Introduction

The external sector is the portion of a country's economy that interacts with the economies of other countries. In the goods market, the external sector involves exports and imports. In the financial market it involves capital flows
Economic features related to the external sector include
Balance of payments
Current account
Capital account
Foreign direct investment
External debt
Exchange rate
Foreign-exchange reserves
International investment position

Foreign-exchange reserves

Foreign-exchange reserves (also called forex reserves or FX reserves) is money or other assets held by a central bank or other monetary authority so that it can pay if need be its liabilities, such as the currency issued by the central bank, as well as the various bank reserves deposited with the central bank by the government and other financial institutions

Balance of payments

The balance of payments, also known as balance of international payments and abbreviated B.O.P., of a country is the record of all economic transactions between the residents of the country and the rest of the world in a particular period (over a quarter of a year or more commonly over a year). These transactions are made by individuals, firms and government bodies. Thus the balance of payments includes all external visible and non-visible transactions of a country.

Current Account

Under current account of the BoP, transactions are classified into merchandise goods (exports and imports) and invisibles. Invisible transactions are further classified into three categories, namely
a) Services – travel, transportation, insurance, Government not included elsewhere (GNIE) and miscellaneous (such as, communication, construction, financial, software, news agency, royalties, management and business services),
b) Income, and
c) Transfers (grants, gifts, remittances, etc. which do not have any quid pro quo

Capital Account

capital inflows can be classified by instrument (debt or equity) and maturity (short or long-term). The main components of capital account include foreign investment, loans and banking capital.

>> Foreign investment comprising Foreign Direct Investment (FDI) and portfolio investment consisting of Foreign Institutional Investors (FIIs) investment, American Depository Receipts/Global Depository Receipts (ADRs/GDRs) represents non-debt liabilities, while loans (external assistance, external commercial borrowings and trade credit) and banking capital including non-resident Indian (NRI) deposits are debt liabilities.

External Debt

>> It is that portion of a country’s debt that was borrowed from foreign lenders including commercial banks, governments or international financial institutions such as the International Monetary Fund (IMF) and World Bank.
>> According to the IMF, “Gross external debt is the amount, at any given time, of disbursed and outstanding contractual liabilities of residents of a country to nonresidents to repay principal, with or without interest, or to pay interest, with or without principal”.
>> Sustainable debt is the level of debt which allows a debtor country to meet its current and future debt service obligations in full, without recourse to further debt relief or rescheduling, avoiding accumulation of arrears, while allowing an acceptable level of economic growth.
>> There are various indicators for determining a sustainable level of external debt. These indicators can be thought of as measures of the country’s solvency. Examples of debt burden indicators include the external debt-to-GDP ratio, external debt-to-total debt ratio etc.

Foreign investment

comprises of two components
1) Foreign Direct Investment
2) Foreign Institutional Investment

1) Foreign Direct Investment

FDI is foreign investment with aim of profit motive and provide unique mixture of resources, technology, knowledge, professionalism and management techniques.
• India’s economy has been opening for more FDI. 100% FDI is permitted in sectors like petroleum sector, road building, power, drugs and pharmaceuticals hotels and tourism.
• No FDI is allowed in gambling, betting, lottery, atomic energy etc.
• FDI in India is allowed under Automatic Route i.e. without prior approval of government/RBI whereas other is government route which requires approval of FIPB

2) Foreign Institutional Investment

FII or Foreign institutional Investment is done in the stock market with the purpose of only trading in shares of companies, in corporate debt and in government securities. Such investments are volatile in nature.

• There is no restriction on FII in the stock market except for the maximum percent shares of a company including in corporate debt instruments and government securities.
• FII also comes in the form of participatory notes (PN) (unregistered FII) and round tipping. Through round tipping, capital goes out of the country only to return from a different route to avoid incidence of tax on profit earned. Much of FII invested in India comes from Mauritius taking advantage of Double Taxation Avoidance Treaty.
• Balance of payment of a country is a separate and independent “record” of all transactions being done in foreign currency in the country. It has great significance for open economies.

