Unit 1: Business Environment and International Business mind map

What surrounds a firm: its features, the micro and macro forces, PESTLE, economic and political systems, and India's post-1991 policy.

Nature of the business environment

Meaning and features of the business environment

The business environment is the sum of all forces outside and inside a firm that affect how it runs.

• It is complex, because many forces act together.
• It is dynamic, because it keeps changing.
• It is multi-faceted and uncertain, so firms must scan it.
• It is never static.

A firm does not work in a vacuum. Customers change their taste, the government changes a tax, a rival cuts its price, and technology moves on. A firm that keeps watching these forces can adjust in time. A firm that ignores them is surprised.

Internal and external environment

The internal environment is what a firm controls. The external environment is what it cannot control but must adapt to.

• Internal: owners, mission, employees, culture, finance, plant.
• External: customers, rivals, laws, economy, technology, society.
• The firm can change the first, and can only respond to the second.

Strengths and weaknesses belong to the inside. Opportunities and threats belong to the outside. This split is the base of the SWOT idea. UGC NET often gives a mixed list and asks you to sort each item.

Micro and macro environment

The micro environment is the close circle around a firm. The macro environment is the wider set of forces that affect every firm.

• Micro: the company itself, suppliers, marketing intermediaries, customers, competitors, publics.
• Macro: economic, natural, technological, political, legal, demographic and cultural forces.
• Technology is a macro force, not a micro one.

Kotler's list is the common source. A firm can build good ties with its suppliers and customers. It cannot decide how inflation or a new law will move. UGC NET often swaps one item between the two lists to test you.

PESTLE framework

PESTLE is a tool to scan the macro environment. Each letter names one force.

• P is Political, E is Economic, S is Social.
• T is Technological, L is Legal, E is Environmental.
• L stands for Legal, not labour.

A firm lists the forces under each letter and notes which are rising threats or chances. For example, a new data-privacy law sits under Legal. A heat wave sits under Environmental. The tool keeps the scan complete.

Economic and non-economic environment

Economic factors shape income, money and markets. Non-economic factors shape values, culture, politics and education.

• Economic: financial system, economic policies, economic planning, structural equilibrium.
• Non-economic: socio-cultural, educational, political and demographic.
• Socio-cultural is the usual odd one out in a list of economic items.

The economic environment sets the buying power and the cost of money. The non-economic environment sets what people like and how they behave. In an odd-one-out question, find the item that is about values rather than money.

Economic and political systems

Capitalism

In capitalism, private owners hold the means of production, and prices guide what is made.

• The profit motive drives people.
• Prices decide who gets which resources, like an invisible hand.
• Producers, buyers and workers compete.
• The state does not own the main means of production.

Adam Smith's invisible hand is the idea behind it. If a good is scarce, its price rises and more people make it. State ownership of the major means of production belongs to socialism, not to capitalism.

Socialism and the mixed economy

Socialism puts key resources under state control. A mixed economy lets the public and private sectors work side by side.

• India chose the mixed economy model after independence.
• The state leads in key sectors, and private firms run the rest.
• Planning steers the broad direction.

A mixed economy tries to take the good side of both systems. The market gives efficiency. The state gives fairness and covers areas the private sector may skip. After 1991 India gave the private sector much more room, but it stayed mixed.

Political systems: democracy and totalitarianism

In a democracy, power rests with the people. In totalitarianism, a group or state controls everything and individual freedom is cut down.

• Totalitarian systems are also called authoritarian.
• Their types include theocratic, right wing, left wing and tribal.
• Conservative is an ideology, not a type of totalitarian rule.

The type depends on who holds the power. In a theocracy, religious leaders rule. In a right-wing or left-wing system, a party or a leader rules by one ideology. The word conservative only names a set of political views.

Transition economies

Transition economies are countries that moved from central planning to a market economy.

• They emerged after the fall of communism.
• Eastern Europe's communist rule collapsed in 1989.
• The USSR collapsed in 1991.

These countries had to privatise firms, free prices and open to trade. The change was fast and often painful. The dates 1989 and 1991 are the usual exam answer.

India's policy framework

Industrial policy since 1991

The 1991 reforms ended the licence raj and gave the private sector and foreign firms more room.

• The private sector's scope was widened.
• The public sector's monopoly in most industries ended.
• Industry was opened to foreign competition and investment.
• Industrial licensing was removed for most industries.

Before 1991, most industries needed a licence and many were reserved for the state. The new policy removed that control. The statement that gives the public sector a monopoly is the wrong one.

Second generation reforms

Second generation reforms are the steps taken after the first 1991 reforms, to deepen growth and improve governance.

• They aim to use the knowledge-based global economy.
• They target a clean environment and sustainable growth.
• They support the growth of Indian transnational corporations.
• Population control is not part of the list.

First generation reforms freed industry and trade. Second generation reforms work on deeper issues such as labour laws, infrastructure, the financial sector and the environment.

Privatisation and disinvestment

Privatisation shifts ownership or control of state firms to private hands. Strategic sale is the most popular route in India.

• A strategic sale hands over a large stake with management control.
• Disinvestment is a sale of a smaller stake, and the state keeps control.
• Air India went to the Tata Group in 2021 by strategic sale.

In a strategic sale, the buyer gets control, not just a share. Other routes include a public offer of shares and a management-employee buyout. The key asks which route India has used most, and the answer is strategic sale.

NITI Aayog

NITI Aayog replaced the Planning Commission in 2015. It gives long-term vision and short-term action in a chain.

• Fifteen-year vision.
• Seven-year strategy.
• Three-year action agenda.
• It does not follow the old five year plan approach.

