Transcript Theory in Life 20.1 Progress Checkpoint 1

20. Exchange Rate and the
Balance of Payment
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Chapter 20 : main menu
20.1
Exchange rates
20.2
The effects of exchange rate
movement on trade
20.3
The linked exchange rate
system
20.4
Theory in Life 20.2
Concept Explorer 20.1
Balance of Payments account Concept Explorer 20.2
Theory in Life 20.3
Progress Checkpoint 2
Theory in Life 20.1
Progress Checkpoint 1
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Theory in Life 20.1
How the linked exchange rate is maintained
(This part is not required by the HKCEE. It can be skipped
without loss of continuity).
Under the currency board system, it is interest rates rather than
the exchange rate of HK dollar which adjusts to inflows or outflows
of funds.
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Theory in Life 20.1
Market
participants
buy HK
dollars
Market
participants
sell HK
dollars
Currency
board sells
HK dollars
Upward
pressure on
the HK
dollar
exchange
rate
Downward
pressure on
the HK
dollar
exchange
rate
Currency
board buys
HK dollars
Monetary
base
expands
Interest
rates
decrease
Interest
rates
increase
Monetary
base
contracts
Capital
inflow
Capital
outflow
The exchange rate between
HK dollar and US dollar is stabilized
Fig. 20.1 The automatic mechanism to maintain the linked exchange rate.
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Theory in Life 20.1
Reminder :
The exchange rate can also be stabilized through an ‘arbitrage and competition’
mechanism among the note-issuing banks.
Therefore, the expansion (contraction) in the monetary base leads to a decrease
(an increase) in interest rates for Hong Kong dollar. This creates the monetary conditions
that counteract the original capital flow automatically. Hence the exchange rate between
HK dollar and US dollar can remain stable.
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Progress Checkpoint 1
Q20.1 Given the following exchange ratio between British pound and Swiss Franc (SFr):
£5 = €7
(a) What is the exchange rate of £1 in terms of €?
(b) What is the exchange rate of €1 in terms of £?
(a) The exchange rate of £1 is €1.4.
(b) The exchange rate of €1 is £0.7143.
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Progress Checkpoint 1
Q20.2 The following shows the exchange ratios of the currencies of Country A ($A)
and B($B) on two dates :
1st August 2002
1st August 2003
$A 3 = $B 1
$A 2= $B 1
How did
(a) the exchange value of $A change relative to $B?
(b) the exchange value of $B change relative to $A?
(a) the exchange value of $A increased relative to $B, i.e. $A has appreciated
against $B.
(b) the exchange value of $B decreased relative to $A, i.e. $B has depreciated
against $A.
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Progress Checkpoint 1
Q20.3 Given the following exchange rates between Japanese Yen (¥) and
Hong Kong dollars (HK$) :
1st July 2001
1st July 2002
¥1,000 = HK$65
¥1,000 = HK$70
How does EACH of the following change in the above period?
(a)
(b)
(c)
(d)
(e)
the exchange value of HK$ relative to ¥?
the exchange value of ¥ relative to HK$?
the price and volume of goods exported from Hong Kong to Japan?
the prices and volume of goods imported from Japan into Hong Kong?
the total expenditure (in HK$) on imports from Japan to Hong Kong?
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Progress Checkpoint 1
(a) the exchange value of HK$ relative to ¥ falls, i.e. HK$ depreciates against ¥
(b) the exchange value of ¥ relative to HK$ rises, i.e. ¥ appreciates against HK$
(c) the price of goods exported from Hong Kong to Japan falls; the volume of exports
from Hong Kong to Japan rises
(d) the prices of goods imported from Japan into Hong Kong rises; the volume of imports
from Japan into Hong Kong falls
(e) there is uncertain change in the total expenditure (in HK$) on imports from Japan
to Hong Kong. If HK’s demand for Japanese imports is elastic, the total expenditure
will fall. If it is inelastic, the total expenditure will rise.
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Theory in Life 20.2
Finding the balance of trade
The following table shows the composition of Hong Kong’s Gross Domestic Product (GDP)
in 1990 and 2000:
Ratio to total GDP
GDP components
1990
2000
Private consumption expenditure
68%
75%
Government consumption expenditure
10%
18%
Gross domestic fixed capital formation
20%
17%
Changes in stocks
10%
-3%
Exports of goods
50%
132%
Imports of goods
75%
113%
Exports of services
46%
92%
Imports of services
29%
118%
Source : Hong Kong Census and Statistics Department
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Theory in Life 20.2
Was there a trade deficit or surplus in 1990 ? in 2000? Suggest a reason for these.