Exchange rate

In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency.
For example, an interbank exchange rate of 60 Indian Rupees to the United States dollar means that INR 60 will be exchanged for each US$1 or that US$1 will be exchanged for each INR60. In this case it is said that the price of a dollar in relation to Indian Rupees is 60, or equivalently that the price of a Indian Rupees in relation to dollars is $1/60
Exchange rates are determined in the foreign exchange market, which is open to a wide range of different types of buyers and sellers, and where currency trading is continuous: 24 hours a day except weekends

Fixed exchange-rate system

A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime where a currency's value is fixed against either the value of another single currency, to a basket of other currencies, or to another measure of value, such as gold.
There are benefits and risks to using a fixed exchange rate. A fixed exchange rate is typically used in order to stabilize the value of a currency by directly fixing its value in a predetermined ratio to a different, more stable or more internationally prevalent currency (or currencies), to which the value is pegged. In doing so, the exchange rate between the currency and its peg does not change based on market conditions, the way floating currencies do. This makes trade and investments between the two currency areas easier and more predictable, and is especially useful for small economies, economies which borrow primarily in foreign currency, and in which external trade forms a large part of their GDP.

Floating Currency Regime

A floating exchange rate is a regime where the currency price is set by the forex market based on supply and demand compared with other currencies. This is in contrast to a fixed exchange rate, in which the government entirely or predominantly determines the rate

Regulation of PNs

Introduction to Participatory Notes

Participatory Notes commonly known as P-Notes or PNs are instruments issued by registered foreign institutional investors (FII) to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the market regulator, the Securities and Exchange Board of India - SEBI.

Regulations on P-Notes

In the background of the hunt for black money, restrictions over P-Notes are tightened. Hence, over the last one decade, SEBI was slowly tightening norms on P-Notes. In May 2016, SEBI has extended the KYC (Know Your Client) norms and anti-money laundering norms to the PN subscribers also. Similarly, back in April 2014, SEBI banned unregulated entities in foreign countries (so called Category III FPIs in India) from subscribing P-Notes.

>> In a recent development, on July 8, 2017, SEBI issued a circular banning FPIs from issuing Participatory Notes for investing in equity derivatives. At the same time, FPIs can issue PNs to overseas investors if the equity derivatives investments are used for hedging the equity shares held by them. This means that a foreign investor can make investment in equity derivatives only if he purchases an equal value of shares in the cash segment. Effectively, this step will help to avoid speculative investment by foreign investors using PN in derivatives. SEBI also instructed ODI-issuing FPIs to liquidate such ODI instruments prior to the timeline of 2020
>> According to market statistics, FPIs hold P-Notes of over Rs 1.9 lakh crore in cash and Rs 40,000 crore in derivatives. This means that banning of PNs for equity derivatives will lead to phasing out of around 25% of investment made through P-Notes.
>> The SEBI’s ban on PNs is on those ones where there is investment in equity derivatives. Investment in the cash segment can be continued. But the current move of eliminating derivate investment in equity shares is a step towards minimising the use of PNs by foreign investors.

Foreign exchange market

The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines the foreign exchange rate. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market.
The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. Since currencies are always traded in pairs, the foreign exchange market does not set a currency's absolute value but rather determines its relative value by setting the market price of one currency if paid for with another. Ex: 1 USD is worth X CAD, or CHF, or JPY, etc

Trade Balance

The trade balance, also known as the balance of trade (BOT), is the calculation of a country's exports minus its imports
When a country imports more than it exports, the resulting negative number is called a trade deficit. When the opposite is true, a country has a trade surplus. For example, if India imported $1 trillion in goods and services last year, but exported only $750 billion in goods and services to other countries, then India had a trade balance of negative $250 billion , or a $250 billion trade deficit.
>> Trade Balance Importantance
The trade balance is used to help economists and analysts understand the strength of a country's economy in relation to other countries

Trade Policy

Trade policy defines standards, goals, rules and regulations that pertain to trade relations between countries. These policies are specific to each country and are formulated by its public officials. Their aim is to boost the nation’s international trade. A country’s trade policy includes taxes imposed on import and export, inspection regulations, and tariffs and quotas.

