barriers to trade and adopt common economic
policies. Example, European Union (EU).
Advantages/benefits of regio1,nl economic integration:
(1) Regional economic market can provide a larger market as compared to
the domestic market. With the widened size of market both intern.al as
well as external economies of scale are possible.
(ii) Large market allows a high degree of sophistication and specialisation of
products conducive to expansion of industrial development Moreover
the specialisation for regional trade would encourage the flow of
investment into industries that have a comparative cost advantage.
Gains from i11ternational trade increases:
(1) Regional economic integration can result in favourable change in cost
and price structure along with desirable change in the structure and
composition of foreign trade for the 01ember countries.
(ii) Regional economic integration can facilitate optimum allocation of
resources thereby increasing the efficiency in production.
(iit) Better production and enhanced consumption along with rise in real
income results in overall growth and development for the member countries.
('iv) Increased competition within the common market is very beneficial for
the consumers.
Disadvantagefi/'cost/limit«tions associated witlr regional economic integration.
(1) Regional economic integration can create trade barriers against non­
member countries.
 8. FOREIGN TRADE PROMOTION MEASURES & ORGANIZATIONS IN INDL� 95
(i1) Due to trade barriers trade may get diverted from a non-member countxy
to a member country despite the inefficiency in cost.
(iii) Regional economic integration requires member countries to give up
certain degree of control over major policies like trade, monetary and
fiscal policies. Higher the level of integration, greater the degree of
controls that need to be given up.
(iv) It can result in employment shifts and reductions. Nations may move to
cheaper labour markets in member countries, while workers may move
to gain access to better jobs and wages.
(v) Retaliation of non-members is another disadvantage of regional
economic integration. Non-members may form their own trade blocks
leading to trade wars.
(rr) Increased competition can lead to substantial corporate restructuring
resulting in layoffs and other undesirable consequences.
(vii) Another disadvantage of regional economic integration is that it provides
protection to inefficient membeI nations.
(viii) Once new regional laws come into effect, member countries may lose
their sovereignty.
(ix) Regional economic integration Hice European Union may create a
common currency. Th.is can lead to financial crisis.
(x) Regional economic integration can result in cultural centralisation.
Q. 5. What are the different modes of payment In Foreign Trade? (2013
Ans. Differe11t modes of payment in Foreig,1 Trade. To succeed in today's global
marketplace and win sales against foreign competitors, exporters must offer their
customers attractive sales tenns supported by appropriate payment methods. An
appropriate payment method must be chosen carefully to minimize the risks
involved while also accommodating the needs of the buyer.
Tliere are four primary met/iods of payment for international transactions.
1. Cash-in-Advance. With cash-in-advance payment terms, the exporter can
avoid credit risk because payment is received before the ownership of the goods
is transferred. For example, Payments made through wire transfers and credit
cards. However, aslcing for payment in advance is the least attractive option for
the buyer, because not only does it create cash-flow problems, but the buyers are
also concerned whether the goods would be delivered or not. Thus, exporters
who insist on advance payment method as their sole manner of doing business
may lose to competitors who offer more attractive payinent tenns.
2 Letter of Credit (Lq. Letters of credit (LC) is one of the most secure
instruments available to international traders. An LC is a commitment by a banlc
on behalf of the buyer that payment will be made to the exporter, provided that
the terms and conditions mentioned there in or agreed u:pon have been roet, as
verified through the presentation of all required documents. The buyer pays his
or her bank to render this service. An LC is useful when reliable credit
information about a foreign buyer is difficult to obtain, but the exporter is
satisfied with the creditworthiness of the buyer's foreign banlc.
3. Documentary collection (D/C). Documentary collection (D/ C) is a
transaction whereby the exporter entrusts the collection of a payment to the
 96 smvA DELHl UNIVERSTIY SERIES
remitting bank (exporter's bank), which sends documents to a collecting bank
(importer's bank), along with instructions for payment. Funds are received from
the importer and remitted to the exporter through the banks involved in the
collection in exchange for those documents.
4. Open Account transaction. An open account transaction is a sale where the
goods are shipped and delivered before payment is due, which is usually within
30 to 90 days. Obviously, this option is the most advantageous option to the
importer in terms of cash flow and cost, but it is consequently the highest risk
option for an exporter. Therefore, exporters who are reluctant to extend credit
may lose a. saJe to their competitors. However, the exporter can offer competitive
open account terms while substantially reducing the risk of non-payment by
using one or more of the appropriate trade finance techniques, such as export
credit insurance.
Q. 6. Distinguish between Trade &; Investment-related modes of entry into
international business.
Ans. Trade-Related modes of entry. Foreign trade is exchange of capital, goods
and services across international borders or territories. In most countries, it
represents a significant share of gross domestic product (GDP). It is a trade
between two or more countries and we can separate it into three parts.
• Import-Affluent countries import resources and commodities when they
find comparative advantages in sourcing from foreign locations.
• Export-It involves selling domestically produced products in foreign
market through brokers or overseas distribution centres.
• Entrepot-lmport goods for re-export after previous operations. Every
country has lack of any resource and due to this fact they have to trade
goods etc. with other countries worldwide. Now-a-days, in the era of
globalization demand for goods and services is increasing. This natural
trade has existed for centuries, but now we have better logistics and
faster shipments and cooperation between countries is easier. Problems
that traders are facing are in general different currencies, Jaw systems,
regulations and in some places trade barriers.
Investment-Related mode of entry. Investment from one country into another
(normally by companies rather than governments), that involves establishing
operations or acquiring tangible assets, including stakes in other businesses. POI
means investment of foreign assets into domestic structures, organizations and
equipments. It is a key element in economic integration and creates direct, stable
and long-lasting llnl<s between economies. Companies that are constantly
involved in international business invest their money in manufacturing and
marketing bases through ownership.
Difference between trade-related and investment-related modes of entry.
When MNCs invest their money to buy assets such as land and machines, it is
known as foreign inveshnent. It is made with the hope that the value of these
assets will increase in future whereas foreign trade is the trade which takes place
between two or more countries through MNCs. Foreign trade includes buying and
selling of goods under an agreement while foreign im,estment only deals with
investment in share of properties in a foreign land.
:J :J :J :J
 University
Question Papers
Modified As per
Latest Syllabus
 INTERNATIONAL BUSINESS-2013
[MOOIAED AS PER THE lATEST S\1.lABUS]
Na.me of the Paper : International Business
Na.me of the Course B.Com. (Hons.) CBCS
Duration: 3 hours Maximum Marks: 75
Attempt All the questions.
Q. 1. What do you mean by International business? List and explain the
factors responsible for the growth of International Business in the recent past.
15
Ans. See Q. 4, Chapter 1, Introduction. to International Bus.iness. [Page 4
Or
Discuss different eleme.nts of cultural environment having impact upon
International Business Operations. 15
Ans. See Q. 6, Chapter 2, Inte.mational Business Environment. [Page 23
Q. 2. (a) Distinguish between Tariff and Non-Tariff Banius to International
Trade.
(b) What is the Balance of Payment Account? \Vb.it are its different
component.s? 7+8
Ans. (a) See Q. 8, Chapter 3, Jntematlonal Trade. [Page 37
(b) See Q. 13, Chapter 3, International Tnde. [Page 42
Or
Disc:uss the organizational structutt, principles and functions of the wro as
a regulator of global trade. 15
Ans. See Q. 1 & Q. 2, Chapter 4, International and Economic Organizations.
[Pages 45-46
Q. 3. "Economic integration passes through different stages". Analyse the
statement giving suitable examples. 15
Ans. See Q. 9, Chapter 3, International Trade. [Page 38
Or
Write short notes on my two:
(a) Foreign Exchange Risk vs. Foreign Exchange Exposure.
(b) Functions of Foreign Exchange Market
(c) European Union 7.5+7.S
Ans. (a) Foreign Exchange Risk. See Q. 3(a)&(b), Chapter 6, International
Financial Environment. [Page 62
(b) Functiotrs of Fureign Exchange M11rket. See Q. 2, Chapter 6, International
Financial Environment. [Page 61
(c) European Ulfion (EU). See Q. 2(c), Chapter 5, Regional Economic
Integration. [Page 57
Q. 4. (a) Write a brief note on demographic dimensions of international
business environment.
(b) Discuss the advantages and disadvantages of regional economic
integration.

99
 100 SIDVA DELBI UNIVl!RSITY SERIES
Ans. (a) See Q. 5, Chapter 2, Intemational Business Environment. [Page 22
(&) See Q. 4, Chapter 8, Foreign Trade Promotion Measures and
Organizations in India. [Page 93
Or
(a) Discuss the theory of comparative advantage in intemational business.
(b) Briefly explain central bank intervention in foreign exchange markets.
Ans. (a) See Q. 2, Chapter 3, Intemational Trade. [Page 31
(b) See Q. 8, Chapter 7, Exchange Rate Determination. [Page 82
Q. 5. (a) What are the different modes of payment in Foreign Trade?
(b) Enumerate the various sources of global business finance. 7+8
Ans. (a) See Q. 5, Chapter 8, Foreign Trade Promotion Measures and
Organizations in India. [Page 95
(b) See Q. 20, Chapter 6, International Financial Environment. [Page 75
Or
Write short notes on any two:
(a) EOUs
(b) Environmental Degradation
(c) Role of SEZs in the Indian economy 7.5+7.5
Ans. (a) EOUs. See Q. 2(b), Chapter 8, Foreign Trade Promotion Measures and
Organizations in India. (Page 92
(b) Enviro11me11tal Degradation. See Q. 9, Chapter 2, international Business
Environment. [Page 27
Z
(c) Role of SEs in the Indian Economy. See Q. 2(a), Chapter 8, Foreign Trade
Promotion Measures and 0,:-ganizations in India. (Page 91

7777
 INTERNATIONAL BUSINESS-2014
[MODIFIED AS PER THE L\TEST Sl'LLABUS]

Name of the Paper : International Business

Name of the Course B.Com. (Hons.) CBCS
Duratiorr: 3 1wurs Mil.Ximum Marks: 75
AHempt All the q11estio11s.
Q. 1. (a) What are the complexities involved in international business?
Compare and contrast it with domestic business. 8
(&) Discuss how diverse political and economic environment impact
international business. 7
Ans. (a) See Q. 7, Oiapter 1, Introduction to International Business. [Page 8
(&) Impact of Political environ,nmt
. on lnternaHonnl Business. See Q. 7,
Chapter 2, International Business En,ironment. [Page 23
Economic enviTonme11t on International Bllsiness. See Q. 8, Chapter 2,
lnt.ernational Business Environment. [Pages 25-26
Or
(a) Discuss the contractual Entry Modes used by firms to enter International
Business. 8
(&) Comment on the trends in India's foreign trade in the last decade. 7
Ans. (a) See Q. 11, Chapter 1, Introduction to International Business.[Page 12
(&) See Q. 10, Chapter 2, International Busin.ess Environment. [Page 28
Q. 2. (a) Explain Porter's theory of National Competitive Advantage as a
theory of international trade. 8
(&) Explain the role of WTO as a regulator of world trade organization. 7
Ans. (a) See Q. 3, Chapter 3, International Trade. [Page 33
(b) Role of WTO as a regulator of world trade. See Q. 1 and Q. 2, Oiapter 4,
International and Economic Organizations. [Pages 45-46
Or
\\lhat are barriers to trade? Distinguish between the effects of Tariff and
Non-Tariff barriers on trade between nations. 15
Ans. See Q. 8, Chapter 3, International Trade. [Page 37
Q. 3. Write short notes on any two of the following:
(1) NAFTA
(i,) SAARC
(ii,) ASEAN 7¼"2
)
Ans. (1 NA.ITA See Q. 2(a), Chapter 5, Regional Economic Integration.
[Page 56
(it) SAARC. See Q. 2(d), Chapter 5, Regional Economic Integration. [Page 57
(iii) ASEAN. See Q. 2(b), Chapter 5, Regional Economic Integration. [Page 56
Or
"The Customs Union, Common market, Economic Union are various stages
in the growth of regional economic integration". Explain. 15
Ans. See Q. 9, Chapter 3, International Trade. (Page 38

