Balance of Payments Analysis of Kuwait

Chapter - I
INTRODUCTION

“Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait.
1

1.1

Origin of Report

To support our theoretical knowledge by the practical experience in the field of balance of
payment we are assigned to prepare this report as a partial fulfillment of the course ―Foreign
exchange & International Risk Management‖ (F-526). Our topic is to prepare a report on
Balance of payment of Kuwait.‖ provided by Dr. M. Masud Rahman, the honorable course
teacher. It was a matter of group discussion and understanding. Assignment submission and
presentation is the requirement for Master of Business Administration (MBA) degree.
The main objective of preparing this report is to broaden our knowledge and understanding the
mechanism and components of Balance of Payment (BOP) and also Interest Rate Parity (IRP),
Purchasing Power Parity (PPP) & International Fisher Effect (IFE).

1.2

Scope of the Report

The scope of the study was mainly based on information available in the publicly available
materials and on knowledge. Data have been collected from the websites regarding the balance
of payment. We have also collected relevant data from the websites of Bangladesh Bank,
Bangladesh Economic Review, Central Bank of Kuwait (CBK), Arab Monetary fund, Federal
Reserve System Journals, Articles, Report of daily newspapers and relevant publications.

1.3

Objective of the Report

1.3.1

Broad Objective

The main objective of preparing this report is to broaden our knowledge and understanding the
mechanism and components of Balance of Payment (BOP) and also Interest Rate Parity (IRP),
Purchasing Power Parity (PPP) & International Fisher Effect (IFE).
1.3.2 Specific Objective
This study is intended for providing us invaluable practical knowledge about trade relationship
between Bangladesh and Kuwait.

2

However, the specific objectives are the followings:
o To have a revelation on the Balance of Payment (BOP).
o To know about Interest Rate Parity (IRP), Purchasing Power Parity (PPP) and
International Fisher Effect (IFE) from a practical viewpoint.
o To know about the components of BOP between Bangladesh and Kuwait.
o To know about the variables that affects the BOP.

1.4

Methodology of the Report

We have collected information from the secondary sources of data are websites regarding BOP
in Bangladesh and Kuwait, Bangladesh Economic Review, Central Bank of Kuwait (CBK), Arab
Monetary fund, Federal reserve system Journals, Articles, Report of daily newspapers and
relevant publications. At the very beginning of the report we have given an overall literature
review which defined the BOP, current account, capital account, financial account, PPP, IFE,
and IRP. Then we have presented the economic recent economic outlook of the Kuwait along
with major economic indicators like GDP, inflation rate, interest rate, per capita income, import,
and export etc. Then we present details of the BOP of Kuwait using BOP data of ten years
(2002-2011). We have also done the following tasks.
o Regression Analysis & Trend Analysis
o Relationships different Components of BOP with GDP
o Relationships between BoP of Kuwait & Bangladesh.
o Drawing & testing the curves of IRP, PPP and IFE lines considering Kuwait as home
country & USA as foreign country.

1.5

Limitation of the Report

o We were not familiar with all the terminologies. That's why we had some difficulty in the
interpretation.
o We have not enough information to do analysis.

3

Chapter - II
LITERATURE REVIEW

4

The Balance of Payments (BOP):
A record of all transactions made between one particular country and all other countries during
a specified period of time. Usually, the BOP is calculated every quarter and every calendar year.
BOP compares the dollar difference of the amount of exports and imports, including all financial
exports and imports. A negative balance of payments means that more money is flowing out of
the country than coming in, and vice versa. Balance of payments may be used as an indicator of
economic and political stability. For example, if a country has a consistently positive BOP,
this could mean that there is significant foreign investment within that country. It may also mean
that the country does not export much of its currency.
All trades conducted by both the private and public sectors are accounted for in the BOP in order
to determine how much money is going in and out of a country. If a country has received money,
this is known as a credit, and, if a country has paid or given money, the transaction is counted as
a debit. Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities
(debits) should balance. But in practice this is rarely the case and, thus, the BOP can tell the
observer if a country has a deficit or a surplus and from which part of the economy the
discrepancies are stemming.

Composition of Balance of Payments
The BOP is divided into three main categories: the current account, the capital account and the
financial account. Within these three categories are sub-divisions, each of which accounts for a
different type of international monetary transaction.

1. The Current Account
The current account is used to mark the inflow and outflow of goods and services into a country.
Earnings on investments, both public and private, are also put into the current account. Within
the current account are credits and debits on the trade of merchandise, which includes goods such
as raw materials and manufactured goods that are bought, sold or given away (possibly in the
form of aid). Services refer to receipts from tourism, transportation (like the levy that must be
5

paid in Egypt when a ship passes through the Suez Canal), engineering, business service fees
(from lawyers or management consulting, for example), and royalties from patents and
copyrights. When combined, goods and services together make up a country's balance of trade
(BOT). The BOT is typically the biggest bulk of a country's balance of payments as it makes up
total imports and exports. If a country has a balance of trade deficit, it imports more than it
exports, and if it has a balance of trade surplus, it exports more than it imports.

Receipts from income-generating assets such as stocks (in the form of dividends) are also
recorded in the current account. The last component of the current account is unilateral transfers.
These are credits that are mostly worker's remittances, which are salaries sent back into the home
country of a national working abroad, as well as foreign aid that is directly received.

2. The Capital Account
The capital account is where all international capital transfers are recorded. This refers to the
acquisition or disposal of non-financial assets (for example, a physical asset such as land) and
non-produced assets, which are needed for production but have not been produced, like a mine
used for the extraction of diamonds.
The capital account is broken down into the monetary flows branching from debt forgiveness,
the transfer of goods, and financial assets by migrants leaving or entering a country, the transfer
of ownership on fixed assets (assets such as equipment used in the production process to
generate income), the transfer of funds received to the sale or acquisition of fixed assets, gift and
inheritance taxes, death levies, and, finally, uninsured damage to fixed assets.
3. The Financial Account
In the financial account, international monetary flows related to investment in business, real
estate, bonds and stocks are documented. Also included are government-owned assets such as
foreign reserves, gold, special drawing rights (SDRs) held with the International Monetary Fund,
private assets held abroad, and direct foreign investment. Assets owned by foreigners, private
and official, are also recorded in the financial account.
6

The Balancing Act
The current account should be balanced against the combined-capital and financial accounts.
However, as mentioned above, this rarely happens. We should also note that, with fluctuating
exchange rates, the change in the value of money can add to BOP discrepancies. When there is a
deficit in the current account, which is a balance of trade deficit, the difference can be borrowed
or funded by the capital account. If a country has a fixed asset abroad, this borrowed amount is
marked as a capital account outflow. However, the sale of that fixed asset would be considered a
current account inflow (earnings from investments). The current account deficit would thus be
funded. When a country has a current account deficit that is financed by the capital account; the
country is actually foregoing capital assets for more goods and services.
Interest Rate Parity
Interest rate parity is an economic concept, in which the interest rate differential between two
countries is equal to the differential between the forward exchange rate and the spot exchange
rate. Interest rate parity plays an essential role in foreign exchange markets, connecting interest
rates, spot exchange rates and foreign exchange rates.
Interest rate parity is a non-arbitrage condition which says that the returns from borrowing in one
currency, exchanging that currency for another currency and investing in interest-bearing
instruments of the second currency, while simultaneously purchasing futures contracts to convert
the currency back at the end of the holding period, should be equal to the returns from
purchasing and holding similar interest-bearing instruments of the first currency. If the returns
are different, an arbitrage transaction could, in theory, produce a risk-free return.

7

Purchasing Power Parity (PPP)
An economic theory that estimates the amount of adjustment needed on the exchange rate
between countries in order for the exchange to be equivalent to each currency's purchasing
power. In other words, the exchange rate adjusts so that an identical good in two different
countries

has

the

same

price

when

expressed

in

the

same

currency.

Purchasing power parity (PPP) is a theory of long-term equilibrium exchange rates based on
relative price levels of two countries. The idea originated with the School of Salamanca in the
16th century and was developed in its modern form by Gustav Cassel in 1918. The concept is
founded on the law of one price, the idea that in absence of transaction costs and official barriers
to trade, identical goods will have the same price in different markets when the prices are
expressed in terms of one currency. In its "absolute" version, the purchasing power of different
currencies is equalized for a given basket of goods. In the "relative" version, the difference in the
rate of change in prices at home and abroad—the difference in the inflation rates—is equal to the
percentage depreciation or appreciation of the exchange rate.
International Fisher Effect
IFE IS an economic theory that states that an expected change in the current exchange rate
between any two currencies is approximately equivalent to the difference between the two
countries' nominal interest rates for that time. Both the Interest Rate Parity theory and the
Purchasing Power Parity theory allows us to estimate the future expected exchange rate. The
Interest Rate Parity theory relates exchange rate with risk free interest rates while the Purchasing
Power Parity theory relates exchange rate with inflation rates. Putting them together basically tell
us that risk free interest rates are related to inflation rates. This brings us to the International
Fisher Effect. The International Fisher Effect states that the real interest rates are equal across
countries. Real interest rates are approximately the risk free rate minus the inflation rate.

8

Chapter – III

Economic Overview of Kuwait
&
BoP Analysis of Kuwait

9

Economic Overview
Of

‘Kuwait’

3.1 General Outlook:
Independent from British control since 1961, Kuwait has experienced steady economic growth
thanks to its vast oil reserves. An invasion by Iraq in 1990 threatened the country’s stability and
economic well-being, but since then Kuwait has recovered and reached unprecedented economic
growth. Today, no traces of the economic devastation following Iraqi attempts to destroy Kuwait
10

oil fields remain, as the country enjoys a steady flow of oil money that is likely to continue for
several decades. However, this presents a long-term problem of diversification-the country
cannot depend its on oil revenues forever and must begin investing in new potential sources of
income. In recent years, the 2008 financial crisis affected the Kuwaiti financial sector.
Fortunately, the government was able to use its considerable resources to stabilize the economy.


Oil Resources: Kuwait has a vast amount of oil reserves that will help it continue to prosper
economically for years to come. It has reserved of around 100 billion barrels -around 9% of
world reserves. Its current production capacity is estimated to be around 2.8 million bpd,
which the government plans to increase to 3.5 million bpd 2015 and 4 million bpd by 2020.
Kuwait has shown a remarkable capability to recover from shocks to the industry, as it has
increased its production form nearly nothing after the Iraq invasion to the current production
levels within a very short time span.



