written by | May 16, 2022

What is Balance of Trade (BOT), and How Does It Work?

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The Balance of Trade is the difference in the money value of imports and exports of material goods (called visible objects) over a given year. The two transactions determining BOT are exports and imports of goods (visible goods). Clothes, shoes and machines are examples of visible items. Balance of trade, or trade balance, is the difference in goods exported and imported.

Balance of trade includes the difference in value over a given timeframe between a nation's imports and exports of services and goods, generally expressed in the currency unit of a specific country or economic union.

We already know the meaning of Balance of Trade, and now, let's get deeper.

Did you know?

India's Balance of Trade between 1957 and 2021 averaged - ₹290 crores. It experienced a low of ₹2290 crores in November 2021, while the maximum was in June 2020.

Also Read: What is International Trade - Features and Advantages

What are the Types of Balance of Trade?

  • Favourable Balance of Trade: A favourable or surplus balance of trade occurs when a country's exports surpass its imports.

  • Unfavorable/Deficit Balance of Trade: An unfavourable or adverse balance of trade is one in which the entire value of goods imported exceeds the total value of products exported.

  • Equilibrium in Balance of Commerce: Equilibrium in balance of trade refers to the total value of products exported and total value of goods imported being equal.

Define Balance of Trade Significance

  • BOT illustrates the fluctuation in the imports/exports of a country and exports over time.
  • When a nation achieves the same status regarding exports and imports, it is known as Trade Equilibrium.
  • A country can produce a trade deficit if the former is greater than the latter, which is not the best situation for any country.
  • If exports' value is greater than that of the import value, a trade surplus is created, putting the economy in a better position.
  • The current account is the Balance of Trade of a country.

What is Trade Surplus?

  • A surplus in trade indicates economic activity that shows a positive trade balance where the country's exports are greater than its imports.
  • Trade Balance = the total value of exports minus the full value of imports.
  • If the calculation results above are positive, we have an increase in our trade surplus.
  • The net flow of currency domestically from foreign markets is an exchange surplus.

The Importance of Trade Surplus

  • A trade surplus could lead to employment and growth in the economy. However, it could increase prices and higher interest rates in an economy.
  • The Balance of Trade between a country could also affect its currencies' value on the world market, as it allows a nation to control the majority of its currency via trade.
  • In many instances, the trade surplus can help boost a country's currency compared to the other currencies and impact the currency's exchange rate. However, it depends on the number of services and goods produced by an individual country compared to other nations and other market variables.
  • Suppose you focus solely on the impact of trade. In that case, the trade surplus can indicate a significant global demand for goods and services from a particular country, which increases the price of these items and causes the local currency to appreciate.

What is a Trade Deficit?

  • A trade deficit is when a nation imports more items and services than what it sells value.
  • Trade Balance = the total value of exports minus the value of imports.
  • If the above calculation results are negative, then we have the result of a trade deficit.
  • Net outflows of domestic currency out of markets outside the country are known as the trade deficit.
  • India was the country with the highest export deficit for November in 2021. It was ₹2290 crores.

There are two causes to have a trade deficit.

Domestic production isn't sufficient to meet the demands.

For instance, we have imports of crude oils, pulses and edible oils as there isn't enough domestic supply to meet the demands.

  • Consumers' preference for imported goods results in an increase in domestic production that is high cost.
  • For steel production, India has enough manufacturing capacity. However, our costs for production are higher than those of China and, therefore, Indian customers, like auto companies, are buying Chinese steel for less cost, but of the identical quality.

The Advantages of Trade Deficits

  • A trade deficit is an obvious advantage of allowing a nation to consume more than it produces.
  • Trade imbalances could help countries avoid shortages of goods and other economic issues in the short run.
  • In the floating exchange rate system, the trade deficit places the country under pressure to lower its currency.
  • Imports are more expensive in countries with an imbalance in trade when the country's currency is more affordable. This causes consumers to lessen their consumption of imports and move to locally produced alternatives.
  • Exports are less costly and more competitive on overseas markets as the currency of the country declines.

