Tag: Business Environment

Once our economy opened up post liberalization and globalization, the import and export industry became a huge sector in our economy. Even today India is one of the largest exporters of agricultural goods. So to provide financial support to importers and exporters the government set up the EXIM Bank.

EXPORT AND IMPORT BANK OF INDIA (EXIM)

The Export and Import Bank of India, popularly known as the EXIM Bank was set up in 1982. It is the principal financial institution in India for foreign and international trade. It was previously a branch of the IDBI, but as the foreign trade sector grew, it was made into an independent body.

The main function of the Export and Import Bank of India is to provide financial and other assistance to importers and exporters of the country. And it oversees and coordinates the working of other institutions that work in the import-export sector. The ultimate aim is to promote foreign trade activities in the country.

The management of the EXIM bank is done by a board, headed by the Managing Director. There are 17 other Directors on the board. The whole paid-up capital of the bank (100 crores currently) is subscribed by the Central Government exclusively.

Functions of the EXIM Bank

Let us take a look at some of the main functions of Export and Import Bank of India bank:

1. Finances import and export of goods and services from India.
2. It also finances the import and export of goods and services from countries other than India.
3. It finances the import or export of machines and machinery on lease or hires purchase basis as well.
4. Provides refinancing services to banks and other financial institutes for their financing of foreign trade.
5. EXIM bank will also provide financial assistance to businesses joining a joint venture in a foreign country.
6. The bank also provides technical and other assistance to importers and exporters. Depending n the country of origin there are a lot of processes and procedures involved in the import-export of goods. The EXIM bank will provide guidance and assistance in administrative matters as well.
7. Undertakes functions of a merchant bank for the importer or exporter in transactions of foreign trade.
8. Will also underwrite shares/debentures/stocks/bonds of companies engaged in foreign trade.
9. Will offer short-term loans or lines of credit to foreign banks and governments.
10. EXIM bank can also provide business advisory services and expert knowledge to Indian exporters in respect of multi-funded projects in foreign countries

Importance of the EXIM Bank

Other than providing financial assistance, the Export and Import Bank of India bank is always looking for ways to promote the foreign trade sector in India. In the early 1990s, EXIM introduced a program in India known as the Clusters of Excellence.

The aim was to improve the quality standards of our imports and exports. It also has a tie-up with the European Bank for Reconstruction and Development. It has agreed to co-finance programs with them in eastern Europe.

In order to promote exports EXIM bank also has schemes such as production equipment finance program, export marketing finance, vendor development finance, etc.

ECGC (Export Credit Guarantee Corporation of India)

The ECGC Limited (Formerly Export Credit Guarantee Corporation of India Ltd) is a company wholly owned by the Government of India based in Mumbai, Maharashtra. It provides export credit insurance support to Indian exporters and is controlled by the Ministry of Commerce. Government of India had initially set up Export Risks Insurance Corporation (ERIC) in July 1957. It was transformed into Export Credit and Guarantee Corporation Limited (ECGC) in 1964 and to Export Credit Guarantee Corporation of India in 1983.

Functions of ECGC

• Provides a range of credit risk insurance covers to exporters against loss in export of goods and services as well.
• Offers guarantees to banks and financial institutions to enable exporters to obtain better facilities from them.
• Provides Overseas Investment Insurance to Indian companies investing in joint ventures abroad in the form of equity or loan and advances.

Facilities by ECGC

• Offers insurance protection to exporters against payment risks
• Provides guidance in export-related activities
• Makes available information on different countries with its own credit ratings
• Makes it easy to obtain export finance from banks/financial institutions
• Assists exporters in recovering bad debt
• Provides information on credit-worthiness of overseas buyers

Institutions in Financing of Foreign Trade

Business activities are conducted on a global level and even between nations. There is an emergence of global markets. To keep the trade fair and manage trade-related issues on a global level, various International Institutions and Trade Agreements were established.

International Trade Associations

The nations were influenced financially because of World War 1 and World War 2. The reconstruction couldn’t happen as there was an interruption in the financial system furthermore there was a shortage of resources. At this crossroads, the prominent economist J. M. Keynes with Bretton Woods establish an association with 44 countries to meet this and to reestablish commonship on the planet.