101
102 SHJVA DELBJ UNIVl!RSITY SERIES
Q. 4. (a) "The Balance of Paymenlll account is a cash flow statement �
records the flow of foreign exchange from all international transa.ctions over a
period of time". Discuss. 8
(b) List the constituents of the Current and Capital and Financial Account of
the Balance of Payments Account. 7
Ans. (a) See Q. 10, Chapter 3, International Trade. (Page 39
(b) Constituents of the Balance of Payments Account. See Q. 13, Chapter 3,
International Trade. (Page 42
Or
Write short notes on any two of the following:
(a) Types of FOi
(b) Interest Rate Parity
(c) Floating Exchange Rate System 7½x2
Ans. (a) Types of FDL See Q. 18(b), Chapter 6, International Financial
Environment. (Page 70
(b) Interest Rate ParihJ, See Q. 13, Chapter 7, Exchange Rate Determination.
(Page 85
(c) Floating Excltange Rate System. See Q. 9(a), Chapter 7, Exchange Rate
Determination. (Page 84
Q. 5. (a) Write a brief note on physical dimension of international business
environment.
(b) What att the measutt1 for pro.moting foreign invesbnents into and from
India?
Ans. (a) See Q. 3, Chapter 2, International Business Environment. (Page 20
(b) See Q. 18(a), Chapter 6, International financial Environment. (Page 70
Or
(a) Write a note on Indian Joint Ventures and acquisition abroad. 4x2
(b) Discuss the objectives and functions of IMF. 7
Ans. (a) See Q. 3, Chapter 8, Foreign Trade Promotion Measures &
Organizations in India. (Page 93
(b) See Q. 6, Chapter 4, International and Economic Organizations. (Page 52

:J 1 J J
 INTERNATIONAL BUSINESS-2015
[MODIFIED AS PER THE LATEST S\'LLABUSJ

Name of the Paper : IntemationaJ Business

Name of the Course B.Com. (Hons.) CBCS
Duration: 3 hours Maximum Marks: 75
Attempt All tlze questions.
Q. 1. (a) What is Globalization? What are the driving forces of
Globalization? 7
(b) Identify the mode of entry in the following c.ases and explain its
advantages and disadvantages: 4+4-S
(1) Airtel has purchased Zain Telecommunications in South Africa.
(2) There are a large no. of Pizza-hut restaurants in India but none of them
is owned by Pizza-hut.
Ans. (a) Globalization & Driving forces of globalization. See Q. 1, Chapter l,
Introduction to lntemationaJ Business. [Page 1
(b) See Q. 12, Chapter 1, Introduction to International Business. [Page 14
Or
(a) Give a brief account of differences in the economic and cultural
environment of business between nations and their implications for business.
8
(b) Discuss the salient features of World trade and analyse recent trends in
\Vorld trade. 7
Ans. (a) See Q. 8, Chapter 2, International Business Environment. [Page 25
(b) See Q. 3, Chapter 4, International and Economic Organizations. [Page 48
Q. 2. (a) Explain the Product Life Cycle theory of international trade. 8
(b) Explain the role and performance of WTO. 7
( )
Ans. a Product Life Cycle tJieory. See Q. 7, Chapter 3, International Trade.
[Page 36
(b) WTO. See Q. 1 & Q. 2, Chapter 4, International &: Economic Organizations.
[Pages 45-46
Or
(a) Discuss the various components of 'Balance of Payment Account'. 7
(&) Explain various commercial policy instruments used by different nations
to regulate Foreign Trade. 8
Ans. (a) See Q. 13, Chapter 3, International Trade. [Page 42
(&) See Q. 12, Chapter 3, International Trade. [Page 41.
Q. 3. (a) Give a brief account of Foreign Exchange risks. How are these risks
managed? 8
(&) How successfully ASEAN has promoted integration among various
countries of Asia? 7
Ans. (a) See Q. 7, Chapter 7, Exchange Rate Determination. [Page 81
(b) See Q. 3, Chapter 5, RegionaJ Economic Integration. [Page 58

103
 104 smvA DELHI UNIVERSITY SEUES
Or
(a) Discuss the contribution of Foreign Investment in India's economic
growth. 8
(b) Write a short note on Exchange Rates. 7
Ans. (a) See Q. 19, Chapter 6, International Financial Environment. (Page 73
(b) See Q. 5, Chapter 7, Exchange Rate Determination. (Page 80
Q. 4. (a) State the various stages of orientation in the context of international
business. 8
(b) Give an overview of UNCTAD. 7
Ans. (a) See Q. 10, Chapter 1, Introduction to International Business.
(Page 11
(b) See Q. 4, 01apter 4, International and Economic Organizations. [Page 50
Or
(a) Describe the theory of Absolute advantage in foreign trade. 8
(b) Briefly explain the theory of Purcasing Power Parity.
h
7
Ans. (a) See Q. 1, O\apter 3, International Trade. [Page 30
(b) See Q. 10, Chapter 7, Exchange Rate Determination. (Page 84
Q. 5. (a) Discuss the promotional measures initiated by the Government of
India to increase exports. 8
(b) Explain the various modes of payment in foreign trade. 7
Ans. (a) See Q. 1, Chapter 8, Foreign Trade Promotion Measures and
Organizations in India. (Page 89
(b) Various m.odes of paljfflmt in foreign trade. See Q. 5, Chapter 8, Foreign
Trade Promotion M.easures and Organizations in India. (Page 95
Or
Write short notes on any two of the following: 7½+7½
(a) SEZs
(b) Joint Ventures
(c) EXIM Bank
Ans. (a) SEZs. See Q. 2(11), 01apter 8, Foreign Trade Promotion Measures &
Organizations in India. [Page 91
(b) foint Venti,res. See Q. 3, Olapter 8, Foreign Trade Promotion Measures &
Organizations in India. [Page 93
(c) EXIM Bank. See Q. 2(c), Olapter 8, Foreign Trade Promotion Measures &
Organizations in India. [Page 92

:JJ:J:J
 INfERNATIONAL BUSINESS-2016
(MODIFIED AS PER THE lAlEST SYLLABUS]

Name of the Paper : International Business

Name of the Course B.Com. (Hons.) CBCS
Duration: 3 hours Maximum Marks: 75
Attempt All the qllestions.
Q. 1. (a) What is a Transnational Corporation (TNC)? Explain its
characteristic features. 8
(&) Enumerate the factors responsible for the rapid growth of International
Business in the last few decades. 7
Ans. (a) See Q. 13, Chapter 1, Introduction to International Business.[Page 16
(&) Factors responsible for rapid growtl, of international business. See Q. 4,
Chapter 1, Introduction to International Business. [Page 4
Or
Distinguish between:
(a) Trade & Investment-related modes of entry into international business.
(&) International Leasing and International Licensing. 8,7
Ans. (a) See Q. 6, Chapter 8, Foreign Trade Promotion Measures &:
Organizations in India. [Page 96
(&) See Q. 21, Chapter 6, rnternational financial Environment. (Page 78
Q. 2. "A global business firm operates in a complex, multi-faceted economic
and political environment." Explain. 15
Ans. See Q. 2, Chapter 2, International Business Environment. [Page 19
Or
What is the Balance of Payments Account? What are the major components
in a country's Balance of Payments Account? 15
Ans. See Q. 13, Chapter 3, International Trade. (Page 42
Q. 3. (a) Explain the objectives and the role of International Monetary Fund
(IMF). 8
(b) What is the impact of imposition of tariff barriers on price of goods? Is it
beneficial for th.e consum.er? 7
Ans. (a) Role and objectives of IMF. See Q. 6, Chapter 4, International and
Economic Organizations. (Page 52
(&) See Q. 11, Chapter 3, Intematio.nal Trad.e. (Page 40
Or
Critically evaluate the Product Life Cycle theory of lnternationaJ Trade. 15
Ans. See Q. 7, Chapter 3, International Trad.e. (Page 36
Q. 4. uEconornic integration is achieved after passing through different
stages." Analyze this statement giving relevant examples. 15
Ans. See Q. 9, Chapter 3, International Trade. (Page 38
Or
Write short notes on any th.ree of the following: 3x5
(a) Asian Development Bank (ADB)
(b) International Development .Association
105
106 smvA DELHI UNIVERSITY SfilUES
(c) Multilateral Investment Guarantee Agency (MIGA)
Ans. (a) Asian Devel.opment Bank (ADBI. See Q. 2(a), Chapter 6, International
Financial Environment. [Page 71
(b) International Development Association. See Q. l(b), Chapter 6, Inter-
national Financial Environment. [Page 72
(c) M11lti.lateral Investment G11arantee Agency (MIGA). See Q. l(c), Chapter 6,
International Financial Environment. [Page 72
Q. 5. What is meant by Special Economic Zone (SEZ)? \Vhat are its
objectives? Enumerate some incentives offered to SEZs in India. 15
Ans. See Q. l(a), Chapter 8, Foreign Tnde Promotion Measures and
Organizations in India. [Page 91
Or
(a) Explain with the help of an example the interest rate parity theory of
exchange rate.
(b) Write a brief note on spot market and its working.
Ans. (a) See Q. 14, Chapter 7, Exchange Rate Detennination. [Page 86
(b) See Q. 6, Chapter 6, International Financial Environment. (Page 65

7777
 INTERNATIONAL BUSINESS-2017
[MODIAED AS PER TIIE lAilST SYLLABUS]

Name of the Paper : Intemationa.1 Business

Name of the Course B.Com. (Hons.) CBCS
Duration: 3 hours Maximum Marks: 75
Attempt All the q11eslio11s.
Q. 1. (a) Define International Business and describe its features.
(b) Why companies globa.lise? Explain with su..itable examples.
Ans. (a) See Q. 4, Oiapter 1, Introdudion to International Business. [Page 4
(b) See Q. 3, Chapter 1, Introduction to International Business. [Page 3
Or
"A global business firm operates in an environment which is complex and
multidimensional." Explain the main features of the international politicaJ
and legal environment.
Ans. See Q. 2, Chapter 2, International Busin.ess Environment. [Page 19
Q. 2. (a) What is free trade? Give arguments in its favour.
(b) Describe briefly trends in India's foreign trade.
Ans. (a) See Q. 14, Chapter 3, International Trade. [Page 43
(b) See Q. 6, Chapter 2, Intenationa.1 Business Environme.nt. [Page 23
Or
(a) Explain the product life cycle theory of international trade.
(b) Explain the role and performance of WTO.
Ans. (a) See Q. 7, Oiapter 3, International Trade. [Page 36
(b) See Q. 1 & Q. 2, 01apter 4, International &c Economic Organizations.
[Pages 45-46
Q. 3. (a) Discuss the stages of internationalization of business.
(b) Discuss the tariff and non-tariff barriers to international trade.
Ans. (a) See Q. 9, Oiapter 1, Introduction to International Business. [Page 10
(b) See Q. 8, Chapter 3, International Trade. [Page 37
Or
(a) List and explain the different functions of the foreign exchange market.
(b) Distinguish between foreign exchange risk and foreign exchange
exposure.
Ans. (a) See Q. 2, Chapter 6, International Financial Environment. [Page 61
(b) See Q. 3(a) & (b), Chapter 6, International Financial Environment.
[Page 62
Q. 4. Regional economic integration is a process that passes through
different stages. Explain the statement with clear contemporary examples.
Ans. Economic integration. See Q. 9, Olapter 3, International Trade. (Page 38
Or
(a) What do you mean by demand for foreign exchange? What are its
determinants?
(b) What is meant by forward market? Discuss the concept of forward rate.

