2. Credits & Debits
Credits – If a transaction earns foreign currency for the nation it
is called as credit .(inflow)
Debits- If a transaction involves spending foreign currency it is
called as debit.(outflow)
3. BALANCE OF PAYMENTS
The balance of payments, of a country is defined as the record
of all economic transactions between the residents of the
country and the rest of the world in a particular period.
6. Merchandise
Also called Balance Of Trade
Includes trade of Goods ( visble items)
There can be a surplus in Balance of trade if exports are more
than imports.
And a deficit In Balance of Trade when when imports are more
than the exports.
9. Unilateral Transfers
Involves Gifts, remittances, indemnities, etc. from
foreigners and are called unrequited receipts because
residents of a country receive ‘for free. Nothing has to
be paid in return at present or in future for these
receipts
12. Foreign Direct Investment
In 2017, for example, U.S.-based Apple announced a $507.1
million investment to boost its research and development
work in China, Apple's third-largest market behind the
Americas and Europe.
India received FDI inflows worth USD 60.1 billion in 2016-
17, which was an all-time high.
13. Portfolio Investment
Also called Foreign Institutional Investment
A foreign institutional investor (FII) is an
investor or investment fund registered in a
country outside of the one in which it is
investing. Institutional investors most
notably include insurance
companies, pension funds and mutual
funds.
14.
15. THE TOTAL OF ALL ACCOUNTS UNDER BOP COMES UP TO 0.
i.e. Current Account+Financial Account+ Capital Account =0
(Including Net errors and omissions)
16.
17.
18. Significance of BOP:
It presents the international financial position of the
country.
It helps the government in taking decisions on
monetary and fiscal policies on the one hand, and on
external trade and payments issues on the other.
dependence of the country’s economic development
on the financial assistance by the developed countries.
to evaluate the degree of its international solvency,
and to determine the appropriateness of the exchange
rate of country’s currency.
19. RATES
EXCHANGE RATES -THE VALUE OF ONE CURRENCY FOR THE
PURPOSE OF CONVERSION TO ANOTHER
FOREIGN EXCHANGE RATES - IS THE RATE AT WHICH ONE
CURRENCY WILL BE EXCHANGED FOR ANOTHER.
FOREIGN EXCHANGE RATE OF DOLLAR AND RUPEE
1 $ = 65 ₹
1 ₹ = 0.015 $
FOREIGN EXCHANGE RATE (E) = FOREIGN CURRENCY/
DOMESTIC CURRENCY = $/₹
E = 0.015$/₹
20. The Foreign exchange market
SUPPLY AND DEMAND CURVE
• SUPPLY OF US DOLLARS FROM US
• DEMAND FROM JAPAN
21.
22. Exchange rate rises with increase in supply
Americans will buy more Japanese goods
Supply of dollar increases
Exchange rate rises
23.
24. Demand curve is a downward curve
Dollar value falls and yen becomes more expensive
Demand of US dollars increases
Increase in demand of goods
• Balance of supply and
demand determine the
Foreign exchange rate
• Stable at equilibrium
point
25. Terminology
DEPRICIATION – Fall in the price of currency
APPRECIATION – Increase in price of currency
DEVAULATION
REVALUATION
26. Effects of changes of
exchange rates in trade
RECESSION leads to
Decrease in demand for dollars
Left shift of demand curve
Depreciation of dollar
27.
28. Right Shift in demand curve
Increase in interest rates
Increase in demand
Dollar appreciates
29.
30. FACTORS AFFECTING
EXCHANGE RATES
INFLATION - Low inflation rates show appreciation
INTEREST RATES – Increase in interest rates leads to
appreciation
COUNTRIES CURRENT ACCOUNTS/BALANCE OF
PAYMENT
GOVERNMENT DEBT – Decrease in exchange rate
TERMS OF TRADE
POLITICAL STABILITY
SPECULATION
31. EFFECT OF EXCHANGE
RATE ON ECONOMY
STRONGER CURRENCY – UMEMPLOYMENT and
NON COMPETIVENESS
WEAKER CURRENCY – DECREASES trade deficit
33. Fixed Exchange Rates : The
Classical Gold Standard
The Government “pegs” the official
exchange rate to another country’s
currency or to the price of gold.
