7.Foreign Trade

economy study material 7

Foreign Trade Globalization

The term “Globalization” means the integration of the economy of each country with the world economy. The essence of globalization is the increasing degree of openness in respect of international trade, international investment, and international finance.

In other words, globalization is the process of transformation of the world into a single integrated economic unit. In a global economy, all the barriers on the flow of trade in goods and services and investment across the national frontiers are removed.

The process of globalization underlies following trends.

  • The spread of international trade. Increasing migration of people.
  • Increasing flow of money or means of payments. More capital flows.
  • An increased flow of finance capital.
  • The emergence of more and more transnational companies and multinational companies. Increasing trade of technology between different countries.
  • The rapid spread of print, electronic and communication media.
  • Growth in trade and production of services of all kinds – including education.


 India opened up the economy early 1991 following a major crisis that led by a foreign exchange crunch with reserves which could hardly finance inputs for two weeks in India. The crisis has dragged the economy close to defaulting on loans.

The credit rating of India had gone down and non-resident Indians (NRIs) had started withdrawing their deposits in foreign currency and the country was on the verge of default with regard to the payments of short-term credits incurred from foreign financial institutions.

Hence, drastic policy measures were introduced on the domestic and external sectors to address all these issues. All these policy measures were partly prompted by the immediate needs and partly by the demand of the multilateral organizations like the World Bank and International Monetary Fund (IMF). The liberalized policy regime rapidly pushed forward in favor of a more open and market-oriented economy.

Policy Measures of Liberalisation:

Major policy measures have been launched as a part of the liberalization, privatization and globalization (LPG) The government announced the devaluation of rupee by about 20% in July 1991, new industrial policy, new trade policy in 1991, and a new export and import policy were also announced.

Other measures followed are scrapping of the industrial licensing regime, reduction in the number of areas reserved for the public sector, amendment of the Monopolies and the Restrictive Trade Practices Act, withdrawal of many governmental controls, start of the privatisation programme, sharp reduction in tariff rates, change over to market-determined exchange rates,many fiscal and financial sector reforms.

All these measures have been grouped together under ‘New Economic Policy’ (NEP). Over the years there has been a steady liberalization of the current account transactions, more and more sectors opened up for foreign direct investments and portfolio investments facilitating entry of foreign investors in telecom, roads, ports, airports, insurance and other major sectors.

Liberalization, privatization, and globalization in the form of increased integration of India with the global economy through trade and investment since the early nineties are some of the major reasons for the high level of economic growth in recent years.

Despite this progress, unemployment, poverty, inequality and low level of human development still remain to be the most serious development challenges to be reckoned with.

The contribution of foreign trade to economic development

 Foreign trade has worked as an ‘engine of growth’ in the past. Recently the “outward-oriented growth strategy” adopted by the Newly Industrializing Economies of Asia, has enabled many countries to overcome the constraints of small resource-poor under-developed economies. Foreign trade contributes to economic development in a number of ways as follows.

  1. It explores means of procuring imports of capital goods, which initiates the development
  2. It provides for flow of technology, it allows an increase in factor
  3. It generates pressure for dynamic change through Competitive pressure from imports, The pressure of competition for export markets, and A better allocation of resources.
  4. Exports allow fuller utilization of capacity, increased exploitation of economies of scale, separation of production patterns from domestic demand, and increasing familiarity with the absorption of new These, in turn, help increase the profitability of the domestic business without any corresponding increases in price.
  5. Foreign trade increases worker’s It does so at least in four ways: Larger exports translate into higher wages; Because workers are also consumers, trade brings them immediate gains through cheaper imports; It enables most workers to become more productive as the goods they produce an increase in value; Trade increases technology transfers from industrial nations to udcs and the transferred technology is biased in favor of skilled labor;
  6. Increased openness to trade has been strongly associated with the reduction of poverty in most developing

In the twenty-first century, we can easily identify the conditions that are favorable for developing economies to the conditions to employ foreign trade as a factor in economic growth. They are as follows:

  1. Increasing spread to globalization translates into larger movement of goods and services across the
  2. Continuing reallocation of manufacturing activities from industrial economies to developing economies offers ample opportunities to expand trade not only in goods but also in services, which are becoming increasingly
  3. Trade is intertwined with another element of globalization: the spread of international production
  4. Growth of trade is firmly buttressed by international institutions of long The WTO, built on the legacy of the GATT, aims to create a commercial environment more conducive to the multilateral exchange of goods and services.
  5. In recent years there have been substantial reductions in trade policy and other barriers inhibiting developing country participation in world trade. Lower barriers have contributed to a dramatic shift in the pattern of developing country trade-away from dependence on commodity exports to much greater reliance on manufactures and

In addition, exports to other developing countries have become much more important.

