What is GDP , Current Account Deficit AND Trade Deficit

Current Account Deficit:

Balance of Payment

Is made up of two components 1. Current account and 2. Capital Account.
This article, deals with Current  Account only.

Current account

It is made up of three parts.

• 1. Balance of Trade
• 2. Earning from Investment
• 3.Cash Transfers

Part #1: Balance of trade

Since we are talking about India’s Current account, whatever money is incoming we take it as positive (+) and whatever money is outgoing, we take it as Negative (-). For 2010-11→

Goods and Services	Worth (Million Dollars)
Export	+299284
Import	-381061
Total	-81777

• We got a negative number, therefore India has a trade “DEFICIT” of 81777 million US$ for year 2010-11. Call this figure (1)
• If we had got a positive number, we could say India had trade “SURPLUS”
• Unfortunately, we can never have “Surplus” because every-year we’ve to import crude oil and gold worth billions of dollar and that disturbs the whole balance.
• Rajiv Gandhi Equity saving scheme was an initiative of Pranab, to make Indians reduce gold-purchase and use that money to invest in capital market. But so far it seems to be heading for #EPICFAIL. Reason: Target audience doesn’t have PAN cards and Demat accounts.
• Note: For the sake of simplicity, I’ve added + and – in front of incoming and outgoing money and did the “total”. But technically it is called “net difference” between exports and imports.

Part #2: Earning on Investment

• Foreigners invest their money in India (both FDI and FII), similarly Indians invest their money abroad.
• On their investment, they earn income: interest rates / dividends etc.
• The amount of money actually invested, is put under Capital Account
• But the amount of income or interest earned on ^above investment, is put under “Current account”
• For example, An FII invests $100 on 8% Bond, therefore earns $8 in interest after one year. The $100 are classified in Capital account and $8 are classified in Current Account.
• Take the difference of incoming and outgoing Earning on Investment for 2010-11 it was  -17309 Million US$…..call this figure (2)
• Question: why was it negative? Because more Foreigners invest in India compared to Indians investing abroad. (we do invest ‘abroad’ but in Swiss bank accounts only :P). Besides even if an Indian had invested in American or European market, he’d not have recieved much income from the investment because of the global financial crisis during that period.

Part #3: Cash Transfer

 The money transferred without exchanging any goods or services. For example an Indian worker sending money from Dubai to his family in Kerala(Remittances)
 Some American nuclear powerplant company using a charity foundation to send donations to Jholachhap NGOs of India, to help them finance the protests, dharnaa pradarshan against Russian nuclear powerplants in India = that is also one type of “service” offered by Indian NGOs but still “Donations” fall under “Cash transfers” and not under the “Goods and services”
 Again take difference of incoming and outgoing money: thankfully this number was positive for 2010-11: it was +53140 Million US$….call this figure (3)
 Why was it positive? Because so many Indian people work abroad and send money to their families, that remittance is soooo high, that it skews to balance in positive direction

 Besides there are very few foreigners working in Indian and remitting money back home. One of them was that Italian tourist-agent in Orrisa but he was kidnapped by naxalites and went back to Italy so that is one less foreigner remitting money from India to abroad = next year the “cash-transfer” of India will look even more positive What's the Difference Between Nominal and Real interest rates?

Real Variables and Nominal Variables Explained

Generally a real variable, such as the real interest rate, is one where the effects of inflation have been factored in. A nominal variable is one where the effects of inflation have not been accounted for. A few examples illustrate the difference:

1. Nominal Interest Rates vs. Real Interest Rates

Suppose we buy a 1 year bond for face value that pays 6% at the end of the year. We pay Rs.100 at the beginning of the year and get Rs.106 at the end of the year. Thus the bond pays an interest rate of 6%. This 6% is the nominal interest rate, as we have not accounted for inflation. Whenever people speak of the interest rate they're talking about the nominal interest rate, unless they state otherwise.
Now suppose the inflation rate is 3% for that year. We can buy a basket of goods today and it will cost Rs.100, or we can buy that basket next year and it will cost Rs.103. If we buy the bond with a 6% nominal interest rate for Rs.100, sell it after a year and get Rs.106, buy a basket of goods for Rs.103, we will have Rs.3 left over. So after factoring in inflation, our Rs.100 bond will earn us Rs.3 in income; a real interest rate of 3%. The relationship between the nominal interest rate, inflation, and the real interest rate is described by the Fisher Equation:

Real Interest Rate = Nominal Interest Rate - Inflation

If inflation is positive, which it generally is, then the real interest rate is lower than the nominal interest rate. If we have deflation and the inflation rate is negative, then the real interest rate will be larger. when prices are declining over time. This is the opposite of inflation; when the inflation rate (by some measure) is negative, the economy is in a deflationary period."

2. Nominal GDP Growth vs. Real GDP Growth

GDP, or Gross Domestic Product is the value of all the goods and services produced in a country. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. On the other hand, Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. An example:
Suppose in the year 2000, the economy of a country produced Rs.100 billion worth of goods and services based on year 2000 prices. If we're using 2000 as a basis year, the nominal and real GDP are the same. In the year 2001, the economy produced Rs.110B worth of goods and services based on year 2001 prices. Those same goods and services are instead valued at Rs.105B if year 2000 prices are used. Then:
Year 2000 Nominal GDP = Rs.100B, Real GDP = Rs.100B
Year 2001 Nominal GDP = Rs.110B, Real GDP = Rs.105B
Nominal GDP Growth Rate = 10%
Real GDP Growth Rate = 5%
Once again, if inflation is positive, then the Nominal GDP and Nominal GDP Growth Rate will be less than their nominal counterparts. The difference between Nominal GDP and Real GDP is used to measure inflation in a statistic called The GDP Deflator.