This gathering brought forth the International Monetary Fund (IMF) International bank Of Reconstruction and Development (IBRD) and the International Trade Organization (ITO). These three associations were considered as three columns for the improvement of the global economy.

World Bank

The International Bank of Reconstruction and Development (IBRD) is usually known as the World Bank. The fundamental point of IBRD is to remake the war influenced the economies of Europe and help the improvement of underdeveloped economies of the world. The World Bank after 1950 focused more on financially unstable nations and invested heavily into social segments like health and education of such immature nations.

Currently, the World Bank includes five universal bodies responsible for offering fund to various countries. These bodies and its partners are headquartered in Washington DC taking into account diverse financial requirements and necessities.

As specified before, the World Bank has been allocated the undertaking of financial development and expanding the extent of the international business. Amid its underlying years of foundation, it gave more significance on creating facilitates like transportation, health, energy and others.

This has profited the underdeveloped nations too, without doubt, however, because of poor regulatory structure, the absence of institutional system and absence of accessibility of skilled labour in these nations has prompted disappointment. World Bank and its Affiliates Institutions:

• International Bank for Reconstruction and Development (IBRD) 1945
• International Financial Corporation (IFC) 1956
• Multilateral Investment Guarantee Agency (MIGA) 1988
• International Development Association (IDA) 1960
• International Centre for Settlement of Investment Disputes (ICSID) 1966

The World Bank is no longer limited to simply offering money related help for infrastructure development, agriculture, industry, health and sanitation. It is somewhat significantly engaged with regions like reducing rural poverty, increasing income of the rural poor, offering specialized help, and beginning research schemes.

International Development Association (IDA)

International Development Association (IDA) was set up in 1960 as a partner of the World Bank. IDA was set up essentially to offer fund to the less developed countries on a soft loan basis. It is because of its intention of providing soft loans that it is called the Soft Loan Window of the IBRD. The objectives of IDA are as follows,

• To help the underdeveloped countries by giving loans in simple terms.
• Help at the end of poverty in the poorest nations
• Give macroeconomics services such as, for example, those relating to health, nutrition, education, human resource advancement and control of the population.
• To offer loans at marked down interests in order to energize economic development, the increment in manufacturing limit and good expectations for standard of living in the underdeveloped nations.

International Finance Corporation (IFC)

Established in July 1956, IFC was aimed to assist in terms of finance to the private sector of developing nations. IFC is also an associate of the World Bank, but it has its own separate legal entity, functions and funds. All the members of the World Bank are entitled to become members of IFC.

Multinational Investment Guarantee Agency (MIGA)

Established in April 1988, The Multinational Investment Guarantee Agency’s aim was to support the task of the World Bank and IFC. Some objectives of the MIGA are:-

• Advance the stream of direct foreign investment into less developed member countries.
• Give protection cover to fund supplier against political risks.
• Guarantee extension of current investment, privatization and economic reconstruction.
• Provide assurance against noncommercial perils, for example, dangers engaged in currency transfer, war and domestic clashes, and infringement of agreement.

Trade Cycle, also known as the business cycle, refers to the recurring fluctuations in economic activity characterized by periods of expansion, peak, contraction, and trough. These cycles reflect the natural rhythm of economic growth and contraction within a market economy. During expansion phases, economic output, employment, and consumer spending increase, leading to prosperity. Peaks mark the highest point of economic activity. Contractions, or recessions, follow, characterized by decreased production, rising unemployment, and reduced consumer spending. Finally, troughs represent the lowest point of the cycle, before the economy begins to recover. Understanding trade cycles is crucial for policymakers, businesses, and investors to anticipate and manage the impacts of economic fluctuations on various sectors and stakeholders.

Four Phases of a Trade cycle are:

1. Prosperity phase: Expansion or the upswing.
2. Recessionary phase: A turn from prosperity to depression (or upper turning point).
3. Depressionary phase: Contraction or downswing.
4. Revival or recovery phase: The turn from depression to prosperity (or lower turning point).

The above four phases of a trade cycle are shown in Fig. 1. These phases are recurrent and follow a regular sequence.