In 1990, since the exports and imports of goods are 50% and 75% of the 1990 GDP, the
value of exports is less than that of imports of goods. Hence there was a trade deficit.
In 2000, since the exports and imports of goods are 132% and 113% of the 2000 GDP, the
value of exports is greater than that of imports of goods. Hence there was a trade surplus.
One reason for the change is the expansion of the trade in China. If China exports more
goods to the western countries through Hong Kong, Hong Kong’s re-exports of goods will
increase. This may lead to a trade surplus in 2000.
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Concept Explorer 20.1
Determining the balance of trade
The following graph shows an economy’s growth rates of exports and imports of goods from
1980 to 2001.
Growth rate (%)
Growth rate of exports of goods
20.0%
Growth rate of imports of goods
15.0%
10.0%
5.0%
0.0%
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
Year
-5.0%
-10.0%
Fig. 20.2 The growth rates of exports and imports of goods.
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Concept Explorer 20.1
Between 1992 and 1997, the growth rate of exports of goods is greater than that of
imports of goods. Under what condition can we say that there was a trade deficit?
The growth rates of exports and imports of goods are different from the values of
exports and imports of goods. If the initial values of imports of goods is significantly
greater than that of exports, and such difference is not offset by a larger growth rate of
the exports of goods, then in the period 1992 and 1997, it is possible to have a trade
deficit.
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Concept Explorer 20.2
The sub-classification of the capital and financial account
The following shows how different economic transactions are recorded
in the capital and financial account. As the HKCEE does not require
students to learn such account in details, this section can be skipped
without loss of continuity.
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Concept Explorer 20.2
Capital Account
a. Capital transfers
This includes the transfer of ownership of a fixed asset or forgiveness of a liability
 (債務減免).
Examples:
1. A businessman in HK donates some machines to an agricultural organization in the
Philippines. [debit]
2. An Australian company forgives a loan owed by a HK company. [credit]
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Concept Explorer 20.2
b. Non-produced and non-financial assets
This includes the transactions of tangible assets (有形資產) that are not actually
produced (e.g. land) and of intangible assets (無形資產) (e.g. patents, copyrights,
trademarks and franchises).
Examples :
1. A US company buys a piece of land in HK. [credit]
2. A HK garment firm buys the patent of a fashion design from a Paris firm. [debit]
3. A HK film production company sells the copyright of a movie to a US firm. [credit]
4. A HK manufacturing firm buys a trademark from a toy company in Japan. [debit]
5. A HK telecommunication firm buys a franchise from a French company for
providing 3G mobile phone service in Europe. [debit]
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Concept Explorer 20.2
Financial Account
c. Direct or Real Investment
 This includes external investment in which an investor of an economy acquires a
lasting interest of an enterprise located in another economy. External investment
in real estate is also a form of direct investment.
Examples :
1. A HK resident buys an apartment in Malaysia. [debit]
2. A US bank invests buys a tower in HK. [credit]
3. A HK resident buys 10% of the shares of a publicly listed company in the
Mainland of China. [debit]
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Theory in Life 20.3
How different economic transactions are recorded in the balance
of payments
How is each of the following economic transactions recorded in the
balance of payments of Hong Kong?
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Theory in Life 20.3
Economic transactions
In which account is it recorded?
Is it a credit or a
debit entry?
(a) A Hong Kong resident receives dividend from the shares
issued by a company in Mainland China.
External factor income flow in the
current account
credit
(b) A Hong Kong music production company buys the
copyright of a song from a Japanese music firm.
Capital and financial account
debit
(c) A Hong Kong advertising firm borrows a loan from a
company in Singapore.
Capital and financial account
credit
(d) A US technology firm sets up a branch in Hong Kong.
Capital and financial account
credit
(e) A Japanese tourist travels by tram in Hong Kong.
Invisible trade in the current account
credit
(f) A Hong Kong resident purchases some warrants of a
bank in London.
Capital and financial account
debit
(g) A Hong Kong resident donates some money to the
victims of an earthquake in Iran.
Current transfers in the current account
debit
Table 20.3 How different economic transactions are recorded in the balance of payments.
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Theory in Life 20.3
Economic transactions
(h) A British investor purchases 0.0001% of the shares of
the Mass Transit Railway Corporation Ltd.
In which account is it recorded?
Is it a credit or a
debit entry?
Capital and financial account
debit
(i) A Hong Kong resident purchases a notebook computer
from Japan.
Visible trade in the current account
debit
(j) A Hong Kong firm forgives a loan owed by an Indian
firm.
Capital and financial account
credit
Table 20.3 How different economic transactions are recorded in the balance of payments.
