Week 12

SMU Classification: Restricted
ECON113: ECONOMICS OF GLOBALISATION

Week 12: Balance of Payments and Exchange Rates
Yuan MEI
2022 – 2023 Term 1
1
Recap from Last Week
• Indian economy
▪ Pre-liberalization era
▪ 1991 economic crisis and reform
▪ Post-liberalization era
• Business process outsourcing
• US-India trade dispute
▪ Compare with China
• COVID-19 and international trade
• Discussion question: Which country will become the largest

economy in Asia in 2050? India or China?
2
Contents
• Balance of payments
▪ Current account
▪ Capital account
▪ US trade deficit
• Exchange rate
▪ Exchange rate regime
• Fixed versus floating
▪ Determinants of exchange rate
▪ Currency manipulation
▪ Monetary Authority of Singapore
3
Balance of Payments
• Balance of Payments: record of the economic transactions

between the residents of one country and the rest of the world
• Each transaction is entered as a credit or debit

▪ A credit transaction results in a receipt of a payment from
foreigners; recorded with a +
▪ A debit transaction is one that leads to a payment to

foreigners; recorded with a –
4
Balance of Payments
• Three subaccounts
▪ Current account
▪ Capital account
▪ Balancing item (errors and omissions)
• Current account + capital account + balancing item = 0
• A surplus occurs when the balance on a subaccount is positive, a

deficit occurs when the balance is negative
5
Current Account
• Current account refers to the monetary values of international

flows associated with transactions in goods, services, income
flows and unilateral transfers.
• Components
▪ Merchandise trade: exports and imports of goods
▪ Services: shipping, tourism, etc.
▪ Income: receiving or giving money from/to foreign

individuals or firms
▪ Unilateral transfer: remittance, gifts, foreign aid

6
Capital Account
• Also known as capital and financial account
• Reflect purchases and sales of assets

▪ Financial assets such as stocks and bonds
▪ Real estate
▪ Bank deposits
• Majority of transactions come from private financial transactions

▪ Direct investment: residents of one country acquire
controlling interest (stock ownership of 10 percent or more)
in business of another country
▪ Transaction in securities: private-sector purchases of debt
issued by governments and private companies
▪ Bank claims and liabilities: loans, overseas deposits,
acceptances, foreign commercial paper, and foreign
government obligations
7
Capital Account
• Capital account balance = change in foreign ownership of

domestic assets – change in domestic ownership of foreign
assets
• Capital account surplus

▪ Money is flowing into the country
▪ Represent borrowings or sales of assets
• Capital account deficit

▪ Money is flowing out of the country
▪ The nation is increasing its ownership of foreign assets
8
Singapore-Malaysia Example
• Singapore exports electronics to Malaysia
▪ Current account: credit to Singapore and debit to Malaysia
• Singapore uses export income to invest in Malaysia

▪ Capital account: credit to Malaysia and debit to Singapore
• Notice that
▪ Singapore investing in Malaysia is a capital account
transaction
▪ But Singapore receiving interest payment is a current account

transaction
▪ Singapore buying capital goods like machines are also current

account transactions 9
Relationship between Current and Capital Account
• Assuming no error or omission, current account and capital

account must sum up to zero
• Example
▪ Singapore is current account is -100 S$
▪ Singapore needs to borrow 100 S$
▪ That 100 borrowed S$ is recorded as credit in

Singapore’s capital account (increase in foreign
ownership of Singapore’s bond)
10
Current Account Balance: Singapore
11
Source: World Bank
Current Account Balance: Europe
12
Source: World Bank
Current Account Balance: China
13
Source: World Bank
Current Account Balance: USA
14
Source: World Bank
US-Trade Deficit
15
16
US Trade Balance under Trump
17
Let’s watch a video.
18
Exchange Rate
19
Exchange Rate
• Exchange rate: price of one currency in terms of another
▪ Appreciation: fewer units of a nation’s currency required
to purchase a unit of foreign currency
▪ Depreciation: more units of a nation’s currency required
to purchase a unit of foreign currency
• On October 30th 2022, 1 Singapore dollar (SGD) can be

