Recent World Trade Scenario of Trading

The global economy has been on a subdued growth path since the advent of ‘Financial Crisis’ of 2008, and has now started to show signs of global recovery. In October 2017, the IMF projected world GDP growth to pick up from 3.2% in 2016 to 3.6% in 2017, and further to 3.7% in 2018. Economic activity has also picked up in developed market economies such as the US, UK, and Europe. There is a rise in global demand, which is expected to remain buoyant. The developing and emerging market economies have seen mixed economic performance. The pickup in momentum of global demand has been led by investment demand. More specifically, production of both consumer durables and capital goods have rebounded since the second half of 2016. Some factors that have contributed to these developments include global recovery in investments, led by infrastructure and real estate investment in China; firming global commodity prices; and end of an inventory cycle in US.

On the back of this global recovery, the world is witnessing a pickup in global trade. The Asian Development Bank, in its recent update1, noted that most of the emerging economies (excluding China) are witnessing a rebound in manufacturing exports, “particularly in electronics, where foreign direct investment has been strengthening”. The economies of south-east Asia are also gaining from increased activity along cross-border manufacturing supply chains. The World Trade Organization (WTO), has recently in its September 2017 press release upgraded the growth forecast for global trade in the year 2017, from 2.4% to 3.6%. Particularly, in the first half of 2017, world trade rose by a robust 4.2% (year on year), driven by exports of developing economies which grew by 5.9 percent as compared to a growth of 3.1 percent witnessed in exports of developed economies. Imports by developed and developing economies also increased by 2.1% and 6.9%, respectively. Moreover, the ratio of trade growth to world GDP growth is also set to recover and reach around 1.3, which will be at a highest level in last 5 years.

This pickup in global growth which has boosted demand for imports, spurred intra-Asia-trade as demand was transmitted through global value chains. In this current scenario, even though India is witnessing a mild rebound in its exports, there are concerns that merchandise exports in Asia’s second largest economy are lagging behind other major Asian economies. Today global attention is riveted on emerging and developing economies and especially Asia, driven by the continent’s growing appetite for industrial investment, burgeoning infrastructural requirements and its quest for expanding trade.

Indian economy and its trade scenario

India’s growth story, especially since the start of the 21st century has been remarkable. The Indian economy has come a long way since its economic liberalisation, and is amongst the fastest growing major economies of the world today. While India witnessed a relatively moderate growth during the period 2011-12 to 2013-14, on account of the global economic slowdown, the economy recorded a robust growth averaging 7.5 percent during the period 2014-15 to 2016-17, much above the growth rate of other emerging and developing economies. In the last one year, it has seen major economic policy developments with the introduction of Goods and Services Tax (GST) and demonetization of higher currency notes.

Even though the GDP growth in the first quarter of current fiscal has fallen down to a low of 5.7%, its lowest since March 2014, it is widely believed that the economy has bottomed out and it can only rise from here. According to the IMF, India is expected to grow at 7.2% in this fiscal year, aided by higher government spending and a pickup in the service sector performance.

Fueling India’s growth through international trade

In recent years, India’s robust growth has been driven by the dynamic private sector. An encouraging phenomenon that has been witnessed has been the emergence of a large number of investment driven small and medium enterprises with immense potential for growth. A large number of such enterprises have also endeavoured to expand their business operations overseas. The Indian economy is more globalized than we could imagine. As a result, India’s foreign trade has seen a multi-fold increase, since liberalization of the economy.

Accordingly, there have been significant structural shifts not only in the product basket, but also in the geographical composition of India’s foreign trade. The opening up of Indian economy led to a massive increase in the foreign trade, which aided in sustained GDP growth over last two decades. During the last 25 years Indian exports have increased by 17 times and imports by 19 times. India’s share in global merchandise exports has risen from 0.6 percent in early 1990s to 1.7 percent in 2016, and similarly the share of imports has risen from 0.6 percent to 2.4 percent during the same period. India’s trade to GDP ratio, a measure of an economy’s openness and integration into the global economy, has witnessed a phenomenal increase over the last few decades. Foreign trade which constituted around 13-15 percent of India’s GDP in the early nineties, peaked at 55 percent in 2012- 13 and today accounts for around 40 percent in 2016-17. India also, ranked as the 20th largest exporter and 14th largest importer in the world in 2016.

Concomitantly, India’s engagement with Global Value Chains (GVCs), which have become dominant feature of world trade, has increased significantly since 1990s. In manufacturing sector, especially for electrical and optical equipment, India is more integrated with the south east Asian region, while for services the integration in GVCs is with western countries like the US and UK. According to an OECD estimate, developing economies with fastest growing GVC participation have experienced a GDP per capita growth rate percent above average.

India has set an ambitious target of achieving exports worth US $ 900 billion by 2020, while accounting for a share of 3.5 percent of global exports4. In the current global macroeconomic scenario, while it seems like a challenging task, concerted efforts would need to be made for India to be able to achieve its trade target and realign its foreign trade policy with the new global trading system.

While the global economic scenario is crucial, the domestic factors are no less important, when it comes to trade. India’s overall trade policy faces certain challenges viz. inadequate export diversification in terms of products and geographical distribution; insignificant involvement of a majority of states in exports; rationalisation of the tariff regime and export promotion schemes; and factor market reforms which are critically linked with export performance. These challenges not only affect the productivity and competitiveness of domestic firms but also restrict them from participating in global production networks.

(i) Integrating into and moving up the value chain

Most manufactured products, often high technology manufactured products, that are part of GVCs are infrastructure critical products whose parts are manufactured in several countries. A robust transport and connectivity network supported by fast entry/exit through port/customs is a precondition to making such products as delay may disrupt the entire value chain. There is a need for India to focus on expanding production capacity along with value addition, and moving up the value chain,while creating an enabling environment to account for a sizeable share in major leading global exports. This gain seven more significance given that India’s labour force is projected to swell by about 110 mn by 2020. The biggest challenge is to employ the surplus labour coming out of agriculture into industry and services.

(ii) Upscaling Manufacturing

The Make in India initiative is an important initiative of the Government of India, which envisages to promote India as a manufacturing hub and investment destination. There is need for highlighting the potential and stimulating the manufacturing sector through supporting mechanisms and conducive policy measures, including support for R&D, technology orientation and investment incentives. A Higher expenditure on R&D generally correlates with increase in high-technology exports, and increased local value addition. R&D expenditure as a percentage share of GDP in India has remained extremely low at less than1 percent, much lower even in comparison to other developing economies. Also, while we lay emphasis on the manufacturing sector and thereby on manufactured exports, it is also important to ensure an enabling environment and improving our competitiveness by investing in infrastructure such as better connectivity through roads and ports, coal availability, labour reforms and flexibility in factor markets.

(iii) Aligning India’s Export Capability in-Line with Global Import Demand

With regard to India’s exports, while merchandise exports have more than doubled over the period 2006-07 to 2016-17 from US$ 126 billion to more than US$276 billion, there remains huge potential for exports of select products to select countries in line with India’s export capability and import demand. There is need for identifying and aligning India’s export capability vis-à-vis global import demand. Such in-depth analysis has been the focus of research studies in Exim Bank. Comparative analyses of global trends in trade, undertaken in such studies have yielded interesting results.