The Planning Commission set rigid five year plans. NITI Aayog works as a policy think tank and works with states as partners. The chain runs from the broad 15 year vision down to a 3 year action plan.

Human Development Index

The Human Development Index, or HDI, is a UNDP measure of average human development in three dimensions.

• Health, shown by life expectancy at birth.
• Education, shown by years of schooling.
• Standard of living, shown by income per person.
• UNDP publishes it.

The HDI shows that income alone does not describe well-being. A country can be rich yet score low on health or education. The three dimensions are health, education and standard of living.

Index of Eight Core Industries

The Index of Eight Core Industries tracks output of eight key sectors. Each sector has a weight. Base year is 2011-12.

• Eight sectors: coal, crude oil, natural gas, refinery products, fertilisers, steel, cement, electricity.
• Refinery products carry the highest weight.
• Fertilisers carry the lowest weight.

Together these industries drive much of industrial output. UGC NET sometimes asks you to arrange them by weight. Remember the order from lowest to highest and you can answer fast.

Shocks and sustainability

Business and the COVID-19 shock

COVID-19 closed shops and kept people at home. Some businesses grew and others collapsed.

• Online education, gaming, e-commerce, e-payments, retail and pharma grew.
• Hospitality and manufacturing suffered.
• Technology adoption and innovation was the strongest driver of change.
• MSMEs received collateral-free loan support.

Firms that could serve people at home won. Firms that needed crowds lost. India's help for MSMEs included collateral-free automatic loans of Rs 3 lakh crore and a revised MSME definition.

Sustainable consumption and production, and COP27

Sustainable consumption and production, or SCP, meets basic needs while using fewer resources and creating less waste.

• It improves the quality of life.
• It minimises use of natural resources and toxic materials.
• It cuts waste and pollutant emissions over the life cycle.
• COP27 in 2022 agreed on a loss and damage fund.

SCP asks firms and buyers to do more with less over the whole life of a product. At the COP27 climate summit in Egypt, countries agreed to create a fund for climate loss and damage. The summit also stressed lowering coal use.

How India's economy opened up, what drives and restrains globalisation, and the digital tools that now power trade.

Globalisation

Meaning and drivers of globalisation

Globalisation is the growing link between national economies through trade, finance, people and ideas.

• Drivers include labour mobility and financial flows.
• Falling transport and communication costs help it.
• Trade liberalisation and MNCs speed it up.

The drivers push people, money and goods across borders. In a UGC NET list, labour mobility and financial flows are the standard drivers. Assembly operations and exporting are results, not drivers.

Forces restraining globalisation

Some forces slow globalisation down. They include nationalism, trade barriers and regulatory controls.

• Nationalism puts the home country first.
• Emerging trade barriers block flows.
• Regulatory controls limit trade and capital.
• Integration and free market moves speed it up, not restrain it.

When the stem asks what restrains globalisation, pick the items that close doors. Economic integration and free marketing systems open doors, so they are not restraints.

Globalisation of Indian business since independence

India's business moved from state-led growth to partial opening and then to full opening of the economy.

• 1950s: government-led public sector investment.
• 1960s and 70s: more state control and import substitution.
• 1980s: partial opening and de-licensing.
• 1990s: FDI opened and customs duties cut.

The story runs in a clear order. First the state built heavy industry. Later it eased controls a little. After 1991 it opened wide. The sequence helps answer arrange-in-order questions.

A.T. Kearney globalisation index

The A.T. Kearney and Foreign Policy index measures globalisation with 12 variables grouped into four baskets.

• Economic integration: trade and FDI.
• Personal contact: travel, phone calls, remittances.
• Technological connectivity: internet users and hosts.
• Political engagement: treaties and organisations.

Think of four baskets of connection: money, people, technology and politics. Each has indicators. A match question gives the indicators and asks for the basket.

Drivers of international business growth

International business grows when new markets open, trade barriers fall and groups of countries trade more freely.

• Strong consumption in the global south pulls exporters.
• Trade-promoting regional groups help.
• Demographic dividend brings workers and buyers.
• Regulated capital flows slow growth rather than drive it.

Big young populations create both labour and customers. Regional groups cut barriers. Currency and interest swings add risk, not growth.

Digital economy

Aadhaar and India Stack

Aadhaar is India's national identification programme. India Stack is a public digital layer built on it for identity, payments and data.

• Aadhaar gives each resident a 12-digit biometric ID.
• It proves residence and helps digital payments.
• India Stack gives low-cost digital identity, payment and data management.
• It also helps lower credit costs.

With one trusted ID, banks can check a customer in seconds. That cuts costs and brings more people into formal finance. India Stack is described as a decentralised public utility.

UPI and ONDC

UPI made small digital payments instant and cheap. ONDC applies the same open idea to online shopping.

• UPI is the Unified Payments Interface.
• ONDC is the Open Network for Digital Commerce.
• ONDC links many e-marketplaces into one network.
• It lowers the cost of intermediation and may dilute market concentration.

After UPI's success, the government pushed ONDC to open e-commerce. A small shop can reach buyers without going through one big platform. The passage claims fees are about a fifth of leaders' fees.

Why nations trade and who said what: mercantilism, absolute and comparative advantage, factor endowments, and the modern theories.

Classical theories

Mercantilism

Mercantilism is the oldest trade idea. It says a nation grows rich by gathering gold, so it should export more and import less.

• It ran from the 16th to the 18th century.
• Wealth was counted in gold and silver.
• It supports high tariffs and a trade surplus.

Mercantilists saw trade as a contest. One nation's gain was another's loss. Later thinkers said that trade can help both sides. That is why Smith and Ricardo came after.

