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Balance of Trade
Welcome friends to the course of International Business. Today, we are going to startwith a new unit. So, in this unit, we will start this unit with the very with a veryimportant concept called the Balance of Payment right.So, today, we will be discussing about balance of payment, what it is; what it is, what isits meaning and how it affects right any economy or any country for that. So, all this wewill cover it in this today’s lecture right. So, let us start with the definition. What isbalance of payment?(Refer Slide Time: 01:02)Balance of payment as it says largely you know BOP, as it said is a statement whichrecords all the monetary transactions made between residents of a country and the rest ofthe world in a particular period of time.So, it could be a year. The balance of payment can be defined as a statistical record of acountry’s international transactions over certain period of time presented in the form ofdouble entry book keeping. Why it is called double entry? Because there is there are twosides and as you will see here, there is a debit entry with correspond to a credit entryright.So, it is like any you know like a balance sheet ok. It is the accounting of all the financialinflows and outflows of a nation. Basically, if somebody ask in a simple term, somebodywould like to understand it is the balance sheet of the country ok, the balance of paymentcan be understood that way.(Refer Slide Time: 01:56)Why balance of payment is vital for a country? A country’s BOP is vital for thefollowing reasons. Let us see what are they? First, it reveals its financial and economicstatus because from the financial you know from the balance sheet, you can find out thecountry’s financial and economic status. It can be used as an indicator to determinewhether the country’s currency value is appreciating or depreciating; both have their ownconsequences right. If it is appreciating, it has its some consequences; it is depreciating,it has own consequences.The statement helps the government to decide on the fiscal and the trade policies. Now,what is fiscal policy and what is trade policy, monetary policy? We have to I think mustbe have I will show you also.It provides important information to analyze and understand the economic dealings of acountry with other countries. So, overall the balance of payment gives you a basic insightabout the country’s economic health right. So, for example, let us talk before we get deepinto it, let us understand these two terms; monetary policy and fiscal policy.(Refer Slide Time: 03:10)And what is the difference because I have seen people are confused a lot on this. So,what is this monetary policy and what is fiscal policy. So, on basis of these attributesright, we have divided. So, on basis of the tool if you see it is nothing but it has theinterest rate falls into the monetary policy. So, the government decides the interest rateand on in the other side, the fiscal policy is something which is basically connected withthe tax and the governments spending right.The government spends on different parameters and so, it levies taxes, different kinds oftaxes. So, all this you know would levying taxes like sales and all these things that comesin. For example, in India, we talk about educational cess right. We talked about theSwatch Bharath Cess right. So, we have different kinds of taxes and we are coming upwith different the GST for example right though and the government is spending, nowthere is at the GST is also a very controversial thing in India the moment.Because different people, different economies are criticising in the different way. So,anyway; so, the spending and the tax this comes under the fiscal and the interest rate andthe money, the printing and all that comes in the monetary policy right. The effect isbasically on through the cost of borrowing and the mortgages.So, the you know the bank, basically the monetary policy is decided by the Central Bank.If you can see here, it is it the monetary policy set by the independent Central Bank. Inour case for example, the RBI.But this is done by the changing tax and government spending is highly a political issueand it is done by the government right, the central government right. So, sometimes orlargely the fiscal policy becomes a matter of a political issue because the governmentwill tend to use it to make a benefit out of it for their you know future elections and allthese things right.So, they may change the tax structure, they may levy some new taxes or they mightexempt some taxes. So, all these are a part of the fiscal policy which is there in the handof the present government.But the monetary policy is since is dictated by the RBI. So, it is less influencedpolitically. Yes, there is some influence, there is no doubt about it maybe there is someinfluence through the you know because the control is still with the government. Butlargely it is dominated or governed by the bank ok.If you look at the distribution higher interest rates hit homeowners, but benefits thesavers right. So, when there is a higher interest rate. So, you know somebody who takesa loan, he has to pay more; but for somebody who is saving the money you know, he willget higher interest rates, depends which taxes you raise right.For example, if the taxes are increased, then the people have to shell out more moneyright. For example, at the current stage in India, there is a pressure in the government todrop the income tax rate a bit to bring it a bit down.Exchange rate, higher interest rates cause appreciation; no effect on the exchange rateright, fiscal policy. Supply side, limited impact; higher taxes may affect incentives towork. So, if you levy a very higher tax, then people might not be interested to do somekind of a work because most of the money is going in the tax right. So, this affect alsowe have seen personally also ok.So, fiscal policy is generally advised in very deep recessions because this was thisconcept of fiscal policy was brought in by Keynes; John Maynard Keynes right andKeynes discussed how the government could use this structure to change the economicstructure of the country or the condition of the people ok. Cut in interest rates may notwork in liquidity trap right. So, all the time interest rate cuts might not work in forcurrents situation for example.India has the RBI, in India the Reserve Bank of India has done a lot of changesconnected to the interest rates right and the even the REPO rate right. So, all these thingsmight all, might not work to uplift the economic mood of a country. So, but, fiscal policyis largely more related with the populism right. How popular that policy can be and howit affects the wood share wood bank of a government.