High Level of Economic Freedom: Kuwait has the 42nd freest economy in the world,
according to researchers at the Heritage Foundation. It has very low tariffs, although there are
restrictive regulations and bureaucracies that inhibit trade somewhat. It also doesn’t levy a
tax on individual income and corporate taxes have been lowered in 2008, increasing its
competitiveness. Opening a business is relatively easy, although once again bureaucracies
and regulations create barriers.



Generous Foreign Assistance: The Kuwait Fund for Arab Economic Development was
established in 1961 to provide financial and technical assistance to foreign Arab countries
and the rest of the developing world. It has distributed over 73.338 million USD in loans and
grants. This ensures a positive relationship with foreign states for years to come

3.2 Economic Structure:


Kuwait’s economy is extremely dependent on oil. Petroleum accounts for around half of
GDP, 95% of export revenues, and 80% of government revenues. Kuwait’s economy has
been progressing at a rapid pace recently due mostly to rising oil prices.

11



Kuwait has very limited agricultural possibilities and has to import most food products from
other countries to meet its demand. There is some fishing, but this is tiny in comparison to
the amount of other food products Kuwait needs from foreign countries in order to sustain
itself. About 75% of potable water must be distilled or imported.



Kuwait’s labor force consists mostly of foreigners, around 60%.

3.3 Economic Indicators: (data are in 2011 US dollars)


GPD (official exchange rate): $176.7 billion



GDP Real Growth Rate: 8.2%



GDP per Capita: $155.5 billion



GDP Composition by Sector:
o Agriculture: 0.3%
o Industry: 47.4%
o Services: 52.3%



Inflation Rate: 4.7%



Investment (gross fixed): 26.1% of GDP



Industrial Production Growth Rate: 8.7%



Exports: $104.3 billion



Export Commodities: Oil and refined products, fertilizers.



Imports: $21.96 billion



Import Commodities: Food, construction materials, vehicles and parts, clothing



Public debt: 6.5% of GDP



External debt: $41.73 billion

12

BoP Analysis -

‘Kuwait’

3.4 BoP of Kuwait – At a glance:
13

Kuwait’s economy is extremely dependent on oil. Petroleum accounts for around half of GDP,
95% of export revenues, and 80% of government revenues. On the back of increasing oil exports
over the past few years, the current account of Kuwait has been significantly growth at a rate of
45% from 2004 to 2011. The country has a consistent positive balance in current & capital
account while has a negative balance of financial account due outflow of FDI is larger than
inflow of FDI. In the below a summarized overview of BoP of the Kuwait have been shown.
COUNTRY :

Kuwait

BALANCE OF PAYMENTS
(MILLION OF U.S .DOLLAR)
Items

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

A. Current Account (a+b+c+d)

4265

9424

18162

34308

51571

47471

58785

25874

37515

51757

(a) Goods (net) /Trade Balance

7250

11914

18426

32733

44307

43056

62454

34521

48812

60213

-4190

-3471

-3843

-3881

-2283

-3446

-3724

-2550

-6011

-5509

© Investment Income (net)

3347

3361

6129

8857

13168

12937

10483

7053

8016

8114

(d) Current Transfers (net)

-2142

-2379

-2550

-3401

-3620

-5076

-10432

-13052

-13249

-11061

1672

1431

433

797

882

1573

1688

1071

2197

2570

-5038

-12106

-16837

-31086

-47962

-37285

-49373

-26509

-35393

-46229

80

4893

-2502

-4908

-8056

-13563

-8051

-7552

-2026

6079

(b) Portfolio Investment (net)

-3227

-13374

-13935

-10475

-25714

-32900

-27430

-8225

-7881

6813

© Other Investment (net)

-1892

-3625

-399

-15703

-14192

9178

-13891

-10733

-25485

33535

D. Net Errors and Omissions

-1869

-574

-1130

-3398

-907

-8541

-10476

3362

-3754

-4836

Overall Balance (A+B+C+D)

-970

-1824

629

621

3584

3218

624

3798

565

3262

970

1824

-629

-621

-3584

-3218

-624

-3798

-565

-3262

(b) Services

B. Capital Account
C. Financial Account (a+b+c)
(a) Direct Investment (net)

Reserve Assets

Table 1: Summary of BoP of Kuwait
The 2011 current account of Kuwait recorded a huge surplus, as it climbed to similar level of
pre-crisis years. The trade surplus expanded as moderate growth in imports was more than offset
by a strong jump in exports, driven by rising oil prices. The surplus was equivalent to 42% of
GDP, which was 29% in 2010, after 24% in 2009. This record goods trade surplus more than
offset record deficits on services and remittance outflows. The capital and financial account
continues to see a net outflow as Kuwait increases its stock of foreign assets

14

3.4.a: Exports:
Kuwait is an oil-export based country. Its balance of trade is positive. That means, it export is
continuously higher than import. On average 95% of its export is coming from oil. In 2011 the
amount of export was $104.3 billion comparing to $65.03billion in 2010. In 2011, export growth
rate is increased by 54% than 2010. In the world ranking, Kuwait is the 38th country in term of
export, Machinery and Equipment

Figure-1: Export trend of Kuwait
Export Commodities:
The main export commodities are oil and refined products, fertilizers. Other non-oil export items
are as follows: Food & Live Animals, Beverages & Tobacco, and Inedible Crude Materials
except Fuels, Minerals, Fuels, Lubricants & Related Materials, Animal and Vegetable Oil &
Fats, Chemicals, Manufactured Goods Classed by Materials, Machinery and Equipment,
Miscellaneous Manufactured Articles, Commodities & Transaction.

15

The exports can be breakdown into two broad categories such as oil exports & non-oil exports.
On average about 93% of total exports is oil based from 2005 to 2011. In 2011 oil-export was
93.5% compared to 92.1% in 2010.

Breakdown Of Exports (%)
Oil Exports

5.1%

5.4%

5.6%

Non-Oil Exports

5.5%
9.4%

94.6%

94.9%

94.4%

94.5%
90.6%

2005

2006

2007

7.9%

2008

2009

92.1%

2010

6.5%

93.5%

2011

Figure-2: Breakdown of Exports (%)
Export partners:
Main export partners are Japan (19.9%), South Korea (17%), Taiwan (11.2%), Singapore (9.9%),
United States (8.4%), Netherlands (4.8%), and China (4.4%) Pakistan (2.4%) in 2007 & IN
2011, IT WAS South Korea 18.3%, Japan 14.2%, India 13.4%, China 9.9%, US 8.7%.

16

3.4.b: Imports:
The import of the country was $21.96 billion in 2011 comparing to $ 20.36 billion in 2010 with a
growth rate of 9% increased. Import of the year 2010 saw an increase of 9.9% after shrinking
19.3% in 2009. This turnaround reflects the weakness in the economy in 2009 and the
subsequent recovery last year. Imports had previously grown pre-crisis (2001-2007) 14% per
year on average. Imports were 3.6 times the size of non-oil exports. In the world ranking, Kuwait
is 71th country in term of imports volume.

Figure-3: Import trend of Kuwait
The imports of Kuwait can be broadly categorized under three major titles - capital goods,
intermediate goods and consumer goods. The consumer goods, composed of foods and
beverages, private cars and transportation equipments, durable, semi durable and non-durable
goods denotes the 40% of the total imports. Intermediate goods, which are composed of
industrial requirements, fuel and lubricants and Spare Parts & Transportation equipment forms
another 35%-40% of the total imports. The rest are the capital goods, composed of machineries,
cars and transportation equipment and other goods.
17

Breakdown of Imports (% form)
Capital Goods

Intermediate Goods

Consumer Goods

Non-Specified Goods

0.5%

44.8%

0.3%

0.5%

0.8%

0.6%

39.5%

0.6%

41.4%

38.4%

39.8%

43.7%

40.2%

39.8%

36.3%

38.3%

34.5%

41.3%

20.1%

21.7%

16.9%

20.9%

19.7%

19.5%

2003

2004

2006

2007

2008

2009

Figure-4: Breakdown of Imports (%)
50.0%
45.0%
40.0%
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
2003

2004

2006

2007

2008

Capital Goods

Intermediate Goods

Consumer Goods

2009

Non-Specified Goods

Figure-5: Trends of Breakdown of Imports

18

Imports – Commodities:
The main imports commodities are food, construction materials, vehicles and parts, clot.
Imports - partners:
US 11.9%, India 10%, China 9.3%, Saudi Arabia 8%, South Korea 6.3%, Japan 5.9%, Germany
4.8%, UAE 4.1% (2011)

3.4.c: Balance of Trade:
The BoT of Kuwait is consistently positive due to export dominance. In 2011, trade surplus was
KD 21583.8 millions compared to KD 12797.1 millions in 2010. The growth rate was 69% in
2011.
Summary of BoT (Million Dinars)
Exports
Period

Oil Exports

Imports

Non-Oil Exports

Balance of Trade

Total

Surplus

Growth

2005

12392.6

709

13101.6

4613.9

8487.7

2006

15429.7

823.2

16252.9

5000.5

11252.4

33%

2007

16780

990.2

17770.1

6061.5

11708.7

4%

2008

22200.1

1281.4

23481.6

6678.7

16802.8

44%

2009

14073.4

1456

15529.4

5852.2

9677.1

-42%

2010

17711.3

1514.2

19225.5

6428.4

12797.1

32%

2011

26688.6

1867.3

28555.9

6972.1

21583.8

69%

All data is the property of Central Bank of Kuwait
Data as of : 28/11/2012

Table-2: Summary of BoT (Million Dinars)

19

Growth of BoT
Growth
69%
44%
33%

32%
4%

2005

2006

2007

2008

2009

2010

-42%

Figure-6: Growth of BoT of Kuwait

3.4.d: Current Account Balance:
Kuwait’s current account surplus experienced further growth in 2011 as the effects of the
financial crisis improved worldwide. The current account surplus was $70.85 billion in 2011
compared to $43.14 billion 2010 with a growth rate of 64%. It is also expected to have grown
faster than GDP, taking its share of GDP to 42%, up from 29% in 2010.

Figure-7: Current account balance of Kuwait
20

Among four components of current account balance, BoT & factor income are continuously
positive whereas services & current transfers are negative. Factor income is consisted of mainly
Compensation of Employees & Investment Income whereas services items are Transportation,
Insurance, Travel, and Other Services.
In the whole world, Kuwait is the 8th country in terms of current account balance.

Figure-8: Ranking of Current Account

21

3.4.e: Capital Account:
The capital account of Kuwait is positive. In 2011, the CA balance was $ 2570 compared to $
2197 million in 2010 with a growth rate of 17%.

