India’s Foreign Trade

Trade is one of the powerful forces of economic integration. The term ‘trade’ means
exchange of goods, wares or merchandise among people. Trade is of two types.
They are:
1. Internal Trade and
2. International Trade.
Sl.No Internal Trade International Trade
1. Trade takes place between different
individuals and firms within the
same nation.
Trade takes place between different
individuals and firms in different
2. Labour and capital move freely from
one region to another.
Labour and capital do not move easily
from one nation to another.
3. There will be free flow of goods and
services since there are no
Goods and services do not easily
move from one country to another
since there are a number of
restrictions like tariff and quota.
4. There is only one common currency. There are different currencies.
5. The physical and geographical
conditions of a country are more or
less similar.
There are differences in physical and
geographical conditions of the two
6. Trade and financial regulations are
more or less the same.
Trade and financial regulations such
as interest rate, trade laws differ
between countries.
7. There is no difference in political
affiliations, customs and habits of
the people and government policies.
Differences are pronounced in
political affiliations, habits and
customs of the people and
government policies.
Balance of Trade (BOT)
Balance of Trade (BOT) refers to the total value of a country’s exports of commodities
and total value of imports of commodities. Only export and import of commodities are

included in the statement of Balance of Trade of a country. Movements of goods
(export and imports of commodities) are also known as ‘visible trade’, because the
movement of commodities between countries can be seen by eyes and felt by hands and
can be verified physically by custom authorities of a country.
Trade balance =export-import
Favourable BOT
When the total value of commodity exports of a country exceeds the total value of
commodity imports of that country, it is said that the country has a ‘favourable’ balance
of trade.
Unfavourable BOT
If total value of commodity exports of a country is less than the total value of
commodity imports of that country, that country is said to have an ‘unfavourable’
balance of trade.
BoP is a systematic record of a country’s economic and financial transactions with the
rest of the world over a period of time.
The principal items shown on the credit side are exports of goods and services, transfer
receipts in the form of gift etc., from foreigners, borrowing from abroad, foreign direct
investment and official sale of reserve When a payment is received from a foreign
country, it is a credit transaction assets including gold to foreign countries and
international agencies.
The principal items on the debit side include imports of goods and services, transfer
payments to foreigners, lending to foreign countries, investments by residents in
foreign countries and official purchase of reserve assets or gold from foreign countries
and international agencies.
Balance of Payment (BOP) Account Chart
Credit (Receipts) – Debit (Payments) = Balance [Deficit (-) , Surplus (+)] Deficit
if Debit > Credit

Components of BOPs The credit and debit items are shown vertically in the BOP
account of a country. Horizontally, they are divided into three categories,
1. The current account,
2. The capital account and
3. The official settlements account or official reserve assets account.
1. The Current Account:
It includes all international trade transactions of goods and services, international
service transactions (i.e. tourism, transportation and royalty fees) and international
unilateral transfers (i.e. gifts and foreign aid). Single time and one-way transaction. It
means transaction either receipt or payment happens once and the transaction ends.
The receipts against export of merchandise goods to other countries. The export of
receipts of service are not included.
The payment for import of merchandise goods from other countries. The payment for
import of services are not included.
Trade Balance
Difference between export receipts and import payments.
Net Invisible
The head of invisibles record the receipt and payment regarding services exports and
imports and other current account payments.
A. Non factor services
B. Income
C. Private transfer.
2. The Capital Account:
Financial transactions consisting of direct investment and purchases of interestbearing financial instruments, non- interest-bearing demand deposits and gold fall
under the capital account. It is two way or multiple way transactions. The paid money
can be recovered through periodical income and/or by disposal of asset created. There
is no deficit or surplus in the capital account.