Absolute advantage (Adam Smith)

Adam Smith said a country should make what it can produce at a lower absolute cost, and trade for the rest.

• It is the first modern theory of trade.
• Smith set it out in The Wealth of Nations in 1776.
• It supports free trade and division of labour.

If India makes tea cheaper than Brazil, and Brazil makes coffee cheaper than India, both gain by trading. The theory fails when one country is better at everything. Ricardo fixed that.

Comparative advantage (David Ricardo)

Ricardo said a country gains from trade even if it is better at everything, as long as its relative cost differs.

• Gains come from specialising where the relative cost is lowest.
• Ricardo stated it in 1817.
• It answers the weakness in Smith's theory.

The key is relative cost, not absolute cost. A senior lawyer may type faster than her clerk, yet she still gives typing to the clerk. She earns more by doing legal work. Countries do the same.

Opportunity cost theory (Haberler)

Gottfried Haberler restated Ricardo's idea in terms of opportunity cost, which is the next best option given up.

• He did this in the 1930s.
• It removes the need for the labour theory of value.
• A country has an edge in the good with the lower opportunity cost.

Instead of counting labour hours, Haberler counted what a country must give up to make one more unit. The country with the lower sacrifice should make that good.

Modern theories

Heckscher-Ohlin theory

Heckscher and Ohlin said a nation exports goods that use its abundant factor and imports goods that use its scarce factor.

• Trade pattern follows factor endowments, not productivity.
• It compares land, labour and capital.
• Trade is greatest between nations whose endowments differ most.

A labour-rich country is cheap in labour. So it should export labour-intensive goods. A capital-rich country should export capital-intensive goods. The theory does not rest on differing technology.

The Leontief paradox

Leontief tested the Heckscher-Ohlin model on US trade. He found the opposite of what it predicted.

• The US is capital-rich.
• Yet its exports were more labour-intensive than its imports.
• This result is called the Leontief paradox.

The paradox does not kill the theory. Later work pointed to different skills of labour and to natural resources as the missing pieces. For the exam, name Wassily Leontief and the test.

Country similarity theory (Linder)

Staffan Linder said countries with similar income and tastes trade more in manufactured goods.

• It explains trade in similar goods among rich nations.
• Demand at home shapes what a firm makes.
• Similar nations then buy each other's goods.

Linder looked at manufactures, not raw materials. A firm first sells to home buyers. Countries with similar tastes want similar goods, so they become each other's markets.

Product life cycle theory (Vernon)

Raymond Vernon said production shifts across countries as a product moves from new to mature to standard.

• It was put forward in 1966.
• The home country first makes the new product.
• Later, other rich countries produce it.
• Finally, low-cost developing countries produce it.

A new product needs skilled people and nearby markets, so it is made at home. As it spreads, others copy it. In the end it is made wherever it costs least. The theory also explains the flow of FDI.

Porter's Diamond of national advantage

Michael Porter said nations win in an industry when four home conditions work together, often called the diamond.

• Factor conditions: skilled labour, knowledge, capital, resources.
• Demand conditions: demanding home buyers.
• Related and supporting industries.
• Firm strategy, structure and rivalry.

The diamond works as a system. Tough home rivals and picky customers push firms to improve. Government and chance sit outside the four corners. Bargaining power of buyers belongs to the Five Forces, not the diamond.

Trade theories and their thinkers

A match question pairs a theory with its thinker. Learn the pairs as a single list.

• Mercantilism: no single author, 16th to 18th century.
• Adam Smith, David Ricardo, Haberler, Heckscher-Ohlin.
• Leontief, Linder, Vernon, Porter.

The match is the most repeated pattern in this topic. It appears almost every year. Keep the chronology in mind: Smith (1776), Ricardo (1817), Haberler (1930s), Heckscher-Ohlin (1919 and 1933), Linder (1961), Vernon (1966), Porter (1990).

How countries restrict trade through tariffs, quotas and rules, how dumping is handled, and how regional blocs cut barriers among members.

Tariffs, quotas and other barriers

Types of tariff

A tariff is a tax on imports. Its form decides how the duty is worked out.

• Specific tariff: fixed money per unit.
• Ad valorem tariff: fixed per cent of value.
• Compound tariff: a mix of both.
• Variable tariff: moves to bring import price to a set price.

If a duty is Rs 50 per kg, it is specific. If it is 10 per cent of price, it is ad valorem. A compound duty adds both, for example 10 per cent plus Rs 5 per unit. A variable tariff changes as world prices change.

Quotas

A quota is a limit on the quantity of a good that may be imported or exported in a period.

• It is a non-tariff barrier.
• Types: absolute, tariff quota, voluntary export restraint.
• Single stage and value added quotas are not standard types.

Under an absolute quota, no more can come in once the limit is reached. Under a tariff quota, the first lot enters at a low duty, and extra units pay a higher one. A voluntary quota is an export limit that the exporter agrees to.

Non-tariff barriers

Non-tariff barriers limit trade without a duty. They include quotas, licensing, quality rules and customs procedure.

• Some rules look neutral but restrict imports in effect.
• Labelling, safety and health rules can work as disguised barriers.
• Phytosanitary rules protect plant health.

A country may require a plant health certificate for fruit. The rule serves a real purpose. But a very strict rule can shut out imports, so it acts as a barrier. Exporters of fruit and vegetables must meet phytosanitary rules.

Dumping and countervailing duty

Dumping is selling goods abroad below their normal value. A countervailing duty offsets an export subsidy.

