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Balance of Trade The balance of trade is the difference between the monetary value of exports and imports in an economy over a certain period of time.

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Presentation on theme: "Balance of Trade The balance of trade is the difference between the monetary value of exports and imports in an economy over a certain period of time."— Presentation transcript:

1 Balance of Trade The balance of trade is the difference between the monetary value of exports and imports in an economy over a certain period of time.

2 Balance of Trade A positive balance of trade is known as a trade surplus and consists of exporting more than is imported; a negative balance of trade is known as a trade deficit or, informally, a trade gap.

3 Govt. Intervention In order to fill the trade gap government intervenes: Artificial shortage created by local traders (hoarding), Prices of commodities are high, Govt. intervenes by importing same commodity at lower price, Then local trades sell their hoarded material.

4 Physical balance of trade Monetary balance of trade is different from physical balance of trade (which is expressed in amount of raw materials). Developed countries usually import a lot of primary raw materials from developing countries at low prices.

5 Often, these materials are then converted into finished products, and a significant amount of value is added

6 1.Exchange rates 2.Trade agreements or barriers 3.Other tax, tariff and trade measures 4.Business cycle at home or abroad. Factors that can affect BOT

7 Balance of Payment The balance of payments, (or BOP) measures the payments that flow between any individual country and all other countries. It is used to summarize all international economic transactions for that country during a specific time period, usually a year.

8 The BOP is determined by the country's exports and imports of goods, services, and financial capital, as well as financial transfers. It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits).

9 What is the Balance of Payments? The balance of payments accounts include: –(a) Trade in goods –(b) Trade in services –(c) The net flow of investment income from India overseas assets –(d) Transfers of money between people and governments (a) to (d) comprises the Current Account

10 The various components of a BOP statement A. Current Account B. Capital Account C. IMF D. SDR Allocation E. Errors & Omissions F. Reserves and Monetary Gold

11 The Reserve Account Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called as The Reserve Account. The IMF account contains purchases (credits) and re-purchase (debits) from International Monetary Fund. Special Drawing Rights (SDRs) are a reserve asset created by IMF and allocated from time to time to member countries. It can be used to settle international payments between monitary authorities of two different countries.

12 Balance of payment Balance of trade both of these must be balanced & to keep them balanced is primary obligation of Central bank.

13 Economic Effects of a Fall in Exports –Negative impact on aggregate demand C+I+G+(X-M) Fall in national output – multiplier effect on incomes and spending Might trigger an economic slowdown / recession Actual GDP will fall below potential GDP (negative output gap)

14 Economic Effects of a Fall in Exports –Negative effect on company profits and business confidence Less demand implies less capital investment Can lead to plant closures / job losses / cyclical unemployment –Government finances will be affected Slower growth hits tax revenues + extra welfare spending –Some regions are more dependent on exports than others

15 Importance of Exports Export earnings are an injection of AD –A rise in exports boosts national income –Multiplier effects should also be considered – a rise in exports will lead to a bigger final increase in national income which may then affect investment demand –Exports are important for manufacturing industry (where exports are a high % of total industrial production) –Exports can help to ‘dampen’ or ‘cushion’ the volatility of our economic cycle – e.g. if there is a domestic economic slowdown / recession

16 Importance of Exports Employment effects from exports –Many thousands of jobs depend directly and indirectly on the export sector –Changes in export demand have effects in other sectors further down the supply chain (e.g. component suppliers for manufacturers and also the distribution and marketing industries) Regional economy and exports –Some regions are more dependent on exports than others

17 Economic Effects of a Fall in Exports –Negative impact on aggregate demand C+I+G+(X-M) Fall in national output – multiplier effect on incomes and spending Might trigger an economic slowdown / recession Actual GDP will fall below potential GDP (negative output gap)

18 Economic Effects of a Fall in Exports –Negative effect on company profits and business confidence Less demand implies less capital investment Can lead to plant closures / job losses / cyclical unemployment –Government finances will be affected Slower growth hits tax revenues + extra welfare spending –Some regions are more dependent on exports than others (e.g. manufacturing industry)- might worsen the “north-south divide”

19 Balance of Payment Questions…. 1.What is meant by (2 marks each = 6 in total) A trade gap? A current account deficit? A current account surplus? 2.Explain why an economic boom may result in a current account deficit. (3 marks) 3.Explain why a recession may result in an improvement in the current account position. (3 marks) 4.To what extent might a current account deficit have an effect on Employment? Inflation? Growth? 4 marks each = 12 marksTotal = 24 marks

20 Current Account The Balance of Payment is a record of all in – and outflows in a country arising from economic activity in the domestic and foreign sectors during a given time period. The balance of payment consists of the current account and capital account. A record of the value of all the transactions between the residents of one country with the residents of all other countries in the world over a given period of time. Current account balance = Balance of trade in goods + The balance in trade in services +Net Income flows

21 Current Account Balance of trade in goods (visible) Revenue received from the export of tangible goods minus the the expenditure on the imports of tangible goods. When expenditure revenue in exports is greater then the amount spent on imports then there is a surplus on the balance of trade in goods – the other way around it is a deficit on the balance of trade in goods.