Phases of a Trade Cycle

1. Expansion Phase:

The expansion phase marks the beginning of the trade cycle. It is characterized by increasing economic activity across various sectors of the economy. During this phase, several key indicators typically show positive trends:

• Gross Domestic Product (GDP) Growth:

GDP, which measures the total value of goods and services produced within a country’s borders, tends to rise during the expansion phase. Increased production, consumer spending, and investment contribute to this growth.

• Employment:

As economic activity expands, businesses experience rising demand for goods and services. This often leads to increased hiring to meet the growing demand, resulting in lower unemployment rates.

• Consumer Spending:

Consumers tend to have more disposable income during periods of economic expansion, leading to increased spending on goods and services. This increased consumer demand further fuels economic growth.

• Business Investment:

Businesses are more likely to invest in capital goods, such as machinery and equipment, during the expansion phase. Higher confidence in future economic prospects encourages firms to expand their productive capacity to meet growing demand.

• Stock Market Performance:

Stock prices typically rise during the expansion phase as investors anticipate higher corporate profits and economic growth. Bull markets, characterized by rising stock prices, are common during this phase.

2. Peak Phase:

The peak phase represents the highest point of economic activity within the trade cycle. It is characterized by several key features:

• Full Capacity Utilization:

During the peak phase, resources such as labor and capital are fully utilized as demand for goods and services reaches its highest levels. Production may be operating at or near maximum capacity.

• Inflationary Pressures:

As demand outstrips supply during the peak phase, prices tend to rise, leading to inflationary pressures. This can be reflected in higher consumer prices, wage growth, and increased production costs.

• Tight Labor Market:

With low unemployment rates and high demand for labor, competition for workers intensifies during the peak phase. This can lead to wage increases and labor shortages in certain industries.

• Business Confidence:

Businesses may become increasingly optimistic about future economic prospects during the peak phase, leading to higher levels of investment and expansion plans.

• Stock Market Volatility:

While stock prices may continue to rise during the peak phase, volatility often increases as investors become more cautious about the sustainability of economic growth.

3. Contraction Phase:

Following the peak phase, the economy enters the contraction phase, also known as a recession or downturn. This phase is characterized by declining economic activity and several negative trends:

• GDP Contraction:

Economic output, as measured by GDP, begins to decline during the contraction phase as demand for goods and services weakens. This can be driven by factors such as reduced consumer spending, declining investment, and falling exports.

• Rising Unemployment:

As businesses cut back on production and investment in response to weakening demand, unemployment rates tend to rise. Layoffs and hiring freezes become more common as companies adjust to the downturn.

• Decreased Consumer Spending:

Consumer confidence often declines during the contraction phase, leading to reduced spending on discretionary goods and services. Consumers may prioritize essential purchases and cut back on non-essential items.

• Declining Business Investment:

Businesses become more cautious about investing in new capital projects and expansion plans during the contraction phase. Uncertainty about future economic conditions and weak demand can lead to a decrease in business investment.

• Stock Market Decline:

Stock prices typically fall during the contraction phase as investors react to negative economic news and uncertainty about future earnings prospects. Bear markets, characterized by falling stock prices, are common during recessions.

4. Trough Phase:

The trough phase represents the lowest point of the trade cycle and marks the end of the contraction phase. While economic conditions remain challenging, there are signs of stabilization and the beginning of recovery:

• Stabilization of Economic Indicators:

Economic indicators such as GDP, employment, and consumer spending may stabilize or show signs of improvement during the trough phase. The rate of decline in economic activity begins to slow down.

• Policy Responses:

Governments and central banks often implement monetary and fiscal policies to stimulate economic growth during the trough phase. These may include interest rate cuts, fiscal stimulus measures, and efforts to restore confidence in the financial system.

• Inventory Rebuilding:

Businesses may start to rebuild inventories during the trough phase in anticipation of future demand. This can contribute to a gradual increase in production and economic activity.

• Bottoming Out of Stock Market:

While stock prices may still be volatile during the trough phase, there may be signs that the market is bottoming out as investors anticipate a recovery in corporate earnings and economic growth.

• Early Signs of Recovery:

Some sectors of the economy may begin to show signs of improvement during the trough phase, signaling the start of the recovery process. These early indicators can include increased consumer confidence, rising business investment, and stabilization in housing markets.

