[Economy Q] Lower trade deficit and its effect on economy

[Economy Q] Lower trade deficit and its effect on economy

Lokraj asked,

How would lower trade deficit strengthen rupee and its effect on economy??what is trade deficit?

 

Answer

in simple terms

Trade deficit

=imports minus exports

 

suppose 2009: India exported 10 billion$ worth stuff, and imported 50 billion$ worth stuff.

So trade deficit (2009)=50-10=40 billion$.

 

in 2010, the case improves, our import remains same, but we export 20 billion$ worth stuff. So,

trade deficit (2009) = 50-20=30 billion$

 

As you see, our trade deficit has lowered from 40 to 30.

How would lower trade deficit in above example, strengthens rupee?

 

Forex market is a place where people buy and sell currency, based on supply and demand.

When you've to import from USA to India, you goto forex market, get your rupees converted into dollar$ to pay the bill and import it.

 

When an American, is importing mangoes from India, he pays the Indian seller in dollar$, and that Indian guy, goes to forex market and gets those dollar$ converted into Rupees, so that he can do his son's wedding, payback the home-loan etc. for which he needs Indian currency (Rs.)

 

So like that, there is a supply-demand of currencies in the Forex Market.

A currency strengthens when its in more demand in forex market.

 

When trade deficit is lower,

means we are exporting more.

Means we are receiving more dollars than earlier.

Means people are demanding more rupees than earlier @ Forex Market.

So Rupee is in higher demand @ Forex market, hence Rupee is strengthened.

 

Effect on economy

When Rupee strengthens, i.e.

(2009) 1$=60 Rs.

(2010) 1$=40 Rs.

 

In above case, Rupee is strengthened. So, when you're importing, you've to pay less Rupees.

But when you're exporting, you also get less Rupees money as payment.

 

So Rupee's strengthening or appreciation, is good for importers but bad for exporters.

Hence lower trade deficit, in long term is good for importers but bad for exporters.

 

In such a scenario, If a country has export oriented economy (like China or Taiwan) it'll move towards recession.

Majority of people make living by working in some export oriented mobile-phone, stuffed toys factory. when they receive less money for export = job loss etc bad things.