To Conclude

All in all, a pick-up in global growth is expected to contribute to the revival of international trade, but the downside risks such as the possible adoption of protectionist trade policies by especially developed market economies, around the world weigh on the recovery of trade. As a result, there is an increasing need for India and other emerging market economies, relying on export led economic growth, to take a proactive stand for globalization and international trade.

There is a need to shift our focus from exporting what we can (or supply based), to items that are globally demanded. A demand-based export basket diversification approach could give a big push to exports. While India has made remarkable progress in the recent past, it facesan even more challenging global environment today. Itis certainly a daunting, yet possible, task to ensure that India repositions itself as an important driver of global economic growth.

Recent Changes in Trade Policy

The commerce ministry is considering rationalising and simplifying certain export promotion schemes such as EPCG in the next foreign trade policy, which provides guideline and incentives for increasing shipments, an official said.

The ministry is in consultation with all stakeholders for the preparation of the next policy (2020-25), as the validity of the old one ends on March 31, 2020, the official said.

The ministry may also include new chapters for services, and e-commerce exports besides simplifying advance authorisation and self ratification schemes.

EPCG is an export promotion scheme under which an exporter can import certain amount of capital goods at zero duty for upgrading technology related with exports.

On the other hand, advance authorisation is issued to allow duty free import of inputs, which is physically incorporated in export product.

Total exports of third party could be counted as export obligation instead of only proceeds realised from third party by EPCG holders, the official said.

Similarly in the advance authorisation scheme, export obligation period could be enhanced from the current 18 months.

For the export oriented units, the ministry is considering getting policy formulation, regulation and administration under one roof.

The ministry’s arm directorate general of foreign trade (DGFT) is formulating the policy.

At present, tax benefits are provided under merchandise export from India scheme (MEIS) for goods and services export from India scheme (SEIS).

In the new policy, changes are expected in incentives given to goods as the current export promotion schemes are challenged by the US in the dispute resolution mechanism of the World Trade Organisation (WTO).

Against this backdrop, the government is recasting the incentives to make them compliant with global trade rules, being formulated by Geneva-based WTO, a 164-nation multilateral body.

Exporters are demanding incentives based on research and development, and product-specific clusters under the new policy.

Ludhiana-based Hand Tools Association President S C Ralhan said the new policy should have provisions for refund of indirect taxes like on oil and power, and state levies such as mandi tax.

During April-September 2019, exports were down 2.39 per cent to USD 159.57 billion while imports contracted by 7 per cent to USD 243.28 billion. Trade deficit during the period narrowed to USD 83.7 billion as against USD 98.15 billion in April-September 2018-19.

8 Important Changes in Foreign Trade Policy 2015-2020

  1. Five different schemes(Focus Product Scheme, Market Linked Focus Product Scheme, Focus Market Scheme, Agri Infrastructure Incentive Scrip, VKGUY) merged into single unconditional scheme named as Merchandise Export from India Scheme(MEIS).
  2. SFIS(Serve from India Scheme) has been replaced by Service Exports from India Scheme(SEIS) so as to allow benefits to all services providers located in India, instead of Indian Service Providers. This amendment has been made to abide by the recent verdict pronounced by Hon’ble Delhi High Court in case of YUM RESTAURANTS(I) Pvt. Ltd. V. UOI & Ors.
  3. Scrips as well as goods under both the aforesaid schemes shall be fully transferable.
  4. MEIS benefit shall be computed on basis of FOB value of exports, whereas benefit under SEIS shall be based on Net foreign exchange earned.
  5. Rates under SEIS shall be 3% and 5%, depending on nature of industry notified.
  6. Import of capital goods under EPCG Authorisation Scheme shall not be eligible for exemption from payment of anti-dumping duty, safeguard duty and transitional product specific safeguard duty.
  7. Scrips under both the schemes can be used for the payment of customs duty, excise duty and service act at the time of procurement;
  8. Certificates by CA/CS/CWA, etc. shall be allowed to be uploaded electronically(digitally signed).

Trade Agreements: Bilateral and Multilateral Trade Agreements

A trade agreement (also known as trade pact) is a wide-ranging taxes, tariff and trade treaty that often includes investment guarantees. It exists when two or more countries agree on terms that helps them trade with each other. The most common trade agreements are of the preferential and free trade types are concluded in order to reduce (or eliminate) tariffs, quotas and other trade restrictions on items traded between the signatories.

The logic of formal trade agreements is that they outline what is agreed upon and the punishments for deviation from the rules set in the agreement. Trade agreements therefore make misunderstandings less likely, and create confidence on both sides that cheating will be punished; this increases the likelihood of long-term cooperation. An international organization, such as the IMF, can further incentivize cooperation by monitoring compliance with agreements and reporting third countries of the violations. Monitoring by international agencies may be needed to detect non-tariff barriers, which are disguised attempts at creating trade barriers.

Trade pacts are frequently politically contentious since they may change economic customs and deepen interdependence with trade partners. Increasing efficiency through “free trade” is a common goal. For the most part, governments are supportive of further trade agreements.

Bilateral Trade

Bilateral trade is the exchange of goods between two nations promoting trade and investment. The two countries will reduce or eliminate tariffs, import quotas, export restraints, and other trade barriers to encourage trade and investment. In the United States, the Office of Bilateral Trade Affairs minimizes trade deficits through negotiating free trade agreements with new countries, supporting and improving existing trade agreements, promoting economic development abroad, and other actions.

Understanding Bilateral Trade

The goals of bilateral trade agreements are to expand access between two countries’ markets and increase their economic growth. Standardized business operations in five general areas prevent one country from stealing another’s innovative products, dumping goods at a small cost, or using unfair subsidies. Bilateral trade agreements standardize regulations, labor standards, and environmental protections.

The United States has signed bilateral trade agreements with 20 countries. It formed bilateral, free trade agreements with Israel (1985), Jordan (2001), Australia, Chile, Singapore (2004), Bahrain, Morocco, Oman (2006), Peru (2007), and with Panama, Colombia, South Korea (2012). The Dominican Republic – Central America FTR (CAFTA – DR) is a free trade agreement signed between the United States and smaller economies of Central America. These are El Salvador, Dominican Republic, Guatemala, Costa Rica, Nicaragua, and Honduras. NAFTA replaced the bilateral agreements with Canada and Mexico in 1994.

Advantages and Disadvantages of Bilateral Trade

Compared to multilateral trade agreements, bilateral trade agreements are easily negotiated, because only two nations are party to the agreement. Bilateral trade agreements initiate and reap trade benefits faster than multilateral agreements. When negotiations for a multilateral trade agreement are unsuccessful, many nations will negotiate bilateral treaties instead. However, new agreements often result in competing agreements between other countries, eliminating the advantages the Free Trade Agreement (FTA) confers between the original two nations.

Bilateral trade agreements also expand the market for a country’s goods. The United States vigorously pursued free trade agreements with a number of countries under the Bush administration during the early 2000s. In addition to creating a market for US goods, the expansion help spread the mantra of trade liberalization and encouraged open borders for trade. However, bilateral trade agreements can skew a country’s markets when large multinational corporations, which have significant capital and resources to operate at scale, enter a market dominated by smaller players. As a result, the latter might need to close shop when they are competed out of existence.