International Monetary Fund (IMF):

 A landmark in the history of world economic co-operation is the creation of the International Monetary Fund (IMF). The decision to start IMF was taken at Bretton woods conference and it commenced its operation in March 1947. According to the Articles of Agreement of IMF, the objectives of IMF are:

To promote international monetary cooperation To promote stability in foreign exchange rates; To eliminate exchange control

To establish a system of multilateral trade and payments To set right the disequilibria in the balance of payments.

The following are the major functions of the IMF:

  • Functions as a short-term credit institution.
  • Provides machinery for the orderly adjustments of exchange rates.
  • Acts as a reservoir of the currencies of all the member countries from which a borrower nation can borrow the currency of other nations.
  • Functions as a sort of lending institution in foreign exchange. It grants loans for financing current transactions only and not capital
  • It also provides machinery for altering sometimes the par value of the currency of a member country.
  • It also provides machinery for international consultations.
  • Provides technical experts to member countries having BOP difficulties and other problems.
  • Conducts research studies and publishes them in IMF Staff papers, Finance and development etc.

Trends in Foreign Trade

 Foreign trade of a country is gaining importance with the goal of achieving economic development and survival of the fittest with the globalization of the market. Foreign trade becomes more and more important for developing countries. Trends in foreign trade will indicate a country’s development ratio. A proper analysis of a country’s foreign trade can be studied through the following components: Volume of trade Composition of trade and Direction of trade.

The balance of Trade and Balance of Payment Meaning and definition of Balance of Payments

Balance of payments means a systematic record of all the economic transactions of a country with the rest of the world during a given period, say one year. It throws light on the international economic position of a country.

The international economic performance of a country is reflected in its balance of payments.

Each country enters into economic transactions with other countries of the world. As a result of such transactions, it receives and makes payments to other counties. So the balance of payments is a statement of accounts of these receipts and payments.

Benham defined Balance of payments as follows: “Balance of Payments of a country is a record of its monetary transactions over a period with the rest of the world” In the words of Kindleberger, “the balance of payments of a country is a systematic record of all economic transactions between its residents and residents of foreign countries”.

The composition of Balance of Payments:

 The balance of payments is a statement or an account, which records all the foreign receipts and payments of a country. It records all the visible and invisible items. Visible items mean the imports and exports of commodities.

Invisible items mean the imports and exports of services and other foreign transfers and transactions. BOPs are classified as the balance of payments on current account and capital account. The BOPs on current account records the current position of the country in the transfer of goods, services, and merchandise as well as invisible items such as donations, unilateral transfers etc.

The balance of payments on capital account shows the country’s financial position in the international scenario, the extent of accumulated foreign exchange reserves, foreign assets and liabilities and the impact of current transactions on international financial positions.

The balance of Trade:

The balance of trade confines to trade invisible items only. Visible items are those, which are physically exported and imported like merchandise, gold, silver, and other commodities.

The invisible items are the services mutually rendered by shipping, insurance, and banking companies, payment of interest and dividend, tourist spending and so on. The balance of trade refers to the difference between physical imports and exports of visible items only for a given period, say, a year. During a given period, exports and imports may be exactly equal. Then, the balance of trade is said to be balanced.

If the value of exports is in excess of the value of imports, the balance of trade is said to be favourable. If the value of imports is greater than the value of exports, the balance of trade is said to be unfavorable.

Component of Balance of Payment: The Balance of Payments position is generally classified into two parts

It consists of –

  • Balance of Trade
  • Balance of Services:
  1. Travel (tourists, etc.,) transportation (shipping etc.) banking, insurance
  2. Income on investment (interest, royalties, dividends, foreign bond earnings)
  3. Government: Receipt from diplomatic and military personnel from overseas and payment to similar overseas and payment to similar overseas
  4. The balance of unrequited transfers, like donation, grants etc.

It deals with borrowings or lending of the Country.

It includes a balance of-

  • Private direct investments
  •  Private portfolio investments
  •  Government loans to foreign governments

Thus, Balance of Payments is the sum of the balance of current account and balance of the capital account. The balance of payments must always balance in a bookkeeping sense. This is because for any surplus (or deficit) in the overall balance of payments, there must be a corresponding debit (or credit) entry in the net changes in external reserves.

In other words, if there is a surplus it adds to external reserves of the country and if there is a deficit, it reduces the external reserves of the country.

The balance of Trade Vs. Balance of Payment

Favorable and Unfavourable:

It records only the import and export of goods.It does not record transactions of capital nature.

A balance of trade is a part of the current account of the balance of payments.The balance of trade may be favorable/ unfavorable/in equilibrium.It records transactions relating to both goods and services.It records transactions of capital nature.

