EXTERNAL SECTOR CONTINUED (05:03 PM)

 

Balance in current account (05:03 PM)

It records all transactions related to goods, services, income, and unilateral transfers by residents of the country with the rest of the world.

Current account can be further divided into:

1. Balance of visible (BOT)

2. Balance of Invisibles

Balance of trade: The difference between the values of imports and exports of only physical goods or visible items is called the balance of trade.

BoT= Value of export (goods) - Value of imports.

If exports are greater than imports, it is called a trade surplus.

If exports are less than imports, it is called a trade deficit.

If the export is equal to imports, then there is trade equilibrium or Balanced trade.

Balance of Invisibles:

It includes services, transfer payments, and net income from and to the rest of the world.

In India, the balance of invisibles has been generally positive due to the net export of services and huge remittances inflow.

Balance of current account Balance of visibles+ invisibles.

Twin deficit hypothesis (05:17 PM)

CAD and Fiscal deficit are called twin deficit.

CAD increases FD and vice-versa.

Desirable CAD (Current Account Deficit):

According to the Rangarajan Committee report, CAD of around 2% of GDP is sustainable for a developing economy like India.

In the recent past RBI and the Government were suggesting a CAD value of 2.5 to 3% of GDP.

However, permissible CAD depends on several other macroeconomic conditions.

Balance in the Capital Account (05:51 PM):

 

It records the capital receipts and payments in the form of investments and loans, slowing in and out of an economy.

The components of this account are:

1. Foreign investments include Foreign Direct Investments and Foreign Portfolio investments;

2. Loans (External Commercial Borrowings, External assistance, trade credit);

3. Banking Capital.

Foreign investments (06:02 PM):

 

They are non-debt-creating capital transactions.

FDI:

It refers to the purchase of assets in the rest of the world which allows control over the assets.

For example, the purchase of firms by TATAs in the UK.

On the recommendations of the Mayaram Panel, a new definition for FDI was adopted:

1. Any foreign investment greater than or equal to a 10% stake in a listed company is treated as FDI;

2. Any investment in an unlisted entity is treated as FDI;

3. It is the percentage that defines whether an investment is an FDI or Portfolio investment;

4. Once an FDI, always an FDI even if the holding comes down to less than 10%;

5. In partnership and proprietor concerns, only NRIs are allowed to invest (Foreigners are not allowed);

6. FDI investments can be classified into brownfield (buying an existing plant or company or factory in order to launch a new production activity) or greenfield investment that is to build new factories;

7. In India, FDI can enter through automatic and non-automatic routes.

Under the automatic route, the FDI is allowed without prior approval of the Government or the RBI.

In the non-automatic route or the government route, prior approval of the government is required.

8. The Foreign Investment Promotion Board (FIPB) was the responsible agency to oversee this non-automatic route was abolished in 2017.

Note: An Indian company having received FDI either under the automatic route or under the Government route is required to comply with the provisions of the FDI policy including the reporting of the FDI to RBI.

In India FDI is prohibited in:

1. Atomic Energy

2. Railways

3. Lottery companies

4. Chit fund companies

5. Housing and real estate except for the development of the township, construction of residential and commercial premises, roads or bridges, and real estate investment trust (under SEBI regulations)

6. Manufacture of tobacco products

7. Trading in TDRs (Transferable Development Rights)

Transferable Development Rights: 

When state governments acquire land for developing infrastructure projects like road widening, metro rails, etc., instead of compensation, a DRC (Development Rights Certificate) may be issued by the Government to the owner of the land.

This DRC allows the landowner, an additional built-up area in return for the area which he or she has relinquished and it enables him to develop the given area by himself or transfer his rights for consideration.

This is known as Transferable Development Rights.

Through TDRs, Landowners get better compensation at no cost to the Government.

Portfolio investment (6:36 PM):

 

It refers to the purchase of an asset in the rest of the world without any control over the same that is having less than a 10% share in a listed company.

In an unlisted company, any quantum of investment is termed FDI.