1. External assistance
External assistance means transactions of official bilateral and multilateral loans
like WB & IMF.
2. External commercial borrowing (ECB)
ECB refer to commercial loans in the form of bank loans, buyers credit, suppliers
credit, securitised instruments availed of from nonresident lenders with a
minimum average maturity of 3 years. ECB can be raised only for specific
purposes such as the import of capital goods, implementation of new projects etc.
This restriction is called end use restriction.
3. short term Debt:
Short term debt are trade credits for a maturity of less than three years.
4. Banking capital
1. Foreign asset commercial banks including rupee overdraft of non resident
banks, foreign currency holdings.
2. Foreign liabilities of commercial banks include NRI Deposits, liabilities other
than NRI.
3. Others banks and international institution like IRDA, IDA, ADB etc.
5. Non resident deposit
1. Non resident external rupee account (NR(E)RA)
The deposits held Indian rupee. Term deposit maturity one year to three years
as well as saving deposit are allowed under this scheme.
2. Non resident ordinary rupee account
The account held by Indians ordinarily living in can open current,
savings, recurring accounts.
CAPITAL ACCOUNT BALANCE TOTAL (net)=external assistance + external
commercial borrowing+non resident deposit +foreign investment+ other flows.
3. The Official Reserve Assets Account:
Official reserve transactions consist of movements of international reserves by
governments and official agencies to accommodate imbalances arising from the current
and capital accounts. The official reserve assets of a country include its gold stock,
holdings of its convertible foreign currencies and Special Drawing Rights (SDRs) and
its net position in the International Monetary Fund (IMF).

BOP Crisis in 1991
India had started facing the Balance of Payments (BoP) issue by the year 1985. The
country was trapped in a serious economic crisis towards the end of 1990. The central
bank i.e the Reserve Bank of India (RBI) had denied to issue new credit. The reserves
of foreign exchange had diminished to a point where it could not finance more than 3
weeks of import. This situation led to the government airlifting the gold reserves of the
nation to the International Monetary Fund (IMF) as a pledge in return for a loan which
could be utilised to pay off the BoP debts.
The Government of India, Ministry of Commerce and Industry announced New
Foreign Trade Policy on 1
st April 2015 for the period of 2015-2020.
Salient Features of “EXIM POLICY (2015-2020)”
The new EXIM policy has been formulated focusing on increasing in exports scenario,
boosting production and supporting the concepts like Make in India and Digital India.
1. Reduce export obligations by 25% and give boost to domestic manufacturing
supporting the “Make in India” concept.
2. As a step to Digital India concept, online procedure to upload digitally signed
document by CA/CS/Cost Accountant are developed and further mobile app for
filing tax, stamp duty has been developed.
3. Repeated submission of physical copies of documents available on Exporter
Importer Profile is not required.
4. Export obligation period for export items related to defence, military store,
aerospace and nuclear energy to be 24 months.
5. EXIM Policy 2015-2020 is expected to double the share of India in World Trade
from present level of 3% by the year 2020.
6. India to be made a significant participant in world trade by 2020
7. Merchandize exports from India (MEIS) to promote specific services for specific
Markets Foreign Trade Policy
8. FTP would reduce export obligations by 25% and give boost to domestic
9. Duty credit scrips to be freely transferable and usable for payment of customs
duty, excise duty and service tax.

10. Debits against scrips would be eligible for CENVAT credit or drawback also.
11. Nomenclature of Export House, Star Export House, Trading House, Premier
Trading House certificate changed to 1,2,3,4,5 Star Export House.
12. Online procedure to upload digitally signed document by Chartered
Accountant/Company Secretary/Cost Accountant to be developed.
13. Inter-ministerial consultations to be held online for issue of various licences.
14. No need to repeatedly submit physical copies of documents available on
Exporter Importer Profile.
15. Validity period of SCOMET export authorisation extended from present 12
months to 24 months.
FOREX is the system or process of converting one national currency into another, and
of transferring money from one country to another. It covers methods of payment,
rules and regulations of payment and the institutions facilitating such payments.
Exchange rate of currency determined by the economy.
External Debt
As India started managing its balance of payment in a more prudent way after the
reform period, its external debt position has also improved in a big way. International
comparison of external debt situation based on World Bank data shows that among the
top 20 developing debtor countries in 2016, India’s external debt stock to Gross
National Income (GNI) ratio at 20.4 percent was the second lowest after China’s 12.8
per cent. In terms of the foreign exchange reserves cover to external debt, India’s
position is the fifth highest and India’s debt service rate is the eight lowest. As per the
World Bank data, though India is the third largest debtor country among developing
countries (after China and Brazil), India’s share of short-term debt to total debt is only
18.6 per cent (by end-June, 2017) compared to 60.1 per cent for China (end-June,
Fixed currency regime
Fixed exchange rate is a type of exchange rate regime where the value of a currency
is fixed against either the value of another currency or to another measure of value,
such as gold. The objective of a fixed exchange rate is to maintain the value of a