22 The balance in trade in services Also know as invisible. Same as visible revenue received from the exports of services minus the expenditure on the imports of services. Examples – banking, insurance, tourism, (tourist from country A spend money in the countries B money coming into money B and out of country A)

23 Net Income flows Net investment incomes (net factor income from abroad) Measure of net monetary movement of profit, interests and dividends moving into and out of the country. Domestic firms have branches in other countries, profits will be sent back. Investments in another countries banks will lead to a gain or payments to another country or resident will count as negative. Purchasing shares in foreign firm may lead to dividends which will be positive or of course if they leave the country will be negative.

24 Net transfer of money Payments between counties when no good or services change hands. Foreign grants and loans. Remittance, by workers, private gifts.

25 Remittances (2003– 2004) Remittances* (2007–2008) India$21.7 billion$60.0 billion China$21.3 billion$40.5 billion Philippines$16 billion$30.8 billion Mexico$18.1 billion$26.2 billion France$12 billion$13.75 billion Bangladesh$3.4 billion$8.9 billion Pakistan $3.9 billion$ 7.0 billion Morocco$6.7 billion Total world wide$401 billion (IFAD)$443 billion (World Bank)

26 Capital Account Buying and selling of assets between countries. This can include anything that can be owned and has value. –Land, real estate, companies, stocks/ shares etc. Capital account measures the net change in foreign ownership of domestic assets –If foreign ownership of domestic assets increased more quickly than domestic ownership of foreign assets then there is more money coming in to the country than going out so there is a capital account surplus. - if it is the other way than there is a capital account deficit.

27 Assets that represent ownership Buying property or a business, stocks etc – the main goal of for the asset to have a positive return in the future by making a profit or increasing in value. May not make any profit and the investment does not have to be paid back.

28 Assets that represent lending Treasury bonds, government bonds. The investors lends the money in order to purchase the assets in the expectation that interest will be paid on the investment and then also a later date they will also get all there money back.

29 Current Account: –The trade in goods (exports – imports-) –The trade in services –Income Flows, interest, dividends. Capital Account: –Sale and purchase of capital assets and non-produced or non-financial assets –Direct investment in bank accounts –Portfolio investment in shares

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33 Imbalance If the current account is in deficit than the capital account will have to balance this out by being in a surplus. –Foreign reserve may be used to increase the capital account – can not be sustained long term –Foreign ownership in a country means they must have faith in the domestic country but at the same time national sovereignty may be an issue. –May be financed by high lending from abroad. Country may withdraw their money and put in other places.

34 Current account in surplus Current account surplus allows a country to have a deficit on its capital account by building up its reserve or by purchasing assets abroad. A surplus will also usually lead to an appreciation of the currency on the foreign exchange markets there is a demand for the currency.

35 How to correct a current account deficit. Depreciate the value of their currency to enable exports to be cheaper and imports to be more expensive. Protectionism – restriction of imports, (embargo, tariffs, quotas etc) – WTO may step in. Expenditure policy – reduce overall expenditure including imports.

36 How do you fix a country with a large Current Account deficit? Encouraging people to buy locally produced products. Attempt to devalue currency to make imported products more expensive and exports more attractive to overseas buyer. Broader expenditure reduction policies – reducing aggregate demand.

37 Links … Balance of Trade (Current Account) ( X – M ) Improves !! Balance of Trade (Current Account) ( X – M ) Improves !! Depreciation or weakening of Exchange Rate Value of export receipts increases Value of import payments decreases Imports become more expensive Exports become cheaper for overseas buyers Suppose exports from India are very elastic? A small drop in price will lead to a more than proportionate change in QD. Therefore… The increase in export receipts will be significant And Current Account will move into surplus faster.