1117
108 smvA DELHI UNIV1!RSITY SfilUES
Ans. (a) See Q. 3, Chapter 7. Excbange Rate Determination. [Page 78
(b) See Q. 10 & Q. 11, Olapter 6, International Financial Environment.
[Pages 66..f,7
Q. 5. What do you mean by International business? List and explain tbe
factors responsible for tbe growth of International Business in tbe recent past.
Ans. See Q. 4, Chapter 1, lntroductio.n to International Business. [Page 4
o,
(a) Explain certain factors affecting foreign exchange rate determination.
(b) How do inflation and inrerest rates influence tbe value of the carrency?
Ans. (a) See Q. 4, Chapter 7, Exchange Rate Determination. [Page 79
(b) See Q. 6, Chapter 7, Exchange Rate Determination. [Page 81

7777
 2018 (May.June)
Name of the Paper International Business
Name of the Course B.Com. (Hons.) CBCS
Semester VI
Duration : 3 hours
Maximum Marks : 75
Attempt All questions and answer all parts togetl,er.
Q. 1. What do you understand by the term "Globalization"? What are the
different facets of globalization? Discuss briefly the driving forces behind it.
5,5,5
Ans. See Q. 1, Chapter 1, Introduction to International Business. [Page 1
Or
What are the complexities involved in international business? Compare and
contrast it with domestic business. Explain how the location of a country and
its topography affect the operations of a global business firm. 4,4,7
Ans. Complexities in International B11siness. See Q. 7, Otapter 1, Introduction
to International Business. [Page 8
Difference behoeen International Business and Domestic Business. See Q. 5,
Chapter 1, lntroduction to International Business. [Page 6
Effect of Location Rnd To11ography on a global business Jinn. Both location and
topography of a nation come under the ambit of geographic factors affecting
international business. Location of a country affects its climate. The climatic
conditions determine the type of goods a country produces and trades.
Geographical location plays a part in access to markets. All great empires have
been based around trade routes. Many of the world's poorest nations are poor
just because of their poor location and because of which they are difficult to
access by other nations for the purpose of busine.ss. These countries are
landlocked or are situated in high mountain ranges. They lack navigable rivers,
long coastlines or good natural harbours. Nations that carry out international
transactions in massive numbers enjoy the benefits of a good location. For
exllltlple, China has three of the world's busiest ports and so does the United
States. These ports provide easy trade access to these countries and with these
ports these countries raise money through tolls and shipping services. On the
other hand, countries like Afghanistan, Rwanda, Malawi or Bolivia are all
hindered by access to ports. Countries like Ethiopia or Lesotho are landlocked
and mountainous. Thus, such countries find it difficult to carry out international
trade. This is the reason why both geographic location and topographical factors
affect international business of a particular country. Availability of land, water
and other natural resources have a direct influence on international trade.
Topographical factors, location, weather, climatic conditions, natural resource,
endowments etc. are all relevant to a country's international trade. Topographical
factors can also affect the demand pattern. For example, in hilly areas with a
difficult terrain, Jeeps may be in greater demand as compared to cars.
Q. 2. (a) Give a brief account of differences .in the economic and legal
environments of business between the nations and their implications for
international business. 8
(b) "By using a tariff, a country can tum the terms of trade in its favour."
Examine the significance of ta.riff in this context. 7
109
 110 SHIVA DELHI UNIVERSITY SERIES
Ans. (a) Economic Environment and its implications 01, international business.
See Q. 8, Chapter 2, International Business Environment. [Pages 25-26
Legal Enuironment and its implications on international business. Legal
system. Differences in the structure of law between countries have important
implications for the practice of International Business. The government of a
country defines the legal framework within which firms do business.
Different types of legal systems are as follows:
(1) Property rights. The degree to which property rights are protected can
vary from country to country. It can be violated in two ways-through
private action and through public action.
(ii) Protection of intellectual property. Patents, copyrights and trademarks
establish ownership rights over intellectual property. It differs from
country to country. For example, many countries have stringent
regulations on the intellectual property rights but Cuna and Thailand
allow the manufacturing selling of pirated computer softwares.
(iir) Product safety and product liability. Product liability can be much
greater if a product does not conform to required safety standards. Both
civil and criminal liability laws are more stringent in the US than in any
other country. Liability laws are typically less extensive in less developed
countries.
In most countries, apart from the laws that control investment and related matters,
there are a number of laws that regulate the conduct of the business. These laws
cover such matters as standards of products, packaging, promotion etc.
In many countries, with a view to protecting consumer interests, regulations have
become stronger. Regulations to protect the purity of the environment and preserve
the ecological balance have assumed great importance in many countries.
Some governments specify certain standards for the products (in.eluding packaging)
to be marketed in the country; some even prohibit the marketing of certain products.
Several European countries restrain the use of children in commercial
advertisements. In a number of countries, in.eluding India, the advertisement of
alcoholic liquor is prohibited. For drugs, food additives, some cosme-tic
preparations, and so forth, a full disclosure requires more knowledge of the long­
range side eflects of materials ingested into the complex human body.
There are a host of statutory controls on business in India. If the MRTP companies
wanted to expand their business substantially, they had to convince the government
that such expansion was in the public interest.
Many countries today have laws to regulate competition in the public interest.
Elimination of unfair competition and dilution of monopoly power are the
important objectives of these regulations. In India, the monopolistic undertakings,
dominants undertakings and large industrial houses are subject to a number of
regulations which prevent the concentration of economic power to the common
detriment. The MRTP Act also controls monopolistic, restrictive and unfair trade
practices which are prejudicial to public interest. Such regulations brighten the
prospects of small and new firms. They also increase the scope of some of the
existing firms to venture into new areas of business. The special privileges available
to th.e small scale sector have also contributed to the phenomenal success of Ninna.
 INTERNATIONAL BUSINESS-2018 (May-June) 111

(b) Significance of tariffs. See Q. 11, Chapter 3, International Trade.

[Pages 40-41
Or
Analyze the trends in India's foreign trade sin.ce 2000 onwards. 15
Ans. Various aspects of foreign trade since i·ndependence 11re discussed below:
1. Volume o£ foreign trade. It is the sum of exports and imports. The volume of
foreign trade has increased manifold in the last two decades. Th.is is clear from
the table given below:
Imports, Exports and Trade Balance
BOP (Current A/c) (In US$ million)
2007-08 2008-2009 2009-10 2010-2011
Exports 1,66,162 1,89,001 1,82,442 2,50,468
Imports 2,57,629 3,08,520 3,00,645 3,81,061
Trade Balance -91,467 -1,19,519 -1,18,203 -1,30,593
Somu: Economic S,m,ey-2011-12
2. Change in the composition of Jndi.i's foreign trade. Composition of foreign
trade refers to the items of exports and imports. In other words, this means what
do we import and what do we export. Before independence, India mainly used to
import consumer goods and export raw materials such as iron-ore, hides and
skins, raw jute, cotton, etc. But since independence our composition of foreign
trade has undergone a drastic change. We all know that India has entered into an
era of economic planning. The process of economic development has
considerably affected her composition of foreign trade. Now the main items of
import are raw materials and spare parts, foodgrains, defence equipment,
petroleum products etc. instead of consumer goods. The main items of export are
manufactured and semi-manufactured engineering and other consumer goods
and many non-traditional items such as handicrafts, gem and jewellery, etc. All
these changes are the result of development activities.
3. Change in the direction of India's foreign trade. Direction of foreign trade
refers to the countries from which we import and the countries to which we
export. Before independence, as a result of British domination, India's foreign
trade was mainly confined to England and other countries of Commonwealth.
But after independence, India adopted a foreign policy of neutrality and non­
alignment. With the result we have cultivated trade relations with more or less
each and every country barring few countries with whom our relations are
hostile. As such, we find that direction of lndia's foreign trade at present is more
well spread and diversified. This has led to a decline in our trade with Great
Britain and an increase with other countries.
4.. Increasing adversity of Balance of Payments. Since independen.ce, all kinds
of imports have increased manifold but corresponding to them, exports have not
increased in the same ratio. With the result, trade-gap has been ever-widening.
Since position of invisible payments has also not been very satisfactory, therefore,
balance of payments' position has not improved much.
Indian Government has taken number of steps in the direction of reducing
deficits in the balance of payments.
 112 SIDVA DELHI UNIV1!RSITY SERIES
(i) lndian rupee has been made convertible. This has encouraged indigenous
exports.
(ir) Custom duties have been rationalised and import duties have been reduced
(iit) Export proceduxes and policies have been liberalised.
(iv) Rupee has been devalued twice.
(v) Exporters have been allowed to make imports using the foreign exchange
they have earned through exports.
These steps have profound influence on India's performance on foreign trade
front.
India's exports (merchandise and services) which also had robust growth of
30.1 % in the five pre-crisis years (2003-07) decelerated to 16.0% per cent in the
five post-crisis years (2009-13). Though the outlook is still better, the situation is
still fragile for both World and Indian trade.
Trends in India'sforeigt, trade in tl,e last decade. Foreign trade includes all the
i.mports and exports to and from lndia. At the level of Central Government it is
administered by the Ministry of Commerce and Industry.
Trends in l.ndia's Foreign Trade:
(t) India's merchandise exports reached a level of US$ 304.62 billion during
2011-12 showing a growth of 21.30 per cent as compared to a growth of
40.49 per cent du.ring the previous year. Despite the recent setback faced
by lndia's export sector due to global slowdown, merchandise exports
still recorded a Compound Annual Growth Rate (CAGR) of 20.3 per cent
from 2004-05 to 2011-12.
(ir) As per WTO's International Trade Statistics 2012, in merchandise trade,
India is the 19th largest exporter in the world with a share of l.7 per cent
and the 12th largest importer with a share of 2.5 per cent in 2011.
(iir) Exports recorded a growth of 21.30 per cent during Apr-Mar 2011-12.
The Government has set an export target of US$ 360 billion for 2012-13.
TI,e merchandise exports have reached US$ 265.95 billion in 2012-13.
(iv) Value of imports during 2012-13 was US$ 448.04 billion as against US$
446.94 billion during the previous year showing a growth of 0.25 per cent
in$ terms. Oil imports were valued at US$155.57 billio.n during 2012-13
which was 11.92 per cent higher than oil imports valued US S 139.00
billion in the previous year.
(v) The trade deficit in 2012-13 (Apr-Feb) was estimated at US $ 182.09
billion which was higher than the deficit of US$ 1.69.81 billion du.ring
20ll-12.
(?'I) Exports of the top five commodities during the period 2012-13 (April­
January) registered a share of 50.8 per cent in US $ terms mainly due to
significant contribution in the exports of Petroleum. (Crude & Products),
Gems & Jewellery, Transport Equipments, Machinery and Instruments
and Drugs, Pharmaceuticals & Fine Chemicals.
(vii) India's Gems and Jewellery exports declined by 9.3 per cent to US$ 39
billion in 2012-13 because of lower demand from global markets,
especially in the US and Europe.
 INTERNATIONAL BUSINESS-2018 (May-June) 113

