External Sector and International Organisations

Think of a country as one big household that trades with the rest of the world. Over a year it sells goods and services abroad and gets foreign money; it buys goods and services from abroad and pays foreign money; its people send money home and abroad; foreigners invest here and Indians invest outside. The Balance of Payments (BoP) is the household's account book of all these money flows with the rest of the world in one year. It has two main parts: the current account (what we earn and spend on goods, services and transfers) and the capital account (what we borrow, lend and invest). Whatever the current account lacks, the capital account must cover, or the country uses up its foreign exchange reserves.

Balance of Trade (BoT) counts only goods (exports minus imports of merchandise). Balance of Payments counts goods, services, income, transfers and capital flows. So BoT is a small part of BoP. A country can have a BoT deficit and still have a healthy BoP if services exports, remittances and capital inflows are large, which is exactly India's position. BoT is in surplus when exports of goods exceed imports, and in deficit when imports exceed exports.

Foreign exchange reserves are the foreign assets held by the RBI, which is their custodian: foreign currency assets (by far the largest part, mostly US government securities and deposits), gold, Special Drawing Rights (SDRs) with the IMF and India's reserve tranche position in the IMF. They protect the country in a crisis and pay for imports; economists measure their strength by how many months of imports they can cover. In 1991 they could pay for barely two weeks. Reserves crossed US$ 700 billion for the first time in September 2024. Low reserves are a critical problem precisely because a country then cannot afford to pay for essential imports and is forced to borrow on harsh terms.

When Radhika's father sends money from Dubai, the bank does not just credit rupees; it first converts dirhams into rupees at a rate. That rate is the foreign exchange rate: the price of one currency in terms of another, for example Rs 85 for one US dollar. Because it is a price, it behaves like one: it rises when demand rises and falls when supply rises. People and firms demand foreign exchange to pay for imports, foreign education and travel, and to invest abroad; they supply it when they export, receive remittances or when foreigners invest in India. The big question is who fixes this price: the market or the government? Different countries and different periods answer differently, and each answer has its own vocabulary.

A foreign investor can come to India in two very different ways. He can build a factory and stay for twenty years (that is FDI), or he can buy shares on the stock exchange in the morning and sell them by evening (that is FPI). Both bring dollars, but the first brings jobs, technology and a long-term partner, while the second can leave overnight and shake the rupee. This difference is why policy-makers welcome FDI warmly and watch FPI nervously. This topic also tells the story of how India's trade policy changed: from keeping foreign goods out (import substitution until 1991) to inviting trade and investment in (after 1991).

Why do policy-makers prefer FDI to FPI? FDI builds productive assets (plants, offices, research centres) and is less sensitive to interest-rate differences, so it is less likely to flee in a panic. FPI goes where returns are higher and can reverse quickly, causing sudden rupee falls and stock market crashes. Both count as capital account inflows and both add to foreign exchange reserves, but only FDI also adds to long-term capacity.

After the Second World War the world remembered what high tariffs had done in the 1930s: every country shut its doors and everyone became poorer. So the Bretton Woods generation wanted three bodies: the IMF for money, the World Bank for reconstruction and an International Trade Organization for trade. The third body was never born, because the United States did not ratify its charter. What survived was a modest agreement, the GATT (General Agreement on Tariffs and Trade, 1947), which ran for nearly fifty years as a 'temporary' club and finally became the World Trade Organization (WTO) on 1 January 1995. In this topic you learn the WTO, its rule-book, its sibling UNCTAD, and the web of bilateral and regional trade agreements India has signed.

Two ideas run through every WTO agreement. Most Favoured Nation (MFN): a favour given to one member (a lower tariff) must be given to all members; the name is misleading, because it really means non-discrimination. National Treatment: once imported goods have entered, they must be treated no less favourably than local goods. Developing countries like India also get special and differential treatment: longer time to implement and some flexibility.

A CEPA or CECA (Comprehensive Economic Partnership / Cooperation Agreement) goes beyond an FTA: besides cutting tariffs on goods, it covers services, investment, rules of origin and cooperation in other areas. A bilateral agreement is between two parties, a regional one among a group of neighbours, and a multilateral one (the WTO) among nearly everyone. The main goal of a bilateral trade agreement is to promote free trade between two countries by lowering barriers.

After the Second World War the world's leaders wanted to avoid two things: the currency chaos and the beggar-thy-neighbour trade wars of the 1930s. In July 1944, delegates of 44 countries met at Bretton Woods (New Hampshire, USA) and designed two institutions. One would keep the system of exchange rates and payments stable and lend to countries in balance-of-payments trouble: the International Monetary Fund (IMF). The other would finance reconstruction and later development: the International Bank for Reconstruction and Development (IBRD), today the core of the World Bank. Both sit in Washington DC and India is a founding member of both. Later, developing countries felt these two were dominated by rich nations, and so newer banks appeared: the Asian Development Bank (1966), the Asian Infrastructure Investment Bank (2016) and the New Development Bank (2015).

One-line split: the IMF is the fire brigade for the balance of payments (short-term, macro stability), while the World Bank is the builder of development (long-term, projects and poverty). In the 1991 crisis India went to the IMF for a balance-of-payments loan; the World Bank supported the reforms that followed.

SDR (Special Drawing Right): an international reserve asset created by the IMF in 1969. It is not a coin or a note; it is a claim on a basket of currencies, so a country can use it to obtain freely usable currency. The basket has the US dollar, euro, Chinese yuan (added in 2016), Japanese yen and pound sterling (as of 2025).

Why the NDB is different: in the IMF and World Bank, voting power follows the money (quota or capital share), so the rich hold the most votes. In the NDB the five founders hold equal shares and equal votes, which is why it is seen as a more equal partnership of emerging economies. It also has a Contingent Reserve Arrangement (CRA) of US$100 billion, a BRICS pool to help members facing short-term payment pressure.

Not every international body is a bank or a rule-maker. Some are clubs of countries that meet to coordinate their economic policy: the BRICS (large emerging economies), the G20 (the biggest economies, old and new), the G7 (rich industrial democracies), the OECD (a policy think-tank of mostly rich countries) and OPEC (oil exporters who coordinate output). The exam does not ask long essays about them; it asks who coined it, when it began, how many members, where the headquarters is. So think of each group as a small identity card: name, year, members, headquarters, purpose. This topic builds those cards.

BRICS is an economic and political forum, not a military alliance and not a treaty organisation. Its purpose is cooperation among large emerging economies and a larger voice for them in global economic governance (reform of the IMF and World Bank, a multipolar world). Unlike the G7, which is a club of rich industrial democracies, BRICS brings together emerging economies from several continents. It has no permanent headquarters; the chair rotates every year, and India holds the BRICS chair in 2026.

India's G20 presidency: from 1 December 2022 to 30 November 2023, with the theme "One Earth, One Family, One Future" (Vasudhaiva Kutumbakam). The leaders' summit was held in New Delhi on 9-10 September 2023. Two outcomes are asked often: the African Union became a permanent member, and the India-Middle East-Europe Economic Corridor (IMEC) was announced. Brazil held the presidency in 2024 and South Africa in 2025.