Trade Cycle refers to fluctuations in economic activities specially in employment, output and income, prices, profits etc. It has been defined differently by different economists. According to Mitchell, “Business cycles are of fluctuations in the economic activities of organized communities. The adjective ‘business’ restricts the concept of fluctuations in activities which are systematically conducted on commercial basis.

Features of a Trade Cycle

• A business cycle is synchronic. When cyclical fluctuations start in one sector it spreads to other sectors.
• In a trade cycle, a period of prosperity is followed by a period of depression. Hence trade cycle is a wave like movement.
• Business cycle is recurrent and rhythmic; prosperity is followed by depression and vice versa.
• Trade cycle is cumulative and self-reinforcing. Each phase feeds on itself and creates further movement in the same direction.
• Trade cycle is asymmetrical. The prosperity phase is slow and gradual and the phase of depression is rapid.
• The business cycle is not periodical. Some trade cycles last for three or four years, while others last for six or eight or even more years.
• The impact of a trade cycle is differential. It affects different industries in different ways.
• Trade cycle is international in character. Through international trade, booms and depressions in one country are passed to other countries.

Theories of Trade Cycle

Many theories have been put forward from time to time to explain the phenomenon of trade cycles. These theories can be classified into non-monetary and monetary theories.

Non-Monetary Theories of Trade Cycle

(a) Sunspot Theory or Climatic Theory

It is the oldest theory of trade cycle. It is associated with W.S.Jevons and later on developed by H.C.Moore. According to this theory, the spot that appears on the sun influences the climatic conditions. When the spot appears, it will affect rainfall and hence agricultural crops.

When there is crop failure, that will result in depression. On the other hand, if the spot did not appear on the sun, rainfall is good leading to prosperity. Thus, the variations in climate are so regular that depression is followed by prosperity.

However, this theory is not accepted today. Trade cycle is a complex phenomenon and it cannot be associated with climatic conditions. If this theory is correct, then industrialised countries should be free from cyclical fluctuations. But it is the advanced, industrialised countries which are affected by trade cycles.

(b) Psychological Theory

This theory was developed by A.C. Pigou. He emphasized the role of psychological factor in the generation of trade cycles. According to Pigou, the main cause for trade cycle is optimism and pessimism among business people and bankers. During the period of good trade, entrepreneurs become optimistic which would lead to increase in production.

The feeling of optimism is spread to other. Hence investments are increased beyond limits and there is over production, which results in losses. Entrepreneurs become pessimistic and reduce their investment and production. Thus, fluctuations are due to optimism leading to prosperity and pessimism resulting depression.

Though there is an element of truth in this theory, this theory is unable to explain the occurrence of boom and starting of revival. Further this theory fails to explain the periodicity of trade cycle.

(c) Overinvestment Theory

Arthur Spiethoff and D.H. Robertson have developed the over investment theory. It is based on Say’s law of markets. It believes that over production in one sector leads to over production in other sectors. Suppose, there is over production and excess supply in one sector, that will result in fall in price and income of the people employed in that sector. Fall in income will lead to a decline in demand for goods and services produced by other sectors. This will create over production in other sectors.

Spiethoff has pointed out that over investment is the cause for trade cycle. Over investment is due to indivisibility of investment and excess supply of bank credit. He gives the example of a railway company which lays down one more track to avoid traffic congestion. But this may result in excess capacity because the additional traffic may not be sufficient to utilise the second track fully.

Over investment and overproduction are encouraged by monetary factors. If the banking system places more money in the hands of entrepreneurs, prices will increase. The rise in prices may induce the entrepreneurs to increase their investments leading to over-investment. Thus Prof. Robertson has successfully combined real and monetary factors to explain business cycle.

This theory is realistic in the sense that it considers over investment as the cause of trade cycle. But it has failed to explain revival.

(d) Over-Saving or Under Consumption Theory

This theory is the oldest explanation of the cyclical fluctuations. This theory has been formulated by Malthus, Marx and Hobson. According to this theory, depression is due to over-saving. In the modern society, there is great inequalities of income. Rich people have large income but their marginal propensity to consume is less.