(viir) The share of Asia comprising of East Asia, ASEAN, West Asia, Other
West Asia, North Bast Asia and South Asia accounted for 50.78 per cent
of India's total exports in US $ terms. The share of Europe and America
in India's exports stood at 18.88 per cent and 18.77 per cent respectively.
USA has been the most important country of export destination followed
by UAE (12.20 per cent), Singapore (4.79 percent), China (4.59 per cent)
and Hong Kong (3.95 per cent).
Q. 3. (a) Distinguish between 'Balan.ce of Trade' and 'Balance of Payment
Account'. Briefly explain the reasons for the adverse balance of paymen.ts
sih1ation in India. 8
(b) Briefly explain the role of WTO as regulator and promoter of world trade..
7
Ans. (a) Difference between Balance of Payment and Balance of Trade.
Basis Balance of Pai1111ent Balance of Trade
1. Meaning Balance of payment is a Balance of trade is a
statement that keeps a track statement that captures the
of all economic transactions country's export and import
done by the country with of goods with the rest of the
the rest of the world. world.
2. Records Transactions related to both Transactions related to
goods and services are goods only are recorded.
recorded.
3. Capital They are included in They are not included in the
transfers Balance of payment account. Balanc. e of trade.
4. Focus It focuses on the dear view It focuses on a partial view
of the economic position of of the country's economic
the country. status.
5. Outcome Under Balance of payment Balance of Trade can be
account both the receipts favourable, unfavourable or
and payment sides tally. balanced.
6. Components Current account and capital BOT is a component of
account are the rna1n current account of balance
components of BOP. of payment.
The main c1mses of adverse Balance of Payments sih1ation in India are:
I. Economic factor3:
(a) The main cause of adverse BOP situation in India is imbalance
between exports and imports. The country's volume of exports have
always been less than the volume of imports.
(b) Another reason behind deficit on BOP is large scale development
expenditure that results iJl larger volume of imports.
(c) High rate of inflation within the country encourages i.lnports. This
also results in excess of imports over exports.
(d) Cyclical fluctuations like depression, recession in general business
activity causes deficit in BOP.
 114 SHJVA DELHI UNIVl!RSITY SERIES
ll. Political factors: Political instability and frequent change of ruling
government causes imbalance between inflow and outflow of capital.
ill. Social factors:
(a) Changes in tastes and preferences of the people influence the pattern
and volume of exports as well as imports resulting in disequilibrium
in BOP.
(b) Another major reason behind deficit in BOP is massive population of
the country. Due to large scale population, the country has been
depending heavily on imports. Large imports a.re required by the
country to cater to the needs of the massive population of the
country. This has been the main reason behind the mismatch
between the country's exports and imports.
(b) WTO. See Q. 1 & Q. 2, Chapter 4, International and F.c:onomic organization.
(Pages 45--46
Or
\\ hat are the measures taken by the Government of India to promote FDI in
1

lndia? Briefly analyze the Impact of such measures in the recent years. 15
Ans. A investment made by foreign business entity into a business entity in
another country is called Foreign Direct investment. Foreign investment is the
investment originating from other countries. Foreign Direct investment plays an
important role in the development of an economy. It helps in achieving a certain
degree of financial stability development and growth. in order to attract Foreign
Direct investment (FDI), the Government has put in place a policy framework
on FOi which is transparent, predictable and easily comprehensible.
Ever since coming to power, the NDA government has taken a number of steps
to bolster the FOi scenario in India. It has enabled international entities like
Carrefour and Walmart to come and invest in the multi-brand retail market in
lndia. The retail market in lndia has been growing at a substantial rate and at
present, it is worth somewhere around 28 billion dollars. It is expected that in
2020, this value will reach approximately 260 billion dollars.
The lndian government has announced a number of reforms and has
implemented several industrial policies:
• The FDI is allowed in India through collaborations such as Joint Venture
collaborations, preferential allotments and investment through EURO
issues.
• It has opened an FOI route by selling up of 100% EOUs /EHTPs/ STPs,
etc. and entering into Foreign technology agreement.
• FOi is encouraged in almost all the economic activities under the
automatic route.
• Huge amounts of FDI is coming into India through non-resident
Indians, international companies and various other foreign investors.
• FOi Approval in India is also done by the Foreign Investment Promotion
Board. The time taken by Foreign Investment Promotion Board for
approving the proposals for foreign direct investment in India is
between four to six weeks.
 INTERNATIONAL BUSlNESS-2018 (May-June) 115

Foreign Direct Investment (FDI) and Economic Growth:

The economic development witnessed during the past two decades in India
rests to a great extent on Foreign Direct Investment (FDI). FDI has been a vital
non-debt financial force behind the economic upsurge in India.. Special
investment vantages like cheap cost wages and tax exemptions on the amount
being invested attract foreign companies to invest in India. FD! in India is done
across a wide range of industries and its relentless in£1ux reflects the tremendous
scope, faith and trust that foreign investors have in the Indian economy.
To ensure an uninterrupted inflow of FDI in India, the Indian government has
created conducive trade atmosphere and effective business policy measures in
place. This strategy is reflected in the steps taken by the government, such as
easing out tl,e restrictions levied on sectors like stock exchanges, power
exchanges, defence, telecommunicatioru and PSU oil refineries to name a few.
11,e Indian Market for FDI:
The last fiscal (2014-15) year saw a considerable increase in the FD! made in
India. India's pro-growth business policies have contributed a great deal in
making this possible. The first five months of the 2014-15 fiscal year noticed a net
inflow of US$ 14.1 million FDI in India, a.mounting to a good 33.5 per cent rise in
the FDI influx.
Advantages of FDI in India:
There are several benefits of increasing foreign direct investment in India. First
of all, witl, more FD!, conswners will be able to save 5 to 10 per cent on their
expenses because products will be available at much Jess rates and to top it all,
the quality will be better as well. It is aJso expected that the farmers who face a
lot of economic problems will also get better payment for their produce. It is
expected that their earnings will increase by 10 to 30 per cent.
FD! is also supposed to have a positive effect on fue employment scenario by
generating approximately 4 million job opportunities. Areas Like logistics will be
benefited as well because of FOi and it is assumed that 6 million jobs wiJJ be
created. The governments-both central and state-will be benefited because of
FDI. An addition of 25-30 billion dollars t'O the national treasury is also expected.
Investments ;,, IndiR during 2015-16:
The Indian government, during the 2014-15 fiscal year, announced that it
would allow FOi worth US$ 14.65 billion into the railways infrastructure. Some
of the most expensive and largest railway projects will be carried out under these
investments. Hundred per cent FOi into the healfu sector will be allowed by the
Department of Indusb:ial Policy and Promotion (DIPP) to enable indigenous
manufacturing and reduce imports of medical devices. By the next fiscal year, the
value of medical devices in fue world market will be worth US$ 400 billion. The
equity investment in the real estate is expected to go two-fold as the Indian
government has allowed 100 per cent FDI into the construction sector.
Q. 4. 'Economic integration is achieved after passing through different
stages.' Analyze the statement by giving suitable examples. How successfully
has ASEAN promoted integration in the Asian region? 15
Ans. Economic Integration. See Q. 1, Olapter 5, Regional F.conomic Integration.
[Page 55
 116 smvA DELHI UNIVl!RSITY SERIES
ASEAN. See Q. 3, Chapter 5, Regional Economic Integration. [Page 58
Or
What are the different functions of foreign exchange market? Distinguish
between the Foreign Evcbaog"' risk and Forei gn Exchange n-posure.
Ans. Functions of Foreign Exchange Market. See Q. 5, Chapter 6, International
Financial Environment [Page 64
Difference between Foreign Excluinge Risk and Foreign Exchange Exposure.
Foreign Exchange Risk is defined as the net potential gains or losses which can
arise from exchange rate changes ID the foreign exchange exposure of an
enterprise. It is possible that an adverse exchange rate m.ovement may tum an
otherwise profitable deal into a loss. It is also possible that an unexpected
movement in the exchange rate is favourable and bring windfall profits.
On the other hand, Forei gn Exchange Exposure is defined as the extend to
which the transactions, assets and liabilities of an enterprise are denominated in
currencies other than the reporting currency of the enterprise itself. The reporting
currency is normally the national currency of the parent company. Exposure
arises because the enterprise denominates transaction in a foreign currency or it
operates in a foreign market.
Foreign exchange risk is related to the variability of the domestic currency,
values of assets, liabilities or operating income due to unanticipated changes in
exchange rates, whereas Foreign Exchange exposw-e is what is at risk. Exposure
relates to the total value of assets, liabilities or cash flows of an enterprise
denominated in foreign currency, while Foreign Exchange risk relates to the
excess or shortfall in the cash flows or value of assets or liabilities likely to arise
on account of exchange rate fluctuations.
Q. 5. (a) What is Outsourcing? Discuss the different facton, which play a key
role in a firm's decisions to outsource some of its business operations. 8
(b) Explain the concept of strategic alliances. Briefly explain the advantages
and disadvantages of strategic alliances. 7
Ans. (a) Business Process Outsourcing (BPO). Outsourcing means to engage
the services of an external service provider (i.e. the outsourcer) to manage and
deliver services in respect of one or more business activities of non-core nature to
the client (or outsourced).
In an outsourcing agreement, there are two parties - the client company or the
outsourced who wants a business activity to be externally performed, and the
vendor or the external service provider or the outsourcer who manages and
delivers the services to the client company.
Business Process Outsourcing may be defined as, "tile co11trncting out of 11
C()mpany's in-ho11se ftmction to a preferred Tlendor with a high q11ality le-oel in a
partic11l11r task nrea."
According to Gamer, "BPO is the delegation of one or more, IT enabled business
processes to a third p11rhJ that owns, administers and manages the business processes
according to n d,'fined set of metrics."
In simple words, BPO means getting a business task accomplished through an
outside agency. For example, the advertisement of its products can be done by a
co,mpany itself, and it could be done through some advertising agency. The latter
 INTERNATIONAL BUSINESS-2018 (May-June) 117
case i.e., getting advertisement done through an advertising agency is an instance
of outsourcing. BPO consists of hiring out the routine and regular tasks on
contract to an outside specialist agency. The idea of business process outsourcing
has its origin in the Core Competency Theory, propounded by famous
management consultant C.K. Prahlad. The basic contention of the Competency
Theory is that a business enterprise should identify what are its core
competencies and should focus only on them.
Nature of Outsourcing:
(1) TI,e idea behind outsourcing is that of specialisation i.e., "a business
enterprise must concentmte its attention only 011 its core activities like
man11fa.:h1ri11g, mnrketi11g, etc.; and get non-core activities done llrro11gl1 some
external agency."
(ii) Outsourcing is getting routine busin.ess activities done through external
service providers on a regular basis.
Need for outsourcing of business operations by a firm:
(t) Concentration on core competency areas leading to specialisation.
Outsourcing enables an enterprise to concentrate its attention on core
competency areas like manufacturing, marketing, capital budgeting etc.,
and thus obtain advantages of specialized performance in those areas. It
can make better use of its human, physical and financial resources.
(ii) Better account.ability. The outsourcer provides services at a fee.
TI1erefore, he is more responsible for the quality of services provided
than the internal staff of the enterprise.
(iii) Specialisation. The service provider is an expert in his field. Moreover,
he keeps in touch with the latest development in his field of expertise.
TI1erefore, through outsourcing, a business enterprise can take full
advantage of the specialized services of the outsourcer vendor.
(-iv) Reduction in cost. Outsourcing agencies are specialists in their activities.
They can perform the same job at a lower cost.
(v) Less labour cost and labour problems. Outsourcing of services reduces
the need for staff in the client company. Hence the labour costs of the
company are reduced. Further with less staff, labour problems are also
minimised.
(vi) Avoiding fixed investment in services. li the enterprise plans to
perform certain services within the organization, there is a need for huge
fixed investment in facilities required for performing those services. In
fact, there is a problem of idle capacities, when these are not in use­
leading to unnecessary expenditure of fixed costs on the maintenance of
those facilities.
(vii) Advantage of consultancy by the outsourcer. The outsourcer often acts
as a consultant for the particular function performed by it and may
advise the client company or the outsourced on better ways of managing
that function.
(viii) Economic progress. Outsourcing enables both i.e. the client company and
the external provider, to perform according to the best of their abilities.
Such a performance all through the economy is a boost to the economic
development of the economy.
 smvA DELHJ UNIVERSITY SERIES
(b) Strategic Alliance. A strategic alliance is an agreement between two
companies that have decided to share resources to undertake a specific, mutually
beneficial project. A strategic alliance is less involved and less binding as
compared to a joint venture, in which two companies pool resources to create a
separate business entity. Under a strategic alliance, each company maintains its
autonomy while gaining a new opportunity. Thus strategic alliance is an
agreement between two or more independent companies to cooperate in the
manufacturing, development or sale of products and services or other business
objectives. For example, in a strategic alliance, Company X and Company Y
combine their respective resources, capabilities and core competencies to
generate mutual interests in designing, manufacturing or distributing of goods
and services.
Following are some of the main advantages of strategic alliances-
(,) A strategic alliance allows a business to get competitive advantage
through access to a partner's resources, including markets, technologies,
capital and people.
(iz) It allows business to grow and expand. Alliances also benefit the
organisation by lowering manufacturing costs and developing and
diffusing new technologies quickly.
(iiz) Strategic alliance is also used to speed up product introduction and to
overcome legal and ttade barriers expeditiously.
(iv) It helps in gaining knowledge from partners and developing
competencies that may be more widely exploited elsewhere.
(v) It provides global access to domestic firms. These firms can quickly reach
international markets with the help of strategic alliance.
(Pt) Strategic alliances also make it possible for each partne.r to concentrate on
activities that best match their capabilities.
(vir) When companies pool their resources and enable each other to a.ccess
manufacturing capabilities, economies of scale can be achieved.
(viii) Using the partner s distribution networks in combination with taking
advantage of a good brand image can help a company to grow faster
than it would ot1 its own.
Following are certain disadvantages of strategic al.liances:
(1) Under a strategic alliance the partners must share resources, profits and
technical know-how. This can be critical if business secrets are included
in tltis knowledge.
(iz) The partner in a strategic alliance can become a competitor in the future.
(iiz) When the decision making powers are unevenly distributed, the weaker
partner might be forced to act as per the will of the powerful partner or
partners.
(iv) Strategic alliance can result in control and coordination difficulties.
(v) There can be a clash between organisation culture, values and climate of
different partners.
(111) Strategic alliance can become ineffective if one of the partners is not
performing as per expectations.
 INTERNATIONAL BUSINESS-2018 (May-June) 119
('Uii) It can limit the flexibility of one partner in decision making.
(viil) A company may require large human and financial invesb:nents to join or
comply with the standards of the alliance.
(ix) In case something goes ·wrong with the business alliance partner, all the
parties to the alliance can be held responsible.
(x) Creating a partnership with an entity that has a very different culture
and management style can cau..<e problems.
(xi) Getting into a strategic alliance with another entity places a business in a
vcry vulnerable position. U a business is not careful, the partner can
cause great damage to its goodwill and reputation.
Or
Write short notes on any two:
(a) Environmmt degradation
(b) Role of IT in international business
(c) Special Economic Zones (SEZs)
(d) Modes of Trade Finance.
Ans. (a) Environment Degradation. See Q. 9, Chapter 2, International Business
Environment. [Pages 27-28
(b) Role of 1T in international business. Information technology has been a
very important facilitating factor of international business. It is a universal factor
that crosses national and cultural boundaries. Once a technology is developed, it
soon becomes available evei:ywhere. For ex mttple, technology revolution like
possession of patented technology encourages industrialisation. International
business has facilitated globalisation of medical and health care sectors.
Technology makes it imperative for the business firms to capture markets in
various countries and share the rising costs and risks. Due to swift changes and
advancements in the field of information technology, many companies are
changing the way they do business internationally by utilising the latest
advancements and communication. New devices like smartphones and tablet
computers, the latest software and media applications and the popularity of
internet and social networking sites make it easy for businesses to communicate
with colleagues and customers around the world. Information technology
provides an opportunity to the business to reach each and every comer of the
world. An international business faces more competition as it operates on a large
scale. Information technology provides speed of communication that helps
companies stay one step ahead of their competitors. Moreover, more jobs are
open to workers in an international business field. Many firms are allowing
workers to perform their jobs from any location with the help of internet
connection. A worker in Delhi can join a meeting in London via video
conferencing. Similarly, a company in the U.S. can sell its products in India
online. Thus, information technology has been responsible for various businesses
to go global.
(c) Special Economic Zones. Special Economic Zone (SEZ) is a geographical
region that has special economic laws cliffeteul from a country's typical economic
laws. An SEZ is a trade capacity development tool with the goal to promote rapid
 120 smvA DELHI tJNIVl!RSITY S£RIES
economic growth by using tax and business incentives to attract foreign
investment and techn.ology. The functions of the SEZs in India are governed by a
three tier administrative body. The Board of Approval is the apex body and is
headed by the Secretary, Deparbnent of Commerce.
111e mai11 objecHves of the SEZ Act, 2005 are:
(1) Generation of additional economic activity;
(ii) Promotion of exports of goods and services;
(ii1) Promotion of investment from domestic and foreign sources;
(iu) Creation of employment opportwrities; and
(v) Development of infrastructure facilities.
It is expected that this will trigger a large £low of foreign and domestic
investment in SEZs, infrastructure and productive capacity, leading to generation
of additional economic activity and creation of employment opportunities. In
India, SEZs have played an important role in facilitating exports, thereby
enabling the country to be a part of the globalization process. The SEZ sector
contributed 92.4 per cent of the total exports from the Central Government SEZs
in FY 2011. Over the years the increasing attractiveness of the Indian market has
lured investors from across the world making India a prefer. red destination for
POI from Asian, European and North American investors.
Some of the successful Indian SEZs i.nclude-
• Nokia Special Economic Zone (felecom Equipment SEZ)
• Mahendra Gty SEZ (Apparel and Fashion Accessories, IT/Hardware,
Auto-ancillary)
• Apache SEZ Development India Private Limited (Footwear SEZ).
(d) Modes of Trade Fillance. See Q. 20, Chapter 6, International Financial
Environment. [Page 75

7177
 2019 (MAY�UNE)
Name of the Paper International Business
Name of the Course : B.Com. (Hons.) CBCS
Duration: 3 hours Maximum Marks: 75
Attempt all questions. Answer all parts together.
All questions carry equal marks.
Q. 1. (a) List and explain the different modes of entry for an international
business firm. 7
(b) What is international business? Briefly explain the factors that have led
to growth of International business in recent years. 8
Ans. (11) See Q. 11, 01apter 1., Introduction to International Business. [Page 12
(b) See Q. 4, Chapter 1, lntroduction to International Business. [Page 4
Or
Explain the salient features of the complex, muJti-dimensionaJ and inter­
related business environment in which the multinational corporation has to
operate. 15
Ans. See Q. 1 & Q. 2, Chapter 2, International Business Environment.
[Pages 18-19
Q. 2. (11) Explain the role of the \VTO as a regulator of world trade. 7
(b) "Balance of payments always ba.lances." Elucidate. But how do you
explain di.sequilib.riu.m in balance of payments? 8
Ans. (11) See Q. l & Q. 3, Chapter 4, International and Economic Organi-
zations. [Pages 45 & 48
(b) See Q. 10, Chapter 3, International Trade. [Page 39
Thus the (mechanical) equality between receipts and payments should not be
interpreted to mean that a country never suffers from the BOP problem and the
international economic transactions of a country are always in equilibrium.
Also, See Q. 13, Chapter 3, International Trade. [Page 42
Or
Explain Porter's theory of national competitive advantage as a theory of
international trade. 15
Ans. See Q. 3, Chapter 3, International Trade. [Page 33
Q. 3. What are the measures ta.ken by the Government of India to promote
FDI in India? 15
Ans. A transparent, predictable and easily comprehensible FOi policy frame­
work is put in place. PDI policy lists sectors where FDI is prohibited and also the
sectors where FOi is permitted subject to investment limits, entry routes and
other conditions. FOL up to 100 per cent is permitted under the automatic route
in most sectors or activities. Permission of the Government is not required for
FOi inflow under this route but it is subject to applicable laws, regulations,
security and other conditionalities.
Recent measures tliat hAve been taken to promou FDI inflows and building
world class infrastrnctr,re in the country. T11ese are as follows:
(t) Construction, maintenance and operation of rail infrastructure are made
eligible for 100% FOi under automatic route except for security sensitive
areas.
121
122 smv DAS DEl.BI UNIVERSITY SERIES
(ii) The definition of Non-Resident Indians (NRis) was amended to
accommodate Persons of Indian Origin (PJOs) and Overseas Citizens of
India (OCis). Investment made by NRis is deemed to be domestic
investment at par with the investment made by residents.
(iii) FDI up to 100% is permitted under the automatic route for
manufacturing of medical devices.
(iv) The sectoral cap of foreign investment in insurance sector increased
from 26% to 49%. Further it has been provided that FOi in the sector
would be permitted under automatic route. Similar changes have also
been brought in the FDl Policy on Pension Sector.
(v) 100% FDJ is permitted in construction development under automatic
route subject to certam conditions. The conditions about floor area restric­
tion, minimum capitalisation, exit and repabiation of foreign investment,
transfer of stake and operation and management has been relaxed.
(vi) Subject to conditions of industrial license, foreign investment up to 49%
is permitted under automatic route in defence sector. Beyond 49% under
Government route is allowed on case to case basis in order to access
modern and 'state-of-art' technology related to manufacturing.
(vii) FD! in broadcasting sector is allowed under government and automatic
route. FD] up to 100% (upto 49% automatic route; beyond 49% under
government route) is permitted in teleports, Direct to Home, cable net­
work, mobile TV, etc. FD! is also permitted in broadcasting content
services in.dude uplinking news and non-news and current affairs, TV
channels and downlinldng of TV channels.
(viii) 100% foreign invesbnent under automatic route is permitted in coffee,
tea, rubber, cardamom, palm oil tree and olive oil tree plantations.
(ix) Manufacturer is permitted to sell products through wholesale and/or
retail, including through e-commerce without government approval.
(x) Foreign investment in Single Brand Retail Trading (SBRT) is permitted
up to 100% where up to 49% is under automatic route and above 49% is
under government route.
(xi) 100% FDI is now permitted under automatic route in Duty Free Shops
located and operated in the Customs bonded areas.
(xii) 100% FDI is now permitted under the automatic route in Limited
Liability Partnerships (LLPs) operating in sectors/activities where 100%
FDI is allowed through the automatic route and there are no FOi-linked
performance conditions.
(xiii) Scheduled Air Transport Service/Domestic Scheduled passenger
Airlines and Regional Air Transport Service is permitted to have foreign
investment up to 49% under automatic route. Further, foreign
investment cap of activities of Non-Scheduled Air Transport Service and
helicopter services, Ground Handling Services, repair and maintenance
organization have been increased to 100% under the automatic route.
(xiv) Foreign investment caps on Satellite-establishment and operation
subject to the sectoral guideline of Deparbnent of Space/ISRO have
been raised to 100%.
(xv) FDI in Credit Information Companies is permitted under automatic
route up to 100%.
 INTERNATIONAL BUSINESS-2019 (MAY-JUNE) 123