country’s currency within an intended limit. Fixed exchange rate is also referred to as
a ‘pegged exchange rate’.
Floating currency regime
Also referred to as ‘fluctuating exchange rate’, floating exchange rate is a type
of exchange rate regime in which a currency’s value is allowed to fluctuate in response
to foreign exchange market mechanism i.e. by the demand and supply for the
respective currency.
Managed exchange rates
A managed-exchange-rate system is a hybrid or mixture of the fixed and flexible
exchange rate systems in which the government of the economy attempts to affect the
exchange rate directly by buying or selling foreign currencies or indirectly, through
monetary policy (i.e., by lowering or raising interest rates on foreign currency bank
accounts, affecting foreign investment, etc.).
In foreign exchange market, it is a situation when domestic currency loses its value in
front of a foreign currency if it is market-driven. It means depreciation in a currency
can only take place if the economy follows the floating exchange rate system.
In foreign exchange market, if a free-floating domestic currency increases its value
against the value of a foreign currency, it is appreciation. In domestic economy, if a
fixed asset has seen increase in its value it is also known as appreciation.
In the foreign exchange market when exchange rate of a domestic currency is cut down
by its government against any foreign currency, it is called devaluation. It means
official depreciation is devaluation.
A term used in foreign exchange market which means a government increasing the
exchange rate of its currency against any foreign currency. It is official appreciation.

An economy might allow its currency full or partial convertibility in the current and the
capital accounts. If domestic currency is allowed to convert into foreign currency for all
current account purposes, it is a case of full current account convertibility. Similarly, in
cases of capital outflow, if the domestic currency is allowed to convert into foreign
currency, it is a case of full capital account convertibility. If the situation is of partial
convertibility, then the portion allowed by the government can be converted into
foreign currency for current and capital purposes. It should always be kept in mind that
the issue of currency convertibility is concerned with foreign currency outflow only.
Convertibility in India
India’s foreign exchange earning capacity was always poor and hence it had all possible
provisions to check the foreign exchange outflow, be it for current purposes or capital
purposes, Remember the draconian FERA. But the process of economic reforms has
changed the situation to unidentifiable levels.
Current Account
1. Current account is today fully convertible operationalised on 19 August, 1994. It
means that the full amount of the foreign exchange required by someone for
current purposes will be made available to him at official exchange rate and
there could be an unprohibited outflow of foreign exchange.
2. India was obliged to do so as per Article VIII of the IMF which prohibits any
exchange restrictions on current international transactions.
Capital Account
After the recommendations of the S.S. Tarapore Committee (1997) on Capital Account
Convertibility, India has been moving in the direction of allowing full convertibility in
this account, but with required precautions. India is still a country of partial
convertibility (40:60) in the capital account, but inside this overall policy, enough
reforms have been made and to certain levels of foreign exchange requirements, it is an
economy allowing full capital account