Hence they save and invest which results in an increase in the volume of goods. This causes a general glut in the market. At the same time, as majority of the people are poor, they have low propensity to consume. Therefore, consumption will not increase. Increase in the supply of goods and decline in the demand create under consumption and hence over production.

This theory is not free from criticism. This theory explains only the turning point from prosperity to depression. It does not say anything about recovery. This theory assumes that the amount saved would be automatically invested. But this is not true. It pays too much attention on saving and too little on others.

(e) Keynes’ Theory of Trade Cycles

Keynes doesn’t develop a complete and pure theory of trade cycles. According to Keynes, effective demand is composed of consumption and investment expenditure. It is effective demand which determines the level of income and employment.

Therefore, changes in total expenditure i.e., consumption and investment expenditures, affect effective demand and this will bring about fluctuation in economic activity. Keynes believes that consumption expenditure is stable and it is the fluctuation in investment expenditure which is responsible for changes in output, income and employment.

Investment depends on rate of interest and marginal efficiency of capital. Since rate of interest is more or less stable, marginal efficiency of capital determines investment. Marginal efficiency of capital depends on two factors – prospective yield and supply price of the capital asset. An increase in MEC will create more employment, output and income leading to prosperity. On the other hand, a decline in MEC leads to unemployment and fall in income and output. It results in depression.

During the period of expansion businessmen are optimistic. MEC is rapidly increasing and rate of interest is sticky. So entrepreneurs undertake new investment. The process of expansion goes on till the boom is reached. As the process of expansion continues, cost of production increases, due to scarcity of factors of production. This will lead to a fall in MEC. Further, price of the product falls due to abundant supply leading to a decline in profits.

This leads to depression. As time passes, existing machinery becomes worn out and has to be replaced. Surplus stocks of goods are exhausted. As there is a fall in price of raw-materials and equipment, costs fall. Wages also go down. MEC increases leading to recovery. Keynes states that, “Trade cycle can be described and analyzed in terms of the fluctuations of the marginal efficiency of capital relatively to the rate of interest”.

The merit of Keynes’ theory lies in explaining the turning points-the lower and upper turning points of a trade cycle. The earlier economists considered the changes in the amount of credit given by banking system to be responsible for cyclical fluctuations. But for Keynes, the change in consumption function with its effect on MEC is responsible for trade cycle. Keynes, thus, has given a satisfactory explanation of the turning points of the trade cycle, “Keynes consumption function filled a serious gap and corrected a serious error in the previous theory of the business cycle”.

Critics have pointed out the weakness of Keynes’ theory. Firstly, according to Keynes the main cause for trade cycle is the fluctuations in MEC. But the term marginal efficiency of capital is vague. MEC depends on the expectations of the entrepreneur about future. In this sense, it is similar to that of Pigou’s psychological theory. He has ignored real factors.

Secondly, Keynes assumes that rate of interest is stable. But rate of interest does play an important role in decision making process of entrepreneurs.

Thirdly, Keynes does not explain periodicity of trade cycle. In a period of recession and depression, according to Keynes, rate of interest should be high due to strong liquidity preference. But, during this period, rate of interest is very low. Similarly during boom, rate of interest should be low because of weak liquidity preference; but actually the rate of interest is high.

(f) Schumpeter’s Innovation Theory

Joseph A. Schumpeter has developed innovation theory of trade cycles. An innovation includes the discovery of a new product, opening of a new market, reorganization of an industry and development of a new method of production. These innovations may reduce the cost of production and may shift the demand curve. Thus innovations may bring about changes in economic conditions.

Suppose, at the full employment level, an innovation in the form of a new product has been introduced. Innovation is financed by bank loans. As there is full employment already, factors of production have to be withdrawn from others to manufacture the new product. Hence, due to competition for factors of production costs may go up, leading to an increase in price.

When the new product becomes successful, other entrepreneurs will also produce similar products. This will result in cumulative expansion and prosperity. When the innovation is adopted by many, supernormal profits will be competed away. Firms incurring losses will go out of business. Employment, output and income fall resulting in depression.

Schumpeter’s theory has been criticised on the following grounds.

Firstly, Schumpter’s theory is based on two assumptions viz., full employment and that innovation is being financed by banks. But full employment is an unrealistic assumption, as no country in the world has achieved full employment. Further innovation is usually financed by the promoters and not by banks. Secondly, innovation is not the only cause of business cycle. There are many other causes which have not been analysed by Schumpter.

