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Balance of Trade: Definition, Calculation, Types, Examples

IndianMoney.com Research Team | Updated On Friday, December 06,2019, 04:04 PM

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Balance of Trade: Definition, Calculation, Types, Examples

 

 

What is the Balance of trade?

In simple words, the balance of trade is the value of a country’s trade i.e. its total exports minus imports. Balance of trade plays a crucial role in calculating the country’s balance of payment. It helps economists and experts determine the strength of a country’s economy.

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Balance of Trade India:

Reports relating to import and export of Indian economy are published every month by the ministry of commerce. India’s economic development is mainly evaluated through India’s merchandise trade with the U.S, E.U and China. India has maintained a trade deficit since 1990.

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According to reports, the trade deficit in India has narrowed down to USD 11 billion from the deficit of USD 18 billion in October 2018. The decline in the trade deficit was the result of a continued decline in imports.

Usually, a narrowing trade deficit is celebrated as it helps contain current account deficit and helps ease pressure on the currency. However, this time, it is a major worry for the Indian economy as it is driven by lower non-oil and non-gold imports, which shows that domestic demand remains weak.

Importance of Balance of Trade:

The balance of trade is an important component that helps the economic analysts estimate the number of goods sold to foreign countries and the number of goods purchased from these nations to cater to the needs of Indian citizens. While importing and exporting for goods there are two situations that arise:

Balance of Trade deficit: when the value of imports surpasses the total value of exports within a year

Balance of Trade surplus: this happens when the value of exports is more than the value of total imports of the country in a year

So, the balance of trade is used to determine the economic strength of the country in comparison to other nations. Balance of trade is considered a crucial factor of the country’s current account. While measuring international transactions, the balance of trade accounts for the biggest factor of the balance of payment. Therefore, the balance of trade is used to measure the country economic and political stability by referring to the level of foreign investment in the country.

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Types of Balance of Trade:

Favourable Balance of Trade:

Favourable balance of trade is a situation when the country’s exports are more than its imports. Most countries encourage and create conditions to favour trade surplus. This is because the surplus trade helps in making a profit by selling more products to foreign nations.

Countries with the favourable balance of trade can enhance the living standard of its population and generate more income.

Unfavourable Balance of Trade:

As we know, the unfavourable balance of trade results due to an increase in imports than exports. Thus a trade deficit is created. As such, countries with trade deficit export raw materials and import a large number of consumer products.

Due to this, the domestic business is not able to add value to their products due to lack of experience and skills. With time, these economies become dependent on global commodity prices.

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Balance of Trade Calculation:

The following equation is used to calculate the balance of trade of a country:

  •  X – M = TB

Here, X stands for exports, M stands for imports and TB is trade balance

A country exports are the good and services that are produced domestically and are sold to a foreign country. Every item produced in a country can be exported, ranging from physical goods like apparels, shoes, metals, foods etc to services like banking, business, software services etc.

Imports are the goods produced in another country and are bought by the residents of a country.

When the exports are greater than imports then there is a trade surplus. This is regarded as a favourable trade balance. But this is not always the best for countries.

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Components of Balance of Trade:

Let’s have a look in the three components of the balance of trade. These indicators are mainly used to compute the trade output and the results can either be trade deficit or surplus. Analysing the balance of trade gives you an idea of the cash outflows and inflows of the country. 

Current Account:

The current account is used to record the inflow and the outflow of goods between nations. The current account is used to record the receipts and payments of all exported and imported goods that include raw material supplies and manufactured goods.

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Financial Account:

The financial account is important to evaluate the change of domestic ownership of foreign assets and foreign ownership of domestic assets. When the foreign ownership is more compared to the domestic ownership it results in a deficit in the financial account. Thus analysing and understanding the changes in financial account allows determining whether the country is selling or acquiring more assets.

Capital Account:

The account that measures financial transactions between countries is known as capital account. It includes the purchase and sale of assets, properties and flow of taxes. The deficit or surplus in the capital account is managed through finance in the current account.

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