IBO 01 International Business Environment Solved Question Paper June 2026 for IGNOU M.Com and PGDIBO

Q2. Balance of Payments and Disequilibrium

Q2. What is balance of payments ? How does disequilibrium occur in balance of payments ? Describe the methods of correcting the disequilibrium. (20 marks)

Meaning of balance of payments

The balance of payments (BoP) is a systematic record of all economic transactions between the residents of a country and the rest of the world during a given period, usually one financial year. It covers trade in goods and services, income flows, transfers and the movement of capital. In India, the Reserve Bank of India compiles and publishes the BoP every quarter.

The BoP is prepared on the double-entry principle. Every receipt from abroad, such as export earnings or an inflow of foreign investment, is a credit. Every payment abroad, such as an import bill or interest on foreign debt, is a debit.

Structure of the balance of payments

Why the BoP always balances, and what disequilibrium means

In an accounting sense the BoP always balances, because double entry makes total credits equal total debits. Economists therefore separate autonomous transactions, which happen for their own sake (exports, imports, investment), from accommodating transactions, which happen only to fill a gap (drawing down reserves or borrowing from the IMF).

Disequilibrium exists when autonomous receipts do not equal autonomous payments. If autonomous payments are larger, the country has a BoP deficit and must run down reserves or borrow. If autonomous receipts are larger, it has a surplus and builds up reserves.

Types of disequilibrium

• Cyclical disequilibrium: arises from trade cycles. A recession abroad cuts demand for a country's exports while its imports stay high.
• Secular disequilibrium: a long-run deficit seen in developing economies, where investment needs run ahead of domestic savings and exports.
• Structural disequilibrium: caused by a change in the structure of demand or supply, such as a fall in world demand for a country's main export or the loss of a key raw material.
• Fundamental disequilibrium: the IMF's term for a persistent imbalance that cannot be corrected without changing the exchange rate or the structure of the economy.

How disequilibrium occurs: the main causes

1. Development spending: a growing economy imports capital goods, technology and fuel faster than its exports grow. India's high dependence on imported crude oil is a standing example.
2. Inflation: when domestic prices rise faster than world prices, exports become costlier abroad and imports become cheaper at home, so the trade balance worsens.
3. Fall in export demand: recession in partner countries, new competitors or tougher standards abroad can cut export earnings sharply.
4. Overvalued exchange rate: if the currency is held above its market level, exports lose price competitiveness and imports rise.
5. External shocks: a jump in oil prices or a war can raise the import bill and cut remittances at the same time.
6. Capital flight and debt servicing: political instability or loss of investor confidence leads to outflow of short-term capital, while heavy repayment of past loans drains reserves.
7. Demonstration effect: people in developing countries copy consumption patterns of richer nations, which raises demand for imported goods.

India's 1991 crisis shows several causes acting together. The Gulf War raised oil prices and hit remittances, NRI deposits flowed out and reserves fell to a level that covered only a few weeks of imports. India pledged gold abroad, devalued the rupee in two steps in July 1991 and turned to the IMF before starting wider reforms.

Methods of correcting the disequilibrium

Corrective measures fall into two groups. Expenditure-reducing measures cut total spending, including spending on imports. Expenditure-switching measures shift spending from foreign goods to home goods.

1. Monetary measures (deflation): the central bank raises the policy rate, sells securities or raises reserve ratios. Lower money supply reduces income and prices, so imports fall and exports become more competitive. The cost is slower growth and possible unemployment.
2. Devaluation or depreciation: under a fixed rate the government lowers the external value of the currency; under a floating rate the market does it. Exports become cheaper and imports dearer. It works only if the Marshall-Lerner condition holds, that is, the sum of the price elasticities of demand for exports and imports exceeds one.
3. Exchange control: the central bank takes charge of all foreign exchange and rations it for essential imports. India used this route widely under FERA 1973, before FEMA 1999 replaced it with a management approach.
4. Trade measures: import duties, quotas and licensing reduce imports, while export promotion through incentives, export processing zones and marketing support raises earnings. These must now respect WTO rules.
5. Fiscal measures: cutting the fiscal deficit and taxing luxury imports lowers the demand that spills over into imports.
6. Attracting capital inflows: liberal FDI rules, special deposit schemes for NRIs (such as Resurgent India Bonds in 1998 and India Millennium Deposits in 2000) and foreign borrowing finance the gap.
7. Official financing: IMF facilities and drawing down reserves give breathing time, but they only finance a deficit; they do not remove its cause.

