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It answers two questions Why is a particular country specialised in the production of certain goods and why does it enter into international trade What forces determine international prices or what are the terms on which international trade takes place. Countries are endowed with different assets and natural resources (land, labour , capital and technology), some countries may produce the same good more efficiently and therefore sell it more cheaply than other countries . If a country cannot efficiently produce an item, it can obtain the item by trading with another country that can. This is known as specialization in international trade.Example: Theory: Example: Theory Let's take a simple example. India and Sri Lanka both produce wheat and tea. India produces 10 units of wheat and 6 units of tea a year while Sri Lanka produces six units of wheat and 10 units of tea a year. Both can produce a total of 16 units. India, however, takes three hours to produce the 10 units of wheat and two hours to produce the units of tea (total of five hours). Sri Lanka, on the other hand, takes one hour to produce 10 units of wheat and three hours to produce six units of tea (total of four hours). But these two countries realize that they could produce more by focusing on those products with which they have a comparative advantage. India then begins to produce only wheat and Sri Lanka produces only tea. Each country can now create a specialized output of 20 units per year and trade equal proportions of both products. As such, each country now has access to 20 units of both products.Opportunity Cost: Opportunity Cost We can see then that for both countries, the opportunity cost of producing both products is greater than the cost of specializing. More specifically, for each country, the opportunity cost of producing 16 units of both wheat and tea is 20 units of both products (after trading). Specialization reduces their opportunity cost and therefore maximizes their efficiency in acquiring the goods they need. With the greater supply, the price of each product would decrease, thus giving an advantage to the end consumer as well. Note that, in the example above Sri Lanka could produce both wheat and tea more efficiently than India (less time). This is called an absolute advantage, and Sri Lanka may have it because of a higher level of technology. However, according to international trade theory, even if a country has an absolute advantage over another, it can still benefit from specialization.Growth rate of GDP and Exports: Growth rate of GDP and Exports 1991-2000 2008 2009 2010 GDP Exp GDP Exp GDP Exp GDP Exp Developed Countries 2.8 7.0 0.6 1.9 -3.4 13.6 1.3 2 Developing Countries 3.6 8.4 6.0 4.6 1.7 -7.2 5.1 3.6 International trade has grown at a tremendous pace since 1990 The global trade has increased at much faster rate than the world output, hence share of exports in GDP has increased significantly.India-International trade practice: India-International trade practice India followed a inward looking, import substitution trade policy Policy underwent a sea change since 1991 Indian economy opened and starting integrating with the international economy Quantitative restriction on imports were phased out as part of WTO commitments Import duties were lowered Foreign investments-direct and portfolio was encouraged and liberalisedIndia-contd: India- contd Exchange rate mechanism was liberalised and adopted market determined exchange rate Current account convertibility was introduced in 1992. This provided a boost for the exports and help in imports of goods and services. Current account convertibility means, Indian citizens can receive foreign exchange for exports and are allowed buy/pay foreign currency for purposes like travel abroad, studying abroad, engaging the services of foreign consultants and for purchase of consumable products and services. Capital account convertibility (CAC) means when a domestic financial asset is converted into foreign financial asset at market determined exchange rate. In Indian we do not have full Capital convertibility. In simple words when a corporate wants to buy a plant/machinery, they cannot just buy the equipment by converting rupees into dollars. They have to take the approval of RBI.Indian Markets-Foreign investment: Indian Markets-Foreign investment Foreign investment have increased rapidly, both inward investment as well as outbound. Indian residents can invest up to $ 200,000 in shares of foreign companies listed in foreign exchanges Foreign companies can invest in Indian companies through FDI and in the stock markets Foreign companies can have a tie-up or joint venture in almost in all sectors including insurance, banks, telecom. Restriction in foreign investment exists in some sensitive sectors like retail, airlines etc Foreign companies are allowed to raised equity capital in India by issuing Indian Depositary receipts or IDRsOutbound investment: Outbound investment The policies governing the outbound investment was liberalised in 2004-5, which has led to sharp increase in cross border acquisition by Indian companies Indian companies have invested across the world. Indian companies have bought marquee companies like Jaguar, Tetley, bought large companies like Corus Group, Novelis , invested in countries like US, Europe, African countries, Latin America etc Outbound FDI by Indian companies has been increasing and reached a peak of $ 18 billion dollars in 2007. Indian companies have raised equity capital in foreign countries through the issue of GDRs (Global Depositary Receipt) and ADRs (American Depositary Receipt)In bound Investment: In bound Investment Inflow of foreign investment through 2 categories FDI: invests directly into a company and actively control operations Portfolio investment: Invest in financial assets with no controlling stake Reasons for FDI: Access to resources, larger markets, low production cost, access to export markets, competitor presence, Government incentives FDI promotes capital flow between the countries Richer countries can invest in developing countries. Developing countries need the capital and the developed countries get better returns. FDI facilities the production of goods and services in locations that have comparative advantages FDI brings in new technology and management techniques and improve efficiency and productivity FDI increases employment opportunities, enhances productivity, higher wages, and improvement of life styleFDI In India: FDI In India India is making efforts to attract FDI. FDI in India is allowed under the following forms: Financial collaborations Joint Ventures