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balance of payment - Coggle Diagram
balance of payment
IMPLICATIONS OF A PERSISTENT CURRENT ACCOUNT DEFICIT
-definition: a situation where a country consistently spends more on imports than it earns from exports
1) DEPRECIATING EXCHANGE RATE
- a persistent current account deficit can put downward pressure (depreciate) on a country's currency as the economy is constantly supplying its currency onto the world markets
2) INCREASING INTEREST RATES
- with downward pressure on the currency, the Central Bank may raise the interest rates in order to attract foreging/ portfolio investment
3) INCREASING FOREIGN OWNERSHIP OF DOMESTIC ASSETS
- persistent current account deficit may result in increased foreign ownership of domestic assets
- can be driven by the need to finance the deficit through foreign capital inflows, potentially leading to a larger share of ownership by foreign entities.
4) INCREASING NATIONAL DEBT
- a chronic current account deficit can contribute to the accumulation of external debt as financing is required to fund the deficit
5) WORSENING INTERNATIONAL CREDIT RATINGS
- if the deficit is viewed as unsustainable or weak economic fundamentals, credit ratings agencies may downgrade the country's creditworthiness, potentially raising borrowing costs
- investors can lose confidence in a country's ability to repay any future borrowing
6) DEMAND MANAGEMENT CONFLICTS
- persistant currenct account deficit may necessitate adjustments in demand management policies and in the process create trade offs
- e.g it may require measures to curb domestic consumption or stimulate exports to reduce the deficit and rebalance the economy
7) IMPACT ON LONG TERM ECONOMIC GROWTH
- a chronic current account deficit can have implications for economic growth
- it may signal an imbalance in the economy, relying on external financing rather than domestic productivity and competitiveness
IMPLICATIONS OF A PERSISTENT CURRENT ACCOUNT SURPLUS
- is when a country consistently exports more goods/services than its imports.
3) BOTH INFLATIONARY AND DEFLATIONARY PRESSURE
- inflationary pressure: increase in net exports shifts AD right and raises price level
- deflationary pressure: currency appreciation makes imports cheaper and the costs of production fall
4) EMPLOYEMENT
- with rising demand for exports, unemployment usually falls as exporting industries require more workers
- rising profits usually result in increased investment
( potentially require more workers)
- decreasing unemployment creates higher average domestic income
2) APPRECIATING EXCHANGE RATES
- with higher exports, foreigners demand more of local currency to pay for goods and services leading to currency appreciation
- resulting in less FDI as it seems less attractive to invest
5) EXPORT COMPETITIVENESS
- appreciating exchange rates a persistent surplus , will gradually erode the nation's export competitiveness over time
- the extent to which is eroded will depend on the price elasticity of demand for the country's exports
if PED is inelastic, then currency appreciation willl not impact the competitiveness as much as ut does to PED elastic goods.
1) RISING CONSUMPTION AND INVESTMENT
- investment increases as exporting firms making excellent profits
- domestic income rises leading to an increase in consumption
THE FINANCIAL ACCOUNT
- records the flow of all transactions assciated with changes of ownership of the country's foreign financial assets and liabilities
- Portfolio investment
- flows of money to purchase foreign company shares and debt securities (gov and corporate bonds). money flowing in is recorded as a credit while out as debit
- Official Borrowing
- government borrowing from other countries or institutions outside of their own economy e.g loans from the International Monetary Fund (IMF) or foreign banks. When the money is receicved, it is recorded as credit, while the money is used to pay interest paymetns, it is considered as debit
- Foreign Direct Investment (FDI)
- flows og money to purchase a controlling interest (10% or more) in a foreign firm. money flowing in is recorded as credit and out is a debit
- Reserve Assets
- these are the assests controlled by the Central bank and available for use in achieving the goals of monetary policy. they include gold, foreign currency positions at the International Monetary Fund (IMF) and foreign exchange held by the central bank
-
CAPITAL ACCOUNT
the capital account records small capital flows between countries and is relatively inconsequential
smaller flows of money between countries
- debt forgiveness
- capital transfers by migrants as they emigrate and immigrate
- transaction is non-produced, non-financial assets
small payments are usually associated with royalties or copyrights (e.g royalty payments by record labels to foreign artists)
THE RELATIONSHIP BETWEN THE CURRENT ACCOUNT AND THE EXCHANGE RATE
- factors such as trade policies, capital flows, global economic conditions and investor sentiment can influence both the current account and the exchange rate
- the current account and the exchange rate is closely linked in international trade
- A stronger exchange rate makes improts cheaper and exports more expensive
A STRONGER EXCHANGE RATE
- its exports become relatively more expansive for foreign buyers, potentially leading to a decrease in exports volumes
- conversely, imports become relatively cheaper for domestic consumers which may lead to an increase in import volumes
A WEAKER EXCHANGE RATE
- its exports become relatively cheaper for foreign buyers. potentially leading to an increase in export volumes
- at the same time, imports become relatively more expensive for domestic consumers, which may result in a decrease in import volumes
THE RELATIONSHIP BETWEEN THE FINANCIAL ACCOUNT AND THE EXCHANGE RATE
- the financial account measures the inflows and outflows of financial assests, including foreign direct investment and portfolio investment
- CHANGES IN THE FINANCIAL ACCOUNT CAN IMPACT THE EXCHANGE RATE
- when there is an inflow of foreign investment into a country, it increases the demand for the country's currency, potentially leading to an appreciation of the exchange rate
- conversely, when there is an outflow of domestic investment to other countries, it increases the supply of the country's currency in the foreign exchange market, potentially leading to a depreciation of the exchange rate
THE EXVCHANGE RATE INFLUENCES THE ATTRACTIVENESS OF A COUNTRY FOR FOREIGN INVESTMENT
- a stronger exchange rate makes foreign investments more expensive in terms of the investor's home currency, potentially reducing the appeal of investing in that country
- a weaker exchange rate can make a country's assets more affordable for foreign investors, potentially increasing the attractive of investing in the country
CURRENT ACCOUNT
- most important account in the BoP
- this account records the net income that an economy gains from international transactions
- goods are also referred t as visible exports/imports
- services are also referred to as invisible export/imports
- net income consists of income transfers by citizens and corporations
- credits are received from the UK citizens who are abroad and send remittances home
- debits are sent by foreigners working in the UK back to their countries
- current transfers are typically payments at government level between countries, contirbutions to the World Bank
BALANCE OF PAYMENT:
(BOP) for a country is a record of all financial transactions that occur between it and the rest of the world
- divided into three sections:
a) CURRENT ACCOUNT (all transactions related to goods and services along with payments related to the transfer of income)
b) FINANCIAL ACCOUNT (all transactions elated to savings, investment and currency stabilisation)
c) CAPITAL ACCOUNT
- money flowing into an account is recorded as credit (+ve) meanwhile money flowing out is recorded as debit (-ve)
- more inflow into the account = account surplus
- more outflow out of the account = account deficit