1. Indian corporate is allowed full convertibility in the automatic route upto $ 500
million overseas ventures (investment by Ltd. companies in foreign countries
allowed) per annum.
2. Indian corporate is allowed to prepay their external commercial borrowings
(ECBs) via automatic route if the loan is above $ 500 million per annum.
3. Individuals are allowed to invest in foreign assets, shares, etc., upto the level of $
2,50,000 per annum.
4. Unlimited amount of gold is allowed to be imported (this is equal to allowing full
convertibility in capital account via current account route, but not feasible for
everybody) which is not allowed now.
The Second Committee on the Capital Account Convertibility (CAC)—again chaired by
S.S.Tarapore—handed over its report in September 2006 on which the RBI/the
government is having consultations.
India announced the Liberalised Exchange Rate Mechanism System (LERMS) in the
Union Budget 1992–93 and in March 1993 it was operationalised. India delinked its
currency from the fixed currency system and moved into the era of floating exchangerate system under it. Indian form of exchange rate is known as the ‘dual exchange rate’,
one exchange rate of rupee is official and the other is market-driven. The marketdriven exchange rate shows the actual tendencies of the foreign currency demand and
supply in the economy vis-á-vis the domestic currency. It is the market-driven
exchange rate which affects the official rate and not the other way round.
The Nominal Effective Exchange Rate (NEER) of the rupee is a weighted average of
exchange rates before the currencies of India’s major trading partners.
When the weight of inflation is adjusted with the NEER, we get the Real Effective
Exchange Rate (REER) of the rupee. Since inflation has been on the higher side in
recent months, the REER of the rupee has been more against it than the NEER

The Extended fund Facility (EFF) is a service provided by the IMF to its member
countries which authorises them to raise any amount of foreign exchange from it to
fulfil their BoP crisis. It is the first agreement of its kind. India had signed this
agreement with the IMF in the financial year 1981–82.
The BoP crisis of the early 1990s made India borrow from the IMF which came on
some conditions. The medium-term loan to India was given for the restructuring of the
economy on the following conditions:
1. Devaluation of rupee by 22 per cent done in two consecutive fortnights—rupee
fell from ‘21 to ‘27 against every US Dollar.
2. Drastic custom cut to a peak duty of 30 per cent from the erstwhile level of 130
per cent for all goods.
3. Excise duty to be increased by 20 per cent to neutralise the loss of revenue due to
custom cut.
4. Government expenditure to be cut by 10 per cent per annum (the burden of
salaries, pensions, subsidies, etc.).
The above-given conditions to which India was obliged were vehemently opposed by
the Indian corporate sector, opposition in the Parliament and majority of Indians. But
by the end of 1999–2000, when India saw every logic in strengthening its BoP position
there was no ideological opposition to the idea. It should always be kept in mind that
the nature of structural reforms India went through were guided and decided by these
preconditions of the IMF. This is how the direction of structural reforms of an economy
are regulated by the IMF in the process of strengthening the BoP position of the crisisdriven economy. The purpose has been served in the Indian case. India has not only
fulfilled these conditions but it has also moved ahead.
Hard Currency
It is the international currency in which the highest faith is shown and is needed by
every economy. The strongest currency of the world is one which has a high level of
liquidity with the highest as well as highly diversified exports that are compulsive
imports for other countries as of high-level technology, defence products, life saving

medicines and petroleum products will also create high demand for its currency in the
world and become the hard currency. It is always scarce.
Soft Currency
A term used in the foreign exchange market which denotes the currency that is easily
available in any economy in its forex market. For example, rupee is a soft currency in
the Indian forex market. It is basically the opposite term for the hard currency.
Hot Currency
Hot currency is a term of the forex market and is a temporary name for any hard
currency. Due to certain reasons, if a hard currency is exiting an economy at a fast pace
for the time, the hard currency is known to be hot. As in the case of the SE Asian crisis,
the US dollar had become hot.
Heated Currency
A term used in the forex market to denote the domestic currency which is under
enough pressure of depreciation due to a hard currency’s high tendency of exiting the
economy. It is also known as currency under heat or under hammering.
Cheap Currency
If a government starts re-purchasing its bonds before their maturities (at full-maturity
prices) the money which flows into the economy is known as the cheap currency, also
called cheap money. In the banking industry, it means a period of comparatively
lower/softer interest rates regime.
Dear Currency
This term was opposite to the cheap currency. When a government issues bonds, the
money which flows from the public to the government or the money in the economy in
general is called dear currency, also called as dear money. In the banking industry, it
means a period of comparatively higher/costlier interest rates regime.
FDI is an important factor in global economy. FDI in the natural resource sector,
including plantations, increases trade volume. Foreign production by FDI is useful to
substitute foreign trade. FDI is also influenced by the income generated from the trade