(xvi) The threshold limit for FIPB approval has been increased from �000
crore to �5000 crore.
(xvii) 100% FDI is permitted in white label ATM operations under tJ1e
automatic route.
Also, See Q. 18(c), Chapter 6, International Financial Environment. (Page 72
Or
\Vrite short notes on any two: 7½)(2=15
(a) Spot rate vs. Forward rate
(b) Foreign exchange risk and Foreign exchange exposure
(c) Greenfield investment vs. Brownfield investment.
Ans. (a) Spot rate. See Q. 7, Chapter 6, International Financial Environment.
(Page 65
Forward rate. See Q. 11, Chapter 6, International Financial Environment.
[Page 67
(b) Foreign exchange risk and Fo,·eign exclrange expos·ure. See Q. 3(a) & (b),
Chapter 6, International Financial Environment. [Page 62
Also, See Q. 4(0r), 2018 (May-June). [Page 116
(c) Greenfield investment vs. Browttfield investment. See Q. 18(,f), Chapter 6,
International Financial Environment. [Page 72
Q. 4. Explain the factors affecting txch.ange rate determination. 15
Ans. See Q. 4, Chapter 7, Exchange Rate Determination. [Page 78
Or
Explain purchasing power parity and interest rate parity theory of exchange
rate with example. 15
Ans. Purc/,nsing power parlttJ t1'eory of excl,ange rate. See Q. 10, Chapter 7,
Exchange Rate Determination. [Page 84
Interest rate parity theory of exchange rate. See Q. 14, Chapter 7, Exchange
Rate Determination. [Page 86
Q. 5. Write short notes on any two of the following: 7½)(2=15
(a) Measures for promoting foreign investments into and from India
(b) SEZ policy of Government of India
(c) EPRG Framework
Ans. (a) Measures for promoting foreign investments into l1tdia. See Q. 3, 2019
(May-June). [Page 122
Measm·es for promoting foreign investments from India. Outbound invest­
ments from India have undergone a considerable transformation not only in
terms of magnitude but also in terms of geographical spread and sectoral
composition. Analysis of the trends in outbound investments from India gained
momentum during the later half of the decade. In the first half of the decade,
overseas investments were directed to resource rich countries only like
Australia, UAE and Sudan. The outbound Indian investment shifted to other
countries in the second half of the decade. These countries provided higher tax
benefits to India. These countries included Netherlands, Mauritius, Singapore
and British Virgin Islands. Indian firms enter into foreign lands through Mergers
and Acquisitions (M & A) transactions. By doing this domestic firms get direct
access to newer and more expensive markets and better technologies.
 124 smv DAS DELHI UNIVERSITY SERIES
Following are certain 1neas11res taken by tJie governme11t and Central Bank to
enco11rage 011tbo11nd Indian investments in forL'ign lands:
• Public Sector Undertakings (PSUs) of Indian government have invested
over US $15 billion in Russia's oil gas projects and are planning to inject
more investments in the country's oil and gas fields.
• The RBI (Reserve Bank of India) encouraged domestic firms to invest
abroad. For this purpose RBI relaxed the norms for Indian companies
investing abroad by doing away with the ceiling for raising funds
through pledge of shares, domestic and overseas assets.
• TI1e Central Bank has also announced concessions pledging of shares in
case of step down subsidiary. In addition to Joint ventures and wholly
owned subsidiaries.
• The RBI has liberalised guidelines for foreign investments abroad by
Indian Companies. It raised the annual overseas investment ceiling to
US $1,25,000 from ceiling US $75,000 to establish Joint ventures and
wholly 01,vned subsidiaries.
• The government's supportive regime complemented by India's experi­
mental outlook can increase the outflow of domestic investments to
foreign countries in the near future.
(b) The Special Economic Zones Act, 2005 was passed by Parliament in May
2005. The SBZ Act Rules came into effect on 1()111 February, 2006, that provides
for drastic simplication of procedures and for single window clearance on
matters relating to central as well as State Governments.
The SEZ Act, 2005 envisages key role for the State Governments in Export
Promotion and creation of related infrastructure. A Single Window SEZ
approval mechanism has been provided through a 19 member inter-ministerial
SEZ Board of Approval (BOA). The SEZ Rules provide for different minim.um
land requirement for different classes of SEZs. Every SEZ is divided into a
processing area where alone the SEZ units would come up and the non­
processing area where the supporting infrastructure is to be created.
The SEZ Rules provide for.
• Simplified procedures for development, operation and maintenance of
the Special Economic Zones and for setting up units and conducting
business in SEZs;
• Single window clearance f or setting up of an SEZ;
• Single window clearance for setting up a unit in an SEZ;
• Single Window clearance on matrers relating to Central as well as State
Governments;
• Simplified compliance procedures and documentation with an emphasis
on self certification.
Also, See Q. 2(a), Chapter 8, Foreign Trade Promotion Measures & Organizations
in India. [Page 91
(c) EPRG Framework. See Q. 10, Chapter 1, Introduction to International
Business. [Page 11
 2020 (MA\')
Na.me of the Paper International Business
Na.me of the Course : B.Com. (Hons.) CBCS
DuraHon: 2 lwurs Mnximum Marks: 75
Attm1pt m1y FOUR q11esticms.
All questions Cllrry equal marks.
Q. 1. A weU established Elec:b'ic Cars company in US set up their first plant
in a developing nation involving huge investment. But within 2 years, it had to
shut down its store in that country with huge losses because the company failed
to understand the consumers and business environment there.
\Vhat would have been the possible reasons of failure? What would you suggest
as one important measure, the company could have taken to avoid failure?
Ans. In the given case the company had to shut down its store in foreign land
as it failed to understand the consumers and business environm.ent there. An
inability to adapt to the needs of the local marketplace and culture can lead to
business failure in that particular country. While expanding a business at
international level, the success really depends on how fast the business is able to
find the critical problematic factors for customers and come up with offerings to
resolve them. This means that the business should put itsell into the shoes of the
users or customers to know their situation and identify what will work best for
them. An overseas market presents this big challenge when the business is not
much familiar with the need of the local users and customers. At times it becomes
hard to establish some way to take the right decisions while operating in the
international market. The people who buy and use firm's products and services
are an important part of external international business envirorunent. Since sales
of a product or service is critical for a firm's survival and growth, it is necessary to
keep the customers satisfied. To take care of customers sensitivity is essential for
the success of a business firm in a foreign market.
Moreover, a business finn has to compete with rival firms in the international
market to attract customers and thereby increase the dCllland and market for its
products. In the present day of intense competition a firm has to spend a lot on
advertisemen.ts to proroote the sales of its products by creating new customers and
retaining the old ones. For this purpose, a business firm is also expected to launch
new products or models as per the needs and wants of the customers.
With increasing globalisation and liberalization, the customers' satisfaction is
of paramount importance as the consumers have the option of buying other
international brands. TI,us, in order to survive and succeed a firm has to make
continuous effort to improve the quality of its products.
Jl.owever, there are some generic reasons as to why the given car manufacturer
failed i11 the internatio11a/ market:
(r) Failure to understand the needs and wants of the consumers can prove
to be detrimental for the business. In the given case, the firm was not able
to understand the foreign consumers well Consequently, it had to shut
down its operations.