Types of Trade Policy

Trade policies can assume varying dimensions and scope depending on the number of parties involved in the policy. Consider the following types of trade policies
1) National trade policy
2) Bilateral trade policy
3) International trade policy

1) National trade policy

Every country formulates this policy to safeguard the best interest of its trade and citizens. This policy is always in consonance with the national foreign policy.

2) Bilateral trade policy

This policy is formed between two nations to regulate the trade and business relations with each other. The national trade policies of both the nations and their negotiations under the trade agreement are considered while formulating bilateral trade policy.

3) International trade policy

International economic organizations, such as Organization for Economic Co-operation and Development (OECD), World Trade Organization (WTO) and International Monetary Fund (IMF), define the international trade policy under their charter. The policies uphold the best interests of both developed and developing nations. The best example is the Doha Development Agenda which was formulated by the WTO.

Depreciation

This term is used to mean two different things. 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 domestic economy, depreciation means an asset losing its value due to either its use, wear and tear or due to other economic reasons. Depreciation here means wear and tear. This is also known as capital consumption. Every economy has an official annual rates for different assets at which fixed assets are considered depreciating.

Devaluation

the reduction in the official value of a currency in relation to other currencies.
Devaluation is a deliberate downward adjustment to the value of a country's currency relative to another currency, group of currencies or standard. Devaluation is a monetary policy tool used by countries that have a fixed exchange rate or semi-fixed exchange rate

Revaluation

A revaluation is a calculated upward adjustment to a country's official exchange rate relative to a chosen baseline; the baseline can be anything from wage rates to the price of gold to a foreign currency. In a fixed exchange rate regime, only a decision by a country's government, such as its central bank, can alter the official value of the currency

Appreciation

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. Appreciation rates for different assets are not fixed by any government as they depend upon many factors which are unseen

Convertibility

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.

LERMS - liberalized exchange rate management system

Exchange rate of Indian Rupee is fixed by market depending on demand & supply theory with effect from March 1, 1993. This is known as LERMS.There is no control by RBI or Government.
Indian form of exchange rate is known as the 'dual exchange rate', one exchange rate of rupee is official and the other is m arket-d riven. The market-driven exchange rate shows the actual tendencies of the foreign currency demand and supply in the economy vis-a-vis the domestic currency. It is the market-driven exchange rate which affects the official rate and not the other way round

NEER - Nominal Effective Exchange Rate

The nominal effective exchange rate (NEER) is an unadjusted weighted average rate at which one country's currency exchanges for a basket of multiple foreign currencies. In economics, the NEER is an indicator of a country's international competitiveness in terms of the foreign exchange (forex) market. Forex traders sometimes refer to the NEER as the trade-weighted currency index.

REER - The real effective exchange rate

the weighted average of a country's currency relative to an index or basket of other major currencies, adjusted for the effects of inflation. The weights are determined by comparing the relative trade balance of a country's currency against each country within the index.

EFF - Extended Fund Facility

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, but on the conditions of structural reforms in the economy put by the body. It is the first agreement of its kind. India had signed this agreement with the IMF in the financial year 1981-82.

