What is the Balance of Trade (BOT)? Analyzing Its Impact on Economy and Currency Rate

The trade balance is a fairly common economic term that you have probably heard many times. However, as an analyst, investor, or FOREX trader, understanding this term is extremely important. So, what is the balance of Trade, and what is its importance to the economy & currency? Let’s find out more in the detailed content of the article below.

What is the Balance of Trade (BOT)

What is the Balance of Trade?

The Balance of Trade (BOT) is an economic term that refers to the difference between the value of exports and imports of a country at a certain point in time. It is also known by other names such as net exports or trade surplus. This term records the difference between the value of imports and exports at a specific point in time of a country.

What is the formula for calculating the Balance of Trade?

The Balance of Trade is calculated by subtracting a country’s import value from its export value.

And then we will have one of 3 cases:

• When exports are greater than imports, the trade balance will have a surplus (Positive).
• When imports are greater than exports, the trade balance will have a deficit (Negative).
• When imports are equal to exports, the trade balance is balanced.

Example: In 2021, Vietnam’s export turnover reached 336.31 billion USD, while import turnover was 332.23 billion USD.

=> Vietnam’s trade balance in 2021 is: 336.31 – 332.23 = 4.8 billion USD

In this case, the trade balance is in surplus.

Factors affecting the Balance of Trade

There are many different factors affecting the final outcome of the Balance of Trade, but below are some key factors:

• Imports: imports tend to increase when GDP rises. The increase in imports when GDP increases depends on the marginal propensity to import (MPI) – that is, the part of GDP that people want to spend on imports. In addition, imports depend on the relative prices between domestically produced goods and foreign-made goods. If domestic prices rise compared to international market prices, then imports will increase and vice versa. For example: if the price of bicycles made in Vietnam increases compared to Japanese bicycles, people tend to consume more Japanese bicycles, leading to an increase in imports of this item.
• Exports: assessing exports is a bit more difficult, as they mainly depend on what is happening in other countries because one country’s exports are another country’s imports. Therefore, this is a self-determining factor. However, if there is low inflation in the country, low commodity prices, then the cost of raw materials is also low, leading to increased competitive advantage in the export market, benefiting exports.
• Exchange Rate: This is a very important factor affecting the trade balance. When the exchange rate of a country’s currency rises, the prices of imported goods become cheaper while the price of exported goods become more expensive for foreigners. Therefore, an increase in the domestic currency exchange rate will be disadvantageous for exports and advantageous for imports, resulting in a decrease in net exports. Conversely, when the domestic currency exchange rate falls, exports will have an advantage while imports are disadvantaged and net exports increase. For example: Product A from Vietnam is priced at 200,000 VND and an equivalent product from China is priced at 58 CNY. With an exchange rate of 3,400 VND = 1 CNY, the product from China will be sold at 197,200 VND, cheaper than the Vietnamese product. But if VND depreciates and the exchange rate becomes 3,600 VND = 1 CNY, then now, Product A from China will be sold at 208,800 VND and be less competitive compared to the Vietnamese product.
• Economic Growth: When the economy grows, the income of domestic people also somewhat affects the demand for imported goods, thus affecting the Balance of Trade. In addition, when the economy of a foreign country grows, they also increase the demand for imports from other countries and make the exports of trading partners increase accordingly.
• Policies: State policies also impact the trade balance. These are usually policies that support or restrict export/import for a certain item/product. For example, government agricultural subsidies can reduce cultivation costs, encourage more production for export. Thus, export volume can be improved.
• Import and Export Taxes: Countries often control the trade balance through the imposition of taxes. However, if too high import taxes are set, it can make the trade deficit worse. The reason is that this invisibly creates barriers to the free trade activities of countries. Therefore, the export situation of countries is also affected, thereby affecting the trade balance.

How to use the Balance of Trade in analysis?

When analyzing the Balance of Trade report, you need to consider the following factors:

• Surplus or Deficit: Evaluate whether the trade balance has a surplus, deficit, or is balanced, as this can indicate the general state of the economy.
• Trend of the Trade Balance: Check the historical data of past trade balance reports to determine the future trade trend of a country.
• Consider Trade Partners: Investigate the geographical distribution of trade partners (other countries) to better understand the country’s trade relationships and potential risks or opportunities.
• Analyze in Economic Context: Investors often use the trade balance index to determine whether a country’s overall economic activity is growing or slowing down. But most importantly, it must be linked to the general economic context to see what stage the country is in. For example:

• A country has had a trade surplus for over a decade, but due to some natural disasters, its export activities are affected. The country may have a trade deficit or reduced trade surplus. Such relative comparisons can help you determine whether a country’s economy is booming or slowing down.

• Whether a trade surplus or a trade deficit, neither can tell the whole story. However, they certainly provide us with a macroeconomic picture of the health of an economy and what a country has experienced in the current business cycle. For example, a country that is a major oil exporter and receives most of its income from it. If oil production doubles, there will automatically be an increased demand for that currency globally. This will lead to an appreciation of that country’s currency.

