BASICS OF INTERNATIONAL FINANCE

1. BASICS OF INTERNATIONAL FINANCE Ketki Bhirdikar Pushkar Borse Reema Rijhwani Shantala Samant

2. FISCAL POLICY

3. Meaning Fiscal policy is the use of government spending and revenue collection to influence the economy. It is the overall effect of the budget outcome on economic activity. Government uses it to regulate expenditure and revenue programme to produce desirable effects and avoid undesirable effects on the national income, production and employment. Operates through the annual budget.

4. Objectives Price level stability Desired consumption level Desired employment level Desired income distribution Increase capital formation Control Degree of inflation To combat recession ( used by Kynes in 1930s in the Great Depression)

5. Instruments of Fiscal Policy • Public expenditure • Taxes • Public debts

6. Types And Tools Of Fiscal Policy

7. Discretionary Policy Deliberate change in government policy & taxation. Aims : To cure recession. To control inflation.

8. Non-discretionary Fiscal Policy No deliberate change made by the government. Automatically cures recession & controls inflation. Tools: Personal Tax Corporate Tax Transfer Payments Corporate Dividend policy.

9. Fiscal Deficit Government expenditure surpasses income. Normally expressed as a percentage of GDP.

10. Monetary Policy

11. Meaning • Policy employing the central bank’s control on the supply of economic policy as an instrument of achieving the objectives of economic policy • Influences publics liquidity position • Monetary policy and credit policy

12. Objectives of Monetary Policy • Feasible output • High rate of growth • Fuller Employment • Greater equality in the distribution of income and wealth • Healthy balance in balance of payments

13. Instruments Quantitative – 1. Open Market Operations (govtn securities) 2. Bank Rate Policy 3. Reserve Policy Qualitative – 1. Rationing of Credit (ceiling and penalty) 2. Changes in Margin requirement 3. Moral suasion

14. Problems • Lag in results • Presence of other financial intermediaries • Contraction in objectives • Underdeveloped nature of money and capital markets

15. Introduction to International Finance

16. The Gold Standard (Pre - 1914) • Rate at which one currency unit could be converted to a weight of gold • ‘Fixed’ exchange rates • Expansionary monetary policy limited to a government’s supply of gold • Since WWI - free movement of gold interrupted • Increasing fluctuation of currencies

17. Bretton Woods System (1944-1973) • Post WWII - US dollar was the only convertible currency • US dollar based international monetary system was developed • IMF and World Bank were created • USD was fixed in terms of gold (USD 35 per ounce) • Other countries fixed their currency relative to the USD

18. Floating Exchange Rates (1973 – ) • Widely diverging monetary and fiscal policies, differential rates of inflation • Growing demand for dollars • Growing balance of payments deficit • Subsequent devaluations of the dollar • Exchange rates became more volatile and less predictable

19. Foreign Exchange Markets • Market where different currencies are traded like commodities • Exchange rate enables translation of prices of foreign goods into units of own currency • Appreciation of a currency makes imports cheaper and exports expensive • Depreciation of a currency makes imports expensive and exports cheaper

20. Exchange Rate Regimes • Flexible rates • Fixed-rate, unified currency • Pegged exchange rates

21. Flexible Exchange Rate Regime • Exchange rate is determined by supply and demand • Demand for foreign exchange originates from imports • Supply of foreign exchange originates from exports • The foreign exchange market brings the quantity demanded and quantity supplied into balance

22. Fixed Rate, Unified Currency Regime • A system where currencies are linked to each other at a fixed rate. • The linkage may be through • use of the same currency • trade of currencies at a fixed rate • Eg: European Monetary Union

23. Pegged Exchange Rate Regimes • The country uses monetary and fiscal policy to maintain the exchange-rate value at a fixed rate or within a narrow band relative to another currency (or bundle of currencies) • A nation can either: • follow independent monetary policy, allowing its exchange rate to fluctuate • tie its monetary policy to the fixed exchange rate • It cannot maintain currency convertibility at a fixed rate while following a expansionary monetary policy

24. Balance of Payments • Accounts that summarize the transactions of a country with foreign countries • Current account balance • Capital account balance • Trade balance • Difference between exports and imports of goods and services • Trade balance = exports – imports

25. Trade Deficits • The amount by which the value of imports exceeds the value of exports in a given time period • It represents a net outflow of home currency to the rest of the world • “Deficit” has negative connotations unless • attractive investment environment (net inflow of capital) • rapid economic growth (high imports)

26. Current Account Balance • Current account transactions • Merchandise trade • Service trade • Income from investments • Unilateral transfers

27. Capital account balance Foreign purchase of U.S. assets U.S. purchases of foreign assets = – Capital Account Balance • Financial assets bought and sold across international borders • direct investments by foreigners • loans to and from foreigners

28. Net balance of payments current-account balance capital-account balance 0 = = – Net Balance of Payments • The capital-account surplus must equal the current-account deficit

29. Reserves of the Country • IMF account • Special Drawing Rights • Reserve assets • Monetary gold • Foreign exchange reserves

30. Weakening of home currency Current account surplus Capital account deficit Called depreciation in floating system Strengthening of home currency Current account deficit Capital account surplus Called appreciation in floating system Devaluation Revaluation

31. Currency Convertibility • Current Account Convertibility • Freedom to switch currencies to buy goods and services • Capital Account Convertibility • Freedom to switch currencies to buy capital assets (bonds, shares)

32. Dimensions of CAC’s merits and demerits • FDI inflow • FDI outflow • FPI inflow • FPI outflow • Inflation, exchange rates, interest rates

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