Conclusion

No single tool corrects every BoP deficit. Short-run gaps can be financed through reserves, borrowing or the IMF, but lasting balance needs higher productivity, competitive exports, a realistic exchange rate and stable inflow of long-term capital. India's post-1991 record shows that combining exchange rate reform with export growth and foreign investment works better than relying on controls alone.

Q7. Foreign Direct Investment and India's FDI Policy

Q7. What is foreign direct investment (FDI) ? Distinguish it from foreign portfolio investment (FIIs). Why is FDI preferable to other routes of international business ? Explain briefly India’s policy towards FDI since 1991. (20 marks)

Meaning of foreign direct investment

Foreign direct investment is investment made by a resident of one country in an enterprise in another country with the aim of gaining a lasting interest and a significant say in its management. The IMF and OECD treat ownership of 10% or more of the voting power as the mark of a direct investment relationship.

FDI can take the form of a new subsidiary built from the ground up (greenfield investment), the purchase of an existing company (brownfield investment, often through cross-border mergers and acquisitions) or a joint venture with a local partner. In India, the FEMA (Non-debt Instruments) Rules, 2019 treat an investment of 10% or more in a listed Indian company, and any investment in an unlisted company, as FDI.

FDI and foreign portfolio investment compared

The question uses the older term FIIs. In 2014 SEBI merged foreign institutional investors and qualified foreign investors into one category called foreign portfolio investors (FPIs), now governed by the SEBI (Foreign Portfolio Investors) Regulations, 2019.

Why FDI is preferable to other routes of international business

A firm can serve a foreign market by exporting, licensing, franchising, contract manufacturing or portfolio investment. FDI is usually the preferred route, for both the investing firm and the host country, for these reasons:

1. Full control: the investor controls production, quality and marketing, which licensing and franchising cannot guarantee.
2. Protection of know-how: technology and brand stay inside the firm instead of being handed to a licensee who may become a future competitor.
3. Jumping trade barriers: producing inside the host market avoids tariffs, quotas and transport costs that hit exports.
4. Closeness to customers: local production makes it easier to adapt products and respond to demand quickly.
5. Non-debt capital for the host: unlike external loans, FDI carries no fixed repayment or interest burden; the investor shares the business risk.
6. Stability: FDI is tied to physical assets, so it does not flee at the first sign of trouble the way portfolio money can.
7. Spillovers: the host country gains technology, managerial skills, employment, supplier development and export capacity.

FDI is not without limits. It can crowd out local firms, lead to profit repatriation and raise concerns in strategic sectors, which is why host countries still regulate it.

India's policy towards FDI since 1991

Before 1991, FDI in India was tightly controlled under FERA 1973, which generally limited foreign equity to 40%. The New Industrial Policy of July 1991 opened the door, and policy has since moved steadily towards liberalisation.

Routes of entry today: under the automatic route, the investor only reports to the RBI after the investment. Under the government route, prior approval from the ministry concerned is needed. A few sectors remain closed, including lottery, gambling and betting, chit funds, Nidhi companies, real estate business, manufacture of tobacco cigars and cigarettes, atomic energy and most railway operations.

Outcome: DPIIT reported that India's cumulative FDI inflows since April 2000 crossed USD 1 trillion in 2024. Services, computer software and hardware, trading and telecom have drawn the largest shares.

Conclusion

FDI differs from portfolio investment in control, stability and what it builds on the ground, which is why both firms and host countries prefer it. India has moved from the controlled regime of FERA to a largely automatic, rule-based policy, while keeping security checks such as Press Note 3 for sensitive sources and sectors.