38 Links … Balance of Trade (Current Account) ( X – M ) Improves !! Balance of Trade (Current Account) ( X – M ) Improves !! If currency depreciates And demand for exports is elastic

39 Double-entry accounting in the BOP All transactions are either debit or credit transactions Credit transactions result in receipt of payment from abroad  Merchandise exports  Transportation and travel receipts  Income received from investments abroad  Gifts received from foreign residents  Aid received from foreign governments  Local investments by overseas residents

40 Double-entry accounting (cont’d) Debit transactions lead to payments to foreigners  Merchandise imports  Transportation and travel expenditures  Income paid on investments of foreigners  Gifts to foreign residents  Aid given by home government  Overseas investments by home country residents Each credit transaction has a balancing debit transaction, and vice versa, so the overall balance of payments is always in balance

41 The BOP is often misunderstood as many people infer from its name that it is a balance sheet, whereas in fact it is a cash flow statement. By recording all international transactions over a period of time such as a year, it tracks the continuing flows of purchases and payments between a country and all other countries. It does not add up the value of all assets and liabilities of a country on a specific date (as an individual firm’s balance sheet would do).

42 Do some more research to answer the question A. Is a current account or capital account deficit or surplus a good or bad thing? B.How “big” does a country allow its current account of capital account deficit or surplus get before it should be worried? C.What have been some of the recent trends in countries with reference to their current account or capital accounts deficits and surpluses (use specific counties and give examples)

43 TRENDS IN INDIA’S BALANCE OF PAYMENTS A country, like India, which is on the path of development generally, experiences a deficit balance of payments situation. This is because such a country requires imported machines, technology and capital equipments in order to successfully launch and carry out the programme of industrialization

44 FIRST PLAN During the first plan period, the balance of payments was affected by the Korean War boom, American recession of 1953 and favorable monsoon at home which helped to boost agricultural and industrial production. balance of payment during the first plan was only Rs. 42 crores.

45 SECOND PLAN An important feature of the second plan period was the heavy deficit in the balance of trade which aggregated to Rs crores. The foreign exchange reserves sharply declined and the country was left with no choice but to think of ways and means to restrict imports and expand exports.

46 THIRD PLAN The balance of current account was unfavorable during the third plan. The serious adverse balance of payments which started with the second plan continued relentlessly during the third and annual plans. Heavy amount had to be paid by India in the form of interest payments on loans

47 FOURTH PLAN One of the objectives of the fourth plan was self-reliance – i.e., import substitution of certain critical commodities on the one side and export promotion so as to match the rising import bill, on the other Accordingly the government managed to restrict imports and succeeded in expanding exports.

48 FIFTH PLAN During the whole of the Fifth Plan India experienced a surplus balance of payments due to a sharp increase in the exports surplus on account of invisibles. From onwards, India started experiencing very adverse balance of payments. India had to meet this colossal deficit in the current account through withdrawals and borrowings from IMF.

49 SIXTH PLAN The Sixth plan characterize the balance of payments position acute. The annual average current account deficit was of the order of rs.2600 crores during the Sixth Plan. During the Sixth Plan, the trade deficit was 3.3 per cent of GDP and current account deficit was 1.4 per cent of GDP.

50 SEVENTH PLAN Exports performance substantially improved in the Seventh Plan with average volume growth exceeding 7 per cent. The share of net invisible earnings in financing trade deficit declines from 63 per cent during the Sixth Plan to 29.5 per cent during the Seventh Plan. The average current account deficit as a per cenr of GDP increased to 2.4 per cent in the Seventh Plan.

51 DEVELOPMENT SINCE In the year , India saw a remarkable turnaround from a foreign- exchange constrained control regime to a more open, market driven by liberalized economy. During the last three years export earnings, on average, accounted for nearly 90 per cent of the value of imports

52 Exports recorded a growth of 20 per cent in dollar terms. The surplus on the invisible account doubled. Foreign currency reserves which were just $1205 million in 990 reached the level of $19386 million in The economy thus moved to a more stable and sustainable balance of payments position.

53 India's Foreign Trade: (In US$ million) (April, 2005-Oct. 2006) Exports Y-O-Y Growth22.08 Imports Y-O-Y Growth33.08 Trade Balance Source: Federal Ministry of Commerce, Govt. of India

54 India's Balance of Payments( ) US $ million Items (P) Trade Balance-38,130-15,454-10, Invisibles, net31,69926,01517,035 9, Current Account Balance -6,43110,5616,345 2,666-9,680 Capital Account 32,17520,54210,840 8,8407,056 Overall Balance ,42116,985 5,868-2,492 Foreign Exchange Reserve Increase (+)/Decrease (-) -26,159-31,421-16,985 -5,8421,278 Source: Reserve Bank of India Annual report ( )

55 India's Foreign Trade ( ) (In US $ million) April, 2004-March, 2005 EXPORTS * % Growth24.41 IMPORTS * % Growth35.62 TRADE BALANCE * Source: Federal Ministry of Commerce, Government of India * Final figures as given by DGCI&S


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