Reminder :
If an economic transaction is not recorded in the current account as visible trade,
invisible trade, external factor income flow or current transfers, then it is recorded
in the capital and financial account.
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Progress Checkpoint 2
Q20.4 State how EACH of the following item will be recorded in the current account
of the balance of payment of Country X:
(a) The government of Country X donates of a sum of money to Country A
(b) A resident of Country X receives wages from working in a company in
Country X for 3 months
(c) A firm in Country X sells some manufactured goods to Country C.
(d) A securities company of Country D provides stock trading services to a tourist
from Country X
(a) A debit entry under current transfers
(b) A credit entry under external factor income flows
(c) A credit entry under visible trade
(d) A debit entry under invisible trade
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Progress Checkpoint 2
Q20.5 Given the following data about the balance of payment components of HK:
HK$ million
Domestic exports of goods
650
Re-exports of goods
230
Imports of goods
420
Exports of services
1,520
Imports of services
1,840
External factor income inflow
2,450
External factor income outflow
2,170
Current transfer inflow
320
Current transfer outflow
770
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Progress Checkpoint 2
(a) Calculate the value of exports of goods.
(b) Calculate the value of retained imports.
(c) Calculate the balance of trade and state whether it is in surplus
or deficit.
(d) Calculate the balance of invisible and state whether it is in surplus
or deficit.
(e) Calculate the value of net external factor income inflow.
(f) Calculate the current account balance and state whether it is in
surplus or deficit.
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Progress Checkpoint 2
(a) Exports of goods = Domestic exports + re-exports
= HK$(650 + 230)m
= HK$880 m.
(b) Retained imports =
=
=
(c) Balance of trade =
=
=
Imports of goods – re-exports of goods
HK$(420 – 230) m
HK$190 m.
Exports of goods – imports of goods
HK$(880 – 420)m
HK$460m (surplus).
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Progress Checkpoint 2
(d) Balance of invisible trade = Exports of services – imports of services
= HK$(1,520 – 1,140)m
= -HK$ 320m (deficit).
(e) Net external factor income inflow
= External factor income inflow – external factor income outflow
= HK$(2,450 – 2,170)m
= HK$280m (surplus).
(f) Current account balance
= all credit entries – all debit entries
= HK$[(650 + 230 + 1,520 + 2,450 + 320) – (420 + 1,840 + 2,170 + 770)]m
= - HK$30m (deficit).
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Progress Checkpoint 2
Q20.6 A current account deficit implies that balance of trade, balance of invisible trade,
net external factor income inflow and net current transfers are all in deficits. Do
you agree?
No. A current account deficit only implies that the sum of all credit entries in
the account is less than the sum of all debit entries. It is possible that some
sub-items (e.g. balance of trade, net current transfers, etc) are in surplus. But
it will be impossible for all sub-items to be in surplus.
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Progress Checkpoint 2
Q20.7 For each of the following, name the account within Country A’s balance of payments
will be affected, and state whether it will be recorded as a credit or debit entry.
(a) A resident of Country A watches a concert in Country X.
(b) A firm in Country A donates some medical equipment to a hospital in Country X.
(c) A resident of Country A receives a remittance from a relative in Country X.
(d) A resident of Country X receives interest from his deposits in a bank in Country A.
(e) A resident of Country X purchases some bonds issued by the government of Country A.
(f) A resident of Country X purchases an MP3 player produced by a firm in Country A.
(a) A debit entry in the current account (invisible trade)
(b) A debit entry in the capital and financial account
(c) A credit entry in the current account (current transfers)
(d) A debit entry in the current account (external factor income flows)
(e) A credit entry in the capital and financial account
(f) A credit entry in the current account (visible trade)
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Progress Checkpoint 2
Q20.8 (a) “A balance of payment may be in surplus.”
(b) “A balance of payment account must always balance."
Is EACH of the above statements true or false ?
(a) True. A balance of payment will be in surplus if the sum of all credit entries
in the current, capital and financial accounts is greater than that of all debit
entries. The official reserve assets will rise, which will be recorded as a debit
entry in the balance of payment.
(b) True. Because the net change in reserve asset just offsets the overall
balance of payment, a balance of payment account which includes the net
change in reserve asset must balance on the credit and the debit sides.
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Progress Checkpoint 2
Q20.9 Is it possible for an economy to have a trade surplus and a
balance of payments deficit in the same year?
Yes. It occurs when the economy’s other items in the current,
capital and financial (non-reserve) accounts altogether have a
deficit, and such deficit is greater than the balance of trade surplus.
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End of Chapter 20
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