Indian merchandise exports stopped their continuous fall for the last 18 months and finally registered a growth of 1.27% compared to last June’s estimates. Imports fell by 7.33% during this period but even then the trade deficit rose to $8.1 billion dollars in June compared to May.
What is trade deficit?
Trade deficit derives from another term called the balance of trade. The balance of trade is, in short, Exports – Imports. When imports are more than exports, the balance of trade becomes negative and there is a trade deficit. It is that simple but gives our economic planners a real headache to maintain.
Is it bad for the economy?
No, not necessarily. A trade deficit can have the following impacts on the economy:
- As imports increase more than exports, the rupee needs to be devalued. The devaluation leads to foreign goods becoming more expensive (thus keeping a check on imports) while exports can increase as Indian goods become cheaper for foreigners.
- Even though Indian goods might become cheaper for foreigners, but a devaluation of the currency leads to inflation. As foreign goods become costlier and Indian goods cheaper, demand for Indian goods will rise, leading to an increase in their price.
- Inflation is usually controlled by the RBI using interest rates. As prices rise, interest rates increase. This makes borrowing costlier as the interest payments rise. Therefore people borrow less and spend less, reducing prices.
- But one positive impact of a trade deficit is that it leads to an increase in FDI. As the devaluation leads to cheaper goods in India, foreigners increase their investment which is beneficial for us as it leads to growth.
It is not necessary that a trade deficit will harm the economy if it is moderate. Otherwise, a high trade deficit or even a high trade surplus (when exports are more than imports) can hamper economic growth.
What can we expect in the future?
The rise in exports is surely a blessing and is being greeted by much optimism by experts all over the country. They now expect exports to rise at 5% per annum for a while. Assuming that imports follow the same trend and do not rise, we can expect the trade deficit to fall moderately in the medium run.
The RBI, under Raghuram Rajan, was mostly able to keep interest rates under control and decreasing slowly towards the target rate of 4%. If the central bank continues with its policy, a further decrease in interest rate can be expected.
To keep up the growth in exports, the policy makers would not want to fiddle around with the exchange rate in the short run, though. It is true that a devaluation would increase exports, but right now the rupee is weak enough and a further fall in its value will lead to imports getting costlier, like petrol.
This is the case if things remain stable worldwide and we are not subject to shocks, of the kind where Trump actually becomes president or North Korea actually launches its pseudo-nuclear weapons.
In that case, nothing will matter anymore…
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Views presented in the article are those of the author and not of ED.