Dr. S.

Venkata Siva Kumar International Business

INTERNATIONAL BUSINESS
UNIT – II: INTERNATIONAL TRADE THEORIES
INTERNATIONAL TRADE THEORIES: Classical Theories: Mercantilism, Absolute
Advantage Theory, Comparative Advantage Theory and Factor Endowment Theory.
Modern Theories: Country Similarity Theory, Product Life Cycle Theory, New Trade
Cycle Theory and National Competitive Advantage Theory. India’s Foreign Trade,
Foreign Direct Investment in India, Balance of Payments.

Introduction
Trade is the concept of exchanging goods and services between entities. International trade,
thus, means the concept of exchange between two separate countries. Entities trade because
they believe that they will benefit from such a trade/exchange. In other words, this seems like
a very simple concept, but in reality, it has many procedures in terms of theory, policy, and
business strategies.

What is international trade

If you walk into a supermarket and you find yourself with a packet of Lays, or even our
favourite Cadbury chocolate, or a can of Coca-Cola, you have experienced international trade.
International trade allows you to get goods and services that you might not get domestically.
As quoted by Wasserman and Haltman, “Trade can be connoted as transactions among the
citizens of different nations. Global economic activities are aided by International trade and
are a catalyst of economic growth for various developed countries and also for the developing
nations. Differences in various conditions, like resource availability, natural climatic
conditions, cost of production, etc., act as the motive behind trade between the countries.
International trade has provided the opportunity for employment services in the developing
nations. International trade is the reason for the rising living standards of people all over the
world.”

The concept of international trade emerged as a sub-part of economic study that deals with the
patterns, causes, and effects of global trade. Since the 18th century, the topic has been debated
to assess its effect and consequences.

Dept. of Management Studies, Vardhaman College of Engineering 1|Page

Dr. S. Venkata Siva Kumar International Business

Different theories of international trade

One of the earliest subfields of economic theory is that of global trade and commercial policy.
Government officials, thinkers, and economists have debated the factors that influence
international trade from the time of the ancient Greeks to the present. They have questioned
whether trade benefits or harms a country and more importantly, have sought to identify the
best trade policies for various nations.

Since the time of Greek philosophers, the only tension in international trade has been that
domestic businesses, workers, and the economy will be affected by foreign competition.
Philosophers analyse the gains from such trade and compare them to the losses of domestic
business, thus comparing them to the conclusion of such trade. The tensions caused by this
dual perspective on trade have never been resolved. The theories of International trade are –

1. Classic or country-based theory of International trade

The classical theory of trade states that goods are exchanged against one another according to
the relative amounts of labour embodied in them. It is based on the labour cost theory of value.
Goods that have equal prices embody equal amounts of labour. The classic or country-based
international trade theory has the following division –
 The Mercantilism theory was developed in the 16th century, and it was one of the earliest
efforts to develop an economic theory.
 The Absolute Cost Advantage was introduced in 1776 by economist Adam Smith. He
questioned the leading mercantile theory of the time in his publishing – The Wealth of
Nations.
 The Comparative Cost Advantage challenged the absolute advantage theory that some
countries may be better at producing both goods and therefore, have an advantage in many
areas.
 The Heckscher-Ohlin theory introduced by Smith and Ricardo didn’t help countries
determine which products would give a country an advantage. Both theories assumed that
free and open markets would lead countries and producers to determine which goods they
could produce more efficiently.

Dept. of Management Studies, Vardhaman College of Engineering 2|Page

Dr. S. Venkata Siva Kumar International Business

2. Modern or firm-based theory of International trade

The modern or firm-based theory emerged after World War II. It evolved with the growth of
multinational firms and their expansion. The theory incorporates other products and factors
like customer loyalty and technology. The modern or firm-based theory of International trade
has the following theories –
 Country similarity theory was given by Swedish economist Steffan Linder in 1961, as he
tried to explain the concept of in-train industry trade. His theory proposed that consumers
in countries that are in the same or similar stages of development would have similar
preferences.
 The Product life cycle theory by Raymond Vernon, a Harvard Business School professor,
developed the product life cycle theory in the 1960s. The theory, originating in the field of
marketing, states that a product’s life cycle has three distinct stages namely new product,
maturing product, and standardised product.
 Global strategic rivalry theory was introduced in the 1980s and was based on the work of
economists Paul Krugman and Kelvin Lancaster. Their theory focused on multinational
companies and their efforts to gain a competitive advantage against other global firms in the
same field.
 Porter’s National Competitive Advantage Theory was part of the continuing evolution of
international trade theories, Michael Porter of Harvard Business School developed a new
model in 1990 to explain national competitive advantage. His theory stated that a nation’s
competitiveness in an industry depends on the capacity of the industry to innovate and
upgrade.