• Three types of dumping: sporadic, persistent, predatory.
• Predatory dumping aims to drive out rivals, so governments act against it.
• A countervailing duty cancels the gain from an export subsidy.
• An anti-dumping duty answers dumping.

Sporadic dumping clears a sudden surplus now and then. Persistent dumping continues for a long time. Predatory dumping is temporary, and the dumper raises prices once rivals leave.

Regional economic integration

Levels of economic integration

Regional integration moves in steps, from a loose tariff cut to a full political union.

• Preferential trade agreement.
• Free trade area.
• Customs union.
• Common market, economic union, then political union.

At each step, members give up more control. A free trade area removes internal barriers. A customs union adds a common external tariff. A common market adds free movement of labour and capital. An economic union adds common economic policy. A political union adds a common government.

Types of trade agreement

Trade agreements differ in depth. Early harvest, preferential, free trade and comprehensive agreements are common types.

• Preferential trade agreement: duty cuts on an agreed list of products.
• Free trade agreement: tariff concessions on most trade.
• CEPA: also covers customs, competition and IPR.
• Early harvest scheme: a small first step before a larger deal.

An early harvest scheme is signed first to build confidence. A CEPA goes further than a plain FTA because it looks at rules as well as tariffs. India and the UAE signed their CEPA on 18 February 2022. It came into force on 1 May 2022.

ASEAN, SAARC and SAFTA

ASEAN and SAARC are Asian groupings. SAFTA is the free trade agreement among SAARC members.

• ASEAN was formed in 1967 at Bangkok. It has ten members.
• ASEAN's secretariat is in Jakarta, Indonesia.
• SAARC was formed in 1985 and has eight members.
• SAFTA splits members into non-LDC and LDC states.

ASEAN members are Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. SAFTA's non-least-developed members are India, Pakistan and Sri Lanka. Bangladesh, Bhutan, Maldives, Nepal and Afghanistan are least-developed.

NAFTA, USMCA, EU and Mercosur

NAFTA, the EU and Mercosur are blocs in other regions. Each sits at a different level of integration.

• NAFTA (1994) joined the US, Canada and Mexico as a free trade area.
• USMCA replaced NAFTA on 1 July 2020.
• The EU came into force in 1993 and is an economic union.
• Mercosur is a South American bloc, treated as a common market.

Brazil was never a member of NAFTA. The USMCA updated NAFTA with new rules on digital trade and labour. Mercosur is described as a common market in the key, though in practice it acts as an imperfect customs union.

Belt and Road Initiative

China's Belt and Road Initiative links Asia, Europe and Africa with roads, rail, ports and pipelines.

• It strengthens logistics and supply chains.
• It aims to improve cost competitiveness.
• It is meant to rebalance trade dominance, not to protect trade.

The BRI is a connectivity plan. Better roads and ports cut shipping costs. Its stated goals are trade promotion and infrastructure, so trade protectionism is not one of its intended aims.

GATT and the WTO, their rounds, principles and agreements, plus the IMF, the World Bank Group and other bodies with their years.

GATT and the WTO

From Bretton Woods to the WTO

The Bretton Woods conference of 1944 built the post-war economic order. GATT followed in 1947 and the WTO replaced it in 1995.

• 1944: Bretton Woods conference, 44 nations. It created the IMF and the World Bank.
• 1947: GATT signed at Geneva by 23 countries, in force from 1948.
• 1974: Multi Fibre Arrangement on textile trade.
• 1995: WTO replaces GATT.

GATT was meant as a temporary deal until an International Trade Organization could be set up. That organisation never came. GATT stayed for nearly fifty years. The WTO then took over, with a legal base and a stronger dispute system.

GATT and WTO negotiation rounds

GATT and the WTO worked through rounds of talks. Each round lowered tariffs and widened the rules.

• Early rounds: Geneva, Annecy, Torquay.
• Middle rounds: Dillon, Kennedy, Tokyo.
• The Uruguay Round led to the WTO.
• The Doha Round began in 2001.

The Kennedy Round focused on tariff cuts and anti-dumping rules. The Tokyo Round dealt with non-tariff barriers. The Uruguay Round was the largest. It created the WTO and brought in services and intellectual property.

Principles of GATT and the WTO

The WTO system rests on a few principles. They keep trade fair, open and predictable.

• Non-discrimination: most-favoured-nation and national treatment.
• Reciprocity and transparency.
• Binding and enforceable commitments.
• Protection mainly through tariffs, and stable trade.

Most-favoured-nation means a concession given to one member goes to all. National treatment means imports are treated like local goods once they enter. Binding means tariff limits are fixed and cannot be raised at will.

Objectives and functions of the WTO

The WTO sets and runs the rules of trade. It does not lend money.

• It administers the trade agreements.
• It is a forum for trade negotiations.
• It settles trade disputes and reviews trade policies.
• It gives technical help and works with the IMF and World Bank.

The WTO is a rule body. Loans and financial aid are the work of the World Bank and development banks. A question that adds a 'balanced growth' or 'payments' task is mixing in the IMF.

WTO agreements: GATS, TRIPS, TRIMs and NAMA

The WTO runs separate agreements for goods, services, investment and intellectual property.

• GATS: trade in services.
• TRIPS: intellectual property rights.
• TRIMs: investment measures linked to trade.
• NAMA: non-agricultural market access.

NAMA covers industrial goods, textiles, jewellery and fish products, in short everything except farm goods. TRIMs and TRIPs make the investment climate safer, so they help FDI.

Agriculture, subsidy boxes and tariffication

The Agreement on Agriculture cut farm trade barriers. Subsidies are grouped by colour boxes.

• Tariffication replaces quotas and bans with tariffs.
• Amber box: distorts trade and must be cut (Article 6).
• Blue box: tied to production limits.
• Green box: does not distort trade.