and regional integration schemes. FDI is helpful to accelerate the economic growth by
facilitating essential imports needed for carrying out development programmes like
capital goods, technical know-how, raw materials and other inputs and even scarce
consumer goods. FDI means an investment in a foreign country that involves some
degree of control and participation in management. It corresponds to the investment
made by a multinational enterprise in a foreign country. It is different from portfolio
investment, which is primarily motivated by short term profit and it does not seek
management control.
Objectives of FDI
FDI has the following objectives.
1. Sales Expansion
2. Acquisition of resources
3. Diversification
4. Minimization of competitive risk.
Foreign Portfolio Investment (FPI) means the entry of funds into a nation where
foreigners deposit money in a nation’s bank or make purchase in the stock and bond
markets, sometimes for speculation. FPI is part of capital account of BoP.
Foreign Institutional Investment (FII) is an investment in hedge funds,
insurance companies, pension funds and mutual funds. Foreign institutional
investment is a common term in the financial sector of India. For example, a mutual
fund in the United States can make investment in an India-based company.
Advantages of FDI
Foreign investment mostly takes the form of direct investment. Hence, we deal here
with the foreign direct investment. The important advantages of foreign direct
investment are the following:
1. FDI may help to increase the investment level and thereby the income and
employment in the host country.
2. Direct foreign investment may facilitate transfer of technology to the recipient

3. FDI may also bring revenue to the government of host country when its taxes
profits of foreign firms or gets royalties from concession agreements.
4. A part of profit from direct foreign investment may be ploughed back into the
expansion, modernization or development of related industries.
5. It may kindle a managerial revolution in the recipient country through
professional management and sophisticated management techniques.
6. Foreign capital may enable the country to increase its exports and reduce import
requirements. And thereby ease BoP disequilibrium.
7. Foreign investment may also help increase competition and break domestic
8. If FDI adds more value to output in the recipient country than the return on
capital from foreign investment, then the social returns are greater than the
private returns on foreign investment.
Disadvantages of FDI
The following criticisms are leveled against foreign direct investment.
1. Private foreign capital tends to flow to the high profit areas rather than to the
priority sectors.
2. The technologies brought in by the foreign investor may not be appropriate to
the consumption needs, size of the domestic market, resource availabilities,
stage of development of the economy, etc.
3. Foreign investment, sometimes, have unfavorable effect on the Balance of
Payments of a country because when the drain of foreign exchange by way of
royalty, dividend, etc. is more than the investment made by the foreign concerns.
4. Foreign capital sometimes interferes in the national politics.
5. Foreign investors sometimes engage in unfair and unethical trade practices.
6. Foreign investment in some cases leads to the destruction or weakening of small
and medium enterprises.
7. Sometimes foreign investment can result in the dangerous situation of
minimizing / eliminating competition and the creation of monopolies or
oligopolistic structures.
8. Often, there are several costs associated with encouraging foreign investment.

