Balance of

Payments and
Exchange Rates
 UK balance of payments: 2001 ($ millions)

CURRENT ACCOUNT

1. Trade in goods
a) Exports +191 211
b) Imports 224 259
Balance on trade in goods 33 048

2. Trade in services
a) Exports +77 076
b) Imports 62 373
Balance on trade in services +11 114

Balance on trade in goods and services 21 345

3. Net income flows (wages and investment income) +11 151

4. Net current transfers (government and private) 7 246

Current account balance –17 440

 UK balance of payments: 2001 (£ millions)

CURRENT ACCOUNT

1. Trade in goods
a) Exports +191 211
b) Imports 224 259
Balance on trade in goods 33 048

2. Trade in services
a) Exports +77 076
b) Imports 62 373
Balance on trade in services +11 114

Balance on trade in goods and services 21 345

3. Net income flows (wages and investment income) +11 151

4. Net current transfers (government and private) 7 246

Current account balance –17 440

 UK balance of payments: 2001 (£ millions)

CURRENT ACCOUNT

1. Trade in goods
a) Exports +191 211
b) Imports 224 259
Balance on trade in goods 33 048

2. Trade in services
a) Exports +77 076
b) Imports 62 373
Balance on trade in services +11 114

Balance on trade in goods and services 21 345

3. Net income flows (wages and investment income) +11 151

4. Net current transfers (government and private) 7 246

Current account balance –17 440

 UK balance of payments: 2001 (£ millions)

CURRENT ACCOUNT

1. Trade in goods
a) Exports +191 211
b) Imports 224 259
Balance on trade in goods 33 048

2. Trade in services
a) Exports +77 076
b) Imports 62 373
Balance on trade in services +11 114

Balance on trade in goods and services 21 345

3. Net income flows (wages and investment income) +11 151

4. Net current transfers (government and private) 7 246

Current account balance –17 440

 UK balance of payments: 2001 (£ millions)

CURRENT ACCOUNT

1. Trade in goods
a) Exports +191 211
b) Imports 224 259
Balance on trade in goods 33 048

2. Trade in services
a) Exports +77 076
b) Imports 62 373
Balance on trade in services +11 114

Balance on trade in goods and services 21 345

3. Net income flows (wages and investment income) +11 151

4. Net current transfers (government and private) 7 246

Current account balance –17 440

 UK balance of payments: 2001 (£ millions)

CURRENT ACCOUNT

1. Trade in goods
a) Exports +191 211
b) Imports 224 259
Balance on trade in goods 33 048

2. Trade in services
a) Exports +77 076
b) Imports 62 373
Balance on trade in services +11 114

Balance on trade in goods and services 21 345

3. Net income flows (wages and investment income) +11 151

4. Net current transfers (government and private) 7 246

Current account balance –17 440

 UK balance of payments: 2001 (£ millions)

CAPITAL ACCOUNT
5. Net capital transfers +1 439

Capital account balance +1 439

FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad + 75 496
b) Net UK investment abroad 118 750
Balance of direct and portfolio –41 254

7. Other financial flows (mainly short-term)

a) Net deposits in UK from abroad and +219 087
borrowing by UK residents
b) Net deposits abroad by UK residents and UK 161 063
lending to overseas residents
Balance of other financial flows +58 024

8. Reserves (drawing on +, adding to –) +3 085

Financial account balance +19 855

 UK balance of payments: 2001 (£ millions)

CAPITAL ACCOUNT
5. Net capital transfers +1 439

Capital account balance +1 439

FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad + 75 496
b) Net UK investment abroad 118 750
Balance of direct and portfolio –41 254

7. Other financial flows (mainly short-term)

a) Net deposits in UK from abroad and +219 087
borrowing by UK residents
b) Net deposits abroad by UK residents and UK 161 063
lending to overseas residents
Balance of other financial flows +58 024

8. Reserves (drawing on +, adding to –) +3 085

Financial account balance +19 855

The Balance of Payments Account

• The capital account

• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
 UK balance of payments: 2001 (£ millions)

CAPITAL ACCOUNT
5. Net capital transfers +1 439

Capital account balance +1 439

FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad + 75 496
b) Net UK investment abroad 118 750
Balance of direct and portfolio –41 254

7. Other financial flows (mainly short-term)

a) Net deposits in UK from abroad and +219 087
borrowing by UK residents
b) Net deposits abroad by UK residents and UK 161 063
lending to overseas residents
Balance of other financial flows +58 024

8. Reserves (drawing on +, adding to –) +3 085

Financial account balance +19 855

The Balance of Payments Account

• The capital account

• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
– flows to and from reserves
 UK balance of payments: 2001 (£ millions)

