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BOP PART 2 (CAUSES OF CURRENT A/C DEFICIT: (1) CHANGES IN GLOBAL DEMAND…
BOP PART 2
CAUSES OF CURRENT A/C DEFICIT:
1) CHANGES IN GLOBAL DEMAND CONDITIONS
FALLING INCOME OF MAIN TRADING PARTNERS
--> fall in demand for the country's exports (our X falls)
HIGHER INFLATION RATES THAN TRADING PARTNERS
--> domestic goods relatively more expensive than imported goods--> consumers will switch to imported gds--> DDm RISE, total EXPENDITURE for M RISE-->at the same time, exported gds more expensive than its trading rivals.Px RISE--> hence quantity demanded for exports fall--> assume PEDx>1, Qdd fall more than proportionately to price rise, hence export revenue fall--> country's current a/c in deficit
2)
LOSS OF COMPARATIVE ADVANTAGE-
-> decrease in country's internal efficiency or competitors's efficiency improved--> exports fall leading to trade deficit
Due to high labour cost, many DC e.g)US lost their comparative advantage in labour intensive manufactured goods to the low cost developing countries e.g)China
Chinese M to US are relatively cheaper and DDm rises, hence US expt. on M rises + US X of labour-intensive goods are more expensive hence Add falls, PEDx>1, Qdd fall more than proportionately, US X earnings fall--> hence current a/c deficit
3)
DETERIORATION OF TERMS OF TRADE
: a country may rely on 1 or 2 major exports (developing countries rely on agricultural X)--> fall in prices of these primary exports may lead to current a/c deficit as the PED<1 for these primary exports--> Qdd increases less than proportionately to fall in price--->X earnings (TRx) fall--> hence CA deficit
4)
OVER-VALUED EXCHANGE RATE
Overvaluation of the US dollars against the Asian currencies--> strength of US dollar has reduced the competitiveness of US exports in overseas mets + encourage imports
CAUSES OF CAPITAL A/C DEFICIT:
2)
EXPECTED FALL IN EXTERNAL VALUE OF MONEY
: Hence hot money outflow--> capital a/c in deficit
1)
LOWER INTEREST RATE THAN FOREIGN COUNTRIES'
: Foreigners will withdraw funds from domestic banks & deposit it in foreign banks with relatively higher I/r rates to earn higher returns--> CAPITAL OUTFLOW, hence capital a/c goes into deficit
3)
FALL IN EXPECTED RETURNS ON INVESTMENT
: e.g due to rising cost of capital// fall in National Y//political instability--> fall in FDI into country--> capital a/c worsen to a deficit
4)
FALLING INCOME GLOBALLY
: global economic slowdown--> rising pessimism & lower business confidence--> firms hold back expansion plans due to uncertainty--> FDI FALL GLOBALLY--> worsen capital a/c
CAUSES OF CURRENT A/C SURPLUS:
1)
RISING INCOME OF TRADING PARTNERS
: increase dd for country's X (economic recovery of global economy is expected to cause SG's X & GDP to rise)
2)
DEVELOPMENT OF NEW NICHE SECTORS
:huge resources devoted to tourism and healthcare sector--> growth of these sectors contributed immensely to improvement in srvs balance on our invisible trade account--> subsequently improve country's current a/c
3)
IMPROVEMENT IN TERMS OF TRADE
: higher dd for country's X--> higher X revenue--> current a/c surplus
4)
UNDER-VALUED EXCHANGE RATE
: causes exports to be cheaper--> higher X earnings assuming PEDx>1--> imports more expensive--> fall in M expenditure assuming PEDm>1 (E.G CHINA)--> Hence current a/c surplus
CAUSES OF CAPITAL A/C SURPLUS:
1)
HIGHER INTEREST RATE THAN FOREIGN COUNTRIES'
: foreigners will deposit their funds in domestic banks to earn higher I/r returns--> capital inflow--> capital a/c surplus
2)
EXPECTED RISE IN EXTERNAL VALUE OF MONEY
: Hot money inflow--> improve capital a/c
3)
RISE IN EXPECTED RETURNS ON INVESTMENT
: due to falling cost of capital//lower corporate tax//large domestic mkt--> rise in FDI into country--> improve capital ac
4)
RISING INCOME GLOBALLY
: Global economic boom lead to rising optimism and business confidence--> firms pursues expansion plans due to higher expected level of future profit and expected returns to investment--> FDI RISE GLOBALLY--> improve capital a/c of many countries(higher LT capital flows)
FDIs important to SG--> SG small, open & lack natural resources
INVESTMENT RISE ---> AD RISE--> INCOME RISE (ACTUAL GROWTH)
INCREASE TALENT POOL (attract foreign talent to relocate to SG)
INCREASE PRODUCTIVITY & EFFICIENCY --> RISE IN LRAS
IMPROVES BOP CAPITAL A/C
CONSEQUENCES OF PERSISTENT BOP
DEFICIT
IN PERSPECTIVES OF...
CONSUMERS :<3:
consumers spend more on better quality foreign gds & srvs --> SOL INCREASE
Govt may impose taxes on foreign gds to reduce consumption of M--> reduces competition in domestic mkt & domestic prices likely to rise--Assume wages rise at slower rate--> PP of consumers fall--> SOL FALLS
to boost its X & bring Bop back to elm, country may be forced to devalue its currency --> fall in external value of country's currency-->raises prices of M--> reduce country's ability to import from overseas--> LOWER SOL with a fall in M of consumer gds + LOWER POTENTIAL EG with a fall in M of capital gds :checkered_flag: :red_flag:
PRODUCERS :<3:
persistent BOP deficit shows lack of competitiveness of domestic firms in terms of prices & quality--> domestic firms face strong competition from foreign M --> mkt shares dwindle, firms cut back investment expenditure--> firms that cannot withstand foreign competition shut down
GOVT :<3:
FALLING FOREIGN RESERVES--> run the risk of exhaustion if deficit continues indefinitely
:checkered_flag: :red_flag:
M may exceeds X & Investment outflow exceeds investments inflow--> indicates net withdrawal from country's circular flow of Y as M>X--> FALL IN AD-> MULTIPLIED FALL IN NATIONAL Y due to multiplier effect + UN worsens
CUT M DUE TO LACK OF ABILITY TO PAY--> GREATLY REDUCE CONSUMER & INVESTOR CONFIDENCE--> Further deterioration In economic performance
CONSEQUENCES OF PERSISTENT BOP
SURPLUS
IN PERSPECTIVE OF...
CONSUMERS :<3:
X & I ARE INCREASING--> AD INCREASE--> multiplied INCREASE IN NATIONAL Y --> if economy below Yf, REAL GDP INCREASE + UN FALL --> if economy initially close to Yf, demand-pull inflation, cost of living rise, SOL fall if wage rises at slower rate
PRODUCERS :<3:
REDUCE LEVEL OF INVESTMENT & PRODUCTION
GOVT :<3:
FOREIGN RESERVES HAVE BEEN INCREASING as net receipts > expenditures
APPRECIATE CURRENCY SHARPLY Due to loss of competitiveness in X in future
BOP DEFICIT/SURPLUS
Is a problem when it exceeds 5-6% of country's GDP
BOP DISEQUILIBRIUM: When there's persistent & substential deficit/surplus