Union budget 2022 | What is the trade deficit? How can it be controlled?

The Narendra Modi government is set to present the Union budget for FY23 amid a raging third wave of Covid-19. All eyes will be on Finance Minister Nirmala Sitharaman as she outlines the country’s fiscal plan for the year ahead amid a fragile post-pandemic recovery still threatened by a fresh spike in infections.

As the budget approaches, here is an overview of some terms related to the annual exercise.

What is a trade deficit?

If a country imports more goods and services than it exports during a given period, such a situation is called a trade deficit. A trade deficit is also called a negative trade balance.

For example, if India imports more goods and services from China than it exports to the neighboring country, India faces a trade deficit with China. Therefore, a lower trade deficit would mean that India has less need to import and other countries buy more Indian goods and services.

Is the trade deficit bad for the economy?

While some economists believe that a long-lasting trade deficit is detrimental to a country’s economy, some economists who advocate free markets suggest that the negative effects of trade deficits will correct themselves over time. Milton Friedman, who won a Nobel Prize in economics, argued that trade deficits, in the long run, are not always harmful because currency can return to the country in the form of foreign investment rather than demand for products exported to foreign markets. .

How does the trade deficit affect the economy?

The value of a country’s currency is closely related to imports and exports, among other factors. If a country has a smaller export footprint, it results in lower demand for the domestic currency. In the case of India, a higher trade deficit can reduce the value of the rupee against the US dollar. However, under a floating exchange rate system, if there is an increased demand for Indian goods in export markets, the value of the rupee is expected to increase as the demand increases.

Theoretically, as the trade deficit increases, more jobs are lost to foreigners, which can increase the unemployment rate. Data from various economies, however, shows that unemployment depends on various other factors and therefore unemployment can exist at high levels even if a country has a trade surplus.

How to reduce the trade deficit?

The trade deficit can be reduced in several ways which are controlled by the Union budget and other trade policies. Here are some of the ways one can fight the trade deficit:

> Depreciation of monetary value

Currency devaluation is a deliberate downward adjustment in the value of one country’s currency against another currency. Reducing the value of the Indian rupee would make Indian exports more competitive, thereby increasing the demand for Indian products. However, this would make imports more expensive and this measure has several other unpleasant side effects such as inflation; this measure is dependent on the elasticity of demand and is therefore not an easy solution for reducing the trade deficit.

> Tax capital inflows to limit consumer borrowing

Making excessive borrowing for consumption more costly by imposing taxes on inflows of non-FDI investment capital is one measure to address the imbalance, but economists fear capital controls will reduce investment and alter prices assets, among other unpleasant effects.

> Protectionist quotas

Setting quotas on imports could reduce the number of goods imported into the economy, but as this is an obstacle to free trade, it could violate WTO rules. In addition, other countries could retaliate by imposing quotas on Indian exports and other measures that could harm Indian exports.

Watch the latest DH videos here:

Comments are closed.