If we only look at the trade balance figures, we cannot immediately conclude whether a country is growing or slowing down. Because the Balance of Trade only shows a part of the picture, not the whole. The trade balance can indicate many things, such as increased employment or expansion or an impending recession, but overall it is quite complex and difficult to analyze separately. It needs to be combined with the overall economic picture to make accurate assessments.

(1) Countries prefer having a trade surplus, and that is obvious. On net, a country earning profits or income from their goods and services means that the people of that country will achieve higher wealth, which automatically leads to a higher standard of living. Additionally, by continually exporting, they will develop a competitive advantage in the global market. This also increases domestic employment, generally being beneficial for the country. However, as mentioned, this condition is not always true.

(2) In other cases, some developing countries may want to import more goods and services from abroad, increasing competition in their respective markets. This keeps prices and inflation low. During these times, the country will have a trade deficit. To outsiders, it may seem like the country is consuming more than it is producing. But, we can’t say that this country’s economy is slowing down, right? And what happens in the case where a country has a trade deficit for the first six months of the year and a trade surplus for the next six months?

Developed countries like the United States and the United Kingdom have experienced long periods of trade deficits, while some economies like China and Japan have maintained trade surpluses for a long time. So, do you evaluate them as growing or slowing down? Therefore, the time frame, business cycle, and relative situation with other countries are all necessary factors to provide an accurate explanation of the BOT.

As briefly mentioned above, there are two types of trade balances – trade surplus/positive or trade deficit/negative. But in this section, I will divide them into positive trade balance & negative trade balance.

Positive Balance of Trade

Mostly, a trade surplus is seen as positive, when a country’s exports exceed its imports. Most countries strive for a trade surplus, as they believe it will generate profits for their country, thereby raising living standards. Additionally, businesses in that country also gain more competitive advantages in producing export goods. This leads to more employment as companies use more workers and generate more income.

An economy with a trade surplus can lend money to deficit countries, while an economy with a large trade deficit borrows money to pay for its goods and services. Additionally, in some cases, the trade balance may correlate with the economic and political stability of a country, reflecting foreign investment. Therefore, most countries view this as a favorable trade balance.

However, under certain conditions, a trade deficit can also be a positive trade balance, as it depends on the stage of the business cycle the country is currently in.

• Let’s take another example of the trade balance – Hong Kong generally always has a trade deficit. But it is considered positive because many of its imported items are raw materials, which are then turned into finished goods and ultimately exported. This gives it a competitive edge in production and finance, while also creating a higher standard of living for its people.

• Another example of the trade balance is Canada, a country with a small trade deficit due to economic growth. As a result, its residents enjoy a better lifestyle simply due to the diversity of imported goods.

Negative Balance of Trade

This often occurs when a country imports more than it exports, also known as a trade deficit. As a criterion, countries with trade deficits typically export raw materials and import many consumer products. The domestic businesses of these countries lack experience in creating value-added products over a long time as they are primarily raw material exporters. Consequently, their economies become dependent on global commodity prices.

Some countries oppose trade deficits to the extent that they adopt mercantilism to control them. This approach involves restricting imports as much as possible, boosting exports, and is often implemented through customs duties or import quotas. Although these measures can reduce the deficit in the short term, they often face opposition from many trading partners in the long run.

Currently, many countries are adopting this policy to gain geopolitical and international trade competitive advantages. Example: China has banned all organizations and government agencies from using imported computers and software from foreign countries.

Impact of Balance of Trade on Currency

Theoretically, an increasing Trade Balance Index is always good for Currency. A lower or negative Trade Balance Index compared to previous periods signals a depreciation of the currency and vice versa.

• If a country exports more than it imports, there will be a high demand for the goods of that country, leading to increased demand for its currency, thus increasing its value.

• Conversely, if a country imports more than it exports, the demand for its currency is relatively lower, leading to a depreciation of its currency.

Example: Assume candy is the only product in the market, and country A imports a lot of candy from country B. As a result, A will need to buy a lot of B’s currency, more than B needs to buy A’s currency. This will lead to a depreciation of A’s currency.

BUT – when a country’s currency depreciates, the attractiveness of its export goods also increases, as the same amount of money can now buy more goods. This will start to impact the trade balance, thereby reducing the trade deficit.

Example: Suppose, the exchange rate between country A’s and B’s currency is 11 (i.e., one unit of B’s currency exchanges for 15 units of A’s currency). After depreciation, the rate becomes 15. That is, initially, a person from country A could buy a candy bar from country B for 11 units. However, after depreciation, they would need 15 units for the same candy bar. => Candy from country B becomes more expensive, leading to a decrease in demand for B’s candy among A’s citizens. Meanwhile, with B’s currency now stronger, they can buy more candy from country A with the same amount of money => Increasing demand for candy made in country A among B’s citizens.

That’s the theory. However, applying it practically in trading, for example in the Forex market, is quite difficult because the Balance of Trade is a data point that helps us understand and make long-term economic judgments, and it does not affect the foreign exchange market in the short term. Therefore, BOT information when released, is not usually deemed highly important.

This article provides information to help you understand what is the Balance of Trade is. Hopefully, through this article, you have gained a clearer understanding of the trade balance, grasped its importance to the economy, and acquired additional knowledge to evaluate an economy, a currency through data related to the trade balance. Wishing you success.