The Disadvantages of Trade Deficits

  • In the long term, trade deficits could be a source of concern for the government.
  • The most pressing and prominent problem is that trade imbalances can lead to economic encroachment. If a country's trade deficits stay, citizens from other countries can access money to invest in the country. Also, if this pattern continues, foreign investors could control most of the nation's wealth.
  • If exchange rates are fixed, trade deficits can be more damaging. A currency's devaluation is not possible in the fixed exchange rate system as trade imbalances tend to last longer, and the rate of unemployment could increase dramatically.
  • There is a link between deficits in trade and budget deficits, as per the twin deficits theory. Trade deficits serve as a precedent for budget surpluses.

Also Read: What are the Pros and Cons of Free Trade?

Methods to Reduce the Trade Deficit

Reduce Consumption and Boost Savings

Imports will drop as borrowing overseas will be needed for consumption if governments or households cut their consumption (companies can save more money than they pay).

Consumption Taxes

Taxes on consumption similar to those found in nearly every other nation can help reduce the deficit by reducing consumption, encouraging savings and helping to reduce the government's deficit.

Depreciating the Currency Rate

A real huge rate of depreciation in the exchange rate is typically the cause of the reversal of trade deficits. A lower rupee increases the cost of imports but decreases the cost of exports, which improves the Balance of Trade.

Taxing Capital Flows

Taxon (non-foreign direct investment) capital inflows that rise proportional to the size of the inflow can aid in reducing the deficit of the government by reducing the excessive borrowing for consumption.

Classification of the Balance of Payment

The Balance of Payment can be divided into the following accounts. They are:

Current Account

It holds the records of both tangible/and intangible things.

Capital Account

It maintains the account of the total earnings generated by both the public and private sectors and capital expenditures. Foreign direct investments are all included in this account.

Errors and Omissions

In case receipts and payment are not in sync. Then there will be a balance reported as errors and omissions.

BOP is released each quarter, half-yearly or annually. The main purpose of BOP is to monitor the flow of cash within the economy and develop policies in line with the flow of money. Alongside governments, companies can also prepare BOPs for their purposes.

The Difference Between the Balance of Trade and Balance of Payment

Here are the main distinctions between Balance of Trade and Balance of Payment

Meaning

BOT is a declaration that records the goods and services exported and imported to other countries over time. In contrast, BOP tracks all economic transactions made by that country in a given time.

Records

One of the major differences between BOP and BOT is the record they keep. Balance of Trade records only physically-based items. In contrast, Balance of Payment records physical/non-physical items.

Capital Transfers

Capital transfers are a major difference from BOT to BOP. Capital transfers are not included in a Balance of Pay, and BOP tracks all capital transactions and payments.

Final Results

BOT may be negative, positive and even balanced. But, BOP must always remain balanced.

Component

Another distinction between BOT and Balance of Payment is that BOT is a significant component of the BOP, and it is part of the BOP's Capital Account section.

Conclusion

There are many options if the administration is serious about reducing the trade imbalance. The government should be careful not to distort the trade policy. Trade imbalances are almost unaffected by higher tariffs on a country or product. However, this can cause commerce to shift to another country or product with lower taxes.

This is because import tariffs reduce foreign money demand, which causes the currency to rise. The result is that tariffs decrease exports and imports, and it causes consumption and production to become distorted. While higher tariffs will likely reduce trade and income, they have little effect on the trade deficit.

Also, import and export businesses require a lot of calculations of transactions online.

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FAQs

Q: What are various types of Balance of Trade?

Ans:

Following are the three types of balance of trade.

  • Favourable Balance of Trade
  • Unfavourable/Deficit Balance of Trade
  • Equilibrium in Balance of Trade

Q: What's the Balance of Trade definition?

Ans:

If we define the Balance of Trade in the simplest words, it's the difference between a country's exports and imports of services/goods over a specific period. The unit of BOT is in local/regional currency.

Q: What is the difference between the Balance of Trade and the Balance of Payment?

Ans:

Balance of Trade is the difference gained from the export/import of goods. On the other hand, the Balance of Payments is the inflow/outflow difference of foreign exchange. BOT includes all transactions (related to goods, transfers and services).

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.