Year

Capital Account ($ mln)

Growth

2002

1672

2003

1431

-14%

2004

433

-70%

2005

797

84%

2006

882

11%

2007

1573

78%

2008

1688

7%

2009

1071

-37%

2010

2197

105%

2011

2570

17%

Table-3: Capital Account balance ($ mln)
From the trends graph, it is observed that flows of CA balance is so much volatile than others
accounts.

22

Trends of Capital Account
Capital Account ($ mln)

105%

84%

78%
11%

-14%
2002
2003

2004

2005

17%

7%
2006

2007

2008-37% 2009

2010

-70%

Figure-9: Trends of Capital Account

3.4.f: Financial Account:
Financial account of Kuwait is negative due to huge FDI outside of the country. In 2011 total
financial account Dr Balance was $ 46229 million compared to $35393 in 2010.
Year

Financial Account

Direct Investment

Portfolio Investment

2002

-5038

80

-3227

2003

-12106

4893

-13374

2004

-16837

-2502

-13935

2005

-31086

-4908

-10475

2006

-47962

-8056

-25714

2007

-37285

-13563

-32900

2008

-49373

-8051

-27430

2009

-26509

-7552

-8225

2010

-35393

-2026

-7881

2011

-46229

-6079

-6813

Table-4: Classification of Financial Account ($ mln)

23

Breakdown of Financial Account ($ mln)
10000
0
-10000

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

-20000
-30000
-40000
-50000
-60000
Financial Account

Direct Investmen

Portfolio Investment

Figure-10: Breakdown of Financial Account ($ mln)
In the world ranking, Kuwait is positioned as 35th country in terms FDI. FDI of the country is
continuously increasing. In 2011 the amount of FDI at abroad was $48.39 billion compared to
$44.31 billion in 2010.

Figure-11: FDI at abroad
24

In 2011 the amount of Stock of direct foreign investment at home were $2.764 billion

$2.366 billion. The world ranking is 93.

Figure-12: FDI at home

3.5: BOP Components with GDP
There are significant relationships between GDP & several components of BoP. In 2011 the
GPD real growth rate of Kuwait was 8.2%. The current account was 49%, financial account
balance was 46% & capital account balance was 3% in 2010. Financial account to GDP is
always higher than other two accounts.

BOP Components with GDP
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Current Acoount

21%

11%

20%

29%

51%

69%

58%

77%

38%

49%

Capital Account

8%

4%

3%

1%

1%

1%

2%

2%

2%

3%

Financial Account

14%

13%

25%

31%

55%

76%

49%

79%

39%

46%

Figure-13: BOP Components with GDP
25

90%
80%
70%
60%
50%

Current Acoount

40%

Capital Account

30%

Financial Account

20%
10%
0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Figure-14: Trends of BOP components with GDP

3.6: Trend Analysis of Kuwait Exports
Regression Statistics
Multiple R
R Square

0.8897
0.7916

Adjusted R Square

0.7656

Standard Error

11684

Observations

10

ANOVA
df

SS

MS

Regression

1

4149630322

4E+09

Residual

8

1092152473

9

5241782795

Coefficients

Standard Error

t Stat

30.396

Significance F

1E+08

Total

F

0.00056485

P-value

Intercept

7045.38

7981.785154

0.882682

0.403151

Time

7092.15

1286.381154

5.513255

0.0005648

26

The trend equation Y=7045.38 + 7092.147*t
Where,
Y= Value of export in US $
t= Time period
α = 7045.38 (intercept)
ß = 7092.147 (Slope)
The equation indicates that in every year export will increase US $ 7092.147 Million.
The formula we will use for calculation of export growth is as follows:

GrowthRate

n 1

Yn
Y1

1 x100

Where,
Yn = export of last year (Here, data for the year of 2010)
Y1= export of base year (in our calculation 2001)
To calculate the rate of acceleration, the formula will take the following form:

AccelerationRate

n

2

Yn
Yn 1
Y2
Y1

1 x100

Where,
Yn-1= export of previous year of last year (in calculation it is 2009)
Y2= export of following year of base year (here, 2002)

27

Application of the formula yields the following result

Rate

Export

Growth Rate

17.32%

Acceleration Rate

3.66%

Growth rate of export 17.32% indicates that export of Kuwait has increased every year on an
average rate of 17.32% from year 2001 to 2010. Acceleration rate of export indicates that growth
rate of export increased on an average 3.66% per year from year 2001 to 2010.

3.7: Trend Analysis of Kuwait Imports
Regression Statistics:
Multiple R

0.9545412

R Square

0.9111489

Adjusted R Square

0.90004252

Standard Error

1988.03452

Observations

10

ANOVA
df

SS

MS

F
82.038281

Regression

1

324238358.7

324238359

Residual

8

31618249.94

9

355856608.7

Coefficients

Standard Error

Intercept

4437.27

1358.086121

3.2673

0.0114

Time

1982.46

218.8753968

9.0575

1.7683E-05

3952281.2

Total

Significance F

0.0000

t Stat

P-value

28

The trend equation Y= 4437.27 + 1982.4636*t
Where,
Y= Value of import in US $
t= Time period
α = 4437.27 (intercept)
ß = 1982.4636 (Slope)
The equation indicates that in every year import will increase US $ 1982.4636 Million.
The formula we will use for calculation of import growth is as follows:

GrowthRate

n 1

Yn
Y1

1 x100

Where,
Yn = import of last year (Here, data for the year of 2010)
Y1=import of base year (in our calculation 2001)
To calculate the rate of acceleration, the formula will take the following form:

AccelerationRate

n

2

Yn
Yn 1
Y2
Y1

1 x100

Where,
Yn-1= import of previous year of last year (in calculation it is 2009)
Y2= import of following year of base year (here, 2002)

29

Application of the formula yields the following result
Rate

Import

Growth Rate

13.96%

Acceleration Rate

-0.35%

Growth rate of import 13.96% indicates that import of Kuwait has increased every year on an
average rate of 13.96% from year 2001 to 2010. Acceleration rate of import indicates that growth
rate of export decreased on an average -0. 35% per year from year 2001 to 2010.

30

Chapter – IV
BoP
‘Kuwait Vs Bangladesh’

4.1: BoP of Bangladesh - General Outlook:
31

Bangladesh has been enjoying a current account surplus since 2005-06. According to the
Statistics Department of Bangladesh Bank, the current account balance was $995 million where
the overall balance for the fiscal year 2010-11 was in the negative territory, (-)$635 million.
However, the encouraging export growth performance has not been able to arrest the
deteriorating trade balance; deficit in trade balance increased to USD (-) 7328 million in 2011
which was USD (-) 5152 million in 2009-2010. A slow growth in the remittance flow and
swelling import payment has largely attributed to the contracting current account surplus. With
that the rising global commodity prices (e.g. food, fuel and cotton prices) and lack of FDI and
low level of foreign aid inflow could only create additional burden for the balance of payment
situation.

COUNTRY :

Bangladesh

BALANCE OF PAYMENTS
(MILLION OF U.S .DOLLAR)
Transactions

01--02

02-03

03-04

04-05

05-06

06-07

07-08

08-09

09-10

10-11

(a) Trade Balance (Deficit)

-1768

-2215

-2319

-3297

-2879

-3458

-5330

-4708

-5152

-7328

(b) Services (net)

-499

-691

-874

-870

-1110

-1255

-1525

-1621

-1237

-2398

(c) Income

-402

-358

-374

-641

-786

-905

-994

-1484

-1487

-1354

(d) Current transfers

2826

3440

3743

4290

5347

6554

8529

10226

11596

12075

Current account balance

157

176

176

-557

572

936

680

2416

3724

995

Capital account (net)

410

428

196

163

242

490

576

451

512

600

Capital transfers

410

428

196

163

242

490

576

451

512

600

Financial account (a+b+c)

391

413

-31

744

-24

762

-457

-825

-746

-1584

(a) Direct Investment (net)

391

376

276

800

675

793

748

961

818

768

(b) Portfolio Investment (net)

-6

2

6

0

32

106

47

-159

-117

-28

© Other Investment (net)

6

35

-313

204

-409

-1065

285

315

561

- 35

Errors and omissions

-550

-202

-279

-323

-425

-695

-468

16

-625

-646

Overall balance

408

815

171

67

365

1493

331

2058

2865

-635

Reserve Assets (BB)

-408

-815

-171

-67

-365

-1493

-331

-2058

-2865

635

Table-5: BoP of Bangladesh

4.2: Current account scenario of Kuwait $ BD:
32

Bangladesh experienced a huge downward shift in its current account balance. Its current
account balance fell by 73% to $995 million in 2011 against $3724 million in 2009-2010. This
result can be attributing to a slow growth in the remittance flow and swelling import. With that
the rising global commodity prices (e.g. food, fuel and cotton prices) and lack of FDI and low
level of foreign aid inflow resulted further deterioration of current account surplus.

Bangladesh

Kuwait
3724

4000

70000

3500
3000

40000

2000
1500

936

1000

572
157 176 176

0

680

25873.9

30000
20000

37514.8

34308
18162

9424
10000 4264.6
0

-500
-1000

995

51757.15

51571
47471

50000

2416

2500

500

58784.6

60000

-557

Figures-15: Current account scenario of Kuwait & BD ($ mln)
Kuwait’s current account surplus experienced further growth in 2011 as the effects of the
financial crisis improved worldwide. The current account surplus was USD 51757 million in
2011, an increase of USD 14.2 billion from 2010, putting it near its 2008 levels. It is also
expected to have grown faster than GDP, taking its share of GDP to 42%, up from 29% in 2010.

33

I.

Exports:

Bangladesh has been experiencing significant export growth since 2002-2003. In 2005-06 the
growth was the highest 21.5%. The next two fiscal years too experienced growth in export by
15.6% and 17.4% respectively. But in 2008-09, the growth was reduced to 10% and in 20092010 it reduced further to $16.23 billion showing a growth of 4.2% on $15.58 billion of previous
year.
According to the Economic Review-2011, the contribution of readymade garments (RMG) to
total export revenue was 77.77%. The economy of Bangladesh is branded worldwide because of
its quality RMG products. But our export is concentrated on a single item. It is not diversified. If
the export of RMG falls by a significant per cent, then our BoP will come under a severe
negative impact. Other exports include Shrimps, jute goods (including Carpet), leather goods and
tea. Bangladesh main exports partners are United States (23% of total), Germany, United
Kingdom, France, Japan and India.