Like traffic lights, red means stop and green means go. Amber subsidies such as price support are limited. Green subsidies such as research or food security stocks are allowed. Outside agriculture, subsidies are called prohibited, actionable or non-actionable.

WTO dispute settlement

The WTO settles trade disputes in fixed steps. The goal is to settle by talking first.

• Consultations come first.
• Then a panel reviews the case.
• Then an appellate review on points of law.
• Then implementation. If not, retaliation follows.

The ladder avoids trade wars. A losing member must follow the ruling. If it does not, the winning member may impose limited retaliation.

WTO membership and recent decisions

Membership facts are often tested. India has been a member since the start of the WTO in 1995.

• China joined in 2001 and Russia in 2012.
• Taiwan joined as a separate customs territory.
• Iran is an observer, not a member.
• In 2011, members allowed preferential treatment of services from least-developed countries.

Members can waive the most-favoured-nation rule in GATS for least-developed countries. This was decided at the 8th Ministerial Conference. The WTO budget is funded by members in proportion to their share of world trade.

International institutions

The IMF and the World Bank

The Bretton Woods conference created the IMF and the World Bank. They have different jobs.

• The IMF looks after exchange rates and short-term balance of payments problems.
• The World Bank lends for long-term development.
• Both are headquartered in Washington.
• The IMF and WTO are not part of the World Bank Group.

A country short of foreign exchange goes to the IMF. A country that wants to build a dam or a school programme goes to the World Bank. Bretton Woods was signed by delegates from 44 nations in 1944.

World Bank Group

The World Bank Group has five institutions. The IMF and BIS are not among them.

• IBRD, IDA, IFC, MIGA and ICSID.
• IFC helps private business.
• IDA gives soft loans to the poorest countries.
• MIGA insures investment against political risk.

IDA uses a Crisis Response Window to give extra finance after natural disasters or health emergencies. The World Bank does not tie loans to purchases from one country. It expects the borrower to be able to repay and to use funds for sound projects.

Years and headquarters of international bodies

Match questions often ask for the year of formation and the headquarters city. Learn both as pairs.

• UNCTAD 1964, ASEAN 1967, WIPO 1967.
• NAFTA 1994, WTO 1995.
• WTO in Geneva, IMF in Washington, FAO in Rome, EU in Brussels.

For arrange-in-order questions, learn the years. UNCTAD was set up by the UN General Assembly in 1964. A scheme such as ASIDE, for export infrastructure, was launched in 2002.

How exchange rates are quoted and managed, the risks they create, the theories that explain them, and how a country records and fixes its trade with the world.

Foreign exchange basics

Meaning of foreign exchange and exchange rate

Foreign exchange means foreign currency used in international payments. The exchange rate is the price of one currency in terms of another.

• It denotes the rate at which monetary units are exchanged.
• It also means the process of settling international payments.
• It covers the rate of sale and purchase of foreign currency.

A buyer in India who pays a US supplier must first get dollars. The price of one dollar in rupees is the exchange rate. The word foreign exchange also names the system that settles such payments.

Spot, forward and swap

A spot deal settles within two business days. A forward deal settles later. A swap pairs a spot deal with a reverse forward deal.

• Spot: agreed now, settled in two business days.
• Forward: maturity is more than two business days away.
• Forex swap: spot sale with a forward repurchase of the same currency.

A forward contract fixes today the rate for a future date. This protects against change in the rate. In a swap, the same currency is sold now and bought back later at a rate fixed today.

Nostro, vostro, bid and ask

Nostro and vostro describe the same account from two ends. Bid and ask are the two sides of a quote.

• Nostro: our account with them, held abroad in foreign currency.
• Vostro: their account with us, held in our currency.
• Bid: the price at which the dealer buys a currency.
• Ask or offer: the price at which the dealer sells.

Nostro means ours and vostro means yours. An Indian bank's Swiss franc account in Switzerland is a nostro. A foreign bank's rupee account in India is a vostro.

Arbitrage

Arbitrage means earning a risk-free profit from a price difference between markets.

• Step 1: spot a price gap.
• Step 2: check that the gap beats transaction costs.
• Step 3: buy where cheap, sell where dear, and keep the profit.

The law of one price says the same good must sell for the same price once both are in the same currency. Arbitrage pushes prices back to equal. It is risk-free because the buy and sell happen together.

Purchasing power parity and the law of one price

Purchasing power parity says exchange rates adjust so that the same basket of goods costs the same in every country.

• It rests on the law of one price.
• It assumes no transport cost and free movement of goods.
• It assumes no cost of converting currency.
• The proposer is Gustav Cassel.

If prices in India rise faster than in the US, the rupee should fall at about the difference. That is relative PPP. The theory works only when goods move freely and cheaply.

Fisher effect and interest rate links

The Fisher effect links interest rates to expected inflation. The international Fisher effect links them to exchange rates.

• Nominal rate equals real rate plus expected inflation.
• Real rate equals nominal rate minus expected inflation.
• The exchange rate change is explained by the interest rate difference.

If the real rate is 3 per cent and expected inflation is 5 per cent, the nominal rate is about 8 per cent. The depreciation of one currency against another is roughly the inflation difference and the interest rate difference between the two.

Why a currency rises or falls

A currency appreciates when demand for it rises. It depreciates when demand falls or supply rises.

• Higher real interest rates and lower inflation make a currency appreciate.
• Portfolio outflows, high imports and debt service weaken the rupee.
• A wider trade deficit also weakens it.