Examples of Bilateral Trade

In October 2014, the United States and Brazil settled a longstanding cotton dispute in the World Trade Organization (WTO). Brazil terminated the case, relinquishing its rights to countermeasures against U.S. trade or further proceedings in the dispute. Brazil also agreed to not bring new WTO actions against U.S. cotton support programs while the current U.S. Farm Bill is in force, or against agricultural export credit guarantees under the GSM-102 program. Because of the agreement, American businesses are no longer subject to countermeasures such as increased tariffs totaling hundreds of millions of dollars annually.

In March 2016, the U.S. government and the government of Peru reached an agreement removing barriers for U.S. beef exports to Peru that had been in effect since 2003. The agreement opened one of the fastest-growing markets in Latin America. In 2015, the United States exported $25.4 million in beef and beef products to Peru. Removal of Peru’s certification requirements, known as the export verification program, assured American ranchers expanded market access.

The agreement reflects the U.S. negligible risk classification for bovine spongiform encephalopathy (BSE) by the World Organization for Animal Health (OIE). The United States and Peru agreed to amendments in certification statements making beef and beef products from federally inspected U.S. establishments eligible for export to Peru, rather than just beef and beef products from establishments participating in the USDA Agricultural Marketing Service (AMS) Export Verification (EV) programs under previous certification requirements.

Multilateral Trade Agreements

Multilateral trade agreements are treaties created between three or more nations looking to trade with each other. Trade agreements have exploded in the last 70 years as nations realized that international trade is critical to domestic health. When trade agreements are created between multiple countries, there are upsides and downsides.

Features of Multilateral Trade

  • Multilateral agreements mean parties negotiate on more even ground, and they’re also more likely to make concessions for the “good of all” as opposed to the bilateral negotiation that can be done from a defensive stance as countries try to get the best deal for themselves.
  • Multilateral trade tends to benefit growing economies, like how trade exploded for Mexico after NAFTA took effect in 1993. It led to trade growing between the nations by over 300 percent in the next 25 years. American companies benefitted from NAFTA, too, with many moving factories south; American jobs, some would say, were the losers in the deal.
  • Companies love multilateral agreements because it means the trading regulations will be the same for each country behind the pact, simplifying the bureaucracy for businesses — but also potentially giving them new markets to access while keeping their legal costs low.
  • Unfortunately, the many partners of multilateral trade agreements mean the treaties are complex and often misunderstood by the public. Part of this is because of concessions countries make during such large deals, which makes the average voter think their country’s coming up empty on the deal.
  • Plus, small businesses often lose out with multilateral trade agreements, since it’s multinational companies who are most likely to profit, thanks to already operating in those regions. It can lead to small and mid-sized businesses having to move operations to new countries and make other big changes just to stay competitive. If their business suffers, it can cause job losses or force businesses to close altogether, making multilateral agreements somewhat unpopular.

General Agreement on Tariffs and Trade (GATT) History, Objectives and Functions

General Agreement on Tariffs and Trade (GATT) was a multilateral agreement regulating international trade. Established in 1947, its main objective was to reduce trade barriers such as tariffs, quotas, and subsidies, promoting economic recovery post-World War II. GATT provided a forum for negotiating trade agreements, settling trade disputes, and enforcing members’ commitments to reduce trade barriers. It laid the foundation for the rules-based trading system, emphasizing non-discrimination and transparency in international trade practices. GATT went through multiple negotiation rounds, each aiming to further liberalize global trade. The most notable was the Uruguay Round, which concluded in 1994, leading to the establishment of the World Trade Organization (WTO) in 1995. The WTO replaced GATT as the global organization overseeing international trade rules, incorporating and expanding on its principles and structures.

History of GATT:

General Agreement on Tariffs and Trade (GATT) was established in the aftermath of World War II, with its genesis rooted in the desire to create a stable trade framework that would prevent the protectionist trade policies that many believed had contributed to the economic downturns and international tensions of the 1930s. The idea was to establish an International Trade Organization (ITO) as part of the Bretton Woods system of international economic cooperation, which also included the International Monetary Fund (IMF) and the World Bank. However, the ITO never came into existence due to the failure of the United States to ratify it. As a provisional workaround, 23 countries signed the GATT in 1947, which then came into effect on January 1, 1948.

GATT was initially intended to be temporary, pending the establishment of the ITO, but it effectively served as the global framework for trade regulation for almost five decades. Its primary aim was to reduce tariffs and other trade barriers, and to provide a platform for the negotiation of trade liberalization. Over the years, GATT underwent several rounds of negotiations, which were named after the host city or country (e.g., Geneva, Annecy, Torquay, Geneva again, Dillon, Kennedy, Tokyo, and Uruguay).

The most significant of these was the Uruguay Round (1986-1994), which led to the creation of the World Trade Organization (WTO) on January 1, 1995. The WTO absorbed GATT, bringing it into a new legal framework and expanding its scope to include not just goods, but also services and intellectual property. The transformation marked a shift from a provisional agreement to a permanent institution, reflecting the evolution of the global economy and the increasing complexity of international trade.

Objectives of GATT:

  • Trade Liberalization:

The primary goal was to reduce tariffs, quotas, and other trade barriers among member countries, facilitating smoother and more accessible international trade.

  • Non-Discrimination:

GATT emphasized the principle of non-discrimination through two key policies: the Most Favored Nation (MFN) clause, which ensured that any trade advantage a country offers to one GATT member must be extended to all members, and the national treatment policy, which required foreign goods to be treated no less favorably than domestically produced goods once they had entered a market.

  • Predictability:

By encouraging countries to bind their tariffs (agree not to raise them beyond agreed levels), GATT aimed to create a more predictable trading environment. This predictability was intended to encourage investment and long-term business planning.

  • Fair Competition:

GATT sought to level the playing field in international trade by establishing rules aimed at fair competition, thereby discouraging practices such as dumping (selling goods abroad at unfairly low prices).

  • Dispute Resolution:

Establishing a formal mechanism for resolving trade disputes between countries was an essential objective. This mechanism was intended to provide a structured process for addressing grievances and conflicts arising from trade relations, helping to avoid unilateral actions that could lead to trade wars.

  • Economic Growth and Development:

Ultimately, GATT aimed to contribute to economic growth and development worldwide, particularly in post-war recovery, by fostering an open and non-discriminatory trading system. This goal was based on the belief that freer trade would lead to more efficient resource allocation, increased production and employment, and a higher standard of living globally.

Functions of GATT:

  • Trade Negotiations:

GATT provided a forum for member countries to negotiate the reduction or elimination of tariffs and other trade barriers. These negotiations occurred in a series of trade rounds, including the notable Kennedy Round, Tokyo Round, and the Uruguay Round, which led to significant reductions in tariffs and the expansion of international trade.

  • Trade Liberalization:

Central to its functions, GATT worked towards liberalizing trade by encouraging member countries to reduce trade barriers. The aim was to create a more open and efficient international trading system.

  • Enforcement of Trade Rules:

GATT established a set of rules governing international trade. These rules were designed to ensure that trade occurred on a stable, predictable, and fair basis. GATT provided mechanisms to enforce these rules and resolve disputes between countries over trade issues.

  • Monitoring and Surveillance:

GATT was responsible for monitoring the trade policies and practices of its member countries. This function involved reviewing national trade policies to ensure compliance with GATT rules and commitments, thereby promoting transparency and accountability in international trade.

  • Dispute Resolution:

An important function of GATT was to provide a mechanism for the resolution of trade disputes between member countries. The dispute resolution process aimed to resolve conflicts in a structured and legal manner, thereby avoiding unilateral actions that could lead to trade wars.