Bangladesh
18000
16000
14000
12000
10000
8000
6000
4000
2000
0

Kuwait
90000.00
80000.00
70000.00
60000.00
50000.00
40000.00
30000.00
20000.00
10000.00
0.00

Export

Export

Figures-16: Exports scenario of Kuwait & BD ($ mln)
Kuwait too has been experiencing significant growth since 2003. The strong global demand and
rising oil price in global market contributed to a 41.5% in 2003, 37.6% in 2004, 55.8% in2005
and 24.6% in 2006. The growth somewhat minimized in 2007 as it came down to 8.5%. But he
34

next year another jump by 34% in export recorded the highest amount of export to date by
$85.23 billion. In 2009 the aftereffect of global financial crisis had a significant impact on
Kuwait’s export as it decreased by 36.5% to $54.166 billion. But in 2010, the growth was
positive again and by increasing 26%, export reached to $68.34 billion.
Now, if we look at the export compositions of Kuwait, we will see that oil dominates the total
export and non-oil exports are less than 10% of the total. As a result, Kuwait’s export is far more
exposed to global economic behaviors than Bangladesh. This becomes more evident in 2009 as
due to global economic crisis Kuwait’s export reduced by 36.5% which is just the same amount
the export of Oil fell.

Kuwait
30000

26689

25000

22200

20000
15000

17711

16780

15430

14073

12393

10000
5000

709

823

990

1281

1456

1514

1867

0
2005

2006

2007
Oil Exports

2008

2009

2010

2011

Non-Oil Exports

Figures-17: Exports scenario of Kuwait & BD ($ mln)
However, revenue from oil exports – the major contributor to the current account surplus –
increased by a third in 2011, reaching $26.68 billion thanks to a 50% rise in oil prices and to
strong global demand. As for non-oil exports, they exhibited a smaller increase and therefore
made up a smaller share of all goods exported in 2010. Non-oil exports made up 7.9% of all
exported goods in 2010, down 1.9 percentage points from 2009. This highlights the fact that
further work needs to be done in order to diversify exports away from oil.

35

II.

Imports:

The main feature and weakness of BoP of Bangladesh are that it is import-dominated. The
growth of import is significantly higher than that of export. The growth in import was 13.0% in
both 2002-03 and 2003-04; 20.6% in 2004-05, 12.1% in 2005-06, 16.6% in 2006-07 and in
2007-08 the growth was 25.6%. In 2008-09 and 2009-10 the import growth substantially reduced
to 4.2% and 5.4% respectively. As our growth of export is lower than that of import most of the
time, our trade balance is negative [in 2010-11 it is minus $7328 million]. Bangladesh imports
mostly petroleum product and oil, machinery and parts, soya bean and palm oil, raw cotton, iron
and steel and wheat. Bangladesh main imports partners are China (17% of total), India,
Indonesia, Singapore and Japan.
Now, to reduce pressure from imports on its BoP, Bangladesh can do two things. One, to reduce
imports and two, increase exports. However, given the compositions of imports (foods, fuel, etc)
it is not possible to reduce sudden decrease in imports or attaining self-sufficiency. So, only
thing it can do is by promoting exports. Again, the exporting goods are either of low price
elasticity of demand or supply. So, one way it can follow is diversifying its export products.

Bangladesh

Kuwait

25000

30000.00

20000

25000.00

15000

20000.00

10000

15000.00
10000.00

5000

5000.00

0

0.00

Import

Import

Figures-18: Imports scenario of Kuwait & BD ($ mln)

36

Turning to Kuwait, import of the year 2010 saw an increase of 9.9% after shrinking 19.3% in
2009. This turnaround reflects the weakness in the economy in 2009 and the subsequent recovery
last year. Imports had previously grown pre-crisis (2001-2007) 14% per year on average. Imports
were 3.6 times the size of non-oil exports.

Kuwait
3000
million Dinar

2500
2000
1500
1000
500
0

2003

2004

2006

2007

2008

2009

Capital Goods

657.4

805.9

843.6

1266.4

1313.9

1142

Intermediate Goods

1130.4

1425.8

2067.1

2435

2656.7

2121.9

Consumer Goods

1467.6

1471.6

2072.4

2326.9

2655.4

2555.2

The imports of Kuwait can be broadly categorized under three major titles - capital goods,
intermediate goods and consumer goods. The consumer goods, composed of foods and
beverages, private cars and transportation equipments, durable, semi durable and non-durable
goods denotes the 40% of the total imports. Intermediate goods, which are composed of
industrial requirements, fuel and lubricants and Spare Parts & Transportation equipment forms
another 35%-40% of the total imports. The rest are the capital goods, composed of machineries,
cars and transportation equipment and other goods.

37

III.

Trade Balance:

Bangladesh has been experiencing significant growth in its exports. But, in most of the time, the
import growth outperformed that of export. Besides, the amount of import is at an average 30%
higher than the amount of export.

Bangladesh
Export Growth

Import Growth

25.6%
20.6%
13.1%
9.5%

15.9%
13.0%

14.0%

21.6%
16.6%
15.6%

17.4%

12.1%

10.1%
4.2%

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

5.4%
4.2%

2009-10

Figure-19: Exports & Imports of BD

As a result, despite a bullish trend in the export sector, the country's trade deficit has increased
by an enormous proportion due to a massive import cost and a slow pace in remittance inflow.
And the encouraging export growth performance has not been able to arrest the deteriorating
trade balance. According to Bangladesh Bank, the deficit in trade balance increased by 42.2% to
USD (-)7328 million in 2011 which was USD (-) 5152 million in 2009-2010. Before that, in
2008-09 the deficit reduced by 11.9% to $4708 million. But a slow growth in the remittance flow
and swelling import payment has largely attributed to further increase of negative trade balance.
With that the rising global commodity prices (e.g. food, fuel and cotton prices) and lack of FDI
and low level of foreign aid inflow could only create additional burden for the balance.

38

Bangladesh
0

Kuwait
70000
60000
50000
40000
30000
20000
10000
0

-1000
-2000
-3000
-4000
-5000
-6000
-7000
-8000
Trade Balance

Trade Balance

Figures-20: BoT scenario of Kuwait & BD ($ mln)
Kuwait on the other hand, continued to be a net exporter of goods with exports 3.5 times the size
of imports. This was mainly driven by a 50% rise in oil exports, which make up more than 90%
of total exports. Almost all of the increase in the current account surplus came from the
surge in the balance on goods, the largest component of the current account. However,
Kuwait’s exposure to global economic situations is evident from the figure. Kuwait has been
experiencing positive trade balance from a high global oil demand and rise in oil prices. But in
2009, the trade balance of Kuwait fell by 55% to a four year minimum of $34.5 billion due to the
global financial crisis. As the world started recovering, Kuwait’s trade balance showed
significant growth of 41.4% in 2010 and 23.3% in 201

IV.

Services:

Bangladesh’s deficit in service income rose to $2298 million in 2010-11 which was 94% higher
than the previous year 2009-10. However, 2009-10 period had a negative growth in this balance.
In that year, the deficit reduced by 23.6%. Before that there was positive growth since 2005-06.
But there was no predictable pattern in this growth. In 06-07, the growth was 27.5%, then
13.06% in 07-08, 21% in 08-09 and 6.3% in 2009-10.

39

Bangladesh

Kuwait

0

0
-1000

-500
-499

-2000

-691

-1000

-874-870
-1110
-1237
-1255
-1525
-1621

-1500
-2000

-4000
-5000

-2500

-2398

-3000

-2283

-3000

-3471
-38433881
-4190

-2550

-3446
-3724

-6000

-5509
-6011

-7000

Figures-21: Services scenario of Kuwait & BD ($ mln)
In Kuwait on the other hand, the services balance stood at a deficit of $5.5 billion. A feature of
this portion of is that, most of this deficit can be attributed to travel services. Its effect can be
seen in 2009. As travel and leisure being one of the most affected sectors in the event of
economic downturn, there was no exception in this case too. In 2009 Kuwait’s deficit at service
balance reduced by 31.5% to $2.5 billion. And with the improvement of the economic situation,
the effect is the most visible here. In 2010, the deficit rose to $6.01 billion signifying a growth of
135.7% from previous year.

V.

Current Transfer:

The strongest component of Bangladesh’s BoP for the fiscal year 2010-11 was the remittance
inflow. This inflow of remittance is keeping its current account balance positive. In the figure
representing the current transfer surplus of Bangladesh, we see that there has been positive
growth during all these years. This growth was highest in 2007-08 in which the balance rose to
$8529 million by increasing 30.1% from the previous year. It increased further 19% in the
following year. But in 2009-10 and 2010-11 the growth was reduced to 13.4% and 4.1%
respectively signifying the aftereffects of economic downturn and on-going political disorder in
Middle East.

40

Bangladesh
14000
12000
10000
8000
6000
4000
2000
0

Kuwait
0
-2000
-4000
-6000
-8000
-10000
-12000
-14000

Current transfer

Current Transfer

Figures-22: Current Transfer scenario of Kuwait & BD ($ mln)
Kuwait has historically been experiencing deficit in current transfer balance. In Kuwait’s
Balance of Payment, this deficit mostly represents the workers’ remittance. The deficit decreased
by 16.5% in 2011 to $11.06 billion from $13.25 billion in 2010. Other than that, the deficit
always had positive growth rate. The largest of which occurred in 2008 in which the deficit rose
to $10.4 billion by increasing 105% over 2007.
VI.

Income:

Bangladesh’s balance of income has been negative during all these years. In 2010-11,
Bangladesh had a deficit in this balance of $1354 million, a fall of 8.9% over the previous year.
However, this deficit was increasing at a high rate since 2003-04. And it was 2004-05 in which it
experienced the highest ever, 71.4% growth in deficit to become $641 million from $374 million
in 2003-04. Since then the deficit was growing at 22.6%, 15.1% and 9.8% respectively for the
following three fiscal years. But in 2008-09 the balance jumped to $1484 million by increasing
49.3% from the previous year.

41

Bangladesh

Kuwait

0
-200

13168
12937

14000
12000

-400
-600
-800
-1000
-1200
-1400
-1600

10483

10000
-402 -358 -374

8000

8857
6129

80168114
7053

6000

-641

4000 33473361

-786
-905

-994

2000
0

-1354
-14841487
-

Figures-23: Income scenario of Kuwait & BD ($ mln)
Kuwait’s investment income, net earnings from international financial assets slightly increased in
2011 by 1.2% to $8114 million. But in 2010 the growth was 13.6 % from 2009. Before that, the
balance took it of the global financial crisis in 2008 and 2009 when the balance fell by 19% and
32.7% respectively. However, earnings have not yet returned to the pre-crisis high of $13.16
billion of 2006, but the trend should continue to head upwards if the global economy and
financial markets continue to improve.
It is notable that the government was the largest recipient of investment income. In 2011, 91.8%
of the income was received by the govt. In 2006, the government, combined with local banks,
received 69.3% of total investment income. Their combined share reached a massive 98.0% in
2010. In fact, the government has taken an increasing share of the investment income flowing
into Kuwait. This has been at the expense of investment companies and other private sector
entities, except for local banks, which have also seen their share increase over the past few years.
Investment companies reduced their assets in the wake of the 2008 crisis.