Foreign investors want a higher return after inflation. When they sell Indian shares and take money out, they sell rupees, so the rupee falls. A bigger import bill needs more dollars, so it also pushes the rupee down.

Central bank intervention and exchange rate regimes

Central banks buy or sell currency to steer the exchange rate. Over time, the world moved from gold to floating rates.

• Reasons: influence production, influence trade flows, smooth fluctuations.
• History: commodity specie, gold standard, fixed parity, floating rates.
• Trilemma: only two of fixed rate, own monetary policy, free capital flow.

If the exchange rate is fixed and capital flows freely, a country cannot also set its own interest rate. That is the impossible trinity. The intervention currency is the currency in terms of which a country's own currency is quoted and managed.

Exchange risk

Types of exchange-rate exposure

Exposure is how much a firm's value or accounts change when exchange rates move. It comes in three kinds.

• Transaction exposure: gain or loss on contracts already made.
• Translation exposure: effect on consolidated accounts.
• Economic exposure: effect on all future cash flows.

Translation exposure is also called accounting exposure. It arises when foreign subsidiary accounts are restated in the parent's currency. Economic exposure is the broadest and the longest term.

Methods of translating foreign accounts

Four accepted methods restate foreign-currency accounts into the parent currency.

• Current and non-current method.
• Monetary and non-monetary method.
• Temporal method.
• Current rate method.

The methods differ on which items use the current rate and which use the old rate. A firm using the current rate on all assets and liabilities carries a translation loss if the foreign currency falls.

Hedging: internal and external techniques

Firms manage exchange risk with internal techniques and external techniques.

• Internal: netting, matching, leading and lagging.
• External: forward contracts, futures, options and swaps.
• Natural hedge: assets and liabilities match in amount and timing.

Netting offsets receivables against payables, so only the difference is exposed. Leading means paying early. Lagging means paying late. A natural hedge needs no contract at all.

Balance of payments

Structure of the balance of payments

The balance of payments records all a country's transactions with the rest of the world over a period.

• Current account: goods, services, income and transfers.
• Capital account: capital transactions and investment flows.
• Official reserves account: changes in gold and foreign currency.
• Balancing item: corrects errors and omissions.

Balance of trade covers goods only. The current account covers goods, services and transfers. The BoP always balances in the books because every credit has a matching debit. No account called a drawings account exists.

Adverse balance and correcting BoP disequilibrium

An adverse balance of trade means imports are greater than exports. Measures to correct a deficit are monetary, trade or direct.

• Monetary measures: monetary contraction, devaluation, exchange control.
• Trade measures: promote exports, curb imports. Abolishing export duties is a trade measure.
• A persistent current account deficit needs fiscal discipline, an export-friendly exchange rate and less costly borrowing.

Monetary contraction cuts spending on imports. Devaluation makes exports cheaper. Cutting export duties helps exporters but works through trade, not money. Exchange control directly limits foreign exchange use.

J-curve and the International Investment Position

The J-curve shows that devaluation first worsens and later improves the trade balance. The IIP shows a country's stock of foreign assets and liabilities.

• Short run: import bill rises, so the balance gets worse.
• Long run: volumes adjust and the balance improves.
• IIP: a statement at a point in time of assets and liabilities against non-residents.

Contracts are fixed in the short run, so volumes do not change quickly. Later buyers shift to cheaper exports. The curve dips and then rises like the letter J. BoP is a flow over a period. IIP is a stock at a date.

International liquidity and the SDR

International liquidity is the total stock of assets a country can use to settle payments. The SDR is the IMF's reserve asset.

• Includes foreign exchange reserves and gold reserves.
• Includes borrowing capacity.
• SDR value is set by a basket of five currencies.

The SDR basket holds the US dollar, euro, Chinese yuan, Japanese yen and British pound. After the dollar, the euro has the largest weight. The yuan joined in 2016.

How firms invest and enter markets abroad: FDI types, routes and theories, MNCs, entry modes and strategy models.

Foreign direct investment

FDI versus foreign portfolio investment

FDI gives lasting interest and management control. FPI is a passive financial investment with no control.

• In India, FDI means 10 per cent or more of a company's equity.
• FPI is a passive holding in shares and bonds, usually under 10 per cent.
• FDI builds plants and jobs. FPI can leave quickly.

A foreign firm that builds a factory or buys a large stake in an Indian company is doing FDI. A foreign fund that buys a few listed shares is doing FPI. Foreign investment enters India through FDI, FPI, private equity and foreign venture capital routes.

Types of FDI

FDI is named after where it sits in the firm's chain. It can also be inward or outward, and greenfield or brownfield.

• Horizontal: same business abroad.
• Vertical: forward moves toward customers, backward moves toward supply.
• Conglomerate: an unrelated business abroad.
• Greenfield builds new assets. Brownfield buys existing ones.

Forward vertical FDI sells the firm's own output abroad. Backward vertical FDI makes inputs for the home plant. Conglomerate FDI starts a business the firm does not run at home. Inward FDI is money coming into the host country.

Motives and determinants of FDI

Firms invest abroad for market, resources, efficiency or strategic assets. Supply and demand factors shape the choice.

• Market-seeking: to serve a large local market.
• Resource-seeking: to get raw materials and labour.
• Efficiency-seeking: to cut costs.
• Supply factors: resource availability and logistics.

FDI in Indian manufacturing has largely been market-seeking, because of the big domestic market. An oil firm in Nigeria is resource-seeking. Customer access is a demand factor, not a supply factor.

Effects of FDI on the host country

FDI can help the host country with technology, jobs and investment. It can also cause profit outflow and dependence.