(Refer Slide Time: 07:55)Why would it be useful? Now, let us go back to the economy the BOP to examine acountry’s balance of payments data. It would be useful for two reasons; first BOPprovides detailed information about the supply and demand of a country’s currency right.Second, it can be used to evaluate the performance of the country in internationaleconomic situation or competition. For example, if a country is experiencing perennialBOP deficits, balance of payment deficit right, it may signal that the country’s industriesare lacking competitiveness.Why? Because if there is a deficit; that means, you are not able to trade more, you arenot exporting enough and you are rather importing more. That means, the acompetitiveness is questioned here. Is balance of payment always balanced? Balance oftrade can be favourable or unfavourable, but balance of payment always remainsbalanced, please remember this ok.(Refer Slide Time: 08:51)What are the components of the balance of payment? So, there are four components. So,right the current account, the capital account, the official reserve account, the net errorand omissions.So, balance of payment this is how it looks like is equal to the balance of the currentaccount, the balance of the capital account, the balance of the official reserve accountplus the net error and omissions. So, this is done in order to balance out. So, that it is azero sum game right, it is like a it is a 0. It has to be balanced. Current account, let us goto the first one.(Refer Slide Time: 09:29)So, the what is the current account? The current account on the balance of paymentmeasures the inflow and outflow of goods, services, investment incomes and unilateraltransfer payments right. So, what are the main components in that current account? Tradein goods, trade in services.So, when you say trade in goods, these are the movable and physical in nature and tradein goods means a change of ownership from resident that means, from the local countryfrom, let us say from India to non resident in a and vice versa to some that means, we areimport exporting from our country to some other country right and export is marked as acredit because money is coming in and in import is noted as a debit because money goesout.So, when we are exporting, money flows into the country; when you are importing, theraw material is coming in, but the money goes out of the country right. Trade in servicesor invisible balance, these transactions include an intangible action such astransportation, business services, insurance, tourism, royalties and licensing. If money isbeing paid for a service, it is recorded as an import, a debit. If money is received, it isrecorded as an export.(Refer Slide Time: 10:57)Net factor receipts, income received or paid in form in from dividends, interest, wagesetcetera. If money is going in or out from the country called credit or debit side entry inbalance of payment account; for example, when Mr. X, let us say from India is receivingrent; is receiving rent right from the USA, then it is credit.Because it is a credit entry in India’s BOP account. While the rent paid to the USA, somesuppose we are paying to somebody in USA, then it is debit side entry in India’s BOPaccount ok.The last point is the unilateral transfers. A unilateral transfer is a one way transfer ofmoney goods or services from one country to another right. International aids, grants,donations, gifts and remittances etcetera.Now, so, how does this equation look like let us see. Current account is equal to balanceof trade in goods and services plus net factor receipts plus unilateral transfer ok; a currentaccount surplus. There could be two situations; there could be a surplus, there could be adeficit. A surplus indicates that the country’s asset have grown over the period.Obviously that means, your economic your export is increasing, your competitiveness isincreasing in the world market; whereas, a current account deficit indicates that thecountry’s liabilities have grown over the period and that means, we are not verycompetitive, we are not matching up to the world standards. That means, we areconsuming more, but we are not able to produce more and give it to the world ok.(Refer Slide Time: 12:52)Now, there is another term called the balance of trade. Now, what is this balance oftrade? So, we said here it could this might not be balanced right. It could be favourableor unfavourable. So, what is this balance of trade; commercial balance or net exports?The balance of trade is the difference between the monetary value of a nations exportsand imports over a certain time period.So, what did I say? Balance of trade is the difference between the monetary value of anation’s export and imports over a certain time period. So, trade balance is equal to totalvalue of experts exports minus total value of imports ok, where what is this value ofexports?Value of exports is the value of the goods and services that are sold to the othercountries. Value of imports is the value of goods and services that are bought from othercountries so right. So, this is the trade balance right.