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S21
IGCSE®/O Level Economics
8.2 Balancing international
payments
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Exports and imports
An export is a good or service sold to overseas residents resulting
in a flow of income into the exporting country
An import is a good or service purchased from overseas producers
resulting in an flow of income out of the importing country
VISIBLE EXPORT
A physical product sold
overseas
INVISIBLE EXPORT
A service sold to
overseas residents
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VISIBLE IMPORT
A physical product
bought from overseas
INVISIBLE IMPORT
A service purchased
from overseas residents
The balance of trade
Balance of trade = value of visible exports - value of visible imports
Balance of trade surplus
Total value of
visible exports
>
Total value of
visible imports
Balance of trade deficit
Total value of
visible exports
<
Total value of
visible imports
Balance on services = value of invisible exports - value of invisible imports
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The balance of payments current account
All monetary transactions between a
country and the rest of the world are
recorded in its balance of payments
The balance of payments on current account records
how well or how badly a national economy is doing in
international trade in goods and services
Credits: money received from overseas
• Balance of trade
• Balance on services
• Balance on income
Debits: money paid overseas
Income credits include wages, profits, interest and
dividends earned overseas by residents
Income debits include wages, profits, interest and
dividends paid out to residents of other countries
• Net current transfers
Including payments of taxes and excise duties by
visiting residents; cross-border gifts, donations and
overseas aid
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The balance on current account
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International trade requires the exchange of
foreign currencies
Indian company uses French advertising
company
Italian invests in an
Argentinian shipping company
Has to exchange Indian
rupees for euros
Has to exchange euros for
Argentinian pesos
UK tourist takes
holiday in the USA
Has to exchanges UK
pounds for US dollars
Payments for imports and exports and for all other international transactions requires the
exchange of national currencies. This takes place on the global foreign exchange market
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The foreign exchange market (Forex)
Forex is the world’s largest financial market. It consists of all those people, organizations and
governments willing and able to buy or sell national currencies.
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An appreciation in the exchange rate
A currency might appreciate because:
•
•
•
•
•
Before: $1 = 2 reals
After: $1 = 2.5 reals
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There is a balance of payments
surplus
Demand for the currency rises as
overseas consumers buy more
exports
Interest rates rise relative to other
countries. This attracts savings from
overseas residents
Inflation is lower than in other
countries so exports will be cheaper
and overseas demand for them, and
the currency required to pay for them,
will rise
People speculate the currency will
rise in value and buy more of the
currency
A depreciation in the exchange rate
A currency might depreciate because:
•
•
•
•
•
Before: $1 = 2 reals
After: $1 = 1.8 reals
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There is a balance of payments deficit
Demand for other currencies rises as
domestic consumers buy more
imports
Interest rates fall relative to other
countries. People move their savings
to bank accounts overseas
Inflation rises relative to other
countries. This makes exports more
expensive and demand for them, and
the currency needed to buy them,
falls
People speculate the currency will fall
in value and sell their holdings of the
currency
Exchange rate speculation
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Changes in exchange rates will affect
product prices
A fall (depreciation) in the exchange rate of a currency will make imports to that country more
expensive but will lower the price of its exports in overseas markets
A rise (appreciation) in the exchange rate of a currency will make imports to that country
cheaper but will increase the price of its exports in overseas markets, for example:
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Problems with trade imbalances
A large and continuous trade surplus can be a problem:
•
Other countries may put political and economic
pressure on the government to reduce the trade
surplus so they can reduce their trade deficits
•
The boost in income from trade may cause a demandpull inflation when it is spent in the economy
•
The value of the currency will rise on the foreign
exchange market and stay high. This will increase the
price of exports overseas and sales could be lost
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A large and continuous trade deficit can be a problem:
• It may be the result of industrial decline in the economy
• It means more income is leaving the economy, leaving
less to spend on domestic goods and services
• The value of the currency will fall on the foreign
exchange market making imports more expensive
• To pay for recurrent deficits a country may have to
borrow from overseas. This will increase the public debt
and total interest charges
Correcting a trade imbalance
A government can try to reduce a trade
deficit in the following ways:
A government can try to reduce a trade surplus
in the following ways:
•
•
•
•
•
Do nothing because the exchange rate
will depreciate, making imports more
expensive (demand will fall) but exports
cheaper to buy (overseas demand will rise)
Use contractionary fiscal policy, by
raising taxes and cutting public
expenditure, which can reduce total
demand for imports
Raise interest rates which can attract an
inflow of savings from overseas, and
reduce borrowing by consumers which
they might otherwise spend on imports
Use trade barriers to restrict imported
goods
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•
•
•
Do nothing because the exchange rate will
appreciate, making imports cheaper (demand
will rise) but exports more expensive to buy
(overseas demand will fall)
Use expansionary fiscal policy which can
boost demand for imports through tax cuts
and increases in public spending
Lower interest rates which can encourage
investors to move their savings overseas and
also encourage more spending on imports by
reducing the cost of borrowing
Remove trade barriers