IMF Conditions on India

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:
(i) Devaluation of rupee by 22 per cent (done in two consecutive fortnights-rupee fell from '21 to '27 against every US Dollar).
(ii) Drastic custom cut to a peak duty of 30 per cent from the erstwhile level of 130 per cent for all goods.
(iii) Excise duty to be increased by 20 per cent to neutralise the loss of revenue due to custom cut.
(iv) 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 oflndians. 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 pre­ conditions 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 crisis-driven 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

Hard currency, safe-haven currency or strong currency is any globally traded currency that serves as a reliable and stable store of value. Factors contributing to a currency's hard status might include the long-term stability of its purchasing power, the associated country's political and fiscal condition and outlook, and the policy posture of the issuing central bank

Soft Currency

A currency with a value that fluctuates as a result of the country's political or economic uncertainty. As a result of the of this currency's instability, foreign exchange dealers tend to avoid it. Also known as a "weak currency".

Hot Currency

hot money is the flow of funds (or capital) from one country to another in order to earn a short-term profit on interest rate differences and/or anticipated exchange rate shifts.

Heated Currency

A term used in the forex market to denote the domestic currency which is under enough pressure (heat) of depreciation due to a hard currency's high tendency of exiting the economy (since it has become hot). It is also known as currency under heat or under hammering

Cheap currency

A loan or credit with a low interest rate, or the setting of low interest rates by a central bank like the Federal Reserve. Cheap money is good for borrowers, but bad for investors, who will see the same low interest rates on investments like savings accounts, money market funds, CDs and bonds. Cheap money can have detrimental economic consequences as borrowers take on excessive leverage.

Dear Currency

A situation in which money or loans are very difficult to obtain in a given country. If you do have the opportunity to secure a loan, then interest rates are usually extremely high. Also known as "tight money".

Special economic zone (SEZ)

A special economic zone (SEZ) is an area in which business and trade laws are different from rest of the country. SEZs are located within a country's national borders, and their aims include: increased trade, increased investment, job creation and effective administration. To encourage businesses to set up in the zone, financial policies are introduced. These policies typically regard investing, taxation, trading, quotas, customs and labour regulations. Additionally, companies may be offered tax holidays, where upon establishing in a zone they are granted a period of lower taxation.

Land Acquisition Issue & SEZ

While the benefits of SEZs are visible and evident, one major issue that has often been raised pertains to the acquisition of agricultural land for setting up SEZs. Acquisition of land is a matter that comes under the purview of the state governments since land/land usage is a state subject. While there is a Central Land Acquisition Act of 1894 extensively amended in 1971, the states have made modifications to the same and have their own compensation and relief & rehabilitation measures depending upon their requirements and necessities.
The need of the hour is to formulate a working land reforms and land acquisition law which could address the emerging new realities (like agitations by farmers after the land has already been acquired and compensation paid to them) related to the issue of land acquisition. The second thing is an active and willing co-operation/participation coming from the state governments. Involving the PRis will provide a more durable and effective way out to this issue.
Meanwhile, on the proposed and revised Land Acquisition Bill, 2013, a political concensus has been reached (on April 18, 2013)-which paved the way for the Bill to get introduced in the current Session of the Parliament-it will replace India's existing Land Acquisition Act, 1894. The Bill is more careful, realistic and futuristic about the contemporary and emerging challenges ofland acquisition in the country. The major highlights of the Bill are as follows:

(i) For the first time, resettlement and rehabilitation both have been emphasised on the same footing;
(ii) Scrutiny of all private purchase of land between 2011 and 2013 (there has been a concern among many that the land mafias have grabbed cheap land from the farmers before the proposed Bill has been passed by the government);
(iii) A provision to enable state legislation on leasing in place of acquisition of land;
(iv) Instead of acquisition, land to be leased to developers, so that the ownership remains with farmers and provides them a regular income. The government to amend the Land Acquisition, Rehabilitation and Resettlement Bill 2011, to provide for an enabling provision to states for enacting laws in this regard (leasing of land is a state subject under the Constitution).
The new government at the centre has, meanswhile, proposed a new Land Acquisition Bill 2015. The bill is faced with stiff opposition from the political parties in opposition farmers alike and is still to be passed by the parliament