42

4.3: Capital account scenario of Kuwait & BD:
Capital account includes the value of financial assets transferred across country borders by
people who move to different country. It also includes non-produced nonfinancial assets that are
transferred across country borders such as patents and trademarks. Net capital account includes
government debt forgiveness, investment grants in cash or in kind by a government entity, and
taxes on capital transfers. Also included are migrants' capital transfers and debt forgiveness and
investment grants by nongovernmental entities. Data are in current U.S. dollars. Microcredit has
been a major driver of economic development in Bangladesh and although most of Bangladeshis
are employed in the agriculture sector, a large part of exports revenues come from garment
industry. The biggest obstacles to sustainable development in Bangladesh are overpopulation,
poor infrastructure, corruption, political instability and a slow implementation of economic
reforms.
From the Bangladesh and Kuwait’s capital account graph we can see that both countries have
positive capital account balance. The capital account in Bangladesh was last reported at 600
million dollar during 2010-11. The Net capital account (BoP; US dollar) in Bangladesh was
reported at 512 million dollar in 2009-10. Between fiscal year 2003-2006 capital account balance
was very low. In this year its balance ranges between 200 to 250 million dollars. And in year
2006-07 it increases to 490 million. That is almost 100% of previous year. In 2008-09 this
balance reduced by 22% and become 451 million. Bangladesh capital account ranges between
500-600 million dollars for the last five fiscal year. And it is increasing for last three year.

43

Kuwait

Bangladesh
3500

600

3000

500

2500

400

2000

$m

US dollar in millions

700

300

1500

200
100

1000

0

500
0

Figure-24: Scenario of Capital account of Kuwait & BD
The capital account continues to see a net inflow in Kuwait. In 2011 Kuwait’s capital account
was 2570.5 million dollar and in 2010 it was 2197 million dollar. In last year it increases almost
17%. In 2009 there balance faces a drastic fall because of Asian crisis. In this year balance
reduced by 37% from previous year. But in year 2010 their balance increased by 105% and they
regain their capital inflow. On the capital account front, it reported its second largest surplus
since 2002 reporting 1573 million dollars of surplus as compared with 882 million dollars of
surplus reported for 2006. This was mainly due to contributions from general government sector.
The unusual surplus in 2007 was partly a reflection of large capital inflows as speculators bet on
a revaluation of the Kuwaiti dinar.

44

4.4: Financial account scenario of Kuwait & BD:
Financial account comprises of foreign direct investment, portfolio investment & other capital investment.

a. Foreign Direct Investment in Bangladesh & Kuwait
Direct foreign investment represents the investment in fixed assets in foreign countries that can
be used to conduct business operations. Examples of FDI include firm’s acquisitions of a foreign
company, its constructions of a new manufacturing plant or its expansion of an existing plant in a
foreign country. It is the sum of equity capital, reinvestment of earnings, other long-term capital,
and short-term capital as shown in the balance of payments. This series shows total net, that is,
net FDI in the reporting economy from foreign sources less net FDI by the reporting economy to
the rest of the world. Data are in current U.S. dollars.
From the graph we can see that in Bangladesh for every year FDI is positive. The Foreign direct
investment in Bangladesh was 768 million dollar during 2010-11. The Foreign direct investment;
net (BoP; US dollar) in Bangladesh was 818 million dollar in 2009-10. A decrease of 6% than
previous year. Foreign direct investment is net inflows of investment to acquire a lasting
management interest (10 percent or more of voting stock) in an enterprise operating in an
economy other than that of the investor. Foreign direct investment (FDI) is an important aspect
of things relating to our BoP. The amount of FDI inflow to Bangladesh has not been at the
desired level. After the fiscal year 2004-05, the growth of FDI flow to Bangladesh on an average
decreased except the FY 2008-09. In 2008-09 highest amount of FDI come in Bangladesh. It was
86% of total financial account. Again after that fiscal year, it has decreased sequentially. From
FY 2004-05 we can see an increase and decrease in inflow each year. Increase inflow followed
by decreased inflow. In FY 2004-05 the contribution of FDI to the country's gross domestic
product (GDP) was 1.33% and in FY 2010-11 it was only 0.70%. Lack of branding of our
investment potential along with a poor R&D wing for FDI and we have poor infrastructural
facilities, insufficient gas and power supply and an unstable political setting, besides the redtapism of bureaucracy these are the reasons for our slow growth of FDI. In fiscal year 2010-11,
the economic growth rate of developing countries was 6.0% but our economy has grown at the
rate of 6.7%. At the same time the world economy has grown at the rate of 5.0% for the year
2010-11, where our economy has grown at 6.7%. Our growth rate is certainly positive, enough
45

for attracting FDIs. Bangladesh has no default history from its inception. This is a very good
indicator for our FDI.

Bangladesh
1200

Kuwait
10000

1000
800

5000

600
400
200
0

-5000

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011

0
FDI

-10000
FDI

-15000

Figure-25: Scenario of FDI account of Kuwait & BD
Kuwait had positive FDI balance in year 2011. After 2003 they face every year negative balance.
Which means Kuwait is investing more abroad than it is receiving from outside between year
2004-10. In 2011 their balance increased by 400%. This had a huge contribution to their balance
of payment. In 2010 it was decreased more because government reduced direct investment
overseas. In 2007 there was a huge deficit of 13563 million dollar. After this year deficit was
reduced. And in year 2010 it reduced by 73% than previous year.
The Foreign direct investment; net (BoP; US dollar) in Kuwait was 6079.1 million dollar in
2011. And in 2010 it was deficit balance of 2026 million dollar. The balance on foreign direct
investment (FDI) has been the least volatile, generating deficit in each of the past seven years.
FDI reflects major, long-term equity stakes taken by Kuwaiti investors in ventures abroad. While
it is encouraging that Kuwaiti institutions have had the means to invest heavily overseas, the
deficit also reflects Kuwait's weak record in attracting large scale investment from abroad.
Direct investment remains a net outflow, representing a net increase in Kuwait’s foreign direct
investment (FDI) abroad. In absolute terms, both inflows and outflows shrank in size in 2010.
46

The primary reason for the decrease in FDI outflows was the government’s reduction of direct
investment overseas. Kuwait does not lack capital and typically only relies on foreign direct
investment for administrative and technical expertise.
b. Portfolio Investment of Bangladesh & Kuwait
Portfolio investment represents transactions involving long term financial assets between
countries that do not affect the transfer of control. Purchase of foreign stock by local investors is
classified as portfolio investment because it represents purchase of foreign assets by local person.
Portfolio investment excluding liabilities constituting foreign authorities' reserves covers
transactions in equity securities and debt securities. Data are in current U.S. dollars.
The Portfolio investment; excluding LCFAR (BoP; US dollar) in Bangladesh was last reported at
deficit balance of 28 million dollar in 2010-11. The Portfolio investment; excluding LCFAR
(BoP; US dollar) in Bangladesh was -117 in 2009-10. Deficit balance reduced significantly by
76% than previous year. In case of portfolio investment we can see that Bangladesh has negative
balance for the year 2009-10 & 2008-09. But before this it was positive. Although in year 20012005 it was very small. In year 2008-09 balance reduced by more than 400% than previous year.
Because of global crisis this drastically falls.
The rough guess is that the contribution of portfolio investment in our capital market is on an
around only 3.0%. The infrastructural facilities at Dhaka Stock Exchange (DSE) and Chittagong
Stock Exchange (CSE) should be improved so that online trading for the foreigners can be
ensured. Political instability is one of the greatest obstacles to attracting more foreign portfolio
investment to the country. Credible financial reporting, quality research and good corporate
governance can serve as catalysts to improve the portfolio investment in the Bangladesh capital
market.

47

32
2

0

6

47

0

-6
-28

-117
-159

Figure-26: Scenario of Portfolio Investment of Kuwait & BD
The Portfolio investment (BoP; US dollar) in Kuwait was 6813.15 million dollar in 2011. The
Portfolio investment (BoP; US dollar) in Kuwait was -7881 million in 2010. In year 2011 there
was positive balance of portfolio investment although before this year there was negative balance
in every year. In 2007 there was large deficit balance of 32900 million dollar. From year 2009
deficit balance reduced every year. Financial account continued to report deficit for Kuwait.
Financial account deficit grew rapidly by 47.2% over the period 2002-07. The net outflow of
short-term foreign investments (portfolio investment) witnessed a slight downward movement in
2010. The driving force behind this shift was government since it is the biggest contributor to net
portfolio investment, with local banks and other private sector institutions only contributing
12.6% to portfolio investments abroad. This major change from 2009 onwards might indicate a
more cautious approach by the government in light of volatile global financial markets, as well
as some pressure to invest locally (via stock portfolios and the recent KIA Kuwaiti real estate
fund).

48

2011

2010

2009

2008

2007

2006

2005

2004

2003

Kuwait
2002

106

10000
5000
0
-5000
-10000
-15000
-20000
-25000
-30000
-35000

2001

Bangladesh

b. Other Capital Investment in Bangladesh & Kuwait
Other capital investment represents transactions involving short term financial assets such as
money market securities between countries. In general FDI measures expansion of firm’s foreign
operations whereas portfolio investment and other capital investment measure the net flow of
funds due to financial asset transactions between individual and institutional investors.
The other capital investment in Bangladesh was last reported at 561 million dollar during 200910. The other capital investment (BoP; US dollar) in Bangladesh was reported at 315 million
dollar in 2008-09. In year 2009-10 balance increased by 78% than previous year. In 2006-07
there was a huge deficit balance of 1065 million dollar from 409 million dollar from previous
year. An increase of 160% from previous year. Between year 2000-05 there was small amount of
capital investment in Bangladesh. The lowest amount occurs in 2001-02 of only 6 million dollar.
After this year Bangladesh regain its positive balance. From year 2004-05 to 2005-06 a surplus
of 204 million dollar becomes deficit of 409 million dollar. Although there is ups and downs in
other capital investment for the last three years there was surplus in our account.