Classical theory of international trade

Adam Smith and David Ricardo developed the classical theories of international trade.
According to the theories given by them, when a country enters into foreign trade, it benefits
from specialisation and efficient resource allocation. The foreign trade also helps to bring new
technologies and skills that lead to higher productivity.

Mercantilism theory
The Mercantilism theory is the first classical country-based theory. It was put forward in the
17th and 18th centuries. The main contention of this theory was that a country or nation should
focus on its welfare and exports rather than imports. The theory focused primarily on

Dept. of Management Studies, Vardhaman College of Engineering 3|Page

Dr. S. Venkata Siva Kumar International Business

strengthening the treasure of the nation and the accumulation of wealth in the form of silver
and gold. The 15th century marked the rise of a few nation-states that wanted to strengthen
their nations through the development of armies and defence. These nations promoted the
export of goods and put restrictions on imports. This is called protectionism. The British
colony is one of the most successful examples of this theory, where nations expand their wealth
through exports and control trade. They used raw materials from other nations by ruling over
them, and then exported the same goods at a higher price to generate wealth for their own
nation. France and Spain were a few nations that were successful in building large colonies and
generating wealth from governing nations. According to this theory, the government should
play a role in the economy by encouraging exports and discouraging imports by using subsidies
and taxes. Even today, we can see a few nations, like Japan and China, that still believe in this
method and allow limited imports and exports. Supporting perfectionist policies comes at the
cost of high taxes and other disadvantages. Mercantilism and protectionist policies only benefit
selected nations, whereas the policy of free trade helps in the development of every nation.

Absolute Advantage theory

The economist, Adam Smith in 1776, criticised the theory of mercantilism and gave the theory
of absolute cost advantage. He was the father of the modern economy. He supported the
necessity of free trade as the only assurance for the expansion of international trade. In this
theory, he stated that the countries should only produce those products in which they have an
absolute advantage. He focused on the production of those goods that they can produce at a
lower cost than other countries and should export those products to countries in which they
have a cost advantage.

In his words, if a foreign country can supply us with a commodity cheaper than we can make
it, we should better buy it with some part of the production of our own industry, employed in
a way in which we have some advantage. Adam’s theory stated that with an increase in
efficiency, people in both countries would benefit, and trade should be encouraged. He stated
that nations’ wealth should not be judged on how much gold or silver they have but rather on
the living standards of their people. Market factors determine trading in a country, not the
government. According to him, trade in a nation must flow according to market factors. He
also denied the promotion of trade by the government and the restriction of trade.

Dept. of Management Studies, Vardhaman College of Engineering 4|Page

Dr. S. Venkata Siva Kumar International Business

Comparative Advantage theory

The economist David Ricardo gave the theory of comparative cost advantage in 1817 through
his book called ‘The Principle of Political Economy and Taxation’. This theory was later
polished by J.S. Mill, Marshall, and others. This theory states that the country should focus on
the production of those goods that it has in abundance. A country should import more goods
that have the least disadvantage of production and export the surplus of what they produce in
their nation.

The theory suggests that a nation should export goods for which its relative cost advantage is
greater than its absolute cost when compared with other nations. A country that effectively
produces goods may still import them if there is a relative advantage. And a country may still
export even if it is not very efficient at importing certain goods from another country. This
theory encourages trade to be mutually beneficial. This theory assumes that labour is the only
factor of production and that there are no trade barriers between the countries.

Factor Endowment Theory (Heckscher-Ohlin theory)

This theory is also known as factor proportion theory. Heckscher and Ohlin in the 1900s, dealt
with the concept of advantages that a country can gain by producing those goods on the basis
of factors that are present in abundance in their country. The main basis of this theory was the
production factors of a country, like land, labour, and capital. They stated that the cost of any
factor of production depended on supply and demand. For example, China and India have
cheap labour and they have become the locations for labour intensive industries. This theory
explains that there is an imbalance in resources throughout the world, and thus nations should
export the resources that they have in abundance.

