Trade Deficit

  • December 19, 2022
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Trade Deficit

Subject :Economy

Context:

Exports grew by 0.6 per cent over November 2021 while imports grew by 5.4 per cent over the same month last year leading to widening of the current account deficit.

Details:

India’s trade deficit during April to November stood at $196 billion highest in the last 10 years.

Trade Deficit:

  • Trade deficit or negative balance of trade (BOT) is the gap between exports and imports. 
  • When money spent on imports exceeds that spent on exports in a country-a trade deficit occurs.
  • The opposite of a trade deficit is a trade surplus.
  • India tends to have a trade deficit every year because it imports far more (in terms of value, measured in $) than it exports.
  • A trade deficit implies that Indians need dollars/forex more than the rest of the world needs rupees for the trades to settle.
  • A trade deficit puts pressure on the rupee’s exchange rate against the dollar and persistently high trade deficits tend to weaken the rupee’s exchange rate.
  • It is a part of the Current Account Deficit.
    • The current account records exports and imports in goods and services and transfer payments. It represents a country’s transactions with the rest of the world and, like the capital account, is a component of a country’s Balance of Payments (BOP).
    • There is a deficit in Current Account if the value of the goods and services imported exceeds the value of those exported.
    • Major components are:
      • Goods,
      • Services, and
      • Net earnings on overseas investments (such as interests and dividend) and net transfer of payments over a period of time, such as remittances.
    • Current Account Balance = Trade gap + Net current transfers + Net income abroad.
      • Trade gap/Trade deficit = Exports – Imports

What causes a trade deficit?

  • Fall in export and rise in import volume
  • Rise in Import price or fall in the export price-India’s exports of a particular commodity, say bananas, doubles in value terms ($ terms) not because India exports more bananas, but because the price of bananas in the international market has doubled.

Is a trade deficit bad for a country’s economy?

  • If the trade deficit increases, a country’s GDP decreases. 
  • A higher trade deficit can decrease the local currency’s value.
  • Impact the jobs market and lead to an increase in unemployment. If more mobiles are imported and less produced locally, then there will be less local jobs in that sector.
  • More imports contribute to imported inflation and an increase in the fiscal imbalance, which is damaging to a developing country.

Balance of Payments

Balance of Payments (BoP) of a country can be defined as a systematic statement of all economic transactions of a country with the rest of the world during a specific period usually one year.

For preparing BoP accounts, economic transactions between a country and the rest of the world are grouped under – Current account, Capital account and Errors and Omissions. It also shows changes in Foreign Exchange Reserves.

  • Current Account: It shows export and import of visibles (also called merchandise or goods – represent trade balance) and invisibles (also called non-merchandise). Invisibles include services, transfers and income. Thus,
    • The balance of trade in goods
    • The balance of trade in services.
    • Net current income e.g. profit from overseas investment.
    • Transfer payments e.g. payments to the EU.

The balance of exports and imports of goods is referred to as the trade balance. Trade Balance is a part of ‘Current Account Balance’.

  • Capital Account: It shows a capital expenditure and income for a country. It gives a summary of the net flow of both private and public investment into an economy. External Commercial Borrowing (ECB), Foreign Direct Investment, Foreign Portfolio Investment, etc form a part of capital account.
  • Errors and Omissions: Sometimes the balance of payments does not balance. This imbalance is shown in the BoP as errors and omissions. It reflects the country’s inability to record all international transactions accurately.
  • Changes in Foreign Exchange Reserves: Movements in the reserves comprises changes in the foreign currency assets held by the Reserve Bank of India (RBI) and also in Special Drawing Rights (SDR) balances.

Overall the BoP account can be a surplus or a deficit. If there is a deficit then it can be bridged by taking money from the Foreign Exchange (Forex) Account

Current Account Deficit-

It is expected that the current account deficit of India will  widen to a 10-year high of 3 percent of GDP in FY23 due to the Ukraine War

A current account deficit occurs when the total value of goods and services a country imports exceeds the total value of goods and services it exports. If there is a deficit on the current account, there will be a surplus on the Financial/Capital account to compensate for the net withdrawals.

The size of current account deficit/surplus is affected by several factors including:

  • Overvalued exchange rate-If the currency is overvalued, imports will be cheaper, and therefore there will be a higher quantity of imports. Exports will become uncompetitive, and therefore there will be a fall in the quantity of exports
  • Economic growth-If there is an increase in national income, people will tend to have more disposable income to consume goods. If domestic producers cannot meet the domestic demand, consumers will have to import goods from abroad.
  • Saving rates – influencing the level of import spending, thus increasing the deficit.
  • Decline in competitiveness/export sector-In the UK, there has been a decline in the exporting manufacturing sector because it has struggled to compete with developing countries in the far east. This has led to a persistent deficit in the balance of trade.
  • Higher inflation-If India’s inflation rises faster than our main competitors then it will make UK exports less competitive and imports more competitive. However, inflation may also lead to a depreciation in the currency to offset this decline in competitiveness.
  • Recession in other countries-If India’s main trading partners experience negative economic growth, then they will buy less of our exports, worsening India’s current account.
  • Borrowing money-If countries are borrowing money to invest e.g. third world countries, then this will lead to deterioration in current account position.
  • Financial flows to finance the current account deficit.-If a country can attract more financial flows (either short-term portfolio investment or long-term direct investment), then these flows on the financial account will enable the country to run a larger current account deficit.

Impact for the economy 

  • Cost Push inflation- due to supply shortage
  • Rise in import bill
  • Decline in forex reserve
  • Rise capital inflows- If there is a deficit on the current account, there will be a surplus on the Financial/Capital account to compensate for the net withdrawals. However, capital flows are likely to be lower than the current account deficit due to war led outflows.
  • Higher external borrowing
economy Trade deficit