  • Technical Assistance and Training:

GATT provided technical assistance and training for developing countries to help them understand and implement GATT rules and benefit from the international trading system. This function was essential for integrating developing countries into the global economy.

  • Promotion of Economic Development:

Through its efforts to liberalize trade and reduce barriers, GATT aimed to promote economic development and raise living standards across the globe. By facilitating increased international trade, GATT sought to contribute to economic growth in both developed and developing countries.

UNCTAD

The United Nations Conference on Trade and Development (UNCTAD) was established in 1964 as a permanent intergovernmental body.

UNCTAD is the part of the United Nations Secretariat dealing with trade, investment, and development issues. The organization’s goals are to: “maximize the trade, investment and development opportunities of developing countries and assist them in their efforts to integrate into the world economy on an equitable basis”. UNCTAD was established by the United Nations General Assembly in 1964 and it reports to the UN General Assembly and United Nations Economic and Social Council.

The primary objective of UNCTAD is to formulate policies relating to all aspects of development including trade, aid, transport, finance and technology. The conference ordinarily meets once in four years; the permanent secretariat is in Geneva.

One of the principal achievements of UNCTAD (1964) has been to conceive and implement the Generalised System of Preferences (GSP). It was argued in UNCTAD that to promote exports of manufactured goods from developing countries, it would be necessary to offer special tariff concessions to such exports. Accepting this argument, the developed countries formulated the GSP scheme under which manufacturers’ exports and import of some agricultural goods from the developing countries enter duty-free or at reduced rates in the developed countries. Since imports of such items from other developed countries are subject to the normal rates of duties, imports of the same items from developing countries would enjoy a competitive advantage.

The creation of UNCTAD in 1964 was based on concerns of developing countries over the international market, multi-national corporations, and great disparity between developed nations and developing nations. The United Nations Conference on Trade and Development was established to provide a forum where the developing countries could discuss the problems relating to their economic development. The organisation grew from the view that existing institutions like GATT (now replaced by the World Trade Organization, WTO), the International Monetary Fund (IMF), and World Bank were not properly organized to handle the particular problems of developing countries. Later, in the 1970s and 1980s, UNCTAD was closely associated with the idea of a New International Economic Order (NIEO).

The first UNCTAD conference took place in Geneva in 1964, the second in New Delhi in 1968, the third in Santiago in 1972, fourth in Nairobi in 1976, the fifth in Manila in 1979, the sixth in Belgrade in 1983, the seventh in Geneva in 1987, the eighth in Cartagena in 1992, the ninth at Johannesburg (South Africa) in 1996, the tenth in Bangkok (Thailand) in 2000, the eleventh in São Paulo (Brazil) in 2004, the twelfth in Accra in 2008, the thirteenth in Doha (Qatar) in 2012 and the fourteenth in Nairobi (Kenya) in 2016.

Currently, UNCTAD has 195 member states and is headquartered in Geneva, Switzerland. UNCTAD has 400 staff members and a bi-annual (2010–2011) regular budget of $138 million in core expenditures and $72 million in extra-budgetary technical assistance funds. It is a member of the United Nations Development Group. There are non-governmental organizations participating in the activities of UNCTAD.

World Trade Organization (WTO) History, Objectives and Functions

World Trade Organization (WTO) is an international body established to oversee and regulate international trade. Founded in 1995 as the successor to the General Agreement on Tariffs and Trade (GATT), the WTO aims to facilitate smooth, free, and predictable trade flows between its member countries. It provides a framework for negotiating trade agreements, a dispute resolution mechanism to enforce members’ adherence to WTO agreements, and a forum for trade negotiations and discussions. The organization’s primary goal is to ensure that trade flows as smoothly, predictably, and freely as possible, thereby contributing to economic growth and development worldwide. By promoting lower trade barriers and providing a platform for the resolution of trade disputes, the WTO helps to create a more open and equitable global trading system.

History of WTO:

World Trade Organization (WTO) was established on January 1, 1995, succeeding the General Agreement on Tariffs and Trade (GATT) that had been in operation since 1948. The creation of the WTO marked a significant evolution in international economic governance, reflecting the need for a more comprehensive and legally binding system to manage the complexities of international trade in the post-Cold War global economy.

The origins of the GATT can be traced back to the aftermath of World War II, when countries sought to rebuild their economies and establish a stable and predictable framework for international trade. The GATT was initially meant to be a temporary arrangement until the establishment of the International Trade Organization (ITO). However, the ITO never came into existence due to the failure of the United States to ratify the agreement, making the GATT the de facto framework for international trade.

Over nearly five decades, the GATT provided the rules for much of world trade and witnessed considerable liberalization, particularly through its trade negotiation rounds. The most notable of these was the Uruguay Round, conducted from 1986 to 1994, which led to the creation of the WTO. This round of negotiations was ambitious in its scope, addressing not only tariffs but also non-tariff barriers, agriculture, textiles, services, intellectual property, and the creation of a dispute settlement mechanism.

The establishment of the WTO brought several new dimensions to global trade governance, including the incorporation of trade in services and intellectual property rights into the multilateral trading system and the introduction of a more robust and legally binding dispute resolution mechanism. Today, the WTO remains the primary international body governing world trade, with a mandate to facilitate trade negotiations, solve trade disputes, and enforce adherence to WTO agreements among its member countries.

Objectives of WTO:

  • Promoting Free Trade:

Reduction of tariffs, elimination of import quotas, and dismantling of other trade barriers to facilitate smoother and freer flow of goods and services across international borders.

  • Ensuring Non-Discrimination:

Implementing the principle of non-discrimination through Most-Favored-Nation (MFN) status and national treatment, ensuring that each member country treats its trading partners equally and without prejudice.

  • Enhancing Predictability and Stability:

Providing a stable, predictable, and transparent trading environment by enforcing trade rules and commitments among member countries, thereby reducing the risk associated with international trade and investment.

  • Promoting Fair Competition:

Aiming to create a level playing field for all traders by establishing and enforcing rules on fair competition, including addressing subsidies, dumping, and other practices that distort the market.

  • Encouraging Development and Economic Reform:

Assisting developing and least-developed countries in their economic development through trade by providing them with technical assistance and support in building their trade capacity, as well as integrating them into the global economy.

  • Protecting the Environment:

Recognizing the importance of ensuring that environmental measures and trade policies are mutually supportive towards sustainable development, the WTO works towards promoting environmental protection alongside open trade.

  • Safeguarding the Interests of Developing Countries:

Ensuring that the needs and interests of developing countries are taken into account in WTO negotiations, aiming to enhance their trade opportunities and support their efforts to integrate into the global trading system.

  • Resolving Trade Disputes:

Providing a mechanism for the resolution of trade disputes among countries, thereby preventing conflict and retaliation in international trade relations.

Functions of WTO:

  • Administering WTO Trade Agreements:

The WTO is responsible for administering a collection of international trade agreements that set legal ground rules for international commerce. These agreements are negotiated and signed by the bulk of the world’s trading nations.

  • Serving as a Forum for Trade Negotiations:

The WTO provides a platform for negotiating trade agreements among its members. These negotiations cover various areas, including tariffs, subsidies, trade barriers, and other issues that impact international trade.

  • Handling Trade Disputes:

The WTO operates a comprehensive system for resolving disputes between countries over the interpretation and application of the agreements. By providing a structured process for settling disputes, the WTO helps ensure that trade flows smoothly and that trade rules are enforced.