Essentials of classical theory

The classical theory provides guidance on the question of national policy. The classical
economists were mainly concerned with two questions. First, which products must a country
import and export? Second, the ratio of the exchange of goods between the countries. The
economists answered the first question by saying that the goods that the country needs to
produce for production must be those goods whose production suits the climate, the quality of
the soil, and the natural resources available for them. Each country should focus on the
production of these goods, keep with themselves the necessary amount, and export the
excess/surplus to other countries. The classical theory of international trade is mainly focused

Dept. of Management Studies, Vardhaman College of Engineering 5|Page

Dr. S. Venkata Siva Kumar International Business

on the labour cost theory of value. It states that goods must be traded in respect of the labour
that is embodied in them. Adam Smith gave an example to explain this, he states that if with
the same expenditure of labour one can kill either one beaver or two deers, then one beaver
will always be exchanged in the market for two deer. Through this, he meant that the exchange
or price in the market must be determined on the basis of labour costs and their influence on
supply and demand.

Criticism of the classical country-based theory

There was a shift from the classical theory of international trade to the modern theory, as these
theories assume that labour is the only factor for production. It ignores other factors such as
land, capital and enterprises. Labour is not perfectly mobile in a country, especially a country
like India with its diverse languages, cultures, and working environments. In this dynamic
world, technological advances are increasing productivity efficiently. A theory cannot be based
only on constant returns. The theory assumes no such change and seems to be very unrealistic.
It is based on the assumption of full employment and free trade. The movement of goods from
one country to another involves transportation costs and storage facilities, but ignores the
interest cost. Classical theory is based on the assumption of trade between two countries and
two products, which realistically involves dimensions of two products or more and involves
multiple countries. It also fails to state that some nations are endowed with similar productive
resources and produce large quantities of the selected goods. These assumptions of the classical
theory may be alright for static economies, but they do not represent the now changing and
growing economies.

Conclusion
The classical theory has helped economists, the government, society, and industries
comprehend international trade in a better way. The mercantilist’s views dominated the
seventeenth and eighteenth centuries. They assumed only two commodities, that is factor and
country. Whereas the new theories that consist of product life theory are based on more
assumptions and also talk about changes in factors. Each nation must focus on the production
of the goods that it manufactures the most. Adam Smith focused on the importance of free
international trade to increase the prosperity of nations. He also states that it is beneficial not
only to nations but also to individuals. Even during the period of economic growth,
international trade has hampered the domestic markets of various countries. The economists
have provided a specific and systematic framework for the issues of international trade. They

Dept. of Management Studies, Vardhaman College of Engineering 6|Page

Dr. S. Venkata Siva Kumar International Business

stated that international trade can be harmful to groups of domestic competitors. They failed to
realise that a few trade policies can be for the benefit of the nation as a whole.

(Source: https://blog.ipleaders.in/classical-theory-of-international-trade/)

Modern or Firm-Based Trade Theories

In contrast to classical, country-based trade theories, the category of modern, firm-based
theories emerged after World War II and was developed in large part by business school
professors, not economists. The firm-based theories evolved with the growth of the
multinational company (MNC). The country-based theories couldn’t adequately address the
expansion of either MNCs or intra industry trade, which refers to trade between two countries
of goods produced in the same industry. For example, Japan exports Toyota vehicles to
Germany and imports Mercedes-Benz automobiles from Germany.

Unlike the country-based theories, firm-based theories incorporate other product and service
factors, including brand and customer loyalty, technology, and quality, into the understanding
of trade flows.

Country Similarity Theory

Swedish economist Steffan Linder developed the country similarity theory in 1961, as he tried
to explain the concept of intraindustry trade. Linder’s theory proposed that consumers in
countries that are in the same or similar stage of development would have similar preferences.
In this firm-based theory, Linder suggested that companies first produce for domestic
consumption. When they explore exporting, the companies often find that markets that look
similar to their domestic one, in terms of customer preferences, offer the most potential for
success. Linder’s country similarity theory then states that most trade in manufactured goods
will be between countries with similar per capita incomes, and intraindustry trade will be
common. This theory is often most useful in understanding trade in goods where brand names
and product reputations are important factors in the buyers’ decision-making and purchasing
processes.