Portfolio investment can be classified into two categories:

1. Foreign institutional investments;

2. Investments through depository receipts (like ADRs, and GDRs).

Foreign institutional investments (FII):

Short-term in nature and is also known as hot money.

FIIs are regulated by SEBI.

Foreign Institutional Investors can invest in securities provided they are registered with the SEBI.

FIIs are allowed to invest in India's primary and secondary markets only through the country's portfolio investment scheme.

Depository Receipts  (06:50 PM):

 

A depository receipt is a negotiable financial instrument issued by a bank that represents a foreign company's publicly traded securities.

ADRs are issued by the US bank that represents securities of a foreign company, trading in the US stock market.

Through this, US investors can invest in non-US companies.

GDRs are equity instruments issued in the international markets, they perform like ADRs but on a global scale.

RBI publishes ADRs and GDRs as portfolio investments.

However, FEMA as well as the Department for Promotion of Industry and Internal Trade treats ADRs and GDRs as FDI.

LOANS (07:14 PM)

 

They are borrowings by a country both government and private sectors from the international money market.

They are debt-creating capital transactions.

Types of loans (07:17 PM):

 

1. External Commercial Borrowings (ECBs):

These are commercial loans raised from the international market that is they are raised at market rates without any concessions.

All entities eligible to receive FDI can raise ECBs along with port trust, units in SEZs, SIDBI, and AXIM Bank of India have also been allowed to raise ECBs.

ECBs have a general maturity period of three years (exceptions allowed).

ECBs can be borrowed in any freely convertible currency.

Types of ECB:

a. Capital Market Instruments like FCCB (Foreign Currency Convertible Bonds):

In India, FCCBs are included in the FDI only when it is converted into equity otherwise FCCBs are treated as ECB.

b. Loans including bank loans;

c. Floating or fixed-rate bonds or debentures other than fully convertible instruments.

2. Trade credit:

Buyers and suppliers credit beyond three years.

Trade credit (07:29 PM)

 

It is provided to an importer by the overseas supplier, banks and other permitted recognized lenders.

Only a resident of India can avail of this credit.

It allows the importer to pay at a later date for the import of capital and non-capital goods permissible under foreign trade policy.

Up to three years for the import of capital goods and up to one year for non-capital goods.

External assistance (7:30 PM):

 

These are borrowings with lower rates of interest and longer maturity (soft loans).

External assistance is generally given by foreign Governments, the World Bank, IMF, or other international monetary institutions.

Banking Capital Transactions (7:31 PM):

 

They mainly include NRI deposits:

1. FCNRB (Foreign currency non-Resident Bank Account):

It can be held only in the form of term or fixed deposits.

The maturity term ranges from one to five years.

Only NRIs or persons of Indian Origin can open FCNR accounts.

It is maintained in Foreign currency.

2. Non-Resident External Rupee Account:

Any NRI can open this account to remit funds to India through banks abroad.

These accounts are maintained in Indian rupee and can be opened as Term or demand deposits.

The interest earned on it is tax-free.

The amount held in this deposit together with interest can be repatriated.

It is prone to exchange rate risk.

3. Non-Resident ordinary rupee account:

Any person residing outside India irrespective of being Indian or not may open or maintain this account for the purpose of handling transactions denominated in Indian rupees or to manage income earned in India.

It can be maintained in the form of Demand and term deposits.

Interest earned is generally taxable.

It is not prone to the risk of exchange rate fluctuations.

4. Autonomous and accommodative transactions:

Autonomous items:

These items refer to international economic transactions that take place due to some economic motive such as profit maximization.

They are also called above-the-line items.

For example, all current and capital account transactions.

Accommodative items:

These items are meant to restore the BoP balance or correct the BoP balance.

They are the official reserve transactions performed by the Central Bank.

These official reserve transactions occur when autonomous receipts are less than independent payments i.e. deficit in BoP.

The central bank finances the deficit through FOREX reserves, borrowing from IMF, and other monetary authorities.

They are also called below-the-line items.

THE TOPIC FOR THE NEXT CLASS: THE EXCHANGE RATE SYSTEM