CAPITAL ACCOUNT
5. Net capital transfers +1 439

Capital account balance +1 439

FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad + 75 496
b) Net UK investment abroad 118 750
Balance of direct and portfolio –41 254

7. Other financial flows (mainly short-term)

a) Net deposits in UK from abroad and +219 087
borrowing by UK residents
b) Net deposits abroad by UK residents and UK 161 063
lending to overseas residents
Balance of other financial flows +58 024

8. Reserves (drawing on +, adding to –) +3 085

Financial account balance +19 855

The Balance of Payments Account

• The capital account

• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
– flows to and from reserves
– financial account balance
 UK balance of payments: 2001 (£ millions)

CAPITAL ACCOUNT
5. Net capital transfers +1 439

Capital account balance +1 439

FINANCIAL ACCOUNT
6. Investment (direct and portfolio)
a) Net investment in UK from abroad + 75 496
b) Net UK investment abroad 118 750
Balance of direct and portfolio –41 254

7. Other financial flows (mainly short-term)

a) Net deposits in UK from abroad and +219 087
borrowing by UK residents
b) Net deposits abroad by UK residents and UK 161 063
lending to overseas residents
Balance of other financial flows +58 024

8. Reserves (drawing on +, adding to –) +3 085

Financial account balance +19 855

The Balance of Payments Account

• The capital account

• The financial account
– investment
• direct
• portfolio
– other financial flows (mainly short term)
– flows to and from reserves
– financial account balance
• Overall balance of payments
 UK balance of payments: 2001 (£ millions)

TOTAL CURRENT + CAPITAL + FINANCIAL ACCOUNTS

Total current account –17 440

Total capital account +1 439

Total financial account +19 855

Total current + capital + financial accounts +3 854

9. Net errors and omissions –3 854

Overall balance of payments 0

 UK balance of payments: 2001 (£ millions)

TOTAL CURRENT + CAPITAL + FINANCIAL ACCOUNTS

Total current account –17 440

Total capital account +1 439

Total financial account +19 855

Total current + capital + financial accounts +3 854

9. Net errors and omissions –3 854

Overall balance of payments 0

 FOREGN EXCHANGE MARKET
• Where foreign currencies are bought and sold (BD export $12053 mil and
import $15511 mil, services $1484 and $2745; Income $245 and $1128;
Remittances $5979)

• Main agents: Banks, Brokers, money changers etc.

• Sources of demand of foreign currency

- Import of goods and services, buying assets or investment abroad,

paying debt
- Sources of supply
- Export of goods and services, remittances, investment at home,
 What is Exchange Rate?

• It is the rate of exchange between two

currencies.
• (a) Number of home currency per unit of
foreign currency e.g.Tk.70=$1
• (b) Number of foreign currency per unit
of local currency e.g. Tk.1=1/70
• Spot and forward exchange rate,
arbitrage
 Determination of the rate of exchange

2.20

2.00

1.80
$ price of £

1.60

1.40

1.20
D by USA
1.00
0 Q of £
 Determination of the rate of exchange
S by UK
2.20

2.00

b a
1.80
$ price of £

1.60

1.40

1.20
D by USA
1.00
0 QD QS Q of £
 Determination of the rate of exchange
S by UK
2.20

2.00

1.80
$ price of £

1.60

d c
1.40

1.20
D by USA
1.00
0 QS QD Q of £
 Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
 Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60

1.40
€/ £

1.20

1.00 D1

0.80

0.60
0 Q of £
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60 S2

1.40
€/ £

1.20

1.00 D1

0.80

0.60
0 Q of £
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60 S2

1.40
€/ £

1.20

1.00 D1

0.80 D2

0.60
0 Q of £
 Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60 S2

1.40
€/ £

1.20

1.00 D1

0.80 D2

0.60
0 Q of £
 Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60 S2

1.40
€/ £

1.20

1.00 D1

0.80 D2

0.60
0 Q of £
 Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
• relative investment prospects
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60 S2

1.40
€/ £

1.20

1.00 D1

0.80 D2

0.60
0 Q of £
 Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
• relative investment prospects
• change in aggregate demand
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60 S2

1.40
€/ £

1.20

1.00 D1

0.80 D2

0.60
0 Q of £
 Exchange Rates
• The rate of exchange
– individual rates of exchange
– exchange rate index
• Determination of exchange rates
– the equilibrium exchange rate
– appreciation and depreciation
– shifts in currency demand and supply
• differences in interest rates
• differences in inflation rates
• relative investment prospects
• change in aggregate demand
• speculation
 Floating exchange rates: movement to a new equilibrium

