J-Curve : Bilateral Trade between India and BRCS
Exchange rate is a highly crucial factor in determining a country’s growth, provided we are referring to an open-economy. Putting it simply, it acts as an indicator as to how an economy fares with respect to other economies. It determines both, the external position as well as the growth.
The topic here aims to find out if there exists a J-Curve relationship for trade between India and the BRCS (Brazil, Russia, China and South Africa) Nations. The effect of exchange rate in an economy is not single fold, but multi-fold. It impacts the investment, business and many policy decisions. Any volatility in the exchange rate creates uncertainty in the real prices of goods and services.
The relationship
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The price effect is due to the change in the terms of trade or relative prices whereas the quantity effect relates to a change in the volume of real good and services. Our economic theory states that the quantity effect dominates the price effect resulting in instantaneous adjustment. However, in the real world, adjustments are not instantaneous. Thus, in the short-run, as a country devalues its currency , the price effect dominates, with a rise in import price and a fall in export price causing trade balance to worsen further. In the long-run, the adjustment of economic agents within the country devaluing its currency, causes exports to rise and imports to fall causing trade balance to improve. Thus, the presence of J-curve effect.
The rationale behind the J-curve is that import prices respond immediately to exchange rate changes, while import and export volumes adjust in a relaxed manner to the movements in relative prices. Thus, the initial effect of depreciation on the trade balance is “perverse” if import value increases more than export value increase. However, in the long-run, the trade balance will improve when import and export volumes adjust to the higher (lower) import (export)
Since 1992, Canada has increased their amount of exports of goods year-in and year-out until slight downfalls in 2001 and 2002. However, between 1992 and 2000 they raised exports from $135 billion to $289 billion, an increase of 114%. Imports of goods also rose consistently over that nine year period from $128 billion to $244 billion. The key fact there though is that imports rose only 90% compared to a rise in exports of 114%. This has allowed Canada to maintain a very healthy trade balance, which has also risen consistently except for a few decreases in 1997, 1998, and 2002. They have not run a trade balance deficit on goods once since 1992.
So when the dollar is depreciating, the exchange rate becomes smaller. Exchange rate (foreign exchange rate, forex rate or FX rate) is the number of units of a given currency that can be purchased for one unit of another currency. The United States capital markets are becoming more attractive to foreign investors. Since the dollar is falling, it makes foreigner’s investment in the United States more affordable. Therefore, foreigners take this opportunity to invest in the United States.
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The stability of currency values plays a significant role for economic and financial stability. It is not difficult to see the exchange rate fluctuations are widely regarded as damaging. As the movements of the exchange rate have significant and large effects on the trade balance, resource allocation, domestic prices, interest rate, national income and other key economic variables. Then can exchange rate movements be predicted by these fundamental economic variables?
Small businesses such as Alliance Design Concepts are great examples that shows a fluctuation in the foreign currency exchange rate that can impact the profitability of the company. Small businesses have to understand the risk when they doing business on an international level. Very often the exchange rate value will not work in their favor. In case with Alliance, since they were using an international supplier, they needed to make sure they have converted all the cost of equipment from USD to CAD. The exchange rate fluctuation caused a direct 8.2 percent decrease in the pre-tax margin on the equipment for Alliance. In the same way Macdonald’s sales in Europe increased in 2011, however the yearly profit went down as a result of the weakening euro. As as result of even small fluctuations in the exchange rate, it can cost companies to lose in the return on exchange. In my opinion, small business such as independent travel agencies can fell the most impact when of the exchange rate floating. Travelers from and to foreign countries have to convert money to that particular country’s currency so they can have enough funds to visit places, stay at the hotel, and do other things. When the USD appreciates against euro or other major currency, American tourist will be able to enjoy more, because the exchange rate will be in favor to them. On the negative side, if you are a traveler to the USA, then most likely the travel agencies will be experiencing the lower number of foreign travelers due to the fluctuation in the exchange rate. When companies such an Alliance Design Concepts doing business with suppliers or customers that operates in different countries, its very important to understand and share the foreign exchange risk with others i...
There are various models that have been constructed to describe exchange rate volatility and trade. Clark (1973) is the first to develop a theoretical framework which includes exchange rate volatility in the simple trade model. He focuses on the consequence of exchange rate volatility on the level of country’s export. He considers a representative firm that produces homogenous good under perfect competition and sells its entire products abroad. This firm does not have any importing input and it receives its income in terms of foreign currency (that is, it is facing a price uncertainty). It is also assumed that the firm is paid in foreign currency for its exports and these earnings are sold in the forward exchange
Dealing with a lot of International markets, the currency fluctuations will have an impact on the export income. Factors such as taxes should also be considered.
Exchange rate is the ratio at which a unit of one country currency can be exchange for another country currency.
There are also many consequences of adverse terms of trade internationally. High costs of debt servicing, even with a greater quantity of export are required to pay back the same amount of foreign debt. Also, falling export receipts can cause current account deficits, which could lead to increased borrowing. Adverse terms of trade reduce the country’s ability to afford much needed imports, which become more expensive. In dealing with illegal crops it may seem attractive to growers, such as cocaine in South America. The worst thing that can lead to long term depletion of resources is the incentive to export more primary products to compensate for lower export prices.
...cy could be depreciated because export should be increases on that country while other country is on appreciating position they will pay lesser currency rate while import any commodities.
As the foundation for the foreign exchange process, exchange rates are one of the most important elements in business, both internationally and domestically. Defined as the rate at which one currency may be converted into another, exchange rates are used by countries in order to purchase products or services from one another. When examining these exchange rates it is important to note that their two distinct types of rates used for global trade: nominal and real.
The foreign exchange market is one of important mechanism in the international business because foreign exchange is an intermediary for all nations in term of the growth of the economy. There are many functions of foreign exchange market in the global economy. In the international business, it uses the foreign exchange markets in four ways. First, the pay...
Daily in the USA about 38 million banknotes of various face value for total amount about 541 million dollars are issued (Facts about USA money).Dollars involve deep consequences both for the USA, and for other countries. Increase of its course relatively reduces the volume of export revenue in dollars, quite often involves more considerable, than change of an exchange rate, falling of the world prices, especially on raw materials. On the contrary, decrease in a dollar rate serves as the powerful tool promoting growth of the American export and a pushing off of competitors of the USA in foreign markets. At the same time import to the USA owing to effect of a rise in prices restrains. Thus, for the USA changes in the exchange rate of dollar anyway bring benefits and advantages.Reduction of leading positions of the USA in world economy is assisted by the international role of dollar which remains the main reserve and settlement means in world monetary system. Foreign currency reserves of the central banks of other countries for 61% consist of dollars, nearly 2/3 calculations in world trade are carried out in dollars; the dollar serves as a measure of value of many important goods (for example: oil) in the world market; in dollars 3/4 international bank crediting is made (Aleksandr Popov). Changes in the exchange rate of dollar involve deep consequences both for the USA, and for other countries. Increase of its course relatively reduces the volume of export revenue in dollars, quite often involves more considerable, than change of an exchange rate, falling of the world prices, especially on raw materials. On the contrary, decrease in a dollar rate serves as the powerful tool promoting growth of the American export and a pushing off...
...Recent Evidence from US Dollar and Japanese Yen. Global Business Review, 3 (1), pp. 53--61. Pacific Exchange Rates”, Review of International Economics, 8:1, 20–43.
For commodity price, the demand and supply are directly contributing to the price volatility. The changes in interest rates and exchange rates are significant influence for commodity output and it also has impact on the commodity prices (Dornbusch 1976). For example, based on the equation of AD=C+I+G+NX. If the government expenditure increases, it will tend to