Answer to Question #33668 in Macroeconomics for Govind

Question

Imports lead to flow of currency out of the country. What does it mean?

Visualize a trade between India and US. Assume first that US exports a certain item to India for 1000$. Say the cost of production is 800$. That equals a profit of 200$=12,000Rs. India pays for this item with 1000$=60,000Rs. So at the end of the trade, US has 60,000Rs in foreign currency. Now is the amount of Indian wealth flowing out of the country 12,000Rs or 60,000Rs? The latter seems illogical to me.

Now assume India exporting to US a certain different item for 1000$. But say the cost of production was 900$=54,000Rs. Now the profit realized by India is 100$=6000Rs. So US just takes out the 60,000Rs from its foreign reserve and pays India.

At the end of the trade it looks like India has managed to buy back the 60,000Rs lost in imports with its export. Which means zero trade deficit. But it's obvious that a loss of 6,000Rs has occured.

So doesn't the pricing of export lead to currency outflow more than the import itself?

Answer 1

If total exports were equal to total imports, these monetary transactions would balance at net zero: people in the country would receive as much in financial flows as they paid out in financial flows. When a country’s imports exceed its exports, it has a current account deficit. There is an offsetting net financial flow consisting of currency, securities, or other real property ownership claims. Its foreign trading partners who hold net monetary claims can continue to hold their claims as monetary deposits or currency.
The net capital flow pays off as a difference between entering and proceeding wealth flowing. The amount of Indian wealth flowing out of the country is 12,000Rs.
The more profit is got by the country at goods sale, the bigger outflow of wealth will be from other country. Even if the balance of payments is equal to zero, the countries that sell more expensive goods, will receive inflow of wealth from the countries that sell cheaper goods. That's why the countries that sell finished goods, receive inflow of wealth from the countries that sell raw materials