8.2. Balancing International Payment (BOP)

1. 8.2. Balancing International Payment (BOP) • International trade concerns the (X –M) component of the Aggregate Demand. It concerns the external economy. • Having a positive BOP is a macro objective of government. • To obtain a positive BOP, a country needs to export more than import. If this is not so, then the country will suffer a negative BOP or BOP deficit. • When we talk about the BOP, we say that there is balance of goods as well as balance of service to the BOP. • The balance of trade would be concern with visible goods while the balance of service would be concern with invisible goods (mostly services). • Together the make up the Balance of Trade and Service of the BOP. • Balance of Services (BOS) • Concerns services. • Eg. Banking services, consultancy services etc. • Balance of Trade (BOT) • Concerns visible goods. • Eg. Computers, shoes, cellphones

2. 8.2. Balancing International Payment (BOP) • The government monitors the Balance of Payment through 3 national accounts and they are: • The current account – visible, invisible, income in and out of the country due to factors of production and net transfer (like grants and donation from other governments. • The capital accounts – international capital transfer from of non-financial assets eg. Land factories, buildings. and machinery between its residents and the rest of the world. • The financial accounts – international monetary flow of funds related to investments in business, government bonds, loan stocks and company shares and foreign direct investments in factories and businesses that would yield profits.

3. 8.2. Balancing International Payment (BOP) • Exchage Rate Mechanism • Money Market For Singapore Dollars • Sing Dollar In • terms of • US Dollar • S • 0.90 • Appreciation of Singapore • 0.85 • Depreciation of Singapore • 0.80 • D • Quantity of • Sing Dollars • Q0

4. 8.2. Balancing International Payment (BOP) • Exchage Rate Mechanism • Money Market For Singapore Dollars • Sing Dollar In • terms of • US Dollar • 1. Assume there is an increase in demand for Singapore Dollars owing to increase demand for Singapore exports. This will shift the DD curve to Shift to the right. • S • 0.90 • 2. This causes the Singapore Dollars to appreciate from 0.85 to 0.90 USD for 1 SGD. • 0.85 • 0.80 • 3. With this SGD appreciation, this means that more USD will be needed to buy a SGD dollar. (used to be 0.85 now 0.95. You now need USD0.1 more to buy 1 SGD) • D1 • D • Quantity of • Sing Dollars • Q0 • Q1

5. 8.2. Balancing International Payment (BOP) • Exchage Rate Mechanism • Money Market For Singapore Dollars • Money Market For US Dollars • Sing Dollar In • terms of • US Dollar • US Dollar In • terms of • Sing Dollar • S • S1 • S • 0.90 • 1.25 • 0.85 • 1.20 • 0.80 • 1.15 • D1 • D • D • Quantity of • Sing Dollars • Q1 • Quantity of • US Dollars • Q0 • Q1 • Q0 • An appreciation in the Singapore Dollars would imply a depreciation in the US Dollar and vice versa.

6. 8.2. Balancing International Payment (BOP) • Exchage Rate Mechanism • TEASER 1 • Using exchange rate diagram(s), explain how the US exchange rate would change when there is an increase in demand for US goods by the Chinese. • (US/RMB exchange is currently at USD1 = RMB6.2) • Presentation: • Bank of China • To hand up : Charmaine, Eunice, SAQuek, Melvin, LSNing, Adi, Kim, Felicia, Dylan, Kenneth.

7. Exchage Rate Mechanism • What Gives Rise to the Demand For A Currency • Changes in the current account ie. Due to imports and export trades. Where there is a demand for a country's exports, foreigners have first to buy the Singapore currency to purchase Singapore exports. • Inflation can cause the price of Singapore produced exports to be more expansive and Singaporean would instead buy cheaper imports. Thus we sell SGD and buy RMB to purchase Chinese exports. • Change in interest rate – This will attract foreign direct investment as a higher interest rate then their country would bring better returns on their deposit for these FDIs. • Speculation – Hot money moving in and out of a country looking for quick returns.