Dept. of Management Studies, Vardhaman College of Engineering 7|Page

Dr. S. Venkata Siva Kumar International Business

Product Life Cycle Theory

Raymond Vernon, a Harvard Business School professor, developed the product life cycle
theory in the 1960s. The theory, originating in the field of marketing, stated that a product life
cycle has three distinct stages: (1) new product, (2) maturing product, and (3) standardized
product. The theory assumed that production of the new product will occur completely in the
home country of its innovation. In the 1960s this was a useful theory to explain the
manufacturing success of the United States. US manufacturing was the globally dominant
producer in many industries after World War II.

It has also been used to describe how the personal computer (PC) went through its product
cycle. The PC was a new product in the 1970s and developed into a mature product during the
1980s and 1990s. Today, the PC is in the standardized product stage, and the majority of
manufacturing and production process is done in low-cost countries in Asia and Mexico.

The product life cycle theory has been less able to explain current trade patterns where
innovation and manufacturing occur around the world. For example, global companies even
conduct research and development in developing markets where highly skilled labor and
facilities are usually cheaper. Even though research and development is typically associated
with the first or new product stage and therefore completed in the home country, these
developing or emerging-market countries, such as India and China, offer both highly skilled
labor and new research facilities at a substantial cost advantage for global firms.

Dept. of Management Studies, Vardhaman College of Engineering 8|Page

Dr. S. Venkata Siva Kumar International Business

New Trade Cycle Theory

The new trade theory of international trade has been stated below.
 The New Trade Theory moves beyond the classical theories by assessing factors like
imperfect competition and economies of scale.
 It argues that international trade occurs due to contrasts in economies of scale and degree of
product differentiation among nations.
 Economies of scale refer to how the average cost of making a good decline as output gains.
This gives large-scale producers a cost advantage.
 Product differentiation refers to how producers make minor distinctions in their products to
make them appeal to specific consumer preferences. This allows them to charge higher
prices.
 According to the theory, nations engage in trade not just based on comparative costs but
also to exploit economies of scale and discern their products.
 When two nations have similar factor endowments, trade can still happen if one nation
specializes in exploiting economies of scale while the other specializes in product
differentiation. Both benefit.
 The theory relaxes some assumptions of classical theories, like perfect competition and
constant returns to scale. It accounts for real-world market structures with monopolistic
competition.

Dept. of Management Studies, Vardhaman College of Engineering 9|Page

Dr. S. Venkata Siva Kumar International Business

Case Study on New Trade Cycle Theory:

Brazilian payment company Ebanx set to start India
operations with Yes Bank
Synopsis
Ebanx helps nearly 300 brands process payments in multiple countries across Latin America
and Africa. It now wants to enter India, which will be its first market in Asia. It will offer
payments infrastructure for global brands looking to sell to Indian consumers, who can use
Ebanx to pay through the local currency and by using local payment methods.

Article:
Brazilian payments major Ebanx has signed a deal with Yes Bank to set up a cross-border
merchant payment infrastructure in India for global brands looking to sell to consumers here.

Indian consumers can use the Ebanx system to pay for such purchases with local currency using
local payment methods including card payment modes including RuPay cards and Unified
Payments Interface (UPI).

“We have partnered with Yes Bank, to enable our platform to provide access to Indian
consumers to global brands who want to sell in India… (and for) digital services and goods
merchants who are looking to expand into the Indian market,” said Paula Bellizia, president,
global payments, at Ebanx.

Ebanx works with around 300 brands, helping them process payments in multiple countries
across Latin America and Africa.

Now, the company wants to add India to the list, as its first market in Asia.

“We are starting with digital services, SaaS (software as a service) companies streaming all the
global brands around those verticals. We are (also) bullish about education platforms looking
to sell these services.”

Dept. of Management Studies, Vardhaman College of Engineering 10 | P a g e

Dr. S. Venkata Siva Kumar International Business

Founded in 2012 in Brazil, Ebanx has raised more than $400 million over three major equity
investments from the likes of Advent International and FTV Capital. After reaching a billion-
dollar valuation in 2019, the company had planned a public listing, but that was eventually
shelved in 2022.

The company entered Africa in September 2022 and announced its India plans in 2023.

Bellizia had told Reuters in 2023 that an IPO could still happen in the United States, but a lot
depended on its business in India.
While the company has not applied for a payment aggregator cross-border (PA-CB) licence
from the Indian central bank right away, Bellizia said she is keeping a close tab on the
regulatory requirements and will follow up on a need to have the licence.

Over the last few months, it has integrated with the systems of Yes Bank to finally launch its
payment stack for Indian consumers. Ebanx processes transactions for large global merchants
like Spotify and Airbnb.