FDI in India
The early 1991 witnessed reforms in the economic policy. This helped to open up
Indian markets to FDI. FDI in India has increased over the years. In India, FDI has
been advantageous in terms of free flow of capital, improved technology, management
expertise and access to international markets.
The major sectors benefited from FDI in India are:
1. Financial sector (banking and non-banking)
2. Insurance
3. Telecommunication
4. Hospitality and tourism
5. Pharmaceuticals
6. Software and information technology.
FDI is not permitted in the industrial sectors like
1. Arms and ammunition
2. atomic energy
3. railways
4. coal and lignite
5. mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper
FDI inflow in India has increased from $97 million in 1990-91 to $5,535 million in
2004-2005. It amounted to $32,955 million in 2011-2012. UNCTAD’s World
Investment Report 2018 reveals that FDI to India declined to $40 billion in 2017 from
$44 billion in 2016.The FDI replaces Mauritius with Singapore.
Globalization is the integration of a country with the world economy. Basically,
globalization signifies a process of internationalization plus liberalization.
Globalization in India
In India the period after 1980-81 was marked by severe balance of payment difficulties
mainly due to
1. Hike in oil price and Gulf war in 1990-91 and hostilities in West Asia.
2. Sharp decline of private remittances

3. inflation peaking at 17%
4. the gross fiscal deficit of central government reaching 8.4% of the GDP.
When the new government took over in June 1991. India had unprecedented balance of
payment crisis. The finances of the central, and state Government had reached a
situation of near bankruptcy. With the downgrading of India’s credit rating by some
international agencies, there was heavy flight of capital out of India. Since India lost its
credit worthiness in the international market, the government mortgaged 40 tons of
gold to the Bank of England. Under these circumstances, the government for 1991-92
presented its budget in July 1991 with a series of policy changes which underlined
globalization, liberalization and privatization. This has come to be called as India’s new
economic policy. This polices were strengthened when India signed the Dunkel Draft in
Reforms made to adopt Globalization:-
(New Economic policy in India)
1. Abolition of Industrial licensing, except for a few industries.
2. Reduction in the number of industries reserved for public sector.
3. Fixation of a realistic exchange rate of rupee to exchange exports of Indian
4. Foreign private sector by making rupee convertible on trade, on current account
and by reducing import duties.
5. Foreign exchanges regulations were suitably amended
6. The Statutory Liquidity Ratio (SLR) was reduced to increase lending by RBI.
Multi National Corporation (MNC)
Multi National Corporation is a Corporate organization which owns or controls
production of goods or services in at least one country other than its home country.
Otherwise called Multinational Corporations (MNCs) or Transnational Corporation
(TNC) or Multinational Enterprise (MNE).
Evolution of MNC
Like, the East India Company, which came to India as a trading company and then its
net throughout the country to become politically dominant, these multinationals first
start their activities in extractive industries or control raw materials in the host
countries during 1920s and then slowly entered. The manufacturing and service sectors

after 1950s. Most of the MNC’s at present belong to the four major exporting countries
viz., USA, UK, France, Germany. However, the largest is American. 11 of the 15 largest
multinationals are American.
Growth of MNCs in India
A common form of MNC Participation in Indian industry is through entering into
cooperation with Indian industrialist. Trends of liberalization in the 1980s gave a
substantial spurt to foreign collaborations. This would be clear from the fact that of the
total 12,760 foreign collaboration agreements in 40 years between 1948-1988. As a
result of liberalized foreign investment policy (FIP) announced in July-Aug 1991 there
has a further spurt of foreign collaborations and increase flow of foreign direct
Reasons for the growth MNC
1. Expansion of Market territory:
As the operations of large sized firm expand, it seeks more and more extension of it
activates beyond the physical boundaries of the country in which it is in corporate.
2. Marketing superiorities:
A multinational firm enjoys a number of marketing superiorities over the national
firms. It enjoys market reputation and faces less difficulty in selling its products it
adopts more effective advertising and sales promotion techniques.
3. Financial Superiorities
It has financial resources and a h high level of funds utilization. It has easier access of
external capital markets. Because of its international reputation it is able to raise more
international resources.
4. Technological superiorities:
The main reason why MNCs have been encouraged by the underdeveloped countries to
participate in their industrial development is on account of the technological
superiorities which these firms possess as compared to national companies.
5. Product innovations:
MNCs have research and development engaged in the task of developing new products
and superior designs of existing products.

