Why in the news: India faces a trade deficit with nine of its top 10 trading partners, including China, Russia, Singapore, and Korea, in 2023-24, according to official data.
UPSC Syllabus:
Prelims: Economy
Main Examination: GS-III: Indian Economy and issues related to planning, resource mobilization, growth, and development.
Balance of Payments (BOP)
- The balance of payments (BOP) is a comprehensive record of all economic transactions between a country’s residents and the rest of the world during a specific period.
- It provides valuable information about the financial and economic condition of a country.
Components of BOP
The BOP is divided into three main components:
Current account: This includes the balance of trade (exports and imports of goods and services), primary income (earnings on foreign investments minus payments made to foreign investors), and secondary income (transfers such as remittances).
Capital Account: Records small transactions involving non-financial and non-produced assets.
Financial account: Captures transactions related to investments in and out of the country, such as direct investment, portfolio investment, and changes in foreign reserves.
What is trade deficit?
- Trade deficit occurs when a country’s total imports of goods and services exceed its exports.
- It is an economic measure that is often used to measure the economic health of a country.
Importance of trade deficit
- While a trade deficit indicates that a country is spending more than it earns on foreign trade, it can also indicate that a country is importing capital for domestic investment.
- The context of what is imported and the state of the global economy often determine the impact of the trade deficit.
India’s top trading partners in 2023-24
India’s trade relations span across various global economies, with different dynamics influencing each bilateral trade relationship.
China: Important focus due to largest source of imports and substantial trade deficit.
United States: An important partner with which India enjoys a trade surplus, reflecting strong export ties.
United Arab Emirates: Another major partner boosted by cultural ties and energy imports.
Saudi Arabia, Iraq, and Russia: Important for energy imports, contributing to trade deficit.
South Korea, Singapore, and Hong Kong: Engaged in diverse trade exchanges ranging from technology to financial services.
Indonesia: Mainly involved in trade in goods.
Economic context
- India has a trade deficit with most of its top partners, especially China, Russia, Singapore and Korea, highlighting the challenges in balancing import requirements with export capabilities.
- In 2023-24, while the overall deficit increased with these countries, some reduction was seen with other countries such as the UAE and Saudi Arabia, suggesting changes in trade policies or market conditions.
India’s trade analysis in 2023-24
- India’s trade activities have shown significant change in the financial year 2023-24, reflecting both challenges and opportunities within its international trade framework.
- A decline in the overall trade deficit has been observed, indicating a complex interplay of factors influencing India’s economic relations globally.
Trade deficit reduction
- India’s overall trade deficit declined to $238.3 billion from $264.9 billion in the previous financial year.
- This decrease suggests improvements in trade efficiency, better management of imports or increased competitiveness of Indian exports.
India’s major trading partners
China as a leading partner
- China has become India’s largest trading partner, surpassing the United States, with $118.4 billion in bilateral trade.
- This change highlights the deep economic ties between India and China despite geopolitical tensions.
US trade relations
- The United States, which was earlier the top trading partner, now ranks second with total trade of $118.28 billion.
- Importantly, India has maintained a substantial trade surplus with the US at $36.74 billion, reflecting strong export performance in the US market.
Major surplus
- India also records trade surpluses with other important partners such as the UK, Belgium, Italy, France and Bangladesh.
- These surpluses are important because they help offset deficits and stabilize the balance of payments with other countries.
Free Trade Agreements and their Impact
- India has enjoyed free trade agreements (FTAs) with its four top trading partners Singapore, UAE, Korea and Indonesia.
- These agreements facilitate easier market access, lower tariffs and increased trade volumes, which contribute positively to India’s trade strategy.
Nature of trade deficit
Economic perspective
- Trade deficit is not inherently harmful.
- According to trade experts, the deficit could be strategic if it involves imports of raw materials and intermediate products that augment domestic manufacturing capacities.
- However, persistent deficit put pressure on the domestic currency, Due to which economic stability was affected.
Insights from the Global Trade Research Initiative
- The Global Trade Research Initiative says that while bilateral trade deficits are not a major concern in themselves, dependence on significant imports from any one country can pose a risk.
- Furthermore, a rising overall trade deficit could harm the economy by depleting foreign reserves and increasing sensitivity to external shocks.
Due to trade deficit
Import –export imbalance
Trade deficit occurs when a country imports more goods and services than it exports. This imbalance can arise from several factors:
Higher domestic demand: Increased consumption or investment within a country can lead to greater imports if domestic production cannot meet demand.
Competitive Disadvantage: If a country’s goods and services are not competitive in the global market, it may have difficulty exporting, while still importing more competitively priced or higher quality goods from abroad.
Currency strength: A strong domestic currency can make imports cheaper and exports more expensive for foreign buyers, increasing the trade deficit.
Economic structure: Countries that rely heavily on imported energy or technology may naturally have a trade deficit if they lack domestic resources or capabilities.
Impact of trade deficit on economy
Short term and long term effects
Although a trade deficit is not inherently negative, its impact depends on the context and duration:
Currency and inflation: Increased demand for foreign currency to pay for imports can devalue the domestic currency, potentially leading to inflation if the devaluation is significant.
Debt accumulation: To finance the trade deficit, a country may borrow money, thereby increasing national debt and interest obligations.
Economic Dependence: Excessive dependence on imports for essential goods can lead to weakness in times of global economic instability or political tension.
Investment effects: In some cases, the trade deficit may reflect strong economic growth, with imports of capital goods boosting future production and growth.
Trade deficit control
Promote exports
Increasing competitiveness: Improving product quality, investing in technology and innovation can make domestic goods more attractive in the international market.
Market diversification: Entering new markets or expanding into existing markets can reduce dependence on domestic sales and balance the trade.
Government support: Subsidies, tax incentives and logistics support can help domestic manufacturers reduce costs and compete globally.
Reducing non-essential imports
Promoting local industries: Supporting local industries through “buy local” campaigns and subsidies can reduce dependence on imports.
Import Substitution: Developing domestic substitutes for imported goods can help maintain the currency within the country.
Tariffs and Quotas: Imposing tariffs or quotas on non-essential goods can make imports more expensive and less attractive than domestic products.
Economic policy adjustment
Currency management: Managing the exchange rate through monetary policy to make exports cheaper and imports more expensive can help reduce the trade deficit.
Fiscal policies: Government spending and taxation policies can influence economic activity and affect the trade balance.
Understanding the dynamics of trade deficit is important for economic planning and policy-making. While deficits may indicate underlying economic issues, they may also reflect a growing, dynamic economy investing in future capabilities. Balancing imports and exports requires a combination of competitive exports, controlled imports, and strategic economic policies to ensure long-term stability and growth.