(Refer Slide Time: 13:50)Now, what is the distinction? Let us see this distinction between balance of trade andbalance of payment because again, this is a you know kind of a confusion which peoplealways hold in their mind. So, and basis of the you know this four points, let us discussit. First, the nature of transaction; so, when you talk about balance of trade, thetransactions concerning trade of goods only are recorded right; whereas, in the balance ofpayment, if you see all the transactions, concerning goods, services and capital transfersare recorded ok.Now, coming to the capital transactions right; so, first was the nature of transaction, nowthe capital transactions. The transactions of capital nature are not included in the balanceof trade, the capital once right; but transactions of capital nature are also recorded in thebalance of payment right, the BOP.Mutual relation, the balance of trade is a part of the current account of the balance ofpayment it is a part of the current account. So, we had current, capital; let us see the four.So, what are these four; current account, capital account, official reserve and net errorright. So, it is a part of the only the current account right. BOP is much larger as it hascurrent and capital account which includes the BOP right, in the BOP.Favourable balance of trade or balance of payment, when export of the goods are higherthan the import of the goods, the balance of trade is considered favourable otherwiseunfavourable. If suppose, the balance of export of goods is lower than the you knowimport of goods, then it is a unfavourable situation.On the other hand, when net balance of current account and capital account is in plus,BOP is considered as favourable. So, the net balance right and at the end the BOP willalways be equated and it will be you know the both side the debit and the credit sidebecause it is like a balance sheet, it has to be equal right that is the condition.(Refer Slide Time: 15:58)Balance of trade, trade surplus; now, let us continue with that. The difference betweenthe value of a country’s exports and the value of its imports, where the value of exportsis greater. So, if it is in a surplus case the country’s exports is greater than the country’simports right.In case of a deficit, the difference between the value of a country’s exports and the valueof its imports is such that the import exceeds the exports. That means, in this case, theexports is less than the imports ok. A trade surplus is also called a favourable balance oftrade and this is called an unfavourable balance of trade right in a trade deficit case.Some economists believe that a trade surplus creates employment and increases GDPgrowth. So, that is generally it is understood that if the export is more, that means moreconsumption, more production is happening, so more jobs are coming up, so more theeconomy is in a better situation.So, it is creating more employment and the GDP is growing; but some economistsbelieve that an unfavourable balance of traded trade causes unemployment and lowerGDP. Same thing that means, the economists generally believe that if balance of trade ispositive right that means, more job is created and the GDP of the nation is growing.(Refer Slide Time: 17:30)But if it is deficit, it is a reverse thing right. Let us say take an example if a country Aimported rupees 1,00,000 in last year, but exported only rupees 75,000 worth of goods toother countries; then, the country has a negative rupees 25,000 right; balance of trade orrupees 25,000 trade deficit. This is how it is to be understood. Trade balance is equal tototal value of the exports minus total value of the imports.If the country export x imported 1.2 trillion in 2018, but exported 1.8 trillion to othercountries; then, the country X has a positive trade balance of 600 billion or a 600 billiontrade surplus. Now, it is very important to understand the health of economy byunderstanding the surplus and then, deficit ok.(Refer Slide Time: 18:24)Let us take this example. Find the current account balance from the followinginformation. [FL] the particulars are exports of goods worth, it is all in crores let us say1545, import of goods 1305, exports of services 490, import of services 365, incomereceipts 410, income payments 525, gifts 100. Can you do the current account balance?Can you find the current account balance? Try to do it on your own ok. So, now, let ustake look at the solution.(Refer Slide Time: 18:59)So, the balance of trade in goods, export of goods minus import of goods. So, 1545minus 1305. So, that is equal to 240 balance of trade in services right; so, these two right.So, 490 minus 365, 125. Net income receipts is 410 minus payment 525. So, this is aminus rupees 115 ok. So, now, the current account balance is equal to balance of trade ingoods plus balance of trade in services plus net factor income plus unilateral transfer thatis gifts.So, that is equal to 240 + 125 - 115. This is actually it should all be plus, but because thisis a minus, it is minus plus 100 the gifts. So, that is equal to 350. So, the current accountbalance is in a 350. This is a positive right.(Refer Slide Time: 20:00)Can a country this is a question, can a country have a trade deficit and a current accountsurplus simultaneously? Now, this is a question for thinking. So, what are you saying cana country have a trade deficit that means, trade deficit means their surplus. That means,you are exporting less and importing more right.So, you are paying more and maybe earning less and a current account surplus. Answeryes, in India although trade deficit is a recurrent feature every year trade deficit, fromthree consecutive years from 2001 to 2002, 2002- 2003, 2003-2004.But there was a surplus on the current account as a same time to the tune of 0.7, 1.3 and2.3 percents of the GDP respectively. This is because that earnings from services andprivate transfers outweighed the trade deficit which was not considered right in the trade.So, this is what you know is a very important understanding and finding which will helpyou to clear out your doubts. For example, this question, can a country have a tradedeficit and a current account surplus? Yes, it is possible, it has happened already in Indiaok.(Refer Slide Time: 21:19)Now, what I will do is will start will wind up today here and maybe we will continue thisin the next session from the capital account and will cover up the other parts of thebalance of payment right. So, that is all for today.Thank you very much. Have a nice day.