Advantages of MNC
1. Producing the same quality of goods at lower cost and without transaction cost.
2. MNC reduce prices and increase the Purchasing power of consumers worldwide.
3. A MNCs is able to take advantage of tax variation.
4. Spurring job growth in the local economies
Disadvantages of MNC
1. They are a way for the corporations to develop a monopoly (for certain products)
2. They are also a detrimental effect on the environment.
3. The introduction of MNC in to a host country’s economy may also lead to the
downfall of smaller, local business.
4. MNC breach ethical standards, accusing them of evading ethical laws and
leveraging their business agenda with capital.
Top 10 Largest Multinational
Companies in India 2018
1. Sony Corporation
2. Hewlett Packard (HP)
3. Tata Group
4. Microsoft Corporation
5. IBM
6. Nettle
7. Procter & Gamble
8. City Group
9. Pepsi Company
10. The Coca-Cola Company
Impact and Challenges of Globalization
Positive Impact
1. A better economy introduces rapid development of the capital market.
2. Standard of living has increased.
3. Globalization rapidly increase better trade so that more people are employed.
4. Introduced new technologies and new scientific research patterns.
5. Globalization increasing the GDP of a country.

6. It helps to increase in free flow of goods and also to increase Foreign Direct
Negative Impact
1. Too much flow of capital amongst countries, Introduces unfair and immoral
distributors of Income.
2. Another fear is losing national integrity. Because of too much exchange of trade,
independent domestic policies are lost.
3. Rapid growth of the economy has required a major infrastructure and resource
extraction. This increase negative ecological and Social costs.
4. Rapid increases in exploitation of natural resources to earn foreign exchange.
5. Environmental standards and regulations have been relaxed.
Challenges of Globalization
1. The benefits of globalization extend to all countries that will not happen
2. The fear that globalization leads to instability in the developing world.
3. The industrial world that increased global competition will lead in race to the
bottom in wages, labour right, and employment practice.
4. It leads to global imbalance.
5. Globalization has resulted with the embarrassment.
6. Globalization has led to an increase in activities such as child labour and slavery.
7. People started consuming more junk food. This caused, the degradation of
health and spread of diseases.
8. Globalization has led to environmental degradation.
It was “Lehman Weekend”. The moment in September 2008 when the 150-year-old
investment bank Lehman Brothers collapsed, precipitating the worst global economic
crisis since the 1930s.The East Asian crisis of 1997 caused a rethink on full capital
account convertibility and fixed exchange rates. The Internet bubble and bust of the
early 2000s led many to question the impact of new technology on long-term

productivity growth. The scandals in the corporate world through the 2000s in the U.S.
provided grist for a fresh debate on corporate governance. The crisis, which peaked
in early September 2008.
Causes for Global Financial Crisis:
The financial crisis was caused by a number of factors. The crisis was caused by banks
being incentivized by deregulation to make risky home loans, which were
then repackaged as overvalued and overrated assets, which were then speculated on by
banks and investors causing “a speculative bubble”. From 2005 to 2007, at the height
of the real estate bubble, when mortgages were given to many home buyers who could
not afford them, and then packaged into securities and sold off.
This failure manifested itself in several ways:
1. Banks were allowed extraordinarily high levels of debt in relation to equity capital.
2. Banks in the advanced economies moved away from the business of making loans
to investing their funds instead in complex assets called “securitised” assets. The
securitised assets consisted of bundles of securities derived from sub-prime loans,
that is, housing loans of relatively higher risk.
As housing prices started falling and the securitised assets lost value, it translated
into enormous losses for banks. Payment defaults triggered massive declines in banks
and real-estate incomes. Lehman Brothers declared bankruptcy in 2008.
What triggered the crisis?
1. The success was followed by an excess supply and ballooning prices of the
underlying properties in the subsequent years.
2. The real estate market begins to cool down and the house prices begin to fall.
3. This made the subprime borrowers unable to pay their existing debt and they
stuck up paying a much larger mortgage payment.
4. This causes many of these borrowers unable to make their house payment.
5. Also, financial institutions no longer want to invest and didn’t trust the bank
6. As a result, the banks further increased the mortgage interest rate so that
borrowers who afford to pay can pay more.