  • Monitoring National Trade Policies:

A key function of the WTO is to review and monitor the trade policies and practices of its member countries. This transparency helps to ensure that trade policies are predictable and that they adhere to WTO agreements.

  • Technical Assistance and Training for Developing Countries:

The WTO offers technical assistance and training programs specifically designed for developing countries. These programs aim to help these countries build their trade capacity, understand WTO agreements, and comply with international trade rules.

  • Cooperation with Other International Organizations:

The WTO collaborates with other international and regional organizations to ensure a coherent global policy framework for trade and economic development. This includes working with the International Monetary Fund (IMF) and the World Bank to achieve greater economic stability and development.

  • Enhancing Transparency in Global Economic Policy-making:

Through its regular monitoring and reporting processes, the WTO promotes transparency and informed dialogue on trade and economic policy issues. This includes publishing a wide range of reports on global trade issues, economic research, and trade statistics.

  • Trade Facilitation:

The WTO works to simplify and standardize customs procedures among member countries through the Trade Facilitation Agreement (TFA). This agreement aims to expedite the movement, release, and clearance of goods, reduce costs, and improve efficiency in international trade.

India’s Balance of Trade

Balance of Trade (BOT) is the difference in the value of all exports and imports of a particular nation over a period of time. A positive or favorable trade balance occurs when exports exceed imports. A negative or unfavorable balance occurs when the opposite happens. Simply put, if a country exports more than what it imports, for a given period of time, it has a positive BOT.

BOT is most often the largest component of a country’s current account or Balance of Payment (BOP) and is a crucial reflection of a country’s business scenario. Moreover, the BOP data also highlights key inferences from the past performances, which help create better strategies for future. The components contributing heavily to exports/imports can be readily identified and improved upon.

The balance of trade (BOT), also known as the trade balance, refers to the difference between the monetary value of a country’s imports and exports over a given time period. A positive trade balance indicates a trade surplus while a negative trade balance indicates a trade deficit. The BOT is an important component in determining a country’s current account.

It is the difference between the money value of exports and imports of material goods during a year.

Examples of visible items are clothes, shoes, machines, etc. Clearly, the two transactions which determine BOT are exports and imports of goods.

Interpretation of BOT for an Economy

To the misconception of many, a positive or negative trade balance does not necessarily indicate a healthy or weak economy. Whether a positive or negative BOT is beneficial for an economy depends on the countries involved, the trade policy decisions, the duration of the positive or negative BOT, and the size of the trade imbalance, among other things.

In short, the BOT figure alone does not provide much of an indication regarding how well an economy is doing. Economists generally agree that neither trade surpluses or trade deficits are inherently “bad” or “good” for the economy.

A positive balance occurs when exports > imports and is referred to as a trade surplus.

A negative trade balance occurs when exports < imports and is referred to as a trade deficit.

Surplus or Deficit BOT:

Balance of trade may be in surplus or in deficit or in equilibrium. If value of exports of visible items is more than the value of imports of visible items, balance of trade is said to the positive or favourable. Thus, BOT shows a surplus. In case the value of exports is less than the value of imports, the balance of trade is said to be negative or adverse or unfavourable.

Balance of Trade: BOT means the discrepancy between a countries’s exported goods and services and its imported goods and services.

Example

Country X exports $1 billion of goods and services for the financial year 2015-2016, while in the same period it imported $1.5 billion of goods. Thus, this country has an unfavorable balance because it imports more than it exports. This is typically considered unfavorable because it shows how little the country produces and how dependent it is on foreign countries.

Country X is a reputed player in the rubber products industry, owing to the climate that accentuates rubber cultivation. It also has a majority share in its export portfolio.

The political and business leaders focus heavily on the same and ensure more and more rubber exports in coming years. However, this has led to jeopardized attention to food grains cultivation, which was observed from the high import value in the balance of trade figures of the particular year.

As such, it becomes imperative to the policy makers that it’s good to focus largely on the main profit centers, but not at the cost of the very basic necessities being left untouched. This can result in costlier imports. Moreover, the BOT data also reflects how effectively a nation has been using its key factors of production in the past and clearly depicts the outlook a nation is heading forth with.

Components of BOT

(1) Current Account:

Current account refers to an account which records all the transactions relating to export and import of goods and services and unilateral transfers during a given period of time.

Current account contains the receipts and payments relating to all the transactions of visible items, invisible items and unilateral transfers.

Components of Current Account:

The main components of Current Account are:

  1. Export and Import of Goods (Merchandise Transactions or Visible Trade):

A major part of transactions in foreign trade is in the form of export and import of goods (visible items). Payment for import of goods is written on the negative side (debit items) and receipt from exports is shown on the positive side (credit items). Balance of these visible exports and imports is known as balance of trade (or trade balance).

  1. Export and Import of Services (Invisible Trade):

It includes a large variety of non- factor services (known as invisible items) sold and purchased by the residents of a country, to and from the rest of the world. Payments are either received or made to the other countries for use of these services.

Services are generally of three kinds:

(a) Shipping,

(b) Banking, and

(c) Insurance.

Payments for these services are recorded on the negative side and receipts on the positive side.

  1. Unilateral or Unrequited Transfers to and from abroad (One sided Transactions):

Unilateral transfers include gifts, donations, personal remittances and other ‘one-way’ transactions. These refer to those receipts and payments, which take place without any service in return. Receipt of unilateral transfers from rest of the world is shown on the credit side and unilateral transfers to rest of the world on the debit side.

  1. Income receipts and payments to and from abroad:

It includes investment income in the form of interest, rent and profits.

Current Account shows the Net Income:

Current Account records all the actual transactions of goods and services which affect the income, output and employment of a country. So, it shows the net income generated in the foreign sector.

Difference between Balance of Trade and Current Account:

Basis Balance of Trade (BOT) Current Account
Components: Balance of trade includes only visible items. Current Account records both visible and invisible items.
Scope: It is a narrow concept as it is only a part of current account It is a wider concept and it includes BOT.

Balance on Current Account:

In the current account, receipts from export of goods, services and unilateral receipts are entered as credit or positive items and payments for import of goods, services and unilateral payments are entered as debit or negative items. The net value of credit and debit balances is the balance on current account.

  1. Surplus in current account arises when credit items are more than debit items. It indicates net inflow of foreign exchange.
  2. Deficit in current account arises when debit items are more than credit items. It indicates net outflow of foreign exchange.

Components of Current Account:

Credit Items Debit Items Net Credit (Credit – Debit)
1. Visible Trade Exports of goods: Imports of goods Net Exports of goods (Balance of Trade)
2. Invisible Trade Exports of services: Imports of services Net Exports of services
3. Unilateral Transfers Transfer Receipts: Transfer Payments Net Transfer Receipts
4. Income Receipts & Payments Income Receipts: Income Payments Net Income Receipts
Current Receipts (1+2+3+4) Current Payments Current Account Balance

(2) Capital Account:

Capital account of BOP records all those transactions, between the residents of a country and the rest of the world, which cause a change in the assets or liabilities of the residents of the country or its government. It is related to claims and liabilities of financial nature.

Capital Account is used to:

(i) Finance deficit in current account; or

(ii) Absorb surplus of current account.

Capital account is concerned with financial transfers. So, it does not have direct effect on income, output and employment of the country.

