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Trade deficit at a 5-year high; is it a bad thing?

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India’s trade deficit widened to its highest in more than five years in June driven largely by a surge in oil prices and a weaker rupee. This could be a challenge for Prime Minister Modi’s plans of boosting economic growth ahead of elections, due early next year.

Though merchandise exports rose 17.57% year-on-year in June, the trade deficit widened to $16.6 billion from $14.62 billion in May. This is the highest deficit in more than five years.

Oil imports rose 56.61% to $12.73 billion. India is the world’s third biggest crude importer, and the rising global oil prices amid concerns that US sanctions against Iran would remove a substantial volume of crude oil from the world markets.

Gold imports fell 2.8 percent year-on-year to $2.39 billion in June, the statement by the ministry of commerce and industry said.

Meanwhile, China’s second quarter GDP grew as expected at 6.7% from a year earlier. The data points to a modest slowdown in the world’s second-largest economy, as the government’s multi-year efforts to tackle debt risks begin to weigh on growth and a trade war with the United States threatens exports.

Is trade deficit always bad?

The answer in a single word no. But persistent a trade deficit is bad for an economy as it negatively impacts employment, growth, and devalues its currency.

The United States, as the world’s largest deficit nation, has consistently proven these theories wrong. This may be due to the special status of the United States as the world’s largest economy and the dollar as the world reserve currency. Smaller countries certainly have experienced the negative effects that trade deficits can bring over time.

However, a section of economists hold the view that any negative effects of trade deficits will correct themselves over time through exchange rate adjustments and competition. Large trade deficits may simply reflect consumer preferences and may not really matter much at all in the long run.

  • Trade deficit or current account deficit is when a country spends more money annually on imports than it receives from its exports. It means an outflow of domestic currency to foreign markets. It is also referred to as a negative balance of trade (BOT).Trade Deficit = Total Value of Imports – Total Value of Exports
  • It could be beneficial or detrimental to a country’s economy depending on the circumstances , the policy decisions that have been made and the duration and size of the deficit.
  • A persistent trade deficit can affect economic growth and stability. If imports are more in demand than exports, domestic jobs may be lost to those abroad. While theoretically, this makes sense, the data suggests high unemployment may occur in countries with surpluses.
  • Currency Value: The demand for a country’s exports impacts the value of its currency. Indian companies selling goods abroad must convert those foreign currencies back into ruppees to pay workers and suppliers, bidding up the price of their home currency. As the demand for exports falls compared to imports, the value of a currency should decline.
  • Interest Rates: Persistent trade deficit can often have adverse effects on the interest rates in that country. A downward pressure on a country’s currency devalues it, making the prices of goods denominated in that currency more expensive; in other words it can lead to inflation.
  • In order to combat inflation, the central bank may be motivated to enact restrictive monetary policy tools that include raising interest rates and reducing the money supply. Both inflation and high interest rates can put a damper on economic growth. Again, the United States as well as Europe have resisted this outcome with historically low interest rates and low levels of deflation over the past decade. However, smaller countries would not fare so well.

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