Monetary Theories of Trade Cycles

(a) Over-Investment Theory

Prof. Von Hayek in his books on “Monetary Theory and Trade Cycle” and “Prices and Production” has developed a theory of trade cycle. He has distinguished between equilibrium or natural rate of interest and market rate of interest. Market rate of interest is one at which demand for and supply of money are equal.

Equilibrium rate of interest is one at which savings are equal to investment. If both equilibrium rate of interest and market rate of interest are equal, there will be stability in the economy. If equilibrium rate of interest is higher than market rate of interest there will be prosperity and vice versa.

For instance, if the market rate of interest is lower than equilibrium rate of interest due to increase in money supply, investment will go up. The demand for capital goods will increase leading to a rise in price of these goods. As a result, there will be a diversion of resources from consumption goods industries to capital goods industries. Employment and income of the factors of production in capital goods industries will increase.

This will increase the demand for consumption goods. There will be competition for factors of production between capital goods and consumption good industries. Factor prices go up. Cost of production increases. At this time, banks will decide to reduce credit expansion. This will lead to rise in market rate of interest above the equilibrium rate of interest. Investment will fall; production declines leading to depression.

Hayek’s theory has certain weaknesses:-

• It is not easy to transfer resources from capital goods industries to consumer goods industries and vice versa.
• This theory does not explain all the phases of trade cycle.
• It gives too much importance to rate of interest in determining investment. It has neglected other factors determining investment.
• Hayek has suggested that the volume of money supply should be kept neutral to solve the problem of cyclical fluctuations. But this concept of neutrality of money is based on old quantity theory of money which has lost its validity.

(b) Hawtrey’s Monetary Theory

Prof. Hawtrey considers trade cycle to be a purely monetary phenomenon. According to him non-monetary factors like wars, strike, floods, drought may cause only temporary depression. Hawtrey believes that expansion and contraction of money are the basic causes of trade cycle. Money supply changes due to changes in rates of interest.

When rate of interest is reduced by banks, entrepreneurs will borrow more and invest. This causes an increase in money supply and rise in price leading to expansion. On the other hand, an increase in the rate of interest will lead to reduction in borrowing, investment, prices and business activity and hence depression.

Hawtrey believes that trade cycle is nothing but small scale replica of inflation and deflation. An increase in money supply will lead to boom and vice versa, a decrease in money supply will result in depression.

Banks will give more loans to traders and merchants by lowering the rate of interest. Merchants place more orders which induce the entrepreneurs to increase production by employing more labourers. This results in increase in employment and income leading to an increase in demand for goods. Thus the phase of expansion starts.

Business expands; factors of production are fully employed; price increases further, resulting in boom conditions. At this time, the banks call off loans from the borrowers. In order to repay the loans, the borrowers sell their stocks. This sudden disposal of goods leads to fall in prices and liquidation of marginal firms. Banks will further contract credit.

Thus the period of contraction starts making the producers reduce their output. The process of contraction becomes cumulative leading to depression. When the economy is at the level of depression, banks have excess reserves. Therefore, banks will lend at a low rate of interest which makes the entrepreneurs to borrow more. Thus revival starts, becomes cumulative and leads to boom.

Hawtrey’s theory has been criticised on many grounds

• Hawtrey’s theory is considered to be an incomplete theory as it does not take into account the non-monetary factors which cause trade cycles.
• It is wrong to say that banks alone cause business cycle. Credit expansion and contraction do not lead to boom and depression. But they are accentuated by bank credit.
• The theory exaggerates the importance of bank credit as a means of financing development. In recent years, all firms resort to plough back of profits for expansion.
• Mere contraction of bank credit will not lead to depression if marginal efficiency of capital is high. Businessmen will undertake investment in-spite of high rate of interest if they feel that the future prospects are bright.
• Rate of interest does not determine the level of borrowing and investment. A high rate of interest will not prevent the people to borrow. Therefore, it may be stated that banking system cannot originate a trade cycle. Expansion and contraction of credit may be a supplementary cause but not the main and sole cause of trade cycle.