Components of Capital Account:

The main components of capital account are:

  1. Borrowings and landings to and from abroad: It includes:
  • All transactions relating to borrowings from abroad by private sector, government, etc. Receipts of such loans and repayment of loans by foreigners are recorded on the positive (credit) side.
  • All transactions of lending to abroad by private sector and government. Lending abroad and repayment of loans to abroad is recorded as negative or debit item.

2. Investments to and from abroad: It includes:

  • Investments by rest of the world in shares of Indian companies, real estate in India, etc. Such investments from abroad are recorded on the positive (credit) side as they bring in foreign exchange.
  • Investments by Indian residents in shares of foreign companies, real estate abroad, etc. Such investments to abroad be recorded on the negative (debit) side as they lead to outflow of foreign exchange.

3. Change in Foreign Exchange Reserves:

The foreign exchange reserves are the financial assets of the government held in the central bank. A change in reserves serves as the financing item in India’s BOP. So, any withdrawal from the reserves is recorded on the positive (credit) side and any addition to these reserves is recorded on the negative (debit) side. It must be noted that ‘change in reserves’ is recorded in the BOP account and not ‘reserves’.

Balance on Capital Account:

The transactions, which lead to inflow of foreign exchange (like receipt of loan from abroad, sale of assets or shares in foreign countries, etc.), are recorded on the credit or positive side of capital account. Similarly, transactions, which lead to outflow of foreign exchange (like repayment of loans, purchase of assets or shares in foreign countries, etc.), are recorded on the debit or negative side. The net value of credit and debit balances is the balance on capital account.

  1. Surplus in capital account arises when credit items are more than debit items. It indicates net inflow of capital.
  2. Deficit in capital account arises when debit items are more than credit items. It indicates net outflow of capital.

In addition to current account and capital account, there is one more element in BOP, known as ‘Errors and Omissions’. It is the balancing item, which reflects the inability to record all international transactions accurately.

Credit Items Debit Items Net Credit (Credit – Debit)
1. Borrowings and lending’s to and from abroad Borrowings from abroad: Landings to abroad Net Borrowings from abroad
2. Investments from abroad Investments from abroad: Investments to abroad Net Investments from abroad
3. Change in Foreign Exchange Reserves. Decreases in foreign exchange reserves: Increases in foreign exchange reserves Net change in foreign exchange reserves
Capital Receipts (1+2+3): Capital Payments Capital Account Balance

Balance on Current Account Vs. Balance on Capital Account:

Balance on current account and balance on capital account are interrelated.

  1. A deficit in the current account must be settled by a surplus on the capital account.
  2. A surplus in the current account must be matched by a deficit on the capital account.

India’s Balance of Payments

The balance of payments (henceforth BOP) is a consolidated account of the receipts and payments from and to other countries arising out of all economic transactions during the course of a year.

In the words of C. P. Kindleberger: The balance of payments of a country is a systematic record of all economic transactions between the residents of the reporting and the residents of the foreign countries during a given period of time.” Here by ‘residents’ we mean individuals, firms and government.

By all economic transactions we mean individuals, firms and government. By all economic transactions we mean transactions of both visible goods (merchandise) and invisible goods (services), assets, gifts, etc. In other words, the BOP shows how money is spent abroad (i.e., payments) and how money is received domestically (i.e., receipts).

Thus, a BOP account records all payments and receipts arising out of all economic transactions. All payments are regarded as debits (i.e., outflow of money) and are recorded in the accounts with a negative sign and all receipts are regarded as credits (i.e., inflow or money) and are recorded-in the accounts with a positive sign. The International Monetary Fund defines BOP as a “statistical statement that subsequently summarises, for a specific time period, the economic transactions of an economy with the rest of the world.”

Components of BOP Accounts

(A) The Current Account

The current account of BOP includes all transaction arising from trade in currently produced goods and services, from income accruing to capital by one country and invested in another and from unilateral transfers— both private and official. The current account is usually divided in three sub-divisions.

The first of these is called visible account or merchandise account or trade in goods account. This account records imports and exports of physical goods. The balance of visible exports and visible imports is called balance of visible trade or balance of merchandise trade [i.e., items 1(a), and 2(a) of Table 6.1].

The second part of the account is called the invisibles account since it records all exports and imports of services. The balance of these transactions is called the balance of invisible trade. As these transactions are not recorded—in the customs office unlike merchandise trade we call them invisible items.

It includes freights and fares of ships and planes, insurance and banking charges, foreign tours and education abroad, expenditures on foreign embassies, tran­sactions out of interest and dividends on foreigners’ investment and so on. Items 2(a) and 2(b) comprise services balance or balance of invisible trade in table 6.1.

The difference between merchandise trade and invisible trade (i.e., items 1 and 2) is known as the balance of trade.

There is another flow in the current account that consists of two items [3(a) and 3(b)]. Investment income consists of interest, profit and dividends on bonus and credits. Interest earned by a US resident from the TELCO share is one kind of investment income that represents a debit item here.

There may be a similar money inflow (i.e., credit item). Unrequited transfers include grants, gifts, pension, etc. These items are such that no reverse flow occurs. Or these are the items against which no quid pro quo is demanded. Residents of a country received these cost-free. Thus, unilateral transfers are one-way transactions. In other words, these items do not involve give and take unlike other items in the BOP account.

Thus the first three items of the BOP account are included in the current account. The current account is said to be favourable (or unfavourable) if receipts exceed (fall short of) payments.

(B) The Capital Account

The capital account shows transactions relating to the international movement of ownership of financial assets. It refers to cross-border movements in foreign assets like shares, property or direct acquisitions of companies’ bank loans, government securities, etc. In other words, capital account records export and import of capital from and to foreign countries.

The capital account is divided into two main subdivisions: short term and the long term move­ments of capital. A short term capital is one which matures in one year or less, such as bank accounts.

Long term capital is one whose maturity period is longer than a year, such as long term bonds or physical capital. Long term capital account is, again, of two categories: direct investment and portfolio investment. Direct investment refers to expenditure on fixed capital formation, while portfolio investment refers to the acquisition of financial assets like bonds, shares, etc. India’s investment (e.g., if an Indian acquires a new Coca- Cola plant in the USA) abroad represents an outflow of money. Similarly, if a foreigner acquires a new factory in India it will represent an inflow of funds.

Thus, through acquisition or sale and purchase of assets, capital movements take place. Investors then acquire controlling interests over the asset. Remember that exports and imports of equipment do not appear in the capital account. On the other hand, portfolio investment refers to changes in the holding of shares and bonds. Such investment is portfolio capital and the ownership of paper assets like shares does not ensure legal control over the firms.

[In this connection, the concepts of capital exports and capital imports require little elabo­ration. Suppose, a US company purchases a firm operating in India. This sort of foreign investment is called capital import rather than capital export. India acquires foreign currency after selling the firm to a US company. As a result, India acquires purchasing power abroad. That is why this transaction is included in the credit side of India’s BOP accounts. In the same way, if India invests in a foreign country,, it is a payment and will be recorded on the debit side. This is called capital export. Thus, India earns foreign currency by exporting goods and services and by importing capital. Similarly, India releases foreign currency by importing visible and invisibles and exporting capital.

(C) Statistical Discrepancy Errors and Omi­ssions

The sum of A and B (Table 6.1) is called the basic balance. Since BOP always balances in theory, all debits must be offset by all credits, and vice versa. In practice, it rarely happens—parti­cularly because statistics are incomplete as well as imperfect. That is why errors and omissions are considered so that the BOP accounts are kept in balance (Item C).