7. But the conditions got worse with more and more borrowers failed to pay their
monthly loan payment due to the interest rate increases.
8. A credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge
funds while payment defaults triggered massive declines in banks and real estate
incomes. In 2008, Lehman Brothers declared bankruptcy.
What is a Sub-Prime Loan?
Sub-prime refers to a loan given to a borrower, who does not qualify for a regular home
loan because of a poor credit record, low income and lack of job security. The banks
gave the loans with the expectation that the value of the underlying security or
property will go up. They increased the mortgage interest rate, higher than the
conventional loan and called it a sub-prime mortgage. They could earn more with the
higher mortgage interest rate and if the borrowers discontinued repayment, they
could sell the property for a higher consideration due to appreciation in the property
What were its objective?
1. Banks did this on the expectation that the value of the underlying security or the
property will go up in future.
2. So, they increased the mortgage interest rate, higher than the conventional loan,
so that they could earn more with it.
3. On their part, Borrowers can rent out their house with higher value or they can
sell the house with higher value.
4. Paying back the loan payment is not a problem at all for them, since the housing
prices were booming at that time.
5. The borrowers also got their loans refinanced with the improvements in their
credit ratings.
6. Even if they discontinued repayment, Banks could sell the property for a higher
consideration due to appreciation in property prices.
7. The banks also repackaged all mortgages into an investment product and sell it
to financial institutions all over the world to further reduce the risks and to get
more loans.

8. This made global financial investors around the world to get involved in the
subprime mortgage.
9. With housing demand exceeding supply, the cycle became beneficial for all the
three stakeholders from 2005 to 2007 (Banks, borrowers and financial
What were the impacts on Indian economy?
1. With lower dependence on exports and a sizeable contribution of its GDP came
from domestic sources, India faced a less severe impact.
2. Indian banks had limited exposure to the U.S. mortgage market as also to the
financially-stressed global financial institutions.
3. Still, India’s fiscal deficit touched 6% of the GDP in 2008-09, from being just
2.7% in the previous year.
4. The fiscal stimulus provided under the backdrop of the crisis was never
withdrawn after that, leading to the rise in twin deficits (FD and CAD).
Growth has slowed down to 7% but that is in line with the trend rate over the past two
decades. India has not embraced full capital account convertibility. It has kept shortterm foreign borrowings within stringent limits. India did not open up to foreign banks
despite pressure from the U.S. and the international agencies.
India faced at least three major crisis-like situations since –
1. A ballooning current account deficit in 2013
2. The non-performing assets that have choked the banking system
3. The rupee slide triggered again by concerns of rising current account deficit
4. Also, Financial Stability and Development Council (FSDC) set up to settle
disputes among regulators are also in need of an independent research team
drawing from global experiences.
5. That would provide for an inter-regulatory coordination and macro-prudential
supervision of the economy so that a sub-prime like crisis in the country could be
avoided in the future.
However, external debt for India is a cause for worry:
1. External debt is the money that borrowers in a country owe to foreign lenders.
2. India’s external debt was $513.4 billion at the end of December 2017, an increase
of 8.8% since March 2017. Most of it was owed by private businesses which

borrowed at attractive rates from foreign lenders. To be precise, 78.8% of the
total external debt ($404.5 billion) was owed by non-governmental entities
like private companies. Most of India’s external debt is linked to the dollar. This
means Indian borrowers will have to pay back their lenders by first converting
their rupees into dollars. As of December 2017, about 48% of India’s total
external debt was denominated in dollars and 37.3% in rupees.
1. Explain salient features of EXIM Policy 2015-2020 briefly.
2. Write about FDI and its Advantages and Disadvantages.
3. What is globalization? Explain the challenges associated with globalisation.
4. What is subprime loan? Give impact of global economic crisis in India.

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