125
 126 smv DAS DELHI UNIVERSITY SERIES
(it) Another reason for failure of business in the given case is failure to
understand the international b11siness environment. International business
environment is multidimensional including the political risks, cultural
differences, exchange risk, legal and taxation issues. Following are tlte main
components of in:temational business envirowne11t:
• Public
• Political Environment
• Economic Environment
• Social and Cultural Environment
• Legal Environment
• Technological Environment
• Natural Environm.ent
• Demographic Environment
In the given case failure to understand the various dimensions of international
business environment has resulted in failure for the firm. Failure to understand
the various dim.ensions of international business environment results in an inability
to adapt to the needs of the local market place and culture. Firms that enter global
markets and fail to use local talent, suppliers and business partners can easily
become outcasts in the local community among residents and government officials.
Cultural influences also greatly affect business. People view products and business
models differently around the world. Companies s01netin,es fail by not getting to
know the markets they enter.
(ii,) Just because a business is havil"lg a good plan and a good solution does not
mean all foreign markets will accept il Often foreign consumers do n.ot accept
certain brands or products. Often fim,s fail to develop promotional
campaigns tl1at hit on the benefits that appeal to the local culture and way
of life of the people. The biggest example of international brands that fail in
foreign markets is global automakers operating in India. India is the only
country among lop automobile markets where one company controls more
than a quarter of the sales. In fact, tl1at company including Maruti Suzuki
has a market share of about 50% in the local car market. It implies that it
makes one in every two cars on Indian roads. The top two companies
including Hyundai Motor being No. 2 keep more than 64% of the passenger
vehicle market to themselves. Automakers that rule the world -Toyota
motors, Volks Wagen, General Motors, Ford Motor and Renault-Nissan have
mostly remained fringe players in India's car market. It's the lack of
knowledge of the Indian market and a mindset that is not timed to the local
requirements tl1at create road blocks for foreign automakers.
(iv) Each set of new customer segment would mean what product offering
works for t1i.em and what key value the customers see in the offerings could
change significantly from one segment to another. Many companies fail to
W"tderstand this and continue to expect that the same product offering and
the same business model would work everywhere they go. This could have
happened witll the given car manufacturer as well.
(v) As the company was not familiar with the local regulations and culture,
it could not recover the costs it incurred in a profitable manner. Moreover,
it failed as its execution of the international expansion was ineffective.
 CNTERNATIONAL BUSINESS-2020 (MAY) 127
In the context of the given case, it is highly recommended that the firm should
have analyzed the business environment before entering the foreign market.
Following points 11/ghlight the importance of analyzing business environment:
(1) First mover's advantage. Environmental understanding helps an enterprise
to come up with a new idea, a new concept or a new product, which helps
it to capture the unexploited avenues in a market and thus reap the benefits
of being a pioneer.
(it) Warning signals. Environmental awareness helps the firms to perceive the
future possible threats-be it from new enlrants in the market or existing
suppliers or change in governmental policies at national or international level.
(iii) Tapping useful resources. Environment provides various resources for
running a business. Environmental understanding helps in tapping useful
resources. Management can tap resources in a better way by understanding
what the environment has to offer and how it can be efficiently utilized.
(iv) Helps in planning and policy formation. Since environment is both
opportunities and threats, its understanding is the basis of planning and
policy formation.
(v) Helps in coping with rapid changes. Business environment is very dynamic.
A proper understanding of the business environment helps the organisation
to tackle the situation carefully and take a suitable course of action.
Q. 2. "The Regionill Economic Integration can both create as well as divert
trade in future to member countries." Critically analyse this statement with
suitable examples.
Ans. 'The Regional Economic Integration can both create as well as divert trade
in future to member countries'. The given statement indicates regarding the pros
and cons of regional economic integration.
Economic integration is an arrangement among nations that typically includes
the reduction or elimination of trade barriers and the coordination of monetary
and fiscal policies. Economic integration aims to reduce costs for both consumers
and producers and to increase trade between the countries involved in the
agreement.
Advocates of regional economic integration claim that it helps nations overcome
divisions that impede the flow of goods, services, capital, people and ideas. These
divisions are a conslraint to economic growth, especially in developing countries.
Under regional economic integration, regional integration is promoted through
common physical and institutional infraslructure.
Divisions between countries created by geography, poor infraslructure and
inefficient policies are an impediment to economic growth. Regional economic
integration allows countries to overcome these costly divisions integrating goods,
services and factor markets, thus facilitating the flow of lrade, capital, energy, people
and ideas. The regional economic integration can be promoted through common
physical and institutional infrastructure. Specifically, regional integration requires
cooperation between counlries in:
• Trade, investment and domestic regulation;
• Transport, JCT (Information and Communication Technologies) and Energy
infrastructure;
 128 SHIV DAS DHLBl UNIVERSITY SliRIES
• Macroeconomic and Financial policy;
• The provision of other common public goods (e.g. shared natural
resources, security, education).
Cooperation in these areas has taken different institutional forms, with different
levels of policy commitnients and shared sovereignty. Such type of cooperation had
different priorities in different world regions. Regional economic integration can
create more trade and lead to substantial economic gains. It allows countries to:
• Improve market efficiency;
• Share the costs of public goods or large infrastructure projects;
• Decide policy cooperatively and have an anchor to reform;
• Have a building block for global integration;
• Reap other non-economic benefits, such as peace and secw:ity.
The best example of regional economic integration is European Union (EU). The
European Union (EU) was created in 1993 and included 28 member states in 2019.
Since 2002, 19 of those nations have adopted the Euro as a shared currency. A
common currency erased trade barriers and financial obstacles that come with
multiple currencies and made prices more transparent. Advocates of regional
economic development claim that it offers the following advantages:
(t) Trade creation: Member countries have:
(a) Wider selection of goods and services not previously available.
(b) Acquire goods and services at a lower cost due to lowered tariffs or
removal of tariffs.
(c) Encourage more trade between member countries. The amount of money
saved from cheaper goods and services, can be used to buy more
products and services.
(it) Greater consensus: Unlike WTO with huge membership, it is easier to gain
consumers' amongst small memberships in regional integration.
(ii-1) Political cooperation: A group of countries can have significantly greater
political influence than each country would have individually. The
integration is an essential strategy to address the effects of conflicts and
political instability that may affect the region. This integration can act as
a useful tool to handle the social and economic challenges associated vvith
globalization.
(iv) Employment opportunities: As economic integration encourages trade
liberation and leads to market expansion, more investment into tile country
and greater diffusion of technology, it creates more employment
opporturuties for people to move from one country to another to find jobs
or to earn higher pay. For example, industries requiring mostly unskilled
labour tends to shift production to countries where average wage is
relatively low.
However, those who are not in favour of regional economic integration claim
that there are risks to regional integration that need to be identified and managed.
Some of the risks and problems assodated with regional eco11omic i11teg-ratio11
are as follows:
1. Cou:ntries may have different preferences or priodties for regional
integration, depending on their connectivity gaps, economic geography,
or preferences for sovereignty in specific areas.
 fNTERNATIONAL BUSINESS-2020 (MAY) 129
2. Regional integrations' impact on trade and investment flows, allocation of
economic activity, growth, income distribution are often difficult to access.
3. Lack of adequate complementary policies and institutions may lead to
inefficient outcomes.
4. Regional integration can exercise positive effects for some countries while
it can even exercise negative impacts on certain nations. Policies and
institutions are required to ensure that regionalism is inclusive and social,
environmental, governance risks are managed.
5. It can lead to trade division. Member countries may trade more with each
other than "rith non-member nati.ons. 1his may mean increased trade with
a less efficient or more expensive producer because it is in a member
country. In this sense, weaker companies can be protected inadvertently
with the bloc agreement acting as a trade barrier.
In essence, regional agreements have formed new trade barriers with countries
outside of the trading blocs. Countries may move production to cheaper labour
markets in member countries. Similarly, workers may move to gain access to better
jobs and wages. Sudden shifts in employment can tax the resources of member
countries. Witl1 each new round of discussions and agreements with.in a regional
bloc, nations may find that they have to give up more of their political and economic
rights. For example, the economic crisis in Greece has threatened not only the EU
in general but also the rights of Greece and other member nations to determine
their own domestic economic policies.
Q. 3. As arbitrage infJow continues, the net gain tends to diminish, and then
disappear, when the interest parity line is reached. Do you agree? Explain.
Ans. Interest rate parity is the outcome of arbitrage in financial markets. lf US
bonds and UK bonds are similar in every respect the currency used to pay the
principal and the interest, then they should yield the similar returns to
bondholders. If US investors can earn a higher return from UK bonds, they are
going to buy more UK bonds and fewer US bonds. This tends to raise the price of
UK bonds, pushing UK interest rates down. At th.e same time, the price of OS
bonds drops, raising US interest rates. The initial higher return on UK bonds and
resulting greater demand for UK bonds increases the demand for pounds and
increases the value of the pound in terms of dollar. As the pound appreciates, if
investors expect the same future exchange rate as they did before the cUirent
appreciation, the expected appreciation over the future falls. The change in the
exchange rate and interest rates equalizes the expected dollar returns from
holding a US bond and a UK bond. UK bonds originally offered a higher return
than US bonds, but the increase in the demand for UK bonds relative to US bonds
raises UK interest rates and the expected appreciation of the pound, so that bond
returns are equalised. This explains why the interest parity condition must hold if
the foreign exchange market is to be in equilibrium.
(1) The domestic currency interest on the bond equals the foreign interest rate
plus the percentage change in the exchange rate.
(ir) Interest rate parity exists when similar financial assets have the same interest
rate when measured in the same currency; or when the domestic interest
rate equals the foreign interest rate plus the expected change in the exchange
rate.
 130 SHIV DAS DELHI UNIV1lRSITY SHRIES
Eq11ilibrium in t1te Foreign Exclumge Market:
When the interest parity condition holds, i.e., when all expected returns are equal,
there is neither excess supply of same type of deposit nor excess demand for
another. Therefore, the foreign exchange market is in equilibrium when the interest
parity condition holds. When dollar deposits offer a higher return than pound
deposits, the dollar will appreciate against the pound as all investors try to shift
their funds into dollars. The converse is also true. The dollar should depreciate
against the pound if pound deposits initially offer the higher return. Thus the
interest rate parity condition explains how exchange .rate changes help to maint..-u"
equilibrium in the foreign exchange market.
Covered Interest Arbitrage Parity (CIAP):
If the financial markets are efficient then in equilibrium the risk-averse investor
will be indiffel'ent between hedging the short-term foreign investment and hedging
by using the forward market. Similarly, the risk-average short-term investor should
be indifferent between the domestic and th.e foreign investments. The link among
the spot market, forward market and the financial market that generates these
equality conditions is established through covered interest arbitrage. For example,
an investor who has to decide whether to place funds at home (e.g. Chicago) or
overseas (e.g. Birmingham). If he chooses to protect himself against the risk of spot
rate fluctuations, that to cover-up he will use the forward market. In this case ·the
equilibrium condition is
i,. = ln11!11St rat.e ol Oikago
ich - ibmg ., P ... (i) ...where[;.,. =Interest rat.eofBirminghaln
P • Foreign llxdulnge Premium
In equilibrium, any difference in the interest rates between the two financial
centres has to be offset by the foreign exchange premium. 1his is the covered interest
arbitrage condition. For example, if icll = 2.5% and i bmg = 2% per quarter
(i.e., 90 days) the financial and foreign exchange markets will be in equilibrium if
the forward pound is contracted at a price which is 0.5% above the spot rate. In
this case the investor in Birmingham is receiving 2% on the short-term investment
plus 0.5% return due to the forward premium.
The sum of the two returns is equal to 25%, i.e., the return that an investor would
receive on a short-term investment in Chicago. Thus it is clear that the interest rate
parity condition cannot be maintained between the USA and the UK so long as
forward rates differ from spot rates.
Now, if both the interest rates in the two countries and foreign exchange market
are taken into consideration, one can easily predict the movement of financial
investment between the USA and the UK.
Following tTiree points should be taken into consideration:
(1) If the interest rate differential (ihomr - it� exceeds the forward premium
(from the home country - from the USA) there will be an inflow of funds
into the home country.
(ii) If the interest rate differential is less than the forward premium, there would
be outflow of funds from the home country.
 INTERNATIONAL BUSIN.ESS-2020 (MAY) 131
(iir) When ihom, = ;foreign and P = 0, there will be equilibrium in the foreign
exchange market and between short-term inflow of funds into or outflow
of funds from the home country (the USA).
Table 1. Equilibrium Condition of the financial and foreign Exchange Markets
Condition T11ves offinnncinlf/ow Sit11ation
1. is - i£ > P From UK to USA Disequilibrium
2 is - i£ < P From USA to UJ( .........
3. is - i£ = P No Short-term financial movements Equilibriwn
The interest rate differential between Chicago and Birmingham is shown on the
vertical axis and the forward premium in the pound on the horizontal axis, with
the minus sign. indicating a forward discount and positive sign incticating a fon'lard
premium on the foreign currency in percent per annum.

r:::::/1
QA i-,.. (%)
inflow
3 B , ,,', , OAP

2 A
, ,' , ,'
-3 -2 ' /
P�rward (-) .--t--1--t-,,:"'>fr- ' +--I--+--+ (+) Forward
Discount
8,
r :,,:,,, -]
/ , 1 2 J Premium (P)