Kuwait
40000
30000

Bangladesh
800
600
400

20000

200

10000

0
-200

0

-400

-10000

-600

-20000
-30000

-800
-1000
-1200

Figure-27: Scenario of other Investment of Kuwait & BD

49

In Kuwait other capital investments made up of trade credit, loans, currency and deposits. The
main factor for this change did not come from government, the central bank, local banks, or
investment companies but rather from a change in currency and deposits in other sectors (other
private sector entities). The other capital investment in Kuwait was last reported at 33435.75
million dollar during 2011. The other capital investment (BoP; US dollar) in Kuwait was
reported at -25845 million dollar in 2010. A huge surplus occurs in Kuwait in year 2011. An
increase of almost 230% than previous year. We can see that in Kuwait negative figure of other
investment almost there. Large change occurs in year 2011. And a huge fall occurs in 2010.
Almost 140% than previous year deficit increase. In 2007 there was a surplus of 9178 million
dollar. After that next three years had deficit balance and in last year there was huge surplus in
Kuwait’s capital investment. Lowest amount of deficit occur in 2004 of 399 million dollar.
Between year 2001-04 there was a very low amount of deficit in there capital investment
account.

4.5: Bangladesh export to Kuwait
Bangladesh export to Kuwait in Financial Year 2004-2005 were Vegetable Products (119.09);
Frozen Foods (82.26); Textile and Textile articles (35.6), Electrical and mechanical equipment
(35.61) etc.
Bangladesh Export to Kuwait
Taka in millions
Fiscal Year

2000-01

2001-02

2002-

2003-04

2004-05

2008-09

2010-11

2011-12

211.47

287.52

879.30

1125

1034

1074992

1450076 1803100

2003
Export to

121.95

196.07

200.36

Kuwait
Total Export
% of Total

346369.2 340502.5 375886.8 443287.74 532831
0.04%

0.06%

0.05%

0.05%

0.05%

0.08%

0.08%

0.06%

Export

Table-6: Bangladesh export to Kuwait
50

4.6: Bangladesh import from Kuwait
Bangladesh major import item from Kuwait in Financial year 2004-2005 were Mineral fuels,
mineral oils and products of their distillation, bituminous substances, mineral waxes (31563.67);
Plastic and article thereof (108.66) etc.
Bangladesh Import from Kuwait
Taka in millions
Fiscal Year

2000-01

2001-02

2002-03

2003-04

2004-05

2008-09

2010-11

2011-12

Import from

2178

2473.2

10725.3

20405.9

60893.2

71644

87441

102681.6

Kuwait
Total Import

454882.8 442038.7 504135.3 579969.6 769954

1580898

2400179 2809657

% of Total

0.48%

4.53%

3.64%

0.56%

2.13%

3.52%

7.91%

3.65%

Import

Table-7: Bangladesh Import from Kuwait

4.7: Bangladesh Remittance from Kuwait
A significant portion of Bangladesh workforce works in Kuwait and thus, a notable amount of
Bangladesh remittance comes from there. The following figure reveals the scenario from 200011.

14%
12%
10%
8%
6%
4%
2%
0%

%

200001

200102

200203

200304

200405

200506

200607

200708

200809

200910

201011

13%

11%

11%

11%

11%

10%

11%

11%

10%

9%

8%

Figure-28: Bangladesh Remittance from Kuwait
51

We see that, at an average 10% of total remittance received by Bangladesh comes from Kuwait.
However, one notable trend is that, the contribution of Kuwait in ours’ remittance has been
decreasing. There may be a number of reasons behind this reduction. The decrease actually
started from 2008-09 showing a 1% decrease from the previous year. The same time global
financial crisis started. And lots of restructuring has been done worldwide and Kuwait was no
exception. So this reduction in Kuwait’s contribution might not be because of separate series of
events. On the contrary, another way to explain this downfall is Bangladesh’s workforce now
work in more geographically dispersed locations. So it may be quite normal that Kuwait’s
contribution has reduced.

52

Chapter – V

‘PPP, IRP, IFE’

53

5.1: PURCHASING POWER PARITY (PPP)

Purchasing Power Parity (PPP) is one of the most powerful and controversial theories of
international finance. There are two versions of PPP. Absolute version of PPP says that, without
international barriers, prices of same basket of goods in two different countries will be same
when measured in a common currency. The relative form of PPP considers market imperfections
like transaction costs, tariffs, and quotas. It says that the rate of changes in the price will be
somewhat similar when measured in a common currency as long as transportation costs and trade
barriers remain unchanged.

5.1.a Rational Behind PPP
If two countries products are substitute for each other, the demand for the products should adjust
as inflation rates differ. If inflation in Kuwait (home) is higher than USA (foreign), it should
cause Kuwait consumers to increase imports from USA and cause USA consumers to decrease
their import from Kuwait. Such forces place upward pressure on the USA dollar value and viceversa. This shifting in consumption will continue from Kuwait to USA until the USA dollar
value has appreciate to the extent that (1) the prices paid for USA products by Kuwait consumers
are no lower than the prices for comparable products made in Kuwait and (2) the prices paid for
Kuwait products by USA consumers are no higher than the prices for comparable products made
in USA.
According to PPP foreign currency effects can be found by using the formula given below:

Here,

=Effect in foreign currency exchange rate

= Inflation in home country
= Inflation in foreign country

54

Assume that inflation in home country Kuwait) is 5% and inflation in foreign country (USA) is
3%. So the changes in foreign currency exchange rate will be:

=0.0194 or 1.94%
That is, foreign currency (US dollar) should appreciate by 1.94% against Kuwaiti dinar. In other
words, Kuwaiti dinar should depreciate by 1.94 % against US dollar.
A simplified but less precise relationship based on PPP is

Using the data given earlier, the changes in then foreign currency exchange rate will be:

= .02 or 2%
That is, US dollar should appreciate against Kuwaiti dinar by 2% or Kuwaiti dinar should
depreciate by 2% against US dollar.
5.1.b: Graphic Analysis of PPP
Ih – If (%)

Increased
purchasing power
of foreign goods

20%

10%

-20%

.D

.C
.A
10%

-10%

.B

PPP Line

-10%

-20%

20%

% change in Foreign
Currency’s spot rate

Decreased
purchasing power
of foreign goods

55

i.

Points on the PPP Line

The points of A and B represents that given the inflation differential between home and foreign
country of X, the foreign currency should adjust by X% due to that inflation differential. Point A
shows that home country inflation rate is 10% higher than foreign country and as PPP says,
foreign exchange spot rate also appreciate by 10%. Point B shows opposite situation of point A.
Here home foreign country inflation is more than home country by 10%, so foreign exchange
spot rate depreciate by 10%. If these situations hold, we can say that PPP line holds.
ii.

Points below the PPP Line

Points below the PPP line reflect the decreased purchasing power of foreign goods. In the graph
the point D represents a situation where home inflation is 20% lower than that of foreign
country, but the foreign currency depreciate only by 10%. All points like D below the PPP line
represent more favorable purchasing power of foreign consumers for home country goods than
from foreign goods.
iii.

Points above the PPP Line

Points above the PPP line reflect the increased purchasing power of foreign goods. In the graph
the point C represents a situation where home inflation is 20% higher than that of foreign
country, but the foreign currency appreciate only by 10%. All points like C above the PPP line
represent more favorable purchasing power of home consumers for foreign country goods than
from foreign goods.

56

5.2: Analysis of the PPP for Kuwait and Bangladesh
The PPP theory not only provides an explanation of how relative inflation rates between two
countries can influence an exchange rate, but it also provides information that can be used to
forecast exchange rates.
Testing of PPP can be done through 2 ways:
 Conceptual tests
 Statistical tests

5.2.a: Conceptual Tests of PPP
One way to test the PPP theory is to choose two countries and compare the differential in their
inflation rates to the % change in the foreign currency’s value during several time periods. Using
a graph, we can plot each point to determine whether these points closely resemble the 45 0 PPP
line.

The table shows the yearly information on change in exchange rate and the inflation rate
differential between Kuwaiti (home country) and USA (foreign country) from 1987 to 2011.

57

Period

Inflation Rate
Kuwait

USA

Difference

% change in spot rate

1987

0.66%

3.66%

-3.01%

4.18%

1988

1.47%

4.08%

-2.61%

-0.03%

1989

3.34%

4.83%

-1.49%

-5.04%

1990

15.80%

5.39%

10.41%

0.86%

1991

8.13%

4.25%

3.88%

0.71%

1992

-0.32%

3.03%

-3.35%

-1.40%

1993

0.60%

2.96%

-2.36%

-2.66%

1994

2.37%

2.61%

-0.24%

1.24%

1995

2.53%

2.81%

-0.28%

-0.28%

1996

3.04%

2.93%

0.11%

-0.32%

1997

0.81%

2.34%

-1.53%

-1.30%

1998

0.60%

1.55%

-0.95%

-0.47%

1999

3.08%

2.19%

0.89%

0.13%

2000

1.57%

3.38%

-1.81%

-0.79%

2001

1.45%

2.83%

-1.38%

0.08%

2002

0.80%

1.59%

-0.79%

0.85%

2003

0.99%

2.27%

-1.28%

1.98%

2004

1.26%

2.68%

-1.42%

1.36%

2005

4.12%

3.39%

0.73%

0.71%

2006

3.09%

3.24%

-0.15%

0.62%

2007

5.47%

2.85%

2.62%

2.08%

2008

10.62%

3.85%

6.77%

5.86%

2009

3.95%

-0.34%

4.29%

-6.67%

2010

4.10%

1.64%

2.46%

0.38%

2011

4.70%

3.16%

1.54%

3.85%

Table-8: % changes in Spot rate & inflation differential of Kuwait & USA
58

5.2.b: Graphic Analysis of PPP for Kuwait & USA
20.00%

Increased
purchasing
power of
foreign goods
% change in
spot rate
-20.00%

15.00%
10.00%
5.00%
0.00%

-15.00%

-10.00%

-5.00%
0.00%
-5.00%

5.00%

15.00%

20.00%

Decreased
purchasing
power of
foreign goods

-10.00%
-15.00%
-20.00%

10.00%

Ih-If

Figure-29: PPP line for Kuwait & USA

Here we assume Kuwait as the home country and USA as the foreign country. Followings are the
result of empirical observation we have found between the period 1987 to 2011.In 1987 inflation
rate differential was -3.01% and change in spot rate was 4.18%. It indicates that inflation rate in
Kuwait (home country) was lower than that of USA (foreign Country). Foreign currency should
depreciate by 3.01% in response to the higher inflation of the foreign country relative to the
home country but here foreign currency was appreciated by 4.18% instead. So PPP did not hold.
In the period 1990 inflation rate differential was 10.41% and change in spot rate was .86%. It
indicates that inflation rate in Kuwait was higher than that of USA. Foreign currency should
appreciate by 10.41% in response to the higher inflation of the home country relative to the
foreign country but here foreign currency appreciated by .86% instead. So the PPP did not hold.
In the period 1994 inflation rate differential was -.24% and change in spot rate was 1.24%. It
indicates that inflation rate in Kuwait (home country) was lower than that of USA (foreign
Country). Foreign currency should depreciate by .24% in response to the higher inflation of the