The balance of payments is more comprehensive. It not only includes the balance of trade but also balances of services, the balance of unrequited transfers and balance on account of capital transactions. The balance of payments always remains balanced in the sense that the receipt side is always made to be equal to the payments side.

Export Promotion

With the continuing large deficits in India’s balance of trade and limited scope for imports reduction, the only long-term solution to the problem lies in promotion of exports to earn sufficient foreign exchange to pay for our growing imports. Export promotion measures opening up wider international market for our entrepreneurs will stimulate industrial development in the country under the incentive of larger world demand for our goods.

Export Promotion Measures

The export promotion measures adopted by the Government of India include monetary and non-monetary incentives, fiscal reliefs, credit facilities, establishment of institutions to help exporters as well as strict quality controls and inspection of goods meant from export. Some of the major steps in this direction are as below: Devaluation:

In July 1991, the rupee was devalued by about 20% in terms of major world currencies. This was expected to cheapen our goods in foreign buyers, thereby encouraging our exports.

Cash Assistance:

Under this scheme, cash assistance is given to exporters to compensate them for indirect taxes (e.g., custom duties) levied on the imported inputs that are used in production of goods for exports.

Income Tax concessions:

Income from exports is given several concessions under the income tax laws. For example, profits from exports are totally exempted from income tax.

Import Concessions:

Several concessions in imports of machinery, equipment and technology are given to export production units. Export-oriented units are allowed duty-free imports of machines, raw materials and technology. Exporters are also allocated foreign exchange for import of raw materials used in production of export goods.

Concessional Bank Credit to Exporters:

Since imported goods fetched very high prices in the domestic market as their imports were highly restricted, the exporters were granted licences for import of goods up to a certain percentage of value of goods exported by them. This was expected to provide added incentive for exports.

Issue of EXIM Scripts:

The system of granting import licences to exporters was later replaced by EXIM scripts. The exporters were given EXIM scripts equivalent to 30% of value of their exports. These EXIM scripts could be used to import a large variety of items. The EXIM scripts could also be sold in the market. Since these enjoyed a premium, the exporters could make additional profits from their sale. This could act as a great incentive to exporters.

Convertibility of the Rupee:

The system of EXIM scripts was also replaced by partial convertibility of rupee in March 1992, Under this scheme, exporters, who earlier had to surrender their entire foreign exchange earnings to the Reserve Bank of India (RBI) at a rate fixed by it, were now obliged to sell only 40% of their exchange earnings at the official rate to the RBI.

The rest, they were free to sell in the market at the market determined rate, which was obviously higher than the official rate.

This indeed was a great liberalisation measure and a bigger incentive. In March 1997, even this was replaced by a system of full convertibility of rupee on the trade account. System of Advanced Licensing:

Exporters are given advance licenses for duty-free import of goods used in production of export items.

Relaxation of Controls on Exports and Simplification of Procedures: Controls on exports have been relaxed. Exports of many items have been decontrolled while export procedures and formalities have been simplified. Export Processing Zones:

Many export processing zone has been set up. The units operating there are allowed free trade with other countries. They also enjoy various concessions like a five-year tax holiday.

Export Promotion Organizations:

Some such organizations are Export Advisory Council., Export Promotion Councils, Directorate of Export promotion, etc.

Export-Import Bank:

The EXIM Bank provides financial services to exporters and importers and coordinates the work of other institutions engaged in financing export trade. It pays special attention to export of capital goods.

The Role of the General Agreement on Tariffs and Trade (GATT):

 The General Agreement on Tariffs and Trade (GATT) was a multilateral trade treaty between countries to regulate international trade and tariffs in accordance with specific rules, norms or code of conduct.

GATT was set up in 1948 in Geneva to follow the objectives of free trade in order to encourage growth and development of all member countries. There are 117 member nations in GATT.

The principal purpose of GATT was to ensure competition in commodity trade through the removal of or reduction in trade barriers. GATT served as an important international forum for carrying on negotiations on tariffs. Under GATT, member nations met at regular intervals to negotiate agreements to reduce quotas, tariffs and such other restrictions on international trade.

GATT became a permanent international trade institution for the multilateral expansion of trade until it was replaced by the World Trade Organisation (W.T.O) in 1995 .

Objectives of GATT:

  • Expansion of international trade;
  • The increase of world production by ensuring full employment in the participating nations.
  • Development and full utilization of world resources; and Revising standard of living of the world community as a whole.
  • The rules adopted by GATT are based on the following fundamental principles: Trade should be conducted in a non-discriminatory way;
  • The use of quantitative restrictions should be condemned, and Disagreements should be resolved through consultations.


Please enter your comment!
Please enter your name here