//
:r -2
,, ,
,
,
, ,' , ' A' -3
/ CIA
outflow
With the two axes scaled in the same way, the point of equilibrium between the
interest rate differential and the premium are on the line that passes through the
origin. This line is known as the Covered Interest Arbitrage Parity (CIAP) line.
The points above the line show ctisequilibrium that will induce inflow of foreign
investment into Chicago, while those points lying below the line also incticate
disequilibrium which induces flow of funds from Chicago to Birmingham.
Above the CIAP line, either the interest differential exceeds the forward premium
on the foreign currency or the negative interest differential is smaller than the
forward discount on the foreign currency (Point B'). ln either case, it pays for
foreigners (Britishers) to invest i.n home country (the USA) and there will be an
arbitrage inflow. However, as the arbitrage inflow continues, the net gain
diminishes and then disappears when the OAP line is reached.
Starting from point A', the transfer of funds ab.road wi.U increase the positive
interest differential (say, from 1 to 1.5) and reduce the forward premium (say, from
+2 to +1.5) so as to reach the OAP line once again. As funds move abroad (from
the USA to the UK), interest rates tend to rise in the USA and decline in the UK
Since interest rates were already higher in the USA, the positive interest diffe.rential
increases.
 132 SHIV DAS DELHI UNIVERSITY SERIES
On the other hand, as American investors purchase the foreign currency (pounds)
to invest in the UK, the spot rate rises. As Americans sell the forejgn currency
forward to cover their foreign exchange risk, the forward rate declines.
Thus, the forward premium (i.e., the excess of the forward rate over the spot rate)
diminishes. With the positive interest differential increasing and the forward
premium decreasing, the net gain from arbitrage outflow diminishes. The process
continues until A becomes zero when the OAP line is reached and the arbitrage
outflow stops.
Q. 4. Real interest rate may remain unchanged even when nominal interest
rate changes. Analyse.
Ans. l11e nominal interest rate refers to the rate of interest before adjusting for
inflation. It also refers to the rate specified in the Joan contract without adjusting for
compounding. The nominal interest rate is in contrast to the real interest rate
regarding the inflation adjustment and effective interest rate regarding the
compounding adjustmenl Nominal int-erest rates can be impact2CI. by different factors,
including the demand and supply of money, the action of the federal government, the
monetary policy of the central bank, and many others such reasons.
Central banks implement the short-term nominal interest rate as a tool of
monetary policy. During an economic recession, the nominal rate is lowered
to stimulate economic activities. During inflationary periods, the nom.inal rate is
raised.
Nominal Interest Rate vs. Real Intettst Rate: Interest rate is the cost of
borrowing or return of lending due to the time value of money. The rate is known
as the nominal rate, which is stated in the loan contract. A nominal interest rate
contains two parts - a real interest rate and an inflation premium.
As an econom y grows with inflation, the purchasing power of each unit of money
declines over time. Thus, the return that a lender earns for each unit of money he
lent before is actually lower than the rate slated in the contract. The rate of return after
adjusting the nominal interest rate for inflation is known as the real interest rate.
It is important for a lender to understand the real interest rate of a bond.
Inflation Adjustment of Nominal Interest Rate
The Fisher Effect describes the relationship between inflation, nominal and real
interest rate through the equation below:
...where
[i
R
= Nominal intere5t
= Realinterest rate
(1 + 1) = (1 + R) (1 + Ii)
h = �ted inflation rate
In a stable economy that is growing at a moderate pace, the inflation rate is
usually low. With a low inflation rate, a simplified version of the Fisher equation
can be implemented. It states that the nominal interest rate is approximately equal
to the real interest rate plus the inflation rate (i = R + h).
For example, a bond investor is expecting a real interest rate of 5%, when the
market shows an expected inflation rate of 3% . Therefore, the investor should look
for a bond with a stated (nominal) interest rate of 8% (5% + 3%).
Nominal interest rate (8%) = Real interest rate (5%) + Inflation premium (3%)
The nominal interest rate can also be calculated through the formula below. The
two methods of calculation give a similar resuJt.
i= (1 +R) (1 +h)-1 =(1 +5%) (1 + 3%)-1 =0.0815or8.15%
 INTERNATIONAL BUSINESS-2020 (MAY) 133
According to the Fisher Effect, if the inflation rate increases and the nominal
interest rate remains constant, the real interest rate will fall. The lender's real return
drops as a result of a fast.er decline in the purchasing power. If the nominal interest
rate and expected inflation rate both increase at the same rate, which means the
inflation premium is compensated, the real interest rate will remain unchanged.
Q. 5. Is there any need to strengthen the SEZ Scheme? Give suitable reasons.
Also explain the approvaJ mechanism for SEZ.
Ans. SEZs. See Q.2 (a), Chapter 8, Foreign Trade Promotion measures &
organisations in India. [Page 91
However, the main question that voices across the country is-if SEZs are truly
meant to boost growth, what is the intended growU1 and for whose benefit? Going
by the SEZ policy, private profit seems to be the barometer of growili and the
preference by policy is for private players to lead ilie nation's growili. The issue of
development and ilic links between growth and development are however missing.
In a country with 65 percent of U1e population depending on agriculture as a means
of livelihood, industries should be complementary to agriculture. Tiu-ough SEZs,
however, industry is being promoted at the cost of agriculture. Valuable resources
spent to create SEZs will be at the cost of building better infrastructure for tl1e rest
of the country, something that will affect boili the domestic industry as well as
agriculture.
Some of the prime concerns being raised by farmer groups, fisher folk
communities, marginalized communities and oilier movements on ilie government's
SEZ policy are:
l. Large scale and unjustified acquisition of land.
2. inadequate resettlement and rehabilitation policies and plans.
3. Inadequate employment opportunities for local people through SEZs
leading to loss of 1.ivelihood.
4. increasing burden on natural resources and the environment and alien
action of local communities from these resources.
5. SEZs contributing to real estate boom and creating real estate zones.
6. Potential revenue loss from heavy subsidies in SEZs.
7. Concerns over the process of approving and implementing SEZs - where
is local government consultation and sanction?
8. No wider public consultation.
9. lhreat to water security.
10. Bypassing local governments and ignoring local communities.
11. increases regional disparities.
Approval mechanism for SEZ
For approval of SEZ, the developer submits the proposal for establishment of
SEZ to fue concerned state govemment The State Government has to forward the
proposal wiili its recommendation within 45 days from the date of receipt of such
proposal to ilie Board of Approval. The applicant also has the option to submit
ilie proposal directly to ilie Board of Approval.
The Board of Approval has been constituted by ilie Central Government in
exercise of ilie powers conferred under fu.c SEZ Act. All the decisions are ta.ken in
134 SHIV DAS DEi.fl UNIVERSITY SERIES
the Board of Approval by consensus. The Board of Approval has 19 Members. Its
constitution is as follows:
S.No. Department Members
(1) Secretary, Department of Commerce Chairman
(ir) Member, CBEC Member
(ii,) Member, IT, CBDT Member
(iv) Joint Secretary (Banking Division), Department of Member
Economic Affairs, Ministry of Finance
(v) Joint Secretarv (SEZ), Department of Commerce Member
(v,) Joint Secretarv, DIPP Member
(vi,) Joint Secretary, Ministry of Science and Technology Member
(vii,) Joint Secretary, Ministry of Small Scale Industries Member
and Agro and Rural Industries
(ix) Joint Secretary, Ministry of Home Affairs Member
(x) Joint Secretary, Ministry of Defence Member
(x,) Joint Secretary, Ministry of Environment and Forests Member
(xi,) Joint Secretary, Ministr of Law and Justice
y Member
(rii1) Joint Secretary, Ministry of Overseas Indian Affairs Member
(xiv) Joint Secretary, Ministrv of Urban Development Member
(xv) A nominee of the State Govemm.ent concerned Member
(xv,) Director General of Foreism Trade or his nominee Member
(xvi,) Development Commissioner concerned Member
(xt•ii,) A professor in the Indian Institute of Management Member
or the Indian Institute of Forei1-,rn Trade
(xix) Director or Deputy Secretary, Ministry of Commerce Member
and Industry, Department of Commerce Secretary
17,e SEZ mies provide for:
• Simplified procedures for development, operation and maintenance of the
Special Economic Zones and for setting up units and conducting business
in SEZs.
• Single window clearance for setting up a unit in a Special Economic Zone.
• Single window clearance on matters relating to Central as well as State
Governments.
• Simplified compliance procedures and documentation with an emphasis
on self certification.
Administrative set 11p:
The functioning of the SEZs is governed by a three tier administrative set up.
The Board of Approval is the apex body and is headed by the Secretary, Department
of Commerce. The Approval Committee at the Zone level deals with approval of
units in the SEZs and other related issues. Each Zone is headed by a Development
Commissioner, who is ex-officio chairperson of the Approval Committee.
 CNTERNATIONAL BUSINESS-2020 (MAY) 135
Once an SEZ has been approved by the Board of Approval and Central
Governn1ent has notified the area of the SEZ, units are allowed to be set up in the
SEZ. All the proposals for setting up of units in the SEZ are approved at the Zone
level by the Approval Committee consisting of Development Commissioner,
Customs Authorities and representatives of State Government. All post approval
clearances including grant of importer-exporter code number, mange in the name
of the company or in1plementing agency, broad banding diversification, etc. are
given at the Zone level by the Development Commissioner. The performance of the
SEZ units arc periodically monitored by the Approval Committee and units arc
liable for penal action under the provisions of Foreign Trade (Development and
Regulation) Act, in case of violation of the conditions of approval.
Q. 6. What induces disequilibrium in Balance of Payments in developing
countries? Also explain the rclevan.ce of export promotion and import
substitution as measures to control the deficit in the Balance of Payments.
Ans. Export promotion and import substitution both are very significant
measures to attain favourable balance of payments and balance of trade situation.
Export promotion comprises all those government and non-government efforts,
rules, procedures, courses of action and techniques that are adopted to boost
exports in terms of value as well as volume. Thus all those measures, schemes,
policies, procedures and methods that are adopted for increasing export are
known as export promotion measures. For developing economies like India export
promotion plays a key role in attaining the objective of self reliance. Export
promotion is the policy of the government designed to encourage the exporters to
export more goods from the country than before. Exports are lifeline and motive
power for economic growth and development. Export promotion refers to those
policies and measures which can result into maximum increase in the exports of
a cou.ntry.
There is an imperative necessity to promote exports in lndian economy due to
the following reasons:
(1) To earn foreign exchange
(it) To motivate organizations to export
(iii) To promote interests of Indian exporters and keeping commitment of WTO
(iv) To import capital goods
(v) To reduce bureaucratic hurdles
(vi) To corre<:t unfavourable balance of trade
(vii) To reduce foreign loans
(viii) To achieve the objective of self reliance
i
(x) To sell surplus production
(x) To finance imports
(xi) Export of new products
(xit) Defray the cost of defence imports, to ensure successful planning, etc.
(xiii) To contribute to the economic development of country.
Import substitution, on the other hand, means production of those goods that
are imported from foreign countries. Import substitution is essential for achieving
self sufficiency.
 136 smv DAS DHLfil UNIVERSITY SmtIES
Following points highligl,t tire role and importance of import s11bstitutio11;
(f) It reduces imports
(if) It increases self sufficiency
(iii) It is a source of earning valuable foreign currencies
(iv) lt reduces imbalance in foreign trade
(v) It encourages industrial development
(vi'.) Creates new sources of recruitment
(vii.) It saves local currency
(viii) It reduces foreign debts
(ix) It reduces dependence on foreign countries
(x) It offers overall assistance in increasing exports and rapid economic
development of the country.
Import substitution is a strategy under trade policy that abolishes the import of
foreign products and encourages for the production of domestic goods. Post
independence India adopted this policy by imposing heavy tariffs on import duty.
Import substitution aims at blocking imports of manufactured goods to help the
domestic economy by increasing the demand for domestically produced goods. For
large developing economies Like India, import substitution can offer several
advantages such as economic growth, improved GDP, employment generation and
elimination of poverty, develop robust domestic manufacturing base and
industrialization, etc. TI,e main objective of the policy of import substitution is to
encourage national production, development of the new products to stimulate
demand and import restrictions. Import substitution can also be discussed as a
policy strategy that attempts to utilize underused capacities, reduce regional
unemployment or protect infant industries. Import substitution policy L5 a set of
measures that aim at stimulating production and competitiveness of domestic
goods, increasing of domestic demand and optimization of demand for imports. It
is deter.mined by the need to reduce the dependence of transitive economy on
economic leaders. Tariff regulation, quotas, introduction of limitation lists and
multiplicity of the national currency are used under this strategy. Moreover,
preferential loans a:nd taxation, overvaluation of the currency, governm.ental
regulation, etc. are also used under import substitution policy.
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