BOT

Question 1

Balance of Payments

Answer 1

The balance of payments of a country is a statement of all the
international transactions of a country with the rest of the world
over a period of time, usually a year.

Question 2

What are the 2 components of BOP

Answer 2

Current Account

Capital & Financial Account

Question 3

What are the components of current account?

Answer 3

Balance of trade
Income balance
Net current transfer

Question 4

What are the components of Capital & Financial Account?

Answer 4

FDI (Long term capital flows)
Portfolio investment (short term capital flow, hot money)

Question 5

Credit vs Debit

Answer 5

Inflow of Singapore currency (+ve)

Outflow of Singapore currency (-ve)

Question 6

Balance of trade

Answer 6

The balance of trade records the inflow and outflow of the local currency arising from international trade in goods and services

Question 7

Current Account

Answer 7

The current account records payments for exports and imports of goods and services, income flows, and current transfers into and out of the country in a year

Question 8

Primary income flows

Income balance

Answer 8

Primary income flows include payments in the form of Wages Rent Interest Profits and Dividends that flow into and out of the country

Question 9

Secondary income flows

net current transfers

Answer 9

Secondary income flows include government and private transfers that do not involve the exchange of any goods, services or financial assets

Question 10

Capital and financial account

Answer 10

The capital and financial account tracks the changes in the assets and liabilities of a country with the rest of the world

Question 11

Short term capital flows

Answer 11

Transactions in financial assets such as stocks and bonds

Question 12

Long term capital flows (FDI)

Answer 12

International sales and purchases of illiquid physical assets such as land, buildings and factories are classified as long term capital flows because such assets are not easily exchanged for cash

Question 13

Assets

Answer 13

Short term and long term capital in foreign countries that are purchased by domestic residents
(outflow of currency becos sg currency converted to overseas currency)

Question 14

Liabilities

Answer 14

Domestic assets purchased by foreigners

Inflow of currency

Question 15

Receipts vs payments

Answer 15

Inflow of currency vs outflow of currency
Capital and financial account surplus/deficit
Receipt (liability)
Payment (assets)

Question 16

What affects hot money flows

Answer 16

1. Expected rates of return in the form of dividends and interest rates
   - > fall in divide from stocks/ shares or fall in i/r => increase in outflow of hot money
2. Expected changes in exchange rate
   - > exchange rate falls => speculators owning assets denominated in local currency => sell away assets becos return when converted to home currency is worth less => increase outflow of hot money
3. Capital controls
   - > lifting of foreign exchange controls => increase outflow of hot money as investors and firms diversify to take advantage of overseas opportunities

Question 17

What affects long term capital flows

Answer 17

1. Expected profits
   -> fall in expected profits => increase outflow of long-term capital
   (Affected by Govt policies, COP, political stability, business confidence)
2. Capital control
   - > lifting of foreign exchange controls => increase outflow of FDI as investors and firms diversify to take advantage of overseas opportunities

Question 18

Net receipts

Answer 18

BOP surplus

Question 19

Net payments

Answer 19

BOP deficit

Question 20

What happens to BOP surplus/deficit

Answer 20

Surplus used to add to foreign exchange reserves

Deficit financed by its existing foreign exchange reserves

Question 21

Causes of BOT deficit

Answer 21

1. national income.
   fall in national income of trading partner -> fall in demand for (sg) exports -> fall in sg export revenue -> worsen BOT.
   Rise in sg income -> demand for import increase -> import expenditure increase -> worsen BOT
2. Inflation rates.
   rise in inflation relative to other country -> exports more expensive in foreign currency and imports cheaper than local substitutes -> fall in Qd for exports and rise in demand for imports -> worsen BOT
3. Loss of CA
   Lose CA -> increase in price of exports -> fall in Qd of exports -> fall in X -> worsen BOT
4. Changes in taste and preferences
5. Appreciation
   Appreciation -> countrys export more expensive in foreign currency -> fall in Qd of exports -> fall in X + imports cheaper in local currency -> rise in Qd of imports -> rise in M -> worsen BOT. (Assume MLC)
6. Govt policies
   Developing countries -> increase demand for capital goods -> increase M -> worsen BOT
   protectionism -> reduces demand of other countries export and X fall -> worsen BOT of other country
7. War/Natural Disaster
   Increase import of capital and consumer goods to rebuild economy -> M increase + export industry destroyed -> reduced X -> worsen BOT

Question 22

What does severity of BOT deficit depend on

Answer 22

Size: larger deficit relative to GDP => greater fall in AD, employment and income

Duration: temporary deficit can be financed via foreign exchange reserves or borrow from
Surplus countries

Cause: if BOT deficit is due to high volume of import of capital goods -> capital accumulation causes quality and quantity of capital goods to increase -> productive capacity increases -> if country nurture industries that promote exports -> deficit can be reduced or turned into surplus

Question 23

What are Government consequences of large and persistent BOT deficit?

Answer 23

1. Fall in national output and employment: reduce AD -> multiplied fall in national output and employment via reverse multiplier effect if there is spare capacity -> derived demand for FOP fall -> DD UNn
2. Higher inflation (imported inflation): persistent BOT deficit -> downward pressure on e/r -> outflow of currency greater than inflow of currency => at prevailing e/r Qs of currency > Qd of currency -> downward pressure on external value of currency -> if use freely floating exchange rate system -> currency depreciate-> price of imports in terms of local currency increases -> imported inflation + increase burden of debt becos value of debt in terms of domestic currency increases
3. Fall in business and investor confidence: reflects loss of country’s international competitiveness -> firms less optimistic about future profits -> loss of business confidence -> outflow of FDI as local and foreign firms move business to higher profits -> results in lower level of direct investment -> worsens potential and actual growth via fall in AD and LRAS -> impact sustained growth
4. Sacrifice future material welfare: deficit -> export revenue CANT cover import expenditure-> incur large external debt to cover deficit OR finance imports via selling assets to foreigners -> greater foreign debt + foreign ownership of domestic assets -> more future income flows out to foreigners in form of interest rent dividends and profits -> reduces GNI -> if reserves are depleted -> unavailable for future purchase of imports for consumption -> enjoying higher current consumption at expense of future material welfare

Question 24

Consequences of BOT deficit to households

Answer 24

1. Loss of employment and income: fall in AD -> fall in real output and employment -> fall in demand for g&s -> firms produce less -> lower derived demand for labour -> higher DD UNn -> fall in employment + income -> lower M.SOL becos ability to purchase goods and services for consumption is reduced
2. Reduced purchasing power: depreciation/ devaluation due to deficit -> imported inflation -> raise COP of firms -> reduce AS -> AS shift up -> GPL increase. Depreciation -> imported goods more expensive in terms of local currency -> increase in price of domestic and imported goods -> reduce purchasing power -> lower M.SOL

Question 25

Consequences of BOT deficit for firms/producers?

Answer 25

1. Fall in production and profits: falling employment + income -> firms cut back on investment as demand for normal goods and services fall and business confidence falls -> fall in revenue and profits -> negatively affect ability to invest and expand production capacity -> limit ability to earn future profits and LR viability
2. Rise in COP: imported inflation via depreciation of currency OR devaluation -> higher prices of imported inputs -> firms that use imported inputs -> higher COP -> lower profits