(D) The Official Reserve Account

The total of A, B, C, and D comprise the overall balance. The category of official reserve account covers the net amount of transactions by governments. This account covers purchases and sales of reserve assets (such as gold, convertible foreign exchange and special drawing rights) by the central monetary authority.

Now, we can summarise the BOP data

Current account balance + Capital account balance + Reserve balance = Balance of Payments

(X – M) + (CI – CO) + FOREX = BOP

X is exports,

M is imports,

CI is capital inflows,

CO is capital outflows,

FOREX is foreign exchange reserve balance.

BOP Always Balances

A nation’s BOP is a summary statement of all economic transactions between the residents of a country and the rest of the world during a given period of time. A BOP account is divided into current account and capital account. Former is made up of trade in goods (i.e., visible) and trade in services (i.e., invisibles) and unrequited transfers. Latter account is made up of transactions in financial assets. These two accounts comprise BOP

A BOP account is prepared according to the principle of double-entry book keeping. This accounting procedure gives rise to two entries— a debit and a corresponding credit. Any transaction giving rise to a receipt from the rest of the world is a credit item in the BOP account. Any transaction giving rise to a payment to the rest of the world is a debit item.

The left hand side of the BOP account shows the receipts of the country. Such receipts of external purchasing power arise from the commodity export, from the sale of invisible services, from the receipts of gift and grants from foreign govern­ments, international lending institutions and foreign individuals, from the borrowing of money from the foreigners or from repayment of loan by the foreigners.

The right hand side shows the payments made by the country on different items to the foreigners. It shows how the total of external purchasing power is used for acquiring imports of foreign goods and services as well as the purchase of foreign assets. This is the accounting procedure.

However, no country publishes BOP accounts in this format. Rather, by convention, the BOP figures are published in a single column with positive (credit) and negative (debit) signs. Since payments side of the account enumerates all the uses which are made up of the total foreign purchasing power acquired by this country in a given period, and since the receipts of the accounts enumerate all the sources from which foreign purchasing power is acquired by the same country in the same period, the two sides must balance. The entries in the account should, therefore, add up to zero.

In reality, why should they add up to zero? In practice, this is difficult to achieve where receipts equal payments. In reality, total receipts may diverge from total payments because of:

(i) The difficulty of collecting accurate trade information

(ii) The difference in the timing between the two sides of the balance

(iii) A change in the exchange rates, etc.

Because of such measurement problems, resource is made to ‘balancing item’ that intends to eliminate errors in measurement. The purpose of incorporating this item in the BOP account is to adjust the difference between the sums of the credit and the sums of the debit items in the BOP accounts so that they add up to zero by construc­tion. Hence the proposition ‘the BOP always balances’. It is a truism. It only suggests that the two sides of the accounts must always show the same total. It implies only an equality. In this book-keeping sense, BOP always balances.

Thus, by construction, BOP accounts do not matter. In fact, this is not so. The accounts have both economic and political implications. Mathe­matically, receipts equal payments but it need not balance in economic sense. This means that there cannot be disequilibrium in the BOP accounts.

A combined deficit in the current and capital accounts is the most unwanted macroeconomic goal of ,an economy. Again, a deficit in the current account is also undesirable. All these suggest that BOP is out of equilibrium. But can we know whether the BOP is in equilibrium or not? Tests are usually three in number:

(i) Movements in foreign exchange reserves including gold

(ii) Increase in borrowing from abroad

(iii) Movements in foreign exchange rates of the country’s currency in question.

Firstly, if foreign exchange reserves decline, a country’s BOP is considered to be in disequilibrium or in deficit. If foreign exchange reserves are allowed to deplete rapidly it may shatter the confidence of people over the domestic currency. This may ultimately lead to a run on the bank.

Secondly, to cover the deficit a country may borrow from abroad. Thus, such borrowing occurs when imports exceed exports. This involves payment of interest on borrowed funds at a high rate of interest.

Finally, the foreign exchange rate of a country’s currency may tumble when it suffers from BOP disequilibrium. A fall in the exchange rate of a currency is a sign of BOP disequilibrium.

Thus, the above (mechanical) equality between receipts and payments should not be interpreted to mean that a country never suffers from the BOP problems and the international economic transactions of a country are always in equilibrium.

Implications of an Unbalance in the BOP

Although a nation’s BOP always balances in the accounting sense, it need not balance in an economic sense.

An unbalance in the BOP account has the following implications:

In the case of a deficit

(i) Foreign exchange or foreign currency reserves decline,

(ii) Volume of international debt and its servicing mount up, and

(iii) The exchange rate experiences a downward pressure. It is, therefore, necessary to correct these imbalances.

BOP Adjustment Measures:

BOP adjustment measures are grouped into four:

(i) Protectionist measures by imposing customs duties and other restrictions, quotas on imports, etc., aim at restricting the flow of imports,

(ii) Demand management policies—these include restrictionary monetary and fiscal policies to control aggregate demand [C + I + G + (X – M)],

(iii) Supply-side policies—these policies aim at increasing the nation’s output through greater productivity and other efficiency measures, and, finally,

(iv) exchange rate management policies— these policies may involve a fixed exchange rate, or a flexible exchange rate or a managed exchange rate system.

As a method of connecting disequilibrium in a nation’s BOP account, we attach importance here to exchange rate management policy only.

Time series models: Addition and Multiplication model

Time series data have a natural temporal ordering. This makes time series analysis distinct from cross-sectional studies, in which there is no natural ordering of the observations (e.g. explaining people’s wages by reference to their respective education levels, where the individuals’ data could be entered in any order). Time series analysis is also distinct from spatial data analysis where the observations typically relate to geographical locations (e.g. accounting for house prices by the location as well as the intrinsic characteristics of the houses). A stochastic model for a time series will generally reflect the fact that observations close together in time will be more closely related than observations further apart. In addition, time series models will often make use of the natural one-way ordering of time so that values for a given period will be expressed as deriving in some way from past values, rather than from future values.

Additive Model:

  1. Data is represented in terms of addition of seasonality, trend, cyclical and residual components
  2. Used where change is measured in absolute quantity
  3. Data is modeled as-is

Additive model is used when the variance of the time series doesn’t change over different values of the time series.

On the other hand, if the variance is higher when the time series is higher then it often means we should use a multiplicative models.

Returni=pricei−pricei−1=trendi−trendi−1+seasonali−seasonali−1+errori−errori−1returni=pricei−pricei−1=trendi−trendi−1+seasonali−seasonali−1+errori−errori−1

If error’s increments have normal iid distributions then returni has also a normal distribution with constant variance over time.

Multiplicative model:

  1. Data is represented in terms of multiplication of seasonality, trend, cyclical and residual components
  2. Used where change is measured in percent (%) change
  3. Data is modeled just as additive but after taking logarithm (with base as natural or base 10)

If log of the time series is an additive model then the original time series is a multiplicative model, because:

log(pricei)=log(trendi⋅seasonali⋅errori)=log(trendi)+log(seasonali)+log(errori)log(pricei)=log(trendi⋅seasonali⋅errori)=log(trendi)+log(seasonali)+log(errori)

So the return of logarithms:

log(pricei)−log(pricei−1)=log(pricei/pricei−1)

Time Series Analysis: Utility of Time Series

A time series is a series of data points indexed (or listed or graphed) in time order. Most commonly, a time series is a sequence taken at successive equally spaced points in time. Thus it is a sequence of discrete-time data. Examples of time series are heights of ocean tides, counts of sunspots, and the daily closing value of the Dow Jones Industrial Average.