Ebanx intends to replicate its success in Brazilian instant payment platform Pix in India, by
riding on the UPI settlement railroad.

“Ebanx is one of the best players in Pix in Brazil. Because of our highly successful stories in
Brazil, we are hopeful of doing well in India too. Pix is inspired by UPI, we understand how
to operate an alternative payment method,” Bellizia said.

Ebanx joins the group of large global merchant payment processors like PayPal, Stripe, and
PayU to operate in India. While PayU has tasted success in domestic payments in India, PayPal
is restricted to cross-border payments only. Other popular global fintech players like Revolut
and Tide also operate in the Indian market, but with limited success.

Bellizia said unlike other global players, the experience of Ebanx in other developing markets
will help it scale up operations in the Indian market. Currently the company has a small team
in India, which is supporting the local business. The senior leadership at Ebanx is yet to finalise
the staff strength they want in India.

Dept. of Management Studies, Vardhaman College of Engineering 11 | P a g e

Dr. S. Venkata Siva Kumar International Business

Explanation:
The scenario described, where a Brazilian payment company like EBANX expands its
operations into India with the partnership of Yes Bank, aligns closely with the concept of trade
in services and international trade facilitation. While it doesn't fit neatly into a single traditional
international trade theory like the classical theories of Ricardo or the factor proportions theory
of Heckscher-Ohlin, it does resonate with aspects of modern trade theories, particularly those
related to trade in services and the role of technology and innovation in facilitating international
transactions.
If we were to categorize it within a specific theory, it would likely fall under the broader
umbrella of New Trade Theory or New Economic Geography. These modern theories
emphasize factors such as economies of scale, imperfect competition, and technology-driven
advantages in shaping international trade patterns. In this case, EBANX's expansion into India
reflects the increasing significance of trade in services, the role of technology in facilitating
cross-border transactions, and the importance of strategic partnerships in navigating foreign
markets, all of which are central themes in modern trade theories.

Read more at:

https://economictimes.indiatimes.com/tech/technology/brazilian-payment-company-ebanx-set-to-start-india-operations-with-yes-
bank/articleshow/109904230.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Porter’s National Competitive Advantage Theory

In the continuing evolution of international trade theories, Michael Porter of Harvard Business
School developed a new model to explain national competitive advantage in 1990. Porter’s
theory stated that a nation’s competitiveness in an industry depends on the capacity of the
industry to innovate and upgrade. His theory focused on explaining why some nations are more
competitive in certain industries. To explain his theory, Porter identified four determinants that
he linked together. The four determinants are (1) local market resources and capabilities, (2)
local market demand conditions, (3) local suppliers and complementary industries, and (4)
local firm characteristics.

Dept. of Management Studies, Vardhaman College of Engineering 12 | P a g e

Dr. S. Venkata Siva Kumar International Business

1. Local market resources and capabilities (factor conditions). Porter recognized the value
of the factor proportions theory, which considers a nation’s resources (e.g., natural resources
and available labor) as key factors in determining what products a country will import or
export. Porter added to these basic factors a new list of advanced factors, which he defined
as skilled labor, investments in education, technology, and infrastructure. He perceived
these advanced factors as providing a country with a sustainable competitive advantage.
2. Local market demand conditions. Porter believed that a sophisticated home market is
critical to ensuring ongoing innovation, thereby creating a sustainable competitive
advantage. Companies whose domestic markets are sophisticated, trendsetting, and
demanding forces continuous innovation and the development of new products and
technologies. Many sources credit the demanding US consumer with forcing US software
companies to continuously innovate, thus creating a sustainable competitive advantage in
software products and services.
3. Local suppliers and complementary industries. To remain competitive, large global
firms benefit from having strong, efficient supporting and related industries to provide the
inputs required by the industry. Certain industries cluster geographically, which provides
efficiencies and productivity.
4. Local firm characteristics. Local firm characteristics include firm strategy, industry
structure, and industry rivalry. Local strategy affects a firm’s competitiveness. A healthy
level of rivalry between local firms will spur innovation and competitiveness.
In addition to the four determinants of the diamond, Porter also noted that government and
chance play a part in the national competitiveness of industries. Governments can, by their
actions and policies, increase the competitiveness of firms and occasionally entire industries.

