BoP Analysis - ‘Kuwait’

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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

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BoP Analysis - ‘Kuwait’

  1. 1. Chapter - I INTRODUCTION “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 1
  2. 2. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 2
  3. 3. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 3
  4. 4. Chapter - II LITERATURE REVIEW “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 4
  5. 5. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 5
  6. 6. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 6
  7. 7. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 7
  8. 8. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 8
  9. 9. Chapter – III Economic Overview of Kuwait & BoP Analysis of Kuwait “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 9
  10. 10. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 10
  11. 11. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 11
  12. 12.  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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 12
  13. 13. BoP Analysis - ‘Kuwait’ 3.4 BoP of Kuwait – At a glance: “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 13
  14. 14. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 14
  15. 15. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 15
  16. 16. 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%. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 16
  17. 17. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 17
  18. 18. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 18
  19. 19. 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) “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 19
  20. 20. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 20
  21. 21. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 21
  22. 22. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 22
  23. 23. 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) “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 23
  24. 24. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 24
  25. 25. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 25
  26. 26. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 26
  27. 27. 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) “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 27
  28. 28. 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: 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 28
  29. 29. 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) “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 29
  30. 30. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 30
  31. 31. Chapter – IV BoP ‘Kuwait Vs Bangladesh’ 4.1: BoP of Bangladesh - General Outlook: “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 31
  32. 32. 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: “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 32
  33. 33. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 33
  34. 34. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 34
  35. 35. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 35
  36. 36. 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) “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 36
  37. 37. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 37
  38. 38. 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 $4708 million. But a slow growth in the remittance flow and swelling import payment has largely attributed to further increase of negative trade balance. With that the rising global commodity prices (e.g. food, fuel and cotton prices) and lack of FDI and low level of foreign aid inflow could only create additional burden for the balance. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 38
  39. 39. Bangladesh 0 Kuwait 70000 60000 50000 40000 30000 20000 10000 0 -1000 -2000 -3000 -4000 -5000 -6000 -7000 -8000 Trade Balance Trade Balance Figures-20: BoT scenario of Kuwait & BD ($ 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 $2298 million in 2010-11 which was 94% higher than the previous year 2009-10. However, 2009-10 period had a negative growth in this balance. In that year, the deficit reduced by 23.6%. Before that there was positive growth since 2005-06. But there was no predictable pattern in this growth. In 06-07, the growth was 27.5%, then 13.06% in 07-08, 21% in 08-09 and 6.3% in 2009-10. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 39
  40. 40. Bangladesh Kuwait 0 0 -1000 -500 -499 -2000 -691 -1000 -874-870 -1110 -1237 -1255 -1525 -1621 -1500 -2000 -4000 -5000 -2500 -2398 -3000 -2283 -3000 -3471 -38433881 -4190 -2550 -3446 -3724 -6000 -5509 -6011 -7000 Figures-21: Services scenario of Kuwait & BD ($ 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 $8529 million by increasing 30.1% from the previous year. It increased further 19% in the following year. But in 2009-10 and 2010-11 the growth was reduced to 13.4% and 4.1% respectively signifying the aftereffects of economic downturn and on-going political disorder in Middle East. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 40
  41. 41. Bangladesh 14000 12000 10000 8000 6000 4000 2000 0 Kuwait 0 -2000 -4000 -6000 -8000 -10000 -12000 -14000 Current transfer Current Transfer Figures-22: Current Transfer scenario of Kuwait & BD ($ 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 $1484 million by increasing 49.3% from the previous year. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 41
  42. 42. Bangladesh Kuwait 0 -200 13168 12937 14000 12000 -400 -600 -800 -1000 -1200 -1400 -1600 10483 10000 -402 -358 -374 8000 8857 6129 80168114 7053 6000 -641 4000 33473361 -786 -905 -994 2000 0 -1354 -14841487 - Figures-23: Income scenario of Kuwait & BD ($ 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 42
  43. 43. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 43
  44. 44. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 44
  45. 45. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 45
  46. 46. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 46
  47. 47. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 47
  48. 48. 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). “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 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
  49. 49. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 49
  50. 50. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 50
  51. 51. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 51
  52. 52. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 52
  53. 53. Chapter – V ‘PPP, IRP, IFE’ “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 53
  54. 54. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 54
  55. 55. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 55
  56. 56. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 56
  57. 57. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 57
  58. 58. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 58
  59. 59. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 59
  60. 60. 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 Regression Statistics 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 60
  61. 61. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 61
  62. 62. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 62
  63. 63. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 63
  64. 64. 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) “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 64
  65. 65.  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: “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 65
  66. 66. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 66
  67. 67. 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: Regression Statistics 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 67
  68. 68. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 68
  69. 69. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 69
  70. 70. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 70
  71. 71. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 71 i(h)-
  72. 72. 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. Regression Statistics Multiple R 0.602740726 R Square 0.363296383 Adjusted R Square 0.272338724 Standard Error 0.001825495 Observations 9 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 72
  73. 73. 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 “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 73
  74. 74. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 74
  75. 75. Chapter - VI Findings & Conclusion “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 75
  76. 76. 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. “Balance of Payments Analysis along with PPP, IRP & IFE Lines” -Focused on Kuwait. 76

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