International Financial Transactions

2.1 International Financial Transactions                            

Prior to First World War, growth in world trade was quite smooth. Gold based monetary standard provided stability to world trade. However, the collapse of gold standard, great depression of 1930s and subsequent events created a high tariff international trade regime which affected the world trade. With the establishment of IMF and GATT world trade started gaining the lost pace again. The General Agreement on Tariffs and Trade (GATT), was established after World War II in the wake of other new multilateral institutions dedicated to international economic cooperation. Seven rounds of negotiations occurred under the GATT for reducing tariffs, anti-dumping and non- tariff trade barriers.

The eighth GATT round — known as the Uruguay Round was the biggest negotiating mandate on trade ever agreed. The talks were going to extend the trading system into several new areas, notably trade in services and intellectual property, and to reform trade in the sensitive sectors of agriculture and textiles. The Final Act concluding the Uruguay Round and officially establishing the WTO regime was signed during the April 1994. The agreements fall into a structure with six main parts:

·         The Agreement Establishing the WTO

·         Goods and investment — the Multilateral Agreements on Trade in Goods including the GATT 1994 and the Trade Related Investment Measures

·         Services — the General Agreement on Trade in Services

·         Intellectual property — the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS)

·         Dispute settlement (DSU)

·         Reviews of governments' trade policies (TPRM)

The WTO agreements deal with agriculture, textiles and clothing, banking, telecommunications, government purchases, industrial standards and product safety, food sanitation regulations, intellectual property, and much more. The fundamental principle of post-WTO international trade is the foundation of the multilateral trading system. The economic case for an open trading system based on multilaterally agreed rules is simple enough and rests largely on commercial common sense. But it is also supported by evidence. Tariffs on industrial products have fallen steeply and now average less than 5% in industrial countries and 25% in developing countries. During the first 25 years after the war, world economic growth averaged about 5% per year, a high rate that was partly the result of lower trade barriers.

During the last four decades of the world economic liberalization, the World trade has not been smooth. At the same time, it is not confined to developed/industrialized countries. World economic activities were affected by international liquidity crisis, credit crunch, high crude oil prices, galloping inflation, severe drought and other natural calamities. World trade is generally affected the international business cycles. The characteristic of international business cycle has been changed a lot since 1980s. Prior of 1980s, 70% of the world output was confined to advanced economies and hence the international business cycles were affected by the performance of these economies

At present, the share of the advanced economies in World output came down to 55% on purchasing power parity basis. Hence, international business cycles are no longer control by these advanced economies; rather it is the emerging market economies which are playing the leading roles in the world output and trade. In 2007, as the slowdown in economic activity in the USA and other advanced economies began, the hope was that emerging and developing economies, with their domestic economic size and strength, would help in keeping the international business cycles upward. As per the  WTO forecast, the collapse in global demand brought on by the biggest economic downturn in decades will drive exports down by about 9% in volume terms in 2009, the biggest such contraction since the Second World War.

Economic contraction has led to steep export declines which already posted in the early months of 2009 by major economies makes for an unusually bleak 2009 trade  assessment, as per the annual assessment of global trade by the WTO. Signs of the sharp deterioration in trade were evident in the latter part of 2008 as demand sagged and production slowed. Although world trade grew by 2% in volume terms for the whole of 2008 it tapered off in the last six months and was well down on the 6% volume increase posted in 2007. The global economy is in a severe recession inflicted by a massive financial crisis and an acute loss of confidence. Wide-ranging and often unorthodox policy responses have made some progress in stabilizing financial markets but have not yet restored confidence nor arrested negative feedback between weakening activity and intense financial strains.

While the rate of contraction is expected to moderate from the second quarter onward, global activity is projected to decline by 1.3 percent in 2009 as a whole before rising modestly during the course of 2010. This turnaround depends on financial authorities acting decisively to restore financial stability and fiscal and monetary policies in the world’s major economies providing sustained strong support for aggregate demand.

The Balance of Payments (BOP) of a country is a systematic record of all its economic transactions with the outside world in a given year. It is merely a way of listing receipts and payments in international transaction for a country. The Balance of payments accounts of a country are constructed on the principle of double-entry book-keeping.  Each transaction is entered on the credit and debit side of the balance sheet. Payment is received from a foreign country is credit transaction and payment to a foreign country is a debit transaction. The collection of all exports, imports and financial transactions in a BOP account are grouped into three main categories.

1.        Current Account: Import and export of goods and services and unilateral  transfer of goods and services including transfer of money for family living expenses.

2.        Capital Account: Transactions related to changes in foreign assets and  liabilities. This includes short-term and long-term borrowings, private and government investments and international capital flows.

3.        Reserves Account: It also relates to international assets and liabilities for such transactions which the country’s monetary authorities uses to settle the deficits and surpluses that arise on the other two categories of accounts.

The structure of BOP account is provided here under:

A.     Current Account                               Debits             Credits                        Net

a.        Merchandise

b.      Invisibles

i.       Services

1.      Travel

2.      Transportation

3.      Insurance

4.      Government

5.      Miscellaneous

ii.   Transfer

1.      Official

2.      Private

iii. Income

1.  Investment Income

2.  Compensation to Employees

Total Current Account (a+b)

B.       Capital Account                                  Debits              Credits            Net

1.   Foreign Investment

a.   In India

i.   Direct

ii.    Portfolio

b.   Abroad

2.   Loans

a.   External Assistance

i.   By India

ii.    To India

b.   Commercial Borrowings(Long and Medium)

i.   By India

ii.    To India

c.   Short-Term Borrowings

i.   To India

3.   Banking Capital

a.   Commercial Banks

i.   Assets

ii.    Liabilities

iii Non-resident Deposits

b.   Others

4.   Rupee Debt Service

5.   Other Capital

Total Capital Account (1to 5)

In accounting sense balance of payments always balances since all international transactions are recorded as per double entry book-keeping methods. However, various subsets of BOP account can have deficit and/or surplus which have economic interpretations. To say that the BOP always balances is to interpret that a net credit balance in one of these accounts must have a counterpart net debit balance in one of the other accounts or in a combination of the two other accounts.