2.5 The Balance Of Payments

Question 1

What are the consequences of a CA deficit? Pt1

Answer 1

1) downward pressure on the exchange rate - caused by a fall in demand for the domestic currency as well as an increase in the demand for foreign currency, since imports are greater than exports
2) reduced foreign exchange reserves - this is a problem since central bank hold foreign reserves to maintain the exchange rate
3) increased foreign ownership of domestic assets - CA deficit needs to be offset by a financial account surplus, this means in the future, further outflows of income from the domestic assets, this may increase the CA deficit in the future

Question 2

What are the consequences of a CA deficit? Pt2

Answer 2

4) loss of domestic sovereignty, if there is increasing foreign influence on decisions in the domestic economy, e.g China in west Africa
5) possible increase in foreign indebtedness - due to increased foreign borrowing. This could lead to increasing costs of external debt servicing
6) negative impact on international credit rating, due to a possible increase in perceived risks and uncertainty for creditors