59

foreign country relative to the home country but here foreign currency was appreciated by 1.24%
instead. So PPP did not hold.
In the period 1995 inflation rate differential was -.28% and change in spot rate was -.28%. It
indicates that inflation rate in Kuwait (home country) was lower than that of USA (foreign
Country). Foreign currency should depreciate by .28% in response to the higher inflation of the
foreign country relative to the home country. Here foreign currency was depreciated by .28%
exactly. So PPP did hold in this case.
In case of 2011 inflation rate differential was 1.54% and change in spot rate was 3.85%. It
indicates that inflation rate in Kuwait was higher than that of USA. Foreign currency should
appreciate by 1.54% in response to the higher inflation of the home country relative to the
foreign country but here foreign currency appreciated by 3.85% instead. So the PPP did not
hold.
In above graphical Presentation of Purchasing Power Parity we see that PPP did not hold in
all most all periods except the year 1990 in which PPP did hold between Kuwait (home
country) and USA (foreign country).
5.2.c: Statistical Tests of PPP:
SUMMARY OUTPUT
Multiple R
0.186702981
R Square
0.034858003
Adjusted R Square
-0.007104692
Standard Error
0.026034615
Observations
25
ANOVA
df
Regression
Residual
Total

Intercept
X Variable 1

1
23
24

SS
MS
F
Significance F
0.000563043 0.000563043 0.830690279 0.371527181
0.015589427 0.000677801
0.01615247

Coefficients Standard Error
t Stat
P-value
Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
0.001711234 0.005258119 0.325446073 0.747785643 -0.009166014 0.012588482 -0.009166014 0.012588482
0.150933751 0.165602467 0.911422119 0.371527181 -0.19164105 0.493508552 -0.19164105 0.493508552

60

The required equation is-

Where,
ef = percentage change in foreign currency
a0 = constant/intercept
a1 = regression coefficient (slope)
µ = error term
From the coefficient table the values of a0 and a1 are taken. The desired equation isy = 0.001711+-0.15093x1
Interpretation:
I.

Here a1 1.106349 indicates that if the inflation rate differential increases for one unit (1%),
percentage change in foreign currency will be appreciated by

II.

%.

The explanatory power of the independent variable can be assed with the help of the
coefficient of determination (R2). From the regression statistics it is found that R2 = 0.0349,
which indicates that only 3.49% of the variations in percentage change in foreign currency
can be explained by the variation of the inflation rate differential.

III.

Significance test for the Regression
Here from the ANOVA table it is found that, the result is not statistically significant, because it’s
P-Value 0.3715 or 37.15%, which is much greater than 0.05 or 5% level.

IV.

Significance of the Intercept
Here P- value of intercept in this regression model is 0.7478 which is greater than .05. So
the test is insignificant .So, it is not significantly different from zero.

61

V.

Significance test for a0 = 0 and a1 = 1:
Significance Test for a0 = 0:
H0=a0=0
H1=a0≠0

t table, n-1= 24 df, a= 0.05 = 2.064
Here, the calculated t value is less than the t table value. The test is insignificant. So it is not
significantly different from zero. So in case of intercept the PPP theory holds.

Significance Test for a1 = 1:
H0=a1=1
H1=a1≠1

t table, n-1= 24 df, a= 0.05 = -2.064
Here, the calculated t value is less than the t table value the test is significant. So it is
significantly different from 1. In case of slop the PPP theory does not hold.

62

Here the statistical tests for Purchasing Power Parity indicate that PPP does not hold between
Kuwait and USA because one of the t-test (slop) finds that the coefficient differs significantly
from what is expect and rest of the t-test finds that the coefficient is not significantly differs from
what is expected. Both of the t-test has to find the coefficients value which are not significantly
differ from what is expected.

The historical coordinates of inflation rate differential and

exchange rate differential indicates that all the points are not on the 45 Degree equilibrium line.
PPP did not hold empirically may be only change in inflation rate differentials is considered in
determining exchange rate movements in PPP theory while other factors like interest rate
differentials, change in relative income level among countries, government influence in market
and international trade, expectations regarding future exchange rates have been ignored.

5.3: International Fisher Effect (IFE)
The International Fisher effect (IFE) theory specifies a precise relationship between relative
interest rates of two countries and their exchange rates. It suggests that an investor who
periodically invests in foreign interest-bearing securities will, on average, achieve a return
similar to what is possible from investing domestically.
According to the Fisher effect, nominal risk-free interest rates contain a real rate of return and an
anticipated inflation. If there is no constrain in investing internationally, then real rate of interest
in all country will be same. Otherwise, funds will flow to the country where interest rate is
higher which will eventually force the rate down to an equilibrium level. In this casenominal
interest rate differentials between countries may be the result of differentials in expected
inflation.
The IFE theory can be used to explain currency exchange rate. Since IFE is closely related to
PPP theory, it suggests that currencies with higher interest rates will depreciate because the
higher rates reflect higher expected inflation.

63

Graphic analysis of IFE
ih – if (%)
30%

IFE Line

Lower returns
from investing in
foreign deposits

20%

B

A

10%

E
0%
-25%

-15%

-5%
-10%

C
F

5%

15%

% change in
25% spot rate

D

-20%

Higher returns
from investing in
foreign deposits

-30%

Figure: Illustration of International Fisher Effect (IFE)

The three situations relating to the IFE line:
i.

Points on the IFE Line

All the points along the IFE line reflect exchange rate adjustments to offset the differential in
interest rates. Investors will end up achieving the same yield investing home or in a foreign
country by adjusting for exchange rate fluctuations.
ii.

Points below the IFE Line

Points below the IFE line reflect the higher returns from investing in foreign deposits. This may
occur due to

If ih> if and foreign currency appreciates (foreign currency appreciation is greater than
interest rate differential- Point E)



If if>ih and foreign currency appreciates (Point D)

64



If if>ih and foreign currency depreciates (interest rate differential is greater than
foreign currency depreciation - Point F)

iii.

Points above the IFE Line

Points above the IFE line reflect returns from foreign deposits are lower than the returns from
domestic deposits. This may occur due to

If ih> if and foreign currency appreciates (interest rate differential is greater than
foreign currency appreciation- Point A)



If ih> if and foreign currency depreciates (Point B)



If if>ih and foreign currency depreciates (foreign currency depreciation is greater than
interest rate differential- Point C)

5.4: Analysis of the IFE for Kuwait and USA:
To test the IFE theory the two countries we choose are Kuwait and USA, Kuwait as home
country and USA as the foreign country. If the IFE theory holds then change in exchange rate of
USD/KWD will be perfectly correlated with the interest rate differential between Kuwait and
USA. As risk free rate, we used the rate of 3 months government Treasury bill. The reason for
choosing 3 months T-bill rate as risk free is, this security is issued by the government of the
respective countries, so it’s virtually default risk free. It’s the most liquid government security in
the market and its maturity is the shortest which presents greater arbitrage opportunity.
The percentage changes in spot exchange rates & difference between interest rates of the two
countries(ih-if )for last nine years are shown in the following table and results of multiple
regression are shown in the next table:

65

Year

Kuwait i(h)

USA i(f)

Difference i(h)-i(f)

Change in spot rate

2003

2.3

1.353

0.947

1.98%

2004

1.7

0.983

0.717

1.36%

2005

2

2.201

-0.201

0.71%

2006

3.1

4.116

-1.016

0.62%

2007

3

5.088

-2.088

2.08%

2008

2.1

3.528

-1.428

5.86%

2009

1

0.806

0.194

-6.67%

2010

0.6

0.238

0.362

0.38%

2011

0.8

0.197

0.603

3.85%

Table-9: % changes in Spot rate & interest rate differential of Kuwait & USA

Graphic Analysis of IFE for Kuwait and USA
The IFE line did not hold for Kuwait and USA during the period from 2003 to 2012.The result of
regression analysis depicted in the figure below to construct the IFE for Kuwait.

Figure-30: Illustration of International Fisher Effect (IFE)

The figure shows is no real pattern or trend. The change in exchange rate is random and shows
very little relation with the interest rate differential. Most of the points are far away from the
theoretical IFE line. Even adjustment for transaction cost will not justify such difference. For
66

example in 2003 interest rate differential was .95%but the change in spot exchange rate was
1.98%. It indicates that interest rate in Kuwait was higher than that of USA. So the Kuwaiti
Dinar should depreciate by .95%. But in reality KWD actually appreciated by 1.98% but here
home currency was appreciated by 2.63% instead.
In 2005 interest rate differential was -0.201%. So, USA offered a higher risk free interest rate
than Kuwait. This indicates inflation in USA was higher than that of Kuwait and KWD should
appreciate. In reality the change in spot rate did not reflect the full effect of interest rate
differential as the change in spot rate of USD/KWD was only.71%.
From the graphical Interest Rate Parity we see that IFE does not hold between Kuwait and
USA does not hold.

Statistical Test of IFE for Kuwait and USA:
Multiple R

0.252406432

R Square

0.063709007

Adjusted R Square -0.07004685
Standard Error

0.035318251

Observations

9

Here the total number of observation was 9 as we used data for 2003 to 2011. The R square value
is .0637 which indicates that .0637% change in the dependent variable can be explained by the
independent variable. In other words, if the interest rate differential between the two countries
changes by 1% the exchange rate will change by .0637%. So, the relationship between interest
rate differential and change in exchange rate is very weak.
ANOVA Table:
df

SS

MS

F

Significance
F

Regression

1

0.000594137

0.000594

Residual

7

0.008731652

0.001247

Total

8

0.476308

0.512324382

0.009325789

67

The ANOVA table shows that the significance of F value is 0.5123. That means the model is
statistically significant at 51.23% which is way higher than 5% significance level. So the model
is not statistically significant. In other words, this model cannot efficiently predict the exchange
rate change.
Coefficients
Intercept
Interest

Standard Error

t Stat

P-value

0.009581548

0.012034671

0.796162

0.452089

rate -0.00812072

0.011766589

-0.69015

0.512324

differential

The Regression Equation
The required equation is-

Where,
ef = percentage change in foreign currency
a0 = constant/intercept
a1 = regression coefficient (slope)
µ = error term

From the coefficient table the values of a0 and a1 are taken. The equation is-

Interpretation:
1. According to IFE theory, the intercept of the IFE line should be zero. Here in our
equation the intercept is a0 = .00958 which means if there is no change in the interest rate
differential, the change in exchange rate will be .00958%. The associated p value is
0.4520 which is way higher than .05. So the p value is not significant. It states that the
intercept is not significantly different from zero. This result is consistent with the IFE
theory.

