Module 2 - The International Flow of Funds

The international flow of funds

 takes place when the transactions of buying and selling
o take place between the international market
 by means of international business that is export and
import from one country to another country.

o The transactions of international business cause the flow of

funds from one country to another which facilitates imports
and exports from one country to another

o and helps into money to flow from one to another market.

o The financial managers of many multinational corporations

keep an eye on the changing trends of the flow of international
business transactions.

o The flow of international business transactions is measured by

the balance of payment in a country.

o The balance of payment statement shows the changes in the

transactions that took place between two countries at an
international level

o The balance of payment statement shows also the fluctuations

in their specific exchange rates of foreign currency.

o The key components included in the balance of payment and the

reasons why the economic factors and other non-economic
factors influence the international flow of funds.

Balance of Payments
The balance of payment

 shows the value of all the transactions that took place between the
domestic and the foreign residents in a specific period of time.

 All of these transactions are recorded in double entry system of

accounting and each transaction has two sides one is debit and the
other is credit.

o So, the balance of payment is the aggregate of both the

transactions.

 The balance of payment can be in surplus or in deficit within a

specific period of time.

 When the export transactions are more than the import transactions
in a given specific period of time it is said as the surplus balance of
payment.

 On the other hand, when the export transactions are less than the
import transactions of the country in a given specific period of time it
is said as deficit balance of payment.

Two Components of the Balance of Payment

1) Current Account

o The short term transactions of a country and the difference

between the savings and the deposits aggregately constitutes
the current account of the balance of payment.

o The transactions in the current account consist of:

 export and import transactions of goods,

 export and import transactions of the services,
 money transfers
  income from the factors like land and foreign shares.
 The total of the current account balance is also stated as
the balance of trade as a subpart of the balance of
payment.

2) Capital Account

o The sum of total inflow and outflow of capital that directly

affect a nation’s foreign assets and liabilities is aggregate
constitutes a capital account.

o It includes all the trade transactions of international business

between one country or a nation or the other country or nation.

o The investments and loans of foreign countries,

o banking and other forms of foreign capital and

o any changes in the foreign reserves all these items are included
in the capital account of the balance of payment.

o All the transactions that are related to the export services by the
United States result in the inflow of funds to the United States

o and all the transactions related to the import services are the
reason behind the outflow of the funds from the United States.

Factors Influencing International Flow of Funds

1. Impact of Inflation

 If the inflation rate of a country increases or rises as compared

to the other countries with whom they trade, then the value of
the current account will decrease after taking an assumption
that all the other factors are constant.
  the country’s exports will decrease as no one would like
to purchase at inflated prices

 the imports of the country will increase as the local

companies will also purchase products from the overseas
market as they can buy from them at a low price which
will definitely assist their working by saving their costs.

2. National Income

 If the gross domestic product of a country increase, it gives a

rise to the per capita income of the people of the country

o It increases the consumption as well as the spending of

the country

o this will definitely increase the demand for the foreign

goods

o this will give adverse impact on the balance of payment

as the imports of the country will increase with the
increase in the level of income of the public.

3. Government policies of a country

 The government policies of a country impact the most on the

trade between two countries at an international level.

 The policies of a country help them or restrict them to do

import and export transactions with the other countries that
can totally change the conditions of the balance of payment

 balance of trade of a country can determine the growth pattern

of a country.
  This is one of the most important factors that affects and
controls the flow of funds from one country to the other

 this constitutes the international trade and flow of funds from

one country to another country.

4. Subsidies provided for traders

 The rate subsidies decide the volume of exports in a country.

o If a country promotes exports then it tends to provide a

lot of subsidies on international trade and mainly on the
export activities.

 In India, huge subsidies are provided on the exports

of goods and services from India to any other
country

 In China where they receive free loans and the free

lands from the government for the production of
goods and services that can be exported in future

 these firms incurred a very low cost of operation as

 most of their fixed cost and fluctuating costs

are subsidizes by the government.

 to promote the international flow

of funds

 for the overall development of the

economy

 for the development of the

country and its growth in respect
of other countries.
 o These subsidies are helpful for a countries exporters and
importers to capture the larger share of the global market.