exchanged for
▪ 0.61 Pound sterling (GBP)
▪ 0.71 Euro (EUR)
▪ 0.71 United States Dollar (USD)
▪ 5.12 Chinese Yuan (CNY)
▪ 104.13 Japanese Yen (JPY)
▪ 1004.18 South Korean Won
▪ 10986.21 Indonesian Rupiah
▪ 17536.15 Vietnamese Dong 20
Zimbabwe Dollar
Source: Wikipedia 21
Foreign Currency Changers
22
Exchange-Rate Regime
• An exchange-rate regime is the way an authority manages its

currency in relation to other currencies and the foreign exchange
market
• Floating: exchange rate determined by market
• Pegged/managed float: exchange rates fluctuate from day to day,

but central banks attempt to influence their countries' exchange
rates by buying and selling currencies to maintain a certain range
• Fixed: value fixed against another currency, a basket of other

currencies, or another measure of value such as gold
▪ Fixed against another currency: currency board
23
Brunei Dollar
US-Singapore Exchange Rate
25
US-China Exchange Rate
26
Currency Board
• Usually fixed against a more stable, more internationally prevalent
currency
▪ Hong Kong dollar against USD, Brunei dollar against SGD,
Danish krone against EUR
• Usually achieved through two methods: open market mechanism

and direct government control
• Open market mechanism

▪ Use foreign reserves to buy/sell its own currency
• Direct government control

▪ Making it illegal to exchange foreign currency at other rates
▪ Difficult to enforce and often lead to black market
27
Let’s watch a video.
28
Venezuela Currency and Black Market
Blue vertical lines represent every time the currency has lost 90% of its value. The currency is
worth 300 K times less than in August 2012 since it has lost more than 99.999% of its value
29
Determinants of Exchange Rate
• Law of one price: identical goods should be sold everywhere

at the same price when converted to a common currency,
assuming
▪ It is costless to ship the good across countries
▪ There are no barriers to trade
▪ Markets are competitive
• A primitive example: the Big Mac Index

▪ According to the law of one price, a Big Mac should cost
the same in a given currency wherever it is purchased
30
Big Mac Index
31
Other Determinants of Exchange Rate
• Key factors that affect exchange rate in the long run:

▪ Relative price levels
▪ Relative productivity levels
▪ Preferences for domestic or foreign goods (balance of

payments)
▪ Trade barriers
32
Government Policies and Exchange Rate
• Interest rate
▪ High interest rate leads to high returns
▪ Capital inflow raises demand for domestic currency
▪ Domestic currency appreciates
• Monetary policy
▪ Expansionary monetary policy leads to inflation
▪ Domestic currency depreciates
• Trade policy
▪ Larger trade barriers reduce imports
▪ Foreign currency depreciates
33
Currency Manipulation
• The United States has accused many Asian countries of keeping

the exchange rate of their currencies artificially low in order to
boost international competitiveness and trade surpluses
• First victim: Japan

▪ Japan keeps a managed exchange rate regime
▪ Before 1985:
• Cheap Japanese Yen (JPY)
• Huge Japan-US trade surplus
▪ Plaza Accord in 1985:
• US forced Japan to substantially appreciated JPY
• Triggered asset price bubble and then the Lost Decade in
Japan
34
Plaza Accord
Japan’s GDP per Capita
36
Currency Manipulator Designation

• Prior to Trump Administration, the US Treasury Department
officially labeled three other countries as currency manipulators
▪ Korean and Taiwan (1988)
▪ China (1994)
• Trade Facilitation and Trade Enforcement Act (2015): a country

needs to satisfy ALL three criteria before it can be called a
currency manipulator
1. Bilateral trade surplus with the US of more than USD 20bn
2. Current account surplus of more than 2% of GDP
3. Persistent one-sided FX intervention, adding to 2% of GDP
over the last 6–12 months
37
Is China a Currency Manipulator?

• In August 2019, China depreciated the CNY and pushed the
CNY/USD exchange rate above 7 (first time in more than a
decade)
• The US Treasury Department soon officially labeled China as a

currency manipulator
• China only satisfies the trade surplus criteria but not the other two
• IMF (2015): Chinese yuan was no longer undervalued