• Benefits: technology, competition, domestic investment, foreign exchange.
• Costs: monopoly, technology dependence, profit outflow.
• Repatriation of profits can drain capital.

UGC NET questions ask for the benefits or the costs, so read the verb. Foreign firms bring skills and capital, but they also send dividends and royalties home. Large foreign firms can close small local firms.

FDI policy in India

India allows FDI through the automatic route and the government route. Sector limits differ.

• Automatic route: no prior approval.
• Government route: prior approval needed.
• Investment from land-border countries needs the government route (2020).
• Report inflows to the RBI within 30 days.

After April 2020, India required prior approval for investment from countries that share a land border, to stop opportunistic takeovers during COVID-19. Real estate business, including trading in TDRs, is barred to FDI.

Theories of international investment

Several theories explain why firms invest abroad. Dunning's OLI framework is the most asked.

• Ownership, Location and Internalisation advantages make up OLI.
• Product life cycle: investment follows the product's life.
• Market imperfection: FDI arises in oligopolistic industries.
• Capital movements: capital goes where it is scarce.

Dunning's eclectic paradigm has three parts. The firm has a unique asset (ownership). The host country offers an edge (location). The firm prefers to keep control inside the firm (internalisation). Appropriability says the firm keeps the gains from its own research.

Multinational corporations

A multinational firm owns and runs production facilities in more than one country.

• It does more than export. It controls units abroad.
• Global corporations operate across a very large number of countries.
• MNCs bring technology and management, but can crowd out small firms.

A firm that only exports is not a multinational. It must control and operate production abroad. Unilever and Toyota are examples. Small local firms have closed in many developing countries because of competition from large MNCs.

Entering and managing international markets

Modes of entering foreign markets

Entry modes range from low commitment and low risk to high commitment and high risk.

• Exporting: lowest risk, easiest to start.
• Licensing and franchising: contract-based.
• Joint venture: shared investment and control.
• Direct investment: highest risk and highest profit potential.

A firm with little experience should start by exporting. It needs no overseas investment and can withdraw easily. Deeper modes need more money and more local knowledge. Risk and potential profit rise together.

Steps in going international

A firm should decide in order, from the broadest question to the narrowest.

• Decide whether to go global.
• Decide which markets to enter.
• Decide when to enter.
• Decide how to enter and which mode.

The sequence runs from why to where, when and how. It helps in arrange-in-order questions. A firm should not choose a mode before it knows the market.

EPRG orientations

Perlmutter's EPRG framework describes four attitudes of a firm to foreign markets.

• Ethnocentric: home ways are best.
• Polycentric: each country is different.
• Regiocentric: manage by region.
• Geocentric: see the world as one market.

An ethnocentric firm treats foreign markets as an extension of home. A polycentric firm sets up subsidiaries and gives local managers power. A geocentric firm uses the best ideas from anywhere.

Uppsala model and piggybacking

The Uppsala model says firms go abroad step by step. Piggybacking lets one firm use another's distribution channel.

• Uppsala stages: domestic, ad hoc exports, agents, sales subsidiary, foreign production.
• It does not fit service firms.
• In piggybacking, the exporter is the rider and the established firm is the carrier.

The Uppsala model learned from manufacturing firms. Service firms such as software or consulting can serve foreign clients almost from day one. In piggybacking, a small firm sells through a big firm's network in the target country.

Porter's Five Forces and country risk

Porter's Five Forces judges an industry's pull. Country risk ratings judge a market's danger.

• Five Forces: rivals, new entrants, substitutes, buyer power, supplier power.
• Know your enemy matches the threat of competitors.
• Country risk raters include BERI, EIU and PRS Group.

A firm studies its rivals before entering. Sun Tzu's 'know the enemy and know yourself' is the force of competitive rivalry. For country risk, firms use ratings from BERI, the Economist Intelligence Unit and the PRS Group.

How India governs and promotes foreign trade: the policy bodies, schemes and zones, and the steps of an export.

India's foreign trade policy

DGFT and the Foreign Trade Policy

The Directorate General of Foreign Trade implements India's Foreign Trade Policy. It works under the Ministry of Commerce and Industry.

• The Department of Commerce is the main agency for trade.
• DGFT promotes and regulates foreign trade.
• The Foreign Trade Policy 2015-20 was extended to 31 March 2023.

FTP 2015-20 aimed to double exports of goods and services and to lift India's share in global exports to 3.5 per cent. It introduced MEIS and SEIS and a simpler Aayat Niryat form. In September 2022 the policy was extended because of global uncertainty.

Export promotion schemes

India runs schemes that make exporting easier and cheaper.

• DFIA: duty-free import of inputs used in export products.
• Niryat Bandhu: mentors new exporters.
• MEIS and SEIS rewarded merchandise and services exports.
• District as Export Hub supports MSMEs.

DFIA exempts customs duty, additional duty, education cess and anti-dumping or safeguard duty on inputs. Niryat Bandhu gives counselling, training and outreach. The DGFT tied up with Amazon to train MSMEs under the District as Exports Hub plan.

Export zones: EPZ and FTZ

Export processing zones and free trade zones are special areas for trade. They differ in what they allow.

• EPZ units are mainly for export production.
• EPZ units are expected to add value by making goods.
• FTZ goods may be re-exported in the same form.

An EPZ is a manufacturing zone for export. An FTZ is more like a duty-free warehouse zone. Goods can land, be stored and be shipped on, with little processing.

Export procedure and documents

Concluding an export deal

An export deal moves from finding a buyer to receiving payment security.

• Identify and negotiate with the importer.
• Confirm the export deal.
• Receive the export order.
• Examine the order, then receive the letter of credit.