5. Restriction on imports

 If a country imposes heavy duties on the imports and related

activities

o it will help the country to improve their balance of

payment position

o the public will not be able to purchase the goods and

products from the other countries

o if they will purchase it will decrease their profitability as

the heavy duties are levied on the imports of the goods

o it will increase their cost of production

 if the country levied less duty on the imports

o then people will import more and more from other

countries

o this will adversely affect the balance of payment position

of a country.

6. Restrictions on the piracy

 a government can affect international trade flows by its lack of

restrictions on piracy.

7. Impact of exchange rates of foreign currency

 Each country’s currency is valued in terms of other currencies

  If the foreign currency in which the export or import
transactions takes place

 more fluctuates at a higher level,

o the balance of payment for that specific period will also

fluctuate at a greater extent and somehow equal to the
extent of changes in the foreign currency in the
international market.

Advantages of International Flow of Funds

1. Increase Aggregate Demand

 The demand for the products overall increases if the

international flow of funds is allowed in a country.

 Before the implementation of globalization all over the world

the demand for the local products were not so good and many
of the industries has faced failure before the globalization

 as the international trade was allowed, the demand for the

local, as well as international product, got a rise

2. Increased Production Capacity

 After the globalization era, many countries emerged as a

manufacturing hub for one or the other good

 existing production capacity also rise

 the manufacturing units as they now had buyers for their

products in a huge quantity which has increased their profits
and thus their production capacity as well.
3. Technological Advancement

 If the import and export from one country to the another is easy
and promoted then the country also becomes technologically
advanced as the new and innovated technology can easily float
from one country to the another.

 if the import and export policy from one country to the other is
restricted then the country becomes obsolete in terms of the
technology and innovations used by them for various purposes
of manufacturing and research and development activities.

4. The surplus on the financial account of the balance of payment

 Capital inflows from any other country out of the world can
help to finance a current account deficit.

 Without these capital inflows, a current account deficit would

lead to a devaluation in the ex-change rate to restore
equilibrium in the balance of payments.

5. Easy Finances

 In the international market the flow of funds is very easy

 it assists the domestic companies and even government to raise

funds from outside the country which is easier with the help of
the flow of funds from outside the country by means of foreign
direct investment.

6. The inflow of Foreign Currencies

 The international flow of funds helps the country to get foreign
currency easily as all the transactions of imports and exports
take place in the foreign currency only.
Disadvantages of International Flow of Funds

1. The loss to Domestic Players

 Internationalization of flow of funds that means the promotion

of imports and exports transaction can destroy the market of
domestic players.

 The domestic market gets affected when the international

player enters the domestic market with its more advanced
products and services and destroys the domestic players.

2. Tax Evasion

 International companies like Facebook and Amazon move to

the countries that have lower tax foundations.

 The companies save their expenditure on corporate taxation by

operating in the underdeveloped and developing countries
where the tax on doing business and related activities is very
less.

o For example; Amazon – Luxumberg, Google in Ireland.

3. Destroying the real estate market

 The international flow of funds can also be in the way of

purchase of assets or real estate property in the other country.

 Many multinational companies invest in the real estate

property in the other countries which helps them:

 to curtail their profits in the form of investments in the

other countries

 to reduce their tax liability on the profits.

  This sometimes increases the price of the real estate
property in the domestic country as multinational
corporations set up their plants in a particular area.

4. Money Laundering

 There can be money laundering when the funds are easily

allowed to flow from one country to another country

 may become the cause of many illegal and criminal

activities like terrorist attacks and emergence of black
money in the banks of other countries.

Take Note:

The international flow of funds takes place when the transactions of

buying and selling take place between the international market by
means of international business that is export and import from one
country to another country.

The balance of payment shows the value of all the transactions that
took place between the domestic and the foreign residents in a
specific period of time.

The international flow of funds assists the countries to make

themselves technologically advanced and helps them to promote
trade between them and the developed countries which is helpful for
the customers as they will be able to have a more variety of products
and services from all the service providers in all over the world.

The international flow of funds is good in most of the aspects for the
development of a country and the world’s economy.