Dept. of Management Studies, Vardhaman College of Engineering 13 | P a g e

Dr. S. Venkata Siva Kumar International Business

Porter’s theory, along with the other modern, firm-based theories, offers an interesting
interpretation of international trade trends. Nevertheless, they remain relatively new and
minimally tested theories.

India’s Foreign Trade

India's foreign trade plays a crucial role in the country's economic development, contributing
significantly to its GDP and fostering international economic relationships. India's trade
involves a diverse range of goods and services, with both exports and imports shaping its trade
balance and economic strategies.
Overview of India's Foreign Trade
India's foreign trade has seen substantial growth over the years, with the country becoming a
major player in the global market. The trade policies and agreements pursued by India aim to
enhance its export competitiveness and secure essential imports to support its growing
economy.
Key Export Commodities
India exports a variety of goods across several sectors, including:
1. Textiles and Garments: India is one of the world's leading exporters of textiles and
apparel, known for its cotton, silk, and synthetic fabrics.
2. Petroleum Products: Refined petroleum products constitute a significant portion of
India's exports, driven by its large refining capacity.
3. Pharmaceuticals: India is a major exporter of generic drugs and pharmaceutical
products, recognized globally for its cost-effective and high-quality medicines.
4. Engineering Goods: This category includes machinery, equipment, and vehicles,
reflecting India's growing manufacturing capabilities.
5. Gems and Jewelry: India is a key player in the global market for diamonds, gold, and
other precious stones and metals.
6. Agricultural Products: Major exports include rice, spices, tea, coffee, and marine
products, showcasing India's agricultural diversity.
Key Import Commodities
India imports a wide range of goods to meet its domestic needs and support its industrial base,
including:
1. Crude Oil: As a major energy consumer, India imports significant quantities of crude
oil to fuel its economy.

Dept. of Management Studies, Vardhaman College of Engineering 14 | P a g e

Dr. S. Venkata Siva Kumar International Business

2. Gold and Precious Metals: These are in high demand for both industrial use and as an
investment, driving substantial imports.
3. Electronics and Machinery: India imports advanced electronics, machinery, and
technological equipment to support its growing industrial sector.
4. Chemicals: Both basic and specialty chemicals are imported for use in various
industries, including pharmaceuticals and manufacturing.
5. Edible Oils: To supplement domestic production, India imports large quantities of
edible oils.
Trade Partners
India's trade relationships are diverse, with key partners including:
1. United States: A major destination for Indian exports, particularly in the IT services,
pharmaceuticals, and textiles sectors.
2. China: A significant source of imports, especially in electronics, machinery, and
chemicals.
3. United Arab Emirates: A vital trade partner for both exports (jewelry, textiles) and
imports (crude oil).
4. European Union: Various EU countries are important markets for Indian goods and
sources of advanced technology imports.
5. Southeast Asia: Countries like Singapore and Malaysia are critical for both exports
and imports, fostering regional economic integration.
Trade Policies and Agreements
India has pursued various trade policies and agreements to enhance its global trade footprint.
Key initiatives include:
1. Free Trade Agreements (FTAs): India has signed several FTAs with countries and
regional blocs to reduce tariffs and facilitate smoother trade flows.
2. Export Promotion Schemes: Government schemes like the Merchandise Exports from
India Scheme (MEIS) and the Service Exports from India Scheme (SEIS) incentivize
exports.
3. Make in India: This initiative aims to boost domestic manufacturing and increase
exports by improving the business environment and infrastructure.
Challenges and Opportunities
India's foreign trade faces several challenges, including:
1. Trade Deficit: The country often experiences a trade deficit due to higher imports than
exports, particularly in energy and technology sectors.

Dept. of Management Studies, Vardhaman College of Engineering 15 | P a g e

Dr. S. Venkata Siva Kumar International Business

2. Global Trade Dynamics: Changes in global trade policies, protectionism, and economic
fluctuations can impact India's trade flows.
3. Infrastructure: Improving logistics, transportation, and port infrastructure is crucial for
enhancing trade efficiency.
Despite these challenges, opportunities abound in diversifying export markets, increasing
value-added exports, and leveraging technology to boost trade efficiency. By continuing to
reform its trade policies and infrastructure, India aims to strengthen its position in the global
trade arena and achieve sustainable economic growth.

Foreign Direct Investment in India

Foreign Direct Investment (FDI) plays a pivotal role in India's economic development,
contributing to the country's growth, technology transfer, and job creation. Over the years,
India has emerged as a preferred destination for FDI, attracting significant inflows across
various sectors due to its large market size, favorable demographic profile, and economic
reforms aimed at improving the business environment.