3. Nominal Wages vs. Real Wages

These work in the same way as the nominal interest rate. So if your nominal wage is Rs.50,000 in 2002 and Rs.55,000 in 2003, but the price level has risen by 12%, then your Rs.55,000 in 2003 buys what Rs.49,107 would have in 2002, so your real wage has gone done. You can calculate a real wage in terms of some base year by the following:

Real Wage = Nominal Wage / 1 + % Increase in Prices Since Base Year

Where a 34% increase in prices since the base year is expressed as 0.34.

4. Other Real Variables

Almost all other real variables can be calculated in the manner as Real Wages. The Federal Reserve keeps statistics on items such as the Real Change in Private Inventories, Real Disposable Income, Real Government Expenditures, Real Private Residential Fixed Investment, etc. These are all statistics which account for inflation by using a base year for prices

What Happens if Interest Rates Go To Zero?

A Negative Interest Rate?

First we need to distinguish between nominal and real interest rates. the nominal interest rates are the ones you typically hear about (prime rate, etc.) whereas real interest rates factor out inflation.
This week we will examine zero nominal interest rates. Next week we will look at zero real interest rates.

Zero Nominal Interest Rates

A zero nominal interest rate occurs when the interest rate is the same as the inflation rate. If inflation is 4% then interest rates are 4%. If you lent or borrowed for a year at a zero real interest rate, you would be exactly back where you started at the end of the year. I loan Rs.100 to someone, I get back Rs.104, but now what cost Rs.100 before costs Rs.104 now, so I'm no better off.
Typically nominal interest rates are positive, so people have some incentive to lend money. During a recession, however, central banks tend to lower nominal interest rates in order to spur investment in machinery, land, factories, etc. If they cut interest rates too quickly, they can start to approach the level of inflation. Inflation will often rise when interest rates are cut, since these cuts have a stimulative effect on the economy.
According to some economists a zero nominal interest rate can be caused by a liquidity trap:

"The Liquidity trap is a Keynesian idea. When expected returns from investments in securities or real plant and equipment are low, investment falls, a recession begins, and cash holdings in banks rise. People and businesses then continue to hold cash because they expect spending and investment to be low. This is a self-fulfilling trap."

There is a way we can avoid the liquidity trap and, for real interest rates to be negative, even if nominal interest rates are still positive. It occurs if investors believe a currency will rise in the future. Suppose the nominal interest rate on a bond in Norway is 4%, but inflation in that country is 6%.

Calculating the Real Rate of Return on Investments

It's not what You Make, but what You Keep

How much did your investments really earn last year? You can calculate a rate of return, but if you don’t adjust it for inflation and taxes, you’re not getting the real rate of return.
This is the difference between the nominal interest rate and the real interest rate. You want to know the real rate, since that is the only number that means anything.
Think of it this way: the nominal interest rate tells you the growth rate of your money, while the real interest rate tells you how much your purchasing power is growing.

Growing Money

For example, if make a Rs.1,000 investment that earns 8% in one year, you end the year with Rs.1,080. In other words, your money has grown by Rs.80.
However if inflation is 3% for the year, your Rs.1,080 is only worth Rs.1,050. Inflation devalues not only the interest you earned, but the principal too. Your real rate of return is only 5%.
Investors depending on dividend income or interest from bonds or other fixed-income securities are most directly affected by the costs of inflation. If you hold a stock, the gains build up until you sell, so it may be possible to avoid the “inflation tax” if you can time the sale for periods of low inflation.
Stocks can generally weather the effects of inflation better than bonds or other savings instruments. Companies can pass on the higher costs of inflation to customers. Of course, this tends to keep the inflationary cycle going.

Taxes

The above exercise adjusted your rate of return for inflation; however, it was purely academic unless your investment was in a tax-deferred account or a tax-free investment.
The other deduction you need to take to reach the real rate of return is for taxes. You don’t get to keep – in most cases – all the money you make. The government will want its share too.

Tax Example

Let’s return to our example. You invested Rs.1,000 and earned 8% nominal return for Rs.1,080. However, inflation is running 3%, so your real rate of return is only 5% giving you purchasing power of Rs.1,050.
Even though your Rs.1,080 will only buy what Rs.1,050 would one year ago, you still have Rs.1,080 in your account and the government wants a piece. For simplicity sake, let’s assume that state and federal taxes totaled 28% in your bracket.
The government will want Rs.22 of your Rs.80 gain in taxes. Now your real bank account is down to Rs.1,058.
If we reapply the 3% inflation to what you will actually get to keep, we will come up with the real purchasing power your investment returned. This figure is Rs.1,026 (97% of Rs.1,058 = Rs.1,026).
The ugly bottom line is this. Your Rs.1,000 investment has bought you a real return of 2.6% increase in purchasing power over last year after taxes.
That doesn’t sound like much, however if you run all investments through the same exercise, you’ll find similar results.

Conclusion

Real returns don’t sound as sexy as nominal rates of return, but they are the truth and not an illusion.