In today’s global economy, consumers have access to products from across the globe giving an edge to additional variety thanks to these products from other countries. Imports help consumers manage their tight household budgets because they are typically manufactured more cheaply than domestically produced equivalents.
The number of goods and services that a country imports and exports can impact the country’s gross domestic product (GDP), its exchange rate, and it’s level of inflation and interest rates.
In this Forex guide for Malaysians, we will look at what a favorable balance of trade is, when it occurs and how it impacts the exchange rate.
What Is a BOT (Balance of Trade)?
The difference between the monetary worth of a country’s imports and exports over a specific period is known as the balance of trade (BOT), or sometimes the trade balance. It is typically represented in terms of the currency unit of a certain country or economic union, such as the dollar.
A trade surplus is indicated by a positive trade balance, whereas a trade deficit is indicated by a negative one. The BOT is crucial in defining a country’s current account balance. The following is the formula for determining the trade balance:
Exports – Imports = Trade Balance
When a country’s imports outnumber its exports, which are products shipped from that country to a foreign destination, its balance of trade is distorted, and its currency devalues.
What Is a Favorable Trade Balance, and when does it occur?
A favorable trade balance is a scenario in which a country exports more goods and services than it imports. It is a phrase used in economics to describe the presence of a surplus in a country’s balance of trade. When a nation sells more products and services than it imports, it is said to be in surplus.
The business cycle and other economic indicators must be taken into account when determining a favorable balance of trade. For example, in a recession, countries like to export more to generate jobs and demand. Countries prefer to import more during periods of economic expansion to stimulate price competition and limit inflation.
Even when the trade balance is favorable, it is not always a positive factor. A favorable balance formed by protectionism may not necessarily be a positive thing, depending on the country’s economic dynamics and foreign trade policies, since it may diminish the standard of living due to scarcity and high pricing due to a lack of competition.
Factors That Influence a Country’s Favorable Trade Balance
The following are some of the factors that influence a country’s favorable balance of trade:
The term “labor” refers to the qualities of a country’s workforce. Land refers to accessible natural resources, such as lumber or oil. Infrastructure and industrial capacity are examples of capital resources.
Policies on Trade
Trade barriers have an impact on a country’s export and import balance. Import restrictions and export subsidies affect the relative prices of those commodities, making them more or less appealing to import or export.
International trade is dependent on the demand for specific goods or services. Oil demand, for example, has an impact on pricing and the trade balance in both oil-exporting and oil-importing nations.
Influence on Exchange Rates
When a country sells more than it imports, its goods and, consequently, its currency are in great demand. When a country imports more than it exports, there is less demand for its currency, so prices should fall. The currency then depreciates or loses value over time.
Let’s imagine chocolates are the sole product on the market, and India buys more chocolates from the United States than it exports, demanding the purchase of more dollars per rupee sold. Because India’s demand for dollars exceeds America’s demand for rupees, the rupee’s value declines. In this case, we’ll predict that rupees will drop to 15 against the dollar. An American now receives 15 rupees for every dollar sold. An Indian must sell 15 rupees in order to purchase $1.
The exchange rate also influences the balance of trade. A weaker home currency boosts exports while increasing import prices. A strong native currency, on the other hand, hampers exports while lowering import costs.
Impact on GDP
A country’s gross domestic product (GDP) is a broad measure of its overall economic activity. When determining GDP, imports and exports are key factors to consider.
A favorable trade balance boosts a country’s GDP. More exports indicate a high level of output from a country’s factories and industrial facilities and a larger number of workers employed to keep these firms running. When a corporation exports a large number of commodities, it also brings money into the country, stimulating consumer spending and contributing to economic growth.
A thriving economy is one in which both exports and imports are increasing. The presence of a favorable balance of trade often indicates economic strength.
Impact on Inflation and Interest Rates
Inflation and interest rates significantly impact imports and exports due to their effect on the currency rate. Inflation causes interest rates to rise, and vice versa.
Higher inflation can directly influence input costs like materials and labor, which can affect exports. These increasing expenses may significantly influence export competitiveness in the international marketplace.
A country’s ability to maintain a favorable balance of trade is a significant measure of its overall health. Since it indicates the quantity of foreign investment received by a country, it has been shown to be associated with political and economic stability.