Overview of FDI in India

FDI refers to investments made by a foreign entity directly into the business or production in
another country, typically by acquiring a lasting interest or significant ownership stake. In
India, FDI is regulated by the Ministry of Commerce and Industry, primarily through the
Department for Promotion of Industry and Internal Trade (DPIIT).

Key Sectors Attracting FDI

1. Services Sector: Including finance, banking, insurance, outsourcing, R&D, courier,
technology testing and analysis.
2. Telecommunications: Attracts substantial FDI due to India's large mobile user base and
growing internet penetration.
3. Information Technology (IT) and Software: India is a global IT hub, drawing significant
investments in software development and IT-enabled services.
4. Construction and Real Estate: Infrastructure development and urbanization drive FDI
into housing, commercial real estate, and townships.
5. Automobiles: India's large automotive market attracts investments from global car
manufacturers and component suppliers.

Dept. of Management Studies, Vardhaman College of Engineering 16 | P a g e

Dr. S. Venkata Siva Kumar International Business

6. Pharmaceuticals: Known for its generic drug production, India attracts investments in
pharmaceutical manufacturing and R&D.
7. E-commerce and Retail: Rapid growth in online shopping and retail market liberalization
draw substantial foreign investments.

Major FDI Sources

India receives FDI from a variety of countries, with significant contributions from:
1. Singapore: Leading source of FDI due to its strategic economic relationship with India.
2. United States: Strong economic ties and significant investments across multiple sectors,
especially technology and services.
3. Mauritius: Popular due to favorable tax treaties with India, channeling investments
primarily in financial and insurance activities.
4. Netherlands: Important source of FDI, particularly in the infrastructure and energy
sectors.
5. Japan: Significant investments in automotive, electronics, and infrastructure projects.

Government Initiatives to Promote FDI

1. Make in India: Launched to transform India into a global manufacturing hub by
encouraging both domestic and foreign investment.
2. Startup India: Aimed at fostering innovation and entrepreneurship, attracting FDI into
the startup ecosystem.
3. Ease of Doing Business Reforms: Regulatory reforms to improve business climate,
reduce bureaucratic hurdles, and enhance transparency.
4. Sector-Specific Policies: Liberalization of FDI norms in key sectors like defense,
insurance, and retail to attract more foreign investments.

Benefits of FDI to India

1. Economic Growth: FDI contributes to GDP growth through capital inflows and increased
economic activity.
2. Employment Generation: Creation of jobs in sectors attracting significant FDI, including
manufacturing, services, and technology.
3. Technology Transfer: Inflow of advanced technologies and practices enhances
productivity and innovation in domestic industries.

Dept. of Management Studies, Vardhaman College of Engineering 17 | P a g e

Dr. S. Venkata Siva Kumar International Business

4. Infrastructure Development: Investments in infrastructure projects, including

transportation, power, and urban development, improve overall economic efficiency.
5. Global Integration: FDI facilitates integration into the global economy, enhancing trade
and investment linkages.

Challenges and Considerations

1. Regulatory Hurdles: Despite improvements, bureaucratic red tape and complex
regulations can still pose challenges for foreign investors.
2. Infrastructure Bottlenecks: Inadequate infrastructure in certain regions can hinder the
smooth operation and profitability of FDI projects.
3. Political and Economic Stability: Consistent policies and stable economic conditions are
crucial for maintaining investor confidence.
4. Intellectual Property Rights (IPR): Protection of IPR remains a concern for technology-
intensive investments.

Future Outlook for FDI in India

The future of FDI in India looks promising, with ongoing reforms aimed at enhancing the
investment climate. Initiatives like the National Infrastructure Pipeline (NIP) and Production
Linked Incentive (PLI) schemes are expected to attract substantial foreign investments.
Continued focus on improving ease of doing business, upgrading infrastructure, and
maintaining stable economic policies will be key to sustaining and increasing FDI inflows. FDI
is a cornerstone of India's economic strategy, driving growth, innovation, and job creation. By
fostering a conducive environment for foreign investors, India aims to further solidify its
position as a leading global investment destination.

