Balance of Payments

Question 1

Structural causes for a CAD

Answer 1

Underinvestment
Relatively low productivity
Persistently high relative inflation,

Question 2

difference between foreign direct investment and portfolio investment

Answer 2

Foreign portfolio investment is the purchase of securities of foreign countries, such as stocks and bonds, on an exchange.

BUT

Foreign direct investment is building or purchasing businesses and their associated infrastructure in a foreign country.

Question 3

difference between the current, capital and financial account on the balance of payments

Answer 3

Current Account: records transactions or represents a country’s net income over a period of time related to the exchange of goods, services, and income, like imports and exports.

Capital Account: tracks money coming in or out of a country through debt relief, and other capital transfers.

Financial Account: keeps track of changes in a country’s foreign assets and liabilities.

Question 4

The sum of the current account and capital account reflected in the balance of payments will always be…

Answer 4

… zero. Any surplus or deficit in the current account is matched and canceled out by an equal surplus or deficit in the capital account.

Question 5

what is visible trade

Answer 5

export and imports of goods and services

Question 6

what is invisible trade

Answer 6

export and import of services

Question 7

Current account consists of

Answer 7

1. Net trade balance in goods
2. Net trade balance in services
3. Primary income
   (records income the UK receives and pays on financial and other assets e.g interest, profits and dividends generated from foreign investment and includes remittances)
4. Secondary income
   (spending and transfers on foreign overseas aid and payment to multinational bodies or charities.)

Question 8

Primary income in 2023

Answer 8

The primary income account recorded a surplus position of £6.6 billion, or 1.0% of GDP, in Quarter 1 2023.

Question 9

currency/money inflows aka

Answer 9

credit

Question 10

currency/money outflows aka

Answer 10

debit

Question 11

Does a depreciation of exchange rate ALWAYS lead to improvement of current account deficit.

THINK 2007-8 financial crisis

Answer 11

During 2007 and 2008 a significant depreciation of exchange rate shown as sterling exchange rate index by 20%.

Theoretically, a 20% depreciation in the value of the Pound would improve the current account.

BUT the evidence is mixed. At the start of 2008 and 2011, a rapid improvement in the current account – partly a reflection of the depreciation and partly due to falling spending on imports due to lack of confidence affecting MPM.

However, since 2011, the current account deficit has widened to near record levels, suggesting the depreciation hasn’t restored competitiveness and thus has not solved the current account deficit.

Question 12

Define Current account deficit (CAD)

Answer 12

A current account deficit is where there is a negative balance on the net current account balance. A consequence of the value of imports of goods/ services/ investments being of greater value than the value of exports.

Question 13

Define Current account surplus (CAS)

Answer 13

A current account surplus is where there is a positive balance on the net current account balance. A consequence of the value of exports of goods/ services/ investments being of greater value than the value of imports.

Question 14

WHY CAD is harmful to economy?

1. Risk of capital flight

Give case study and chain

Answer 14

CHAIN:
a high CAD - loss of confidence- capital flight - great outflows- devaluation of currency - decline in living standards - further declines in confidence etc.

CASE STUDY
A factor behind the Asian crisis of 1997 was that countries had run up large current account deficits by attracting capital flows (hot money) to finance the deficit. But, when confidence fell, these hot money flows dried up, leading to a rapid devaluation and crisis of confidence. When confidence fell and the exchange rate fell, there was a degree of capital flight as foreign investors sought to return assets.

Question 15

WHY CAD is harmful to economy?

2. Unsustainable

Give case study and chain

Answer 15

if CAD is financed through borrowing this in long term is unsustainable as these countries will be burdened by high interest payments.

i.e following 2022 post-COVID Sri Lanka’s bond yield spiked to about 32% whilst pre-COVID levels were below 15%. Mainly due to plummets in confidence after Sri Lanka defaulted on its debts for the first time.