▪ US government disagreed
38
US-China Exchange Rate
39
Symbolic Move?
• If no progress is observed one year after engagement in
discussions with the country, the US must initiate actions:
▪ Prohibit the Overseas Private Investment Corporation (OPIC),
a US government agency that helps with development projects
▪ Prohibit the federal government from procuring from that

country.
▪ Instruct the US executive director of the IMF to call for

additional rigorous surveillance of the macroeconomic and
exchange-rate policies of that country
▪ Instruct the US Trade Representative to renegotiate trade

agreements with that country
40
Monetary Authority of Singapore (MAS)
• MAS: Singapore's central bank and financial regulatory authority

since 1981
• Mission: to promote sustained non-inflationary economic growth,

and a sound and progressive financial center
• Does not regulate the monetary system via interest rates
• Instead, it chooses to do it via the foreign exchange mechanism

▪ Singapore is a small and open economy
▪ Exchange rate has a much stronger influence on inflation than
the interest rate
41
Main Features
• SGD is managed against a basket of currencies of our major

trading partners
▪ Official name: S$NEER (Singapore dollar nominal effective
exchange rate)
• MAS operates a managed float regime for the Singapore dollar

with the trade-weighted exchange rate allowed to fluctuate
within a policy band
• Periodically reviewed to ensure that the policy band remains

consistent with the underlying fundamentals of the economy
42
Tools of MAS
• Two common tools used by MAS to adjust the policy band

▪ Slope: determines the rate at which the SGD appreciates
▪ Adjustment in the mid-point either upwards or downwards
• Adjustment in the mid-point is likely to yield a quicker and

bigger impact on the currency
• Also possible to adjust the width of the policy band in times of

massive volatility
43
Slope Adjustment
44
Mid-Point Adjustment
45
Band Width Adjustment
46
Some Examples
• April 2009
▪ The financial crisis triggered an economic recession and
a sharp fall in inflation in Singapore
▪ The band was moved downwards -> SGD depreciated
• October 2001
▪ Massive volatility in financial markets after September
11th terrorist attack in the U.S.
▪ The band was widened
• Oct 14th 2019

▪ The MAS said it will “reduce slightly the rate of
appreciation of the S$NEER policy band.”
▪ SGD will be allowed to strengthen at a slower pace
47
Quiz Time
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Week 12

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SMU Classification: Restricted

ECON113: ECONOMICS OF GLOBALISATION

2022 – 2023 Term 1

Recap from Last Week

▪ 1991 economic crisis and reform

▪ Compare with China

• COVID-19 and international trade

• Discussion question: Which country will become the largest

• Balance of Payments: record of the economic transactions

• Each transaction is entered as a credit or debit

▪ A debit transaction is one that leads to a payment to

▪ Balancing item (errors and omissions)

• Current account + capital account + balancing item = 0

• A surplus occurs when the balance on a subaccount is positive, a

• Current account refers to the monetary values of international

▪ Services: shipping, tourism, etc.

▪ Income: receiving or giving money from/to foreign

▪ Unilateral transfer: remittance, gifts, foreign aid

• Reflect purchases and sales of assets

• Majority of transactions come from private financial transactions

• Capital account balance = change in foreign ownership of

• Capital account surplus

• Capital account deficit

• Singapore uses export income to invest in Malaysia

▪ But Singapore receiving interest payment is a current account

▪ Singapore buying capital goods like machines are also current

Relationship between Current and Capital Account

• Assuming no error or omission, current account and capital

▪ Singapore needs to borrow 100 S$

▪ That 100 borrowed S$ is recorded as credit in

Current Account Balance: Singapore

Current Account Balance: Europe

Current Account Balance: China

Current Account Balance: USA

US Trade Balance under Trump

Let’s watch a video.

• On October 30th 2022, 1 Singapore dollar (SGD) can be

Foreign Currency Changers

• An exchange-rate regime is the way an authority manages its

• Floating: exchange rate determined by market

• Pegged/managed float: exchange rates fluctuate from day to day,

• Fixed: value fixed against another currency, a basket of other

US-Singapore Exchange Rate

US-China Exchange Rate

• Usually achieved through two methods: open market mechanism

• Open market mechanism

• Direct government control

Let’s watch a video.

Venezuela Currency and Black Market

Determinants of Exchange Rate

• Law of one price: identical goods should be sold everywhere

▪ There are no barriers to trade

▪ Markets are competitive

• A primitive example: the Big Mac Index

Big Mac Index

Other Determinants of Exchange Rate

• Key factors that affect exchange rate in the long run:

▪ Relative productivity levels

▪ Preferences for domestic or foreign goods (balance of

Government Policies and Exchange Rate

• The United States has accused many Asian countries of keeping

• First victim: Japan