8. Exchage Rate Mechanism • How the Government Can Us The Exchange Rate to Improve a Negative • BOP (BOP Deficit) • If country is suffering a negative BOP, they can depreciate their currency ie. Sell down or give up their local currency and buy up USD causing the SGD to depreciate and in the process making the SGD depreciate. • This will make Singapore exports more competitive and thus we can export more thereby creating an increasingly more positive BOP through the current account.

9. 8.2. Balancing International Payment (BOP) • Depreciating a Currency Towards A Positive BOP • Money Market For US Dollars • Money Market For SGD Dollars • US Dollar In • terms of • SGD Dollar • SGD Dollar In • terms of • US Dollar • S • S1 • S • 0.90 • 1.25 • 0.85 • 1.20 • 0.80 • 1.15 • D1 • D • D • Quantity of • Sing Dollars • Q1 • Quantity of • US Dollars • Q0 • Q1 • Q0 • A depreciation in the Singapore Dollars would imply an appreciation in the US Dollar. When SGD is lower against the USD, Singapore exports will become more competitive and foreigners will buy more of Singapore exports.

10. 8.2. Balancing International Payment (BOP) • The Marshal Lerner Condition • 1. This condition states that a country can correct a BOP deficit by depreciating its currency on condition that the sum of its imports and exports is greater than 1. (price elastic in demand) • 2. this means that there would be a net increase in demand for the country’s export thereby causing a net inflow of total revenuesinto the country.

11. 8.2. Balancing International Payment (BOP) • Floating Exchage Rate Mechanism • Fixed Exchage Rate Mechanism • Money Market For Singapore Dollars • Money Market For Singapore Dollars • Sing Dollar In • terms of • US Dollar • Sing Dollar In • terms of • US Dollar No Limit to appreciation. • S • S • No movement in Exchange Rate • 0.90 • 0.85 • 0.85 • 0.80 • D • D No Limit to depreciation • Quantity of • Sing Dollars • Quantity of • Sing Dollars • Q0 • Q0 • Advantages and Disadvantages • Advantages and Disadvantages Will allow the external economy to adjust price of exports if its too high. However, can cause wild spectulation of currency and cause foreigners to lose confidence in the currency. Advantage can control exchangre rate fluctuation making it good for trade. But government needs lots of reserve to do maintain fixed ex.

12. 8.2. Balancing International Payment (BOP) • Managed Float Exchage Rate Mechanism (Singapore) • Money Market For Singapore Dollars • Sing Dollar In • terms of • US Dollar • The MAS will intervene when the exchange rate is at the Upper or lower Band. • S • Upper Band • 0.90 • Upper Band: When ex rate is at upper band it means that SGD is getting strong and affects our exports. To prevent deficit BOP, government will sell down the SGD so as to depreciate the SGD. • 0.85 • Lower Bond • 0.80 • D • Lower Band: When ex rate is at lower band it means that SGD is getting weaker and affects our import of high priced resources causing cost push inflation. To prevent this, government will buy up the SGD in the money markets so as to appreciate the SGD. • Quantity of • Sing Dollars • Q0

13. 8.2. Balancing International Payment (BOP) • Managed Float Exchage Rate Mechanism (Singapore) • Money Market For Singapore Dollars • Sing Dollar In • terms of • US Dollar • The MAS would also do the folloiwng: • S • Upper Band • 0.90 • 1. Steepen the slope of the band: When prices of raw materials from other countries, the MAS will steepen the slope of the band to fight imported inflation (cost push inflation) • 0.85 • Lower • Band • 0.80 • D • Quantity of • Sing Dollars • Q0

14. 8.2. Balancing International Payment (BOP) • Managed Float Exchage Rate Mechanism (Singapore) • Money Market For Singapore Dollars • Sing Dollar In • terms of • US Dollar • The MAS would also do the folloiwng: • S • Upper Band • 0.90 • 2. Widen the band: When exchange rate between SGD and its major trading partners countries are volatile, the MAS will widen the band. • 0.85 • Lower • Band • 0.80 • D • Quantity of • Sing Dollars • Q0