1.80 S1

1.60 S2

1.40
€/ £

1.20

1.00 D1

0.80 D2

0.60
0 Q of £
Exchange Rates and Balance of Payments

• Exchange rates and the balance of

payments: no government intervention

– a floating exchange rate

• how rates are determined by dealers

– automatic balancing of overall balance of

payments

– current, capital and financial accounts may

not separately balance
Exchange Rates and Balance of Payments

• Exchange rates and the balance of

payments: government intervention
– reducing short-term fluctuations
• using reserves
• borrowing from abroad
• changes in interest rates
– maintaining a fixed rate of exchange over
the longer term
• deflation / reflation
• supply-side policies
• import controls
Fixed versus Floating Exchange Rates

• Advantages of fixed exchange rates

– certainty
– no speculation (if rate is absolutely fixed)
– prevents 'irresponsible' government policies
• Disadvantages of fixed exchange rates
– conflicts with other macro objectives
– danger of competitive deflations
– problems of international liquidity
– difficulties in adjusting to shocks
– speculation
Fixed versus Floating Exchange Rates

• Advantages of free-floating rates

– automatic correction
– no problem of international liquidity
– insulation from external events
– less constraint on domestic macro policy
• Disadvantages of free-floating rates
– possibly unstable exchange rates
– speculation
– uncertainty for business
• but use of forward markets
– lack of discipline on economy
 The Origins of the Euro

• Post-war regulation of exchange rates

– the Bretton Woods system
– its collapse in the early 1970s
– dirty floating
• The ERM
– features of the ERM
– the 1980s
– crisis in the ERM
• events of 1992
• events of 1993
– a return of calm
 The Origins of the Euro

• The Maastricht Treaty

– the timetable for EMU
– the convergence criteria
• inflation
• interest rates
• budget deficits
• general government debt
• exchange rates
• Birth of the euro
– meeting the convergence criteria
– role of the European Central Bank (ECB)
European Economic and Monetary Union

• How desirable is EMU?

– Advantages of a single currency
• eliminating conversion costs
• increased competition and efficiency
• elimination of exchange-rate uncertainty
• increased inward investment
• lower inflation and interest rates
– Disadvantages of EMU
• political arguments
• adjustment to shocks
– problem of asymmetric shocks
• EU12 may not be an optimal currency area
• regional problems
Globalisation and the Problem of Instability

• Interdependence through trade

– international effects of changes in
aggregate demand

– vulnerability of open economies

• Financial interdependence
– size of international financial flows

– international effects of changes in interest

rates
Globalisation and the Problem of Instability

• The need for policy co-ordination

– the search for policy co-ordination
• G7/G8 meetings: attempts at harmonisation
• but lack of convergence
• Difficulties in achieving harmonisation
– differences in budget deficits and debt
– interest rate divergence
– different internal structures of economies
– politicians more concerned with domestic
issues
 Debt and Developing Countries

• The debt problem

 Debt ratios: average of all developing countries

1974 1980 1982 1984 1986 1990 1993 1995 1998 2000 2002

Ratio of debt
15 18 31 34 36 31 39 43 44 41 41
to GNY (%)

Ratio of debt
80 85 124 147 213 171 176 151 153 119 113
to exports (%)

Ratio of debt
service 12 13 20 22 27 18 18 23 27 22 19
to exports (%)
 Debt ratios: average of all developing countries

1974 1980 1982 1984 1986 1990 1993 1995 1998 2000 2002

Ratio of debt
15 18 31 34 36 31 39 43 44 41 41
to GNY (%)

Ratio of debt
80 85 124 147 213 171 176 151 153 119 113
to exports (%)

Ratio of debt
service 12 13 20 22 27 18 18 23 27 22 19
to exports (%)
 Debt ratios: average of all developing countries

1974 1980 1982 1984 1986 1990 1993 1995 1998 2000 2002

Ratio of debt
15 18 31 34 36 31 39 43 44 41 41
to GNY (%)

Ratio of debt
80 85 124 147 213 171 176 151 153 119 113
to exports (%)

Ratio of debt
service 12 13 20 22 27 18 18 23 27 22 19
to exports (%)
 Debt and Developing Countries

• Origins of the debt problem

– borrowing to finance development
– the 1973/4 oil shock
– the 1979/80 oil shock
• world recession  fall in export earnings
• fall in commodity prices (exports)
• high interest rates  cost of servicing debt
• Rescheduling debt
– rescheduling official loans
– rescheduling commercial bank loans
 Debt and Developing Countries

• Dealing with debt

– structural reforms
– IMF structural adjustment programmes
• tight fiscal policies to reduce budget deficits
• privatisation and market liberalisation
• open trade policy
• hardship from IMF programmes
– debt forgiveness
• HIPC initiative
– successes / failures to date
• pressure to cancel debts