Eg. Saudi Arabia: 3.75 Riyal pegged to 1.00
USD
Gold Std. most used on & off from 1717-
1933.
Provides greater certainty for exporters and
importers.
34. Advantages
Currency Stability.
Avoiding Inflation.
Imposes discipline
on the monetary
authority.
Disadvantages
Expensive to
maintain
Currency a target for
speculators.
Prevents market
adjustments.
35. Hume’s Adjustment Mechanism
System needs to facilitate adjustment to shocks.
In flexible sys., rate could depreciate to offset
domestic inflation.
However, in fixed sys., equilibrium restored by
deflation at home or inflation abroad.
36. Hume’s Argument
Outflow of gold kept international
payments in balance.
Countries with increasing money supply;
inflation occurs as prices of goods and
services rose.
Countries with decreasing money
supply; deflation occurs as prices of
goods and services fell.
37. Quantity Theory of Prices
General price level of goods and services
is directly proportional to the amount of
money in circulation, or money supply.
38. Four-Pronged Mechanism and
Example
Consider Hume’s argument and
quantity theory of prices.
Suppose America runs a large trade
deficit with Britain and begins to lose
gold.
This reduces America’s prices and
costs.
39. Resulting Four “Prongs”
First Prong- Decline in American
Import of goods.
Second Prong- Rise in exports of
American goods.
40. Effect in Britain and other foreign
countries
Due to Britain’s rapid export
growth, gold is received.
Money Supply increases thereby
increasing prices and costs.
This introduces 2 more prongs.
41. Third Prong- Rise in British import
of goods.
Fourth Prong- Decline in British
exports of goods.
All the prongs result in a stable
equilibrium.
42. Post World War II
World Trade Organization, Bretton Woods system,
International Monetary Fund and the World Bank.
These institutions helped industrial democracies to
rebuild and grow rapidly.
USA and the Bretton Woods system responsible for
ushering into an era of flexible rates.
43. Bretton Woods Agreement
Currencies were pegged to the price of
gold, USD was reserve currency linked to
price of gold.
Exchange rates were FIXED but
ADJUSTABLE.
The ability to adjust when fundamental
disequilibrium arose differed BWS and gold
standard.
Then Richard Nixon happened.
44. Nixon Shock
BWS functioned effectively till the early 1970s.
Dollar overvalued, US refused to take
contractionary steps.
Richard Nixon and the USA left the BWS,
ushering into an era of flexible rates.
Eventually resulting in European ERM in 1979
and adoption of Euro.
45. Flexible Exchange Rates
Exchange rates move purely under the
influence of supply and demand.
Government neither announces nor
enforces an exchange rate.
Used by three major economic regions
USA
Countries of Euroland
Japan
46. Determination of ER under Flexible ER.
Example of the Mexican Peso. In 1994, peso
was allowed to float.
Original ER : 4 Pesos/$. Excess supply of
pesos
At this ER, supply of pesos outweighed the
demand of pesos.
Outcome : Peso depreciated relative to $,
resulting in rate of 6 pesos/$ resulting into
supply demand equilibrium
47. Two Main Forces Involved
(1)With $ more expensive, it costs more for
Mexicans to buy American products causing
supply of pesos to fall off.
(2)Depreciation of the peso, Mexican
products became cheaper thereby
increasing demand for pesos.
Government on the side-lines, allowing the
market to determine the value of dollar.
48. Managed Exchange Rates
Middle ground b/w fixed and flexible
exchange rates.
Government has a role to play.
This system is becoming less
important as countries gravitate
towards other too system.
49. Conclusion
No exchange rate system is
defined in today’s world unlike the
earlier uniform system under either
the gold standard or Bretton Woods.
Without anyone’s having planned it,
the world has moved to a hybrid
exchange rate system.