and technical collaborations Issues in capital markets Private placements or preferential allotment Various forms of organisation Licensing Franchising Joint Venture New foreign subsidiaries Management contractsFDI (Contd): FDI ( Contd ) FDI is not permitted in Arms and ammunition Atomic energy Railway transport Coal and Lignite MiningEffects of International trade: Effects of International trade Emergence of gigantic multinational corporations with production facilities spread across the world Establishment of global brands and products Availability of technology, products, services across the world Exchange of cheap labour and transfer of patented technology Capital flow into developing markets and availability of larger markets for developed markets. There has been tremendous growth and increased sophistication of the international monetary and financial systemFinancial system: Financial system Increased and safe means of payment in international transactions There has been an elaborate network of banks and financial systems which provides credit, guarantees, insurance, innovative risk management products, sophisticated payment systems across countries and time-zones at competitive rates Liberalisation, Integration and innovation have created a giant international financial market that is extremely dynamic and complex International market offers a huge bouquet of funding techniques, risk management products and speculative opportunities Financial engineering, a term used has become a reality.Importance of International trade: Importance of International trade India needs substantial amounts of foreign capital for investment purpose Import of technology for industries like power, renewable energy, infrastructure, engineering and defence India does not receive concessional aid now. Hence has to resort to commercial borrowings India is diversifying its export to include infrastructure services, engineering equipments. Hence has to provide long term financing to buyers Many companies have to expand in foreign countries for strategic purposes. It could be either a JV or a subsidiary Many Indian companies are acquiring companies outside India to tap the resources, talent or funding opportunities Going forward, the policy is towards more openness, more competition and international exchange of technology, capital and services.Finance Function: Finance Function As with finance function, even International finance has 2 broad functions Accounting and control Function and Treasury function. Accounting and control function are in the domain of recording, rules and policies and control, while treasury function involves financial analysis, planning, acquisition and deployment of funds. Acquisition and allocation of financial resources so as to minimise the cost and maximise the returns consistent with the acceptable risk profile of the company Companies can adopt 2 approaches. The management may not take any positions in the financial markets unrelated to the core business of the company or the management may take an active role to exploiting the market imperfections to profit from these financial transactionFinance Function-contd: Finance Function- contd To keep up to date all the significant environmental changes and analyse their implications for the firm To analyse the complex inter relationship between various changes and corporate responses Change in policies, rules of all the concerned markets To take corrective actions at the earliest in case of some lapses To take advantage of the various opportunities without spreading too thinFinancial system: Financial system The boundaries between national markets and offshore markets are becoming blurred Both banks and financial services companies have grown extensively across the globe They offer wide range of services to both the potential borrower and the potential investor Liberalisation, deregulation ad innovation in financial services has led to unprecedented growth of financial systems and companies Lifting of exchange controls, removal of withholding taxes on interest paid, access to international markets have led to liberalisationDeregulation & Innovation: Deregulation & Innovation Deregulation: Foreign financial institutions were allowed to enter the national markets and compete with domestic Financial institutions Financial institutions offer all services both from demand side and supply side Brokerage fees were reduced Financial innovation has been instrumental for both sharp rise as well as the recent debacles in the markets FII offered various innovative products like options, swaps, futures and many permutations and combinations On the demand side, due to foreign exchange fluctuations and hence changes in interest rates, risk has to be mitigated Banks and FII with similar services were competing with each other. They started innovating and offering complex and innovative products.Innovation: Innovation Banks and FIIs started offering very complex and esoteric products which the bankers themselves did not understand This led to the collapse of many FIIs and Governments across the world had to bail out banks and FIIsChallenges of Finance manager: Challenges of Finance manager Foreign exchange risk: The finance manager will have to deal with the risk of volatility in foreign exchange rates. Fixed rate system was discontinued in 1970 and since then rate are fluctuate in unpredictable manner. Exchange rate affects the profitability and the finance manager should understand the risks to anticipate and take necessary steps to mitigate it Political Risk: In international finance, this is a big factor. The change in rules, policies, regulation, restrictions, tax structure, legal interpretation can cause lots of uncertainties and losses. Complex relationship between environmental variables and corporate responses. Utilising the opportunity of market specific factor to its advantage Adapting to the socio-cultural aspects of the host country Minimise the adverse impact of a past actionRisk : Risk Multiplicity of currency and associated risks Multiplicity and complexity of the taxation system: reduce the tax burden and transfer funds from high to low tax countries by using tax havens Multiplicity of sources of funds: change in interest rates, credit norms, political risk, fiscal/monetary changes: MNCs can raise funds from the countries with cheaper rates and invests in markets which offer better returns MNCs can reduce risk, can reduce cost, can increase returns by using this diverse and complex system to its advantage By: Mrinmoy You do not have the permission to view this presentation. In order to view it, please contact the author of the presentation.