Dept. of Management Studies, Vardhaman College of Engineering 18 | P a g e

Dr. S. Venkata Siva Kumar International Business

Balance of Payments
The Balance of Payments (BoP) is a comprehensive record of a country's economic transactions
with the rest of the world over a specific period, typically a year. It includes all transactions
between residents of a country and non-residents, covering goods, services, income, and
financial flows. The BoP is crucial for understanding a country's economic position,
influencing its exchange rates, foreign exchange reserves, and overall economic policy.
In simple terms, the Balance of payment is a statement that summarizes all the economic
transactions between a country and the rest of the world for a given period. It provides
insights into a country's economic health and international economic position.

Components of the Balance of Payments

The BoP is divided into three main accounts:
1. Current Account Balance
2. Capital Account Balance
3. Financial Account Balance
1. Current Account
The current account records the flow of goods, services, income, and current transfers in and
out of a country. It is further subdivided into:
 Trade Balance: The difference between the value of a country’s exports and imports
of goods. A trade surplus occurs when exports exceed imports, while a trade deficit
occurs when imports exceed exports.
 Services Balance: The balance of trade in services such as banking, insurance, tourism,
and consulting.
 Income Balance: Earnings from investments and wages. This includes income from
foreign investments (interest, dividends, etc.) and compensation to employees.
 Current Transfers: Transfers of money where no goods or services are exchanged,
such as foreign aid, remittances, and gifts.

2. Capital Account
The capital account records capital transfers and the acquisition or disposal of non-produced,
non-financial assets. It includes:
 Capital Transfers: Transfers involving the ownership of fixed assets or the forgiveness
of debts.

Dept. of Management Studies, Vardhaman College of Engineering 19 | P a g e

Dr. S. Venkata Siva Kumar International Business

 Non-produced, Non-financial Assets: Transactions involving natural resources,

patents, copyrights, and trademarks.

3. Financial Account
The financial account records transactions that involve financial assets and liabilities, and it
includes:
 Direct Investment: Investments where a resident in one country has control or
significant influence over a business in another country, typically involving ownership
of 10% or more of the voting stock.
 Portfolio Investment: Investments in equity and debt securities that do not provide
significant control over the enterprise.
 Other Investments: Loans, currency, deposits, and trade credits.
 Reserve Assets: Foreign currency reserves and other assets held by a country’s central
bank to manage the balance of payments and influence exchange rates.

Importance of the Balance of Payments

The BoP is a critical indicator of a country’s economic health and helps in:
 Economic Policy Making: Governments use BoP data to formulate economic policies,
manage exchange rates, and address economic imbalances.
 Exchange Rate Determination: The BoP affects currency demand and supply,
influencing exchange rates.
 Foreign Investment Decisions: Investors analyze the BoP to assess the stability and
attractiveness of a country for investment.
 International Relations: BoP data influences economic relations and trade agreements
between countries.

Balancing the BoP

The BoP should theoretically balance, as every transaction has a corresponding counter-
transaction. For example, an export (credit) should have a matching payment (debit). However,
in practice, discrepancies can arise due to timing differences, statistical errors, and unrecorded
transactions. The overall balance is achieved through adjustments in reserve assets or financial
account transactions.

Dept. of Management Studies, Vardhaman College of Engineering 20 | P a g e

Dr. S. Venkata Siva Kumar International Business

Deficits and Surpluses

 Current Account Deficit: Indicates that a country is importing more goods, services,
and capital than it is exporting, often financed by borrowing or drawing down reserves.
 Current Account Surplus: Indicates that a country is exporting more than it is
importing, leading to an accumulation of foreign assets or reduction in liabilities.
 BOP Surplus: A country's receipts exceed payments
 BOP Deficit: A country's payments exceed receipts

BOP Equation: CAB + KAB + FAB = 0

Current Account Balance + Capital Account Balance

+ Financial Account Balance

Factors Affecting Balance of Payment

Exchange Rate
Exchange rate plays a significant role in balance of payment. A country with an overvalued
currency will have a trade deficit, while a country with an undervalued currency will have a
surplus.
1. Terms of Trade - The ratio of export prices to import prices affects the trade surplus
or deficit of a country.
2. Income Level - Higher income leads to higher demand for imported goods. Thus,
countries with higher income tend to have a trade deficit.

Examples and Implications

1. Persistent Deficits: Can lead to increased foreign debt, depreciation of the domestic
currency, and potential economic instability.
2. Persistent Surpluses: Can lead to appreciation of the domestic currency, impacting
export competitiveness but increasing foreign reserves.

Dept. of Management Studies, Vardhaman College of Engineering 21 | P a g e