International Trade — Fundamentals
The Balance of Payments — current account in depth
The current account records trade in goods (the traditional "trade balance" — exports minus imports of physical goods), trade in services (increasingly significant for India, given its large IT/business-services export sector), income (earnings on foreign investments, both received and paid), and transfers (remittances — money sent home by workers abroad, a substantial and economically significant component of India's current account given its large overseas workforce). A current account deficit means a country is importing more (goods, services, and net income/transfers combined) than it's exporting — not automatically a crisis, but a position that must be financed somehow, connecting directly to the capital account below.
The Balance of Payments — capital/financial account in depth
The capital/financial account records cross-border investment and financial flows: FDI (Foreign Direct Investment — investment establishing lasting management interest in a foreign enterprise, like a foreign company building a factory or acquiring significant ownership in a domestic firm) and FII/FPI (Foreign Institutional/Portfolio Investment — foreign investment in financial assets like stocks and bonds, without seeking management control). This account also includes external borrowing and changes in foreign exchange reserves. The current account and capital account together must balance by construction — a current account deficit is financed by a net capital account inflow (or reserve drawdown), which is why a country with a persistent current account deficit needs healthy, sustained capital inflows to avoid depleting its foreign exchange reserves.
Foreign exchange markets — how exchange rates are determined
Currency exchange rates are determined in foreign exchange (forex) markets through the interaction of currency supply and demand — a currency's demand rises when foreigners want to buy that country's goods, services, or assets (requiring them to first buy that currency), and falls under the opposite conditions. Under a floating exchange rate regime (which India broadly follows, with periodic central bank intervention), the exchange rate adjusts based on these market forces rather than being fixed by government decree — a rising demand for rupees (from exports, FDI inflows, remittances) tends to appreciate the rupee, while a rising demand for foreign currency (from imports, capital outflows) tends to depreciate it.
Why exchange rates matter for trade competitiveness
A weaker (depreciated) domestic currency makes a country's exports cheaper for foreign buyers (in their own currency terms) and imports more expensive for domestic buyers — generally improving trade competitiveness, at least in the short run, though this effect isn't automatic or immediate (a concept sometimes discussed through the J-curve, where a currency depreciation can initially worsen the trade balance before improving it, since import/export volumes adjust more slowly than prices). A stronger (appreciated) currency has the opposite effect — cheaper imports, but less competitive exports. This is why exchange-rate movements are watched closely as both a symptom and a driver of a country's trade position.