The exporter first finds a buyer and agrees terms. After the deal is confirmed, the importer places the order. The exporter checks the order and asks for changes if needed. Then the importer's bank opens a letter of credit.

Export finance and port procedure

Banks finance an exporter before shipment through packing credit. At the port, documents follow the cargo.

• Packing credit is given after evidence of export.
• The bank calculates the amount and releases the funds.
• The C&F agent takes delivery of cargo and arranges port procedures.
• The shipping company issues the bill of lading.

The exporter first shows an order or letter of credit as evidence. The bank then works out the amount and credits it. At the port, the cargo goes to the shed, customs check follows, the ship takes it, and the bill of lading is issued.

Foreign trade documents

Foreign trade runs on documents. The commercial invoice is the main one.

• The commercial invoice is the substantive document.
• Others include the certificate of origin, bill of exchange and inspection certificate.
• The invoice lists goods, quantity, price and terms of sale.

Customs rely on the invoice to value the goods. Other documents support it: the certificate of origin shows where goods were made, and an inspection certificate shows quality.

E-commerce exports

Cross-border e-commerce exports have grown fast. A separate policy and export hubs are suggested for them.

• E-commerce exports need warehousing and a returns process.
• Export hubs offer repacking, labelling and logistics links.
• Hubs cut upfront export costs.

A passage in a past paper compared India's online exports with China's. India's share was small. Hubs near ports and clusters give agglomeration benefits such as shared logistics and quicker clearance.

The moral and legal duties of a company: ethical theories, social responsibility, the 2013 Act's CSR rule, and how a company is governed.

Business ethics

Meaning and principles of business ethics

Business ethics means moral principles that guide how a firm behaves with its stakeholders.

• Pay taxes and discharge obligations promptly.
• Avoid secret kickbacks and pay-offs.
• Social responsibility is wider than ethics.
• Economic policies are not ethics. They are state tools.

Ethics asks what is right, not only what is legal. Stakeholders are the groups a business affects: consumers, shareholders, suppliers, creditors, employees. A match question pairs each term with its meaning.

Ethical theories and moral development

Ethical theories judge an act by its result, its duty or its fairness. Moral development moves in three stages.

• Utilitarianism: the greatest good for the greatest number.
• Ethics of duty follows rules. Theory of justice follows fairness.
• Kohlberg's stages: preconventional, conventional, principled.

A utilitarian weighs the net benefit of a decision. Preconventional behaviour avoids punishment and seeks reward. Conventional behaviour follows group rules. Principled behaviour follows universal ideals.

Consumerism

Consumerism is a movement to protect consumers against unfair business practice.

• It shows that business failed to guarantee consumer rights.
• Government also plays a role in consumer protection.
• It points to a need for better marketing, not a set-back.

Consumers demand safe products, fair prices and honest information. Governments back this with laws. A statement that says the government has no role in consumer protection is the wrong one.

Corporate social responsibility

Concept and scope of CSR

CSR is a firm's continuing commitment to behave ethically and contribute to society and the environment.

• It covers public health, education and literacy.
• It covers the environment and ecological balance.
• It covers fair dealing with consumers.
• Political awareness is not a CSR activity.

CSR is owed to different groups. To consumers a firm owes reasonable prices, safe products and a hearing for grievances. A firm earns a competitive edge when its sense of social responsibility is strong.

Carroll's pyramid and the triple bottom line

Carroll's pyramid has four layers of CSR. The triple bottom line looks at people, planet and profit.

• Carroll: economic, legal, ethical, philanthropic.
• Economic is the base. Philanthropic is the top.
• Triple bottom line: people, planet and profit.
• The sustainability approach says business must respect the biosphere.

A firm must first be profitable, then obey the law, then act ethically, and then give back. The sustainability approach says all economic activity depends on nature.

CSR under the Companies Act 2013

Section 135 of the Companies Act makes CSR spending compulsory for large companies.

• Any one test applies: net worth, turnover or net profit above a limit.
• Spend at least 2 per cent of average net profit.
• A shortfall must be moved to government-run funds.

The tests apply in the previous year, and meeting any one is enough. The firm sets up a CSR committee. India was among the first countries to make CSR spending a legal duty. Earlier, a firm that did not spend 2 per cent had to give reasons. Now it must transfer the unspent amount.

Corporate governance

Meaning and benefits of corporate governance

Corporate governance is the system by which a company is directed and controlled.

• Board, shareholders and management share roles.
• It fixes who is responsible and brings order to decisions.
• It builds investor confidence through openness.
• The Cadbury Committee of 1992 gave the classic definition.

Good governance exposes mismanagement and excessive pay. It shows the true financial performance to investors. It is an open democratic system, though it can look slow. A passage in a past paper listed these points.

Agency theory and stewardship theory

Agency theory sees a conflict between owners and managers. Stewardship theory sees managers as trustworthy.

• Agency: materialistic, opportunistic managers and owners.
• Stewardship: trustworthy managers, aligned interests, sociological approach.
• Stewardship says management is not mainly about monitoring.

In agency theory the owner is the principal and the manager is the agent. Their goals can differ, so the owner monitors. In stewardship theory the manager wants to do a good job for the firm. Trust replaces control.

Corporate governance rules in India

Indian law sets basic rules for the board and the auditor.

• Every company must appoint an auditor, an individual or a firm.
• Certain companies must have at least one woman director.
• A public company can have at most 15 directors without a special resolution.
• There is no rule that independent directors must attend three meetings.

Reform came through reports such as the Kumar Mangalam Birla Committee and Narayana Murthy Committee. The Companies Act 2013 then made several of these ideas into law. Independent directors give an outside view.