Time series are very frequently plotted via line charts. Time series are used in statistics, signal processing, pattern recognition, econometrics, mathematical finance, weather forecasting, earthquake prediction, electroencephalography, control engineering, astronomy, communications engineering, and largely in any domain of applied science and engineering which involves temporal measurements.

Time series analysis comprises methods for analyzing time series data in order to extract meaningful statistics and other characteristics of the data. Time series forecasting is the use of a model to predict future values based on previously observed values. While regression analysis is often employed in such a way as to test theories that the current values of one or more independent time series affect the current value of another time series, this type of analysis of time series is not called “time series analysis”, which focuses on comparing values of a single time series or multiple dependent time series at different points in time. Interrupted time series analysis is the analysis of interventions on a single time series.

Time series data have a natural temporal ordering. This makes time series analysis distinct from cross-sectional studies, in which there is no natural ordering of the observations (e.g. explaining people’s wages by reference to their respective education levels, where the individuals’ data could be entered in any order). Time series analysis is also distinct from spatial data analysis where the observations typically relate to geographical locations (e.g. accounting for house prices by the location as well as the intrinsic characteristics of the houses). A stochastic model for a time series will generally reflect the fact that observations close together in time will be more closely related than observations further apart. In addition, time series models will often make use of the natural one-way ordering of time so that values for a given period will be expressed as deriving in some way from past values, rather than from future values.

Analysis of time series has a lot of utilities for the various fields of human interest viz: business, economics, sociology, politics, administration etc. It is, also, found very useful in the fields of physical, and natural sciences. Some such points of its utilities are briefly here as under:

(i) It helps in studying the behaviours of a variable. 

In a time series, the past data relating to a variable over a period of time are arranged in an orderly manner. By simple observation of such a series, one can understand the nature of change that takes place with the variable in course of time. Further, by the technique of isolation applied to the series, one can tendency of the variable, seasonal change, cyclical change, and irregular or accidental change with the variable.

(ii) It helps in forecasting

The analysis of a time series reveals the mode of changes in the value of a variable in course of the times. This helps us in forecasting the future value of a variable after a certain period. Thus, with the help of such a series we can make our future plan relating to certain matters like production, sales, profits, etc. This is how in a planned economy all plans for the future development are the analysis of time series of the relevant data.

(iii) It helps in evaluating the performances.

Evaluation of the actual performances with reference to the predetermined targets is highly necessary to judge the efficiency, or otherwise in the progress of a certain work. For example, the achievements or out five-Year Plans are evaluated by determining the annual rate of growth in the gross national product. Similarly, our policy of controlling the inflation, and price rises is evaluated with the help of various price indices. All these are facilitated by analysis of the time series relating to the relevant variables.

(iv) It helps in making comparative study

Comparative study of data relating to two, of more periods, regions, or industries reveals a lot of valuable information which guide a management in taking the proper course of action for the future. A time series, per se, provides a scientific basis for making the comparision between the two, or more related set of data as in such series, the data are chronologically, and the effects of its various components are gradually isolated and unraveled.

Limitations

Forecasting

The central logical problem in forecasting is that the “cases” (that is, the time periods) which you use to make predictions never form a random sample from the same population as the time periods about which you make the predictions. This point is vividly illustrated by the 509-point plunge in the Dow-Jones Industrial Average on October 19, 1987. Even in percentage terms, no one-day drop in the previous 40 years (comprising some 8000 trading days) had ever been more than a fraction of that size. Thus this drop (which occurred in the absence of any dramatic news developments) could never have been forecast just from a time-series study of stock prices over the previous 40 years, no matter how detailed. It is now widely believed that a major cause of the drop was the newly-introduced widespread use of personal computers programmed to sell stock options whenever stock prices dropped slightly; this created a snowball effect. Thus the stock market’s history of the previous 40 or even 100 years was irrelevant to predicting its volatility in October 1987, because nearly all that history had occurred in the absence of this new factor.

The same general point arises in nearly all forecasting work. If you have records of monthly sales in a department store for the last 10 years, and are asked to project those sales into the future, those statistics will not reflect the fact that as you work, a new discount store is opening a few blocks away, or the city has just changed the street in front of your store to a one-way street, making it harder for customers to reach your store.

A second problem that arises in time-series forecasting is that you rarely know the true shape of the distribution with which you are working. Workers in other areas often assume normal distributions while knowing that assumption is not fully accurate. However, such a simplification may produce more serious errors in time-series work than in other areas. In much statistical work the problem of non-normal distributions is greatly ameliorated by the fact that you are really concerned with sample means, and the Central Limit Theorem asserts that means are often approximately normally distributed even when the underlying scores are not. However, in time-series forecasting you are often concerned with just one time period–the period for which you want to forecast. Thus the Central Limit Theorem has no chance to operate, and the assumption of normality may lead to seriously wrong conclusions. Even if your forecast is just one of a series of forecasts which you update after each new time period, the forecasts are made one at a time, so that a single seriously wrong forecast may bankrupt your company or lead to your dismissal, and nobody will ever learn that your next 50 forecasts would have been within the range predicted by a normal distribution. Some stock market speculators, who had previously been quite successful, were bankrupted or driven into retirement by the stock market plunge of 1987. That’s very different from the situation in which a company hires, all at once, 50 workers identified by a competence test. If one out of the 50 is a spectacular failure, the company (and you the forecaster) will survive because at the very same time the other 49 were turning out well.

Analyzing the Impact of Single Events

When you try to assess the impact of a single event, the major problem is that there are always many events occurring at any one time. Suppose you are trying to assess the effect of a new toll on bridge A on traffic across bridge B, but a new store opened near bridge B the same day the toll was introduced, permanently increasing traffic on bridge B. When critics remind us that “correlation does not imply causation”, they are mostly talking about the possible effects of overlooked variables. But in these time-series examples we are talking about the possible effects of overlooked events. It’s difficult to say which type of problem is more intractable, but they do seem to be two different types of problem.

Analyzing Causal Patterns

When scientists use time series to study the effects of one variable on another, they usually have at least two time series–one for the independent variable and one for the dependent–as in our earlier example on the relation between unemployment and crime. The problems in analyzing causal patterns are difficult but not impossible.

One problem with such research is that because the observations within each series are not independent of each other, the probability of finding a high correlation between the two series may be higher than is suggested by standard formulas. Later we describe a solution to this problem.

A second problem is that it is rarely reasonable to assume that the time sequence of the causal patterns matches the time periods in the study. Thus if increased unemployment typically produced an increase in crime exactly six months later but not five months later, then it would be fairly easy to discover that relationship by correlating monthly changes in unemployment with monthly changes in crime six months later. However, it is much more plausible to assume that increased unemployment in January produces a slight rise in crime during February, a further slight rise during March, and so on for several months. Such effects can be much more difficult to detect, though later we do suggest a solution to this problem.

A third problem in analyzing causal patterns is the familiar problem that correlation does not imply causation. As in ordinary regression problems, it helps to be able to control statistically for covariates. Later we describe one way to do this in time-series problems.

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