2. IFE theory suggests that the slope of IFE line will always be 1. Here in our equation the
slope or interest rate coefficient a1=

. This indicates that if the interest rate

differential increases for one unit (1%), percentage change in home currency will be
68

appreciated by

. So, KWD will appreciate. The associated p value is 0.5123

which is way higher than .05. This means the p value is not significant and the coefficient
of interest rate differential is significantly different from 1. This result is not consistent
with the IFE theory. The table value of tdf=9,α=.05 is 2.262. The calculated value of t=.69015. So, we do not reject the null hypothesis.

5.5: Interest Rate Parity (IRP)

Interest Rate Parity is a theory which states that the forward exchange rate premium of currency
with respect to another currency will change in response to change in interest rate differential
between those two countries.
It uses nominal interest rates to analyze the relationship between spot rate and a corresponding
forward rate. It relates interest rate differentials between home country and foreign country to the
forward premium/discount on the foreign currency. The size of the forward premium or discount
on a currency should be approximately equal to the interest rate differential between the
countries of concern.
Rational behind IRP
If there is interest rate differential in two countries, the investors of lower interest providing
country can earn higher return by investing in higher interest providing country. The only risk in
this case is the risk of converting the foreign currency into domestic currency. This risk can very
easily be overcome by using forward exchange rate. If forward exchange rate is lower than the
interest rate differential, investors can earn a risk free profit which is called Covered Interest
Arbitrage. Interest Parity Theorem states that this arbitrage opportunity will not be sustainable
for a long time. Forward exchange rate will be adjusted sufficiently to offset the gain from
interest rate differential. Making forward contract to sell foreign currency will lower the demand
of foreign currency and make the exchange rate higher and vice versa.

69

So the implication of IRP is that the forward premium has to be equal to the interest rate
differential to make the covered interest rate not feasible.
Graphic analysis of IRP:
Ih – If (%)
20%

Covered Interest
Arbitrage by the
investors
of
foreign countries
-20%

10%

IRP Line

.G
.A
10%

-10%

.B

-10%

.S

-20%

20%

Forward Rate
Premium/Discount

Covered Interest
Arbitrage by the
investors of Home
countries

Figure: Interest Rate Parity (IRP)
1. Points Representing IRP Line
Points lying on the diagonal line cutting the intersection of the axes represent IRP. As we know,
in this line covered interest Arbitrage is not possible. On the graph above, points of A and B
represents the IRP line. Here we can see the 10% interest rate differential in points A and B is
offset by the forward rate discount or premium.
2. Points below the IRP Line
Points below the IRP line give the covered interest rate arbitrage opportunity for the investor of
home country. On the graph, we can see, at point S the interest rate of foreign currency is 20%
more than that of home currency but forward rate discount is only 10%. So it gives the investors
of home countries arbitrage opportunity of getting approximately 10% of risk free profit.

70

3. Points above the IRP Line
At point G, we see the home countries interest rate is 20% higher than that of the foreign
country. But there is only 8% premium of forward rate. So it creates an arbitrage opportunity for
the investors of foreign country to make a profit of 12% approximately.

5.6: Analysis of the IRP for Kuwait and USA
To test the IRP theory the two countries we choose are Kuwait and USA, Kuwait as home
country and USA as the foreign country. If the IRP theory holds then forward rate premium of
USD/KWD will be perfectly correlated with the interest rate differential between Kuwait and
USA. As risk free rate, we used the rate of 3 months government Treasury bill. The reason for
choosing 3 months T-bill rate as risk free is, this security is issued by the government of the
respective countries, so it’s virtually default risk free. It’s the most liquid government security in
the market and its maturity is the shortest which presents greater arbitrage opportunity. The
forward rates are collected from the investing.com. It should be noted that forward rate of
USD/KWD in different exchange or broker can be different at the same time. The forward rate
premium for USD/KWD & difference between interest rates of the two countries (ih-if) for last
nine years are shown in the following table and results of multiple regressions are shown in the
next table:
Year

Forward rate

Exchange rate

Forward

rate Difference

premium

i(f)

2003

3.5511

3.5537

-0.07%

0.947

2004

3.5537

3.5486

0.14%

0.717

2005

3.5537

3.5511

0.07%

-0.201

2006

3.5511

3.5524

-0.04%

-1.016

2007

3.5474

3.5499

-0.07%

-2.088

2008

3.5461

3.5549

-0.25%

-1.428

2009

3.5461

3.5436

0.07%

0.194

2010

3.5575

3.5448

0.36%

0.362

2011

3.5575

3.5423

0.43%

0.603

Table-10: % changes in Spot rate & nominal interest rate differential of Kuwait & USA
71

i(h)-

Graphic analysis of IFE for Kuwait and USA:
The IRP line did not hold for Kuwait and USA during the period from 2003 to 2012.The result of
regression analysis depicted in the figure below to construct the IRP line for Kuwait.
1.5
1
0.5
0
-0.60%

-0.40%

-0.20%

0.00%
-0.5

0.20%

0.40%

0.60%

Real
IRP

-1
-1.5
-2
-2.5

Figure-31: IRP line for Kuwait & USA
From the above graph it is evident that the IRP line of Kuwai and USA does not hold in reality.
Most of the points fall so far away from the theoretical IRP line. Even adjustment for transaction
cost will not justify such difference. For example in 2003 interest rate differential between
Kuwait and USA was .947% indicating the forward rate should increase too. But the average
forward rate of that year actually shows a discount of .07%. Similarly in 2007, Kuwait offered an
interest rate 2.088% less than that of USA at that time. As a consequence KWD should
depreciate and KWD should sell at a discount in forward market. But the forward discount of
.07% is too far less than what the interest rate differential warranted.
Multiple R

0.602740726

R Square

0.363296383

Adjusted R Square

0.272338724

Standard Error

0.001825495

Observations

9

72

Here the total number of observation was 9 as we used data for 2003 to 2011. The R square value
is .3633 which indicates that 36.33% change in the dependent variable can be explained by the
independent variable. In other words, if the interest rate differential between the two countries
changes by 1% the exchange rate will change by .3633%. So, the relationship between interest
rate differential and change in exchange rate is moderate.
ANOVA Table:
df

SS

MS

F

Significance
F

Regression

1

1.33102E-05

1.33102E-

3.994126332 0.085805013

05
Residual

7

2.3327E-05

3.33243E06

Total

8

3.66372E-05

The ANOVA table shows that the significance of F value is 0.0858. That means the model is
statistically significant at 8.58% which is higher than 5% significance level. So the model is not
statistically significant. In other words, this model cannot efficiently predict the exchange rate
change.
Coefficients

Standard

t Stat

P-value

Error
Intercept
Interest

0.000970252 0.000622036 1.559800043 0.162772014
rate 0.001215467 0.00060818

1.998531044 0.085805013

differential

73

The regression equation
According to IRP Forward rate premium can be found by using the formula:
Here, = Forward rate premium
= Interest Rate of home country
= Interest Rate of foreign country

From the above table we can put the value of

and

in the equation and rewrite it as:

Interpretation:
1. According to IRP theory, the intercept of the IRP line should be zero. Here in our
equation the intercept is a0 = .00097 which means if there is no change in the interest rate
differential, the forward exchange rate premium will be .00097%. The associated p value
is 0.1627 which is higher than .05. So the p value is not significant. It states that the
intercept is not significantly different from zero. This result is consistent with the IFE
theory.
The table value of tdf=9,α=.05 is 2.262. The calculated value of t=1.5598. So, we do not
reject the null hypothesis.
2. IRP theory suggests that the slope of IRP line will always be 1. Here in our equation the
slope or interest rate coefficient a1=

. This indicates that if the interest rate

differential increases for one unit (1%), forward rate premium will appreciate
by

.The associated p value is 0.0858 which is higher than .05. This means the p

value is not significant coefficient of interest rate differential is significantly different
from 1. This result is not consistent with the IRP theory.
The table value of tdf=9,α=.05 is 2.262. The calculated value of t=1.9985. So, we do not
reject the null hypothesis.

74

Chapter - VI
Findings & Conclusion

75

Kuwait trade surplus expanded as moderate growth in was more than offset by a strong jump in
exports, driven by rising oil prices. The surplus was equivalent to 42% of GDP, which was 29%
in 2010, after 24% in 2009. This record goods trade surplus more than offset record deficits on
services and remittance outflows. The capital and financial account continues to see a net
outflow as Kuwait increases its stock of foreign assets.
We have discussed their export in two broad categories such as oil exports & non-oil exports.
Non-oil export items are as follows: Food & Live Animals, Beverages & Tobacco, and Inedible
etc. In the world ranking, Kuwait is the 38th country in term of export volume in 2010.
Kuwait main export partners are South Korea 18.3%, Japan 14.2%, India 13.4%, and China
9.9%, US 8.7% in 2011.
Imports of Kuwait under three major titles are - capital goods (20%-25% of total import),
intermediate goods (35%-40% of total import) and consumer goods (40% of total import). Kuwait’s
major import partners are US 11.9%, India 10%, China 9.3%, Saudi Arabia 8%, South Korea
6.3%, Japan 5.9%, Germany 4.8%, UAE 4.1% (2011). In the world ranking, Kuwait is 71th
country in term of imports volume.

We have observed that Kuwait’s current account surplus was $70.85 billion in 2011 compared to
$43.14 billion 2010 with a growth rate of 64%. It is also expected to have grown faster than
GDP, taking its share of GDP to 42%, up from 29% in 2010. In the whole world, Kuwait is the
8th country in terms of current account balance.
The capital account of Kuwait is positive. In 2011, the CA balance was $ 2570 compared to $
2197 million in 2010 with a growth rate of 17%. Financial account of Kuwait is negative due to
huge FDI outside of the country. In 2011 total financial account Dr Balance was $ 46229 million
compared to $35393 in 2010.
In the analysis of Balance of Payments between Bangladesh and Kuwait indicates that Kuwait has
positive and Bangladesh has negative BOT over the period. Bangladesh has recently current account
surplus and Kuwait persistently shown current account surplus.

76

Balance of Payments Analysis of Kuwait

Balance of Payments Analysis of Kuwait

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