The Definition of the (BOP) The (BOP) structure The Surplus and Deficit of (BOP) Purposes of Official Reserve The nominal and real exchange rate The exchange rate regimes

1. The Relation between Balance of
Payment and Foreign Exchange
Rate
by
By
Dr. Amr Feteha
Lecture of public economics
– faculty of commerce
Alexandria university
&
Dr. Mohamed Osman
Lecture of public economics – faculty
of commerce Alexandria university

2. Discussion Goals
• •The Definition of the (BOP)
• ••The (BOP) structure
• The Surplus and Deficit of (BOP)
• Purposes of Official Reserve
• The nominal and real exchange rate
• •The exchange rate regimes

3. Balance of Payment
(BOP) is a record of the economic transactions between
the residents of the country and the residents of the
other countries during certain period of time.

4. Residents
Business units GovernmentIndividuals
Economic Transactions
Goods & Services
Bilateral
transactions
Unilateral
Transactions

5. Why?
To determine how much money is going in and out of a
country.
If a country has received money
the transaction is counted as a
Credit
(+)
If a country has paid or given money
the transaction is counted as a
Debit
(-)

7. Balance of Payment Structure

8. The Current Account

9. The Capital Account
is where all international capital transfers are
recorded. This refers to the acquisition or disposal of
non-financial assets (e.g. land) and non-produced
assets, which are needed for production but have not
been produced.

10. The Financial Account
is where international monetary flows related to investment in
business, real estate, bonds, and stocks ,government-owned
assets such as foreign reserves, gold,(SDRs),private assets
held abroad and assets owned by private and official foreigners
are recorded.

12. Purposes of Official Reserve

13. 1-liquidity Function:
•To provide the country by sufficient international
liquidity to finance short- term deficit especially
in the current account.

14. 2- Stability Function :
The relation between (FER) and (BOP)
• To keep exchange rate at desired value, the central
banks sometimes buy or sell official reserve assets
in the private capital markets to stabilize the
currency exchange rate.

15. • In the cases of managed floated, adjustable peg and
pegged exchange rate, if the state does not want a
currency depreciation due to the deficit of (BOP) , it
will draw on reserve and sell foreign currency in
local market, thus the foreign exchange increases to
fund the deficit of (BOP) and vice versa.

16. Errors and Omissions Item
From accounting point of view, the double entry record system is used, to make the
value of the credit side equals the value of the debit side, but as a result of shortage of
data and information about the international transactions especially that are related to
capital and financial transactions, the credit side doesn’t equal the debit side. So, the
errors and omissions item is treated as a part of the capital and financial account
because short term financial transactions are generally the most frequent source of
errors.

17. Surplus and Deficit of Balance of Payment
The relation between (FER) and (BOP)

18. The debit side of (BOP) represents the demand
on foreign currency, in floating exchange rate if
debit side > the credit side (deficit) home
currency will depreciate

19. The credit side of (BOP) represents the supply
of foreign currency, in floating exchange rate if
the credit side > the debit side (surplus)the
home currency will appreciate

20. in the case of currency depreciation or
devaluation, by reducing the value of the home
currency, government can correct the
disequilibrium in BOP. As a result imports
become expensive and exports become
cheaper, which causes a reduction in the BOP
deficit ( J Curve)

22. Factors of success
1- Must be able to have a huge domestic production.
2- Must be able to export more than you have before.
3- Must be able to decrease your imports more than
you have before.

23. The Paradox of
Capital Flow Between Developing and Industrial Countries
In normal situation, we can expect the developing countries should be net capital
importers and the developed countries should be net capital exporters, but in the first
decades of the 2000s saw the opposite direction of the net capital flows. The
developing countries as a group is became net capital exporter not net capital
importers and the rich industrial countries as a group became net capital importers.

24. This situation is called capital flowing "uphill"
which disagree with economic logic that the
developed countries must be net capital
exporter.

25. Why?
Many developing countries achieve surplus in current account, some of them have
underdeveloped domestic financial market, so they export their capital to rich countries
to invest it , some others their production process requires little capital and there have
not enough saving tools, so they have to purchasing capital abroad, also some others
do not desire for their currencies to be appreciated due to the surplus in current
account, so they purchase capital assets from abroad to save the competitiveness
value for their currencies.

26. The iconic example of the this paradox is each year, hundreds of billions of dollars
flow from China (where the productivity of capital is very high) to the United States
(where the potential return is lower) than vice-versa. if the China’s central bank didn’t
buy huge quantities of dollars (mostly in the form of U.S. Treasury securities) as a
means for holding down the value of China’s currency, Walmart and friends might well
find it cheaper to buy goods in, say, Thailand or Mexico.

27. Foreign Exchange Rate
Any changes of the foreign exchange rate will affect
positively or negatively on the nation's
competitiveness. To know the dual impacts on the
competitiveness we have to distinguish between
nominal and real exchange rate.

28. Nominal Exchange Rate (NER)
The price of one currency in terms of another
currency, which determines according to demand
and supply of foreign exchange currencies, but it
does not reflect the changes of price level of trading
partners.

29. Is nominal exchange rate is suitable to explain
international competitiveness position?
The nominal exchange rate index is the weighted
average of the exchange rate with in the period of
time for each party of the international trade , which
called the effective exchange rate.

30. Real Exchange Rate (RER)
(What Money Can Buy)
is a measure of the 'real' value of a currency - how
many goods and services a unit of the currency will
buy. (nominal exchange rate adjusted for relative
price levels)

31. Real Exchange Rate formula

32. Example
Suppose 1$=17.6L.E and Egypt price level = 110 and USA price level= 102.
So the RER for dollar=16.32 L.E but the NER= 17.6 L.E per each dollar.
It means (Appreciation of US dollar (overvalued) and depreciation of the
Egyptian pound)) undervalued)

33. Real Effective Exchange Rate (REER)
is the weighted average of a country's currency in
relation to an index or basket of other major currencies.
The weights are determined by comparing the relative
trade balance of a country's currency against each
country within the index.

34. Regimes of exchange rate

35. Fixed Exchange Rate
- The Central Bank ties the country's currency to another country's
currency
(even though what happen in economy be revival or fall down )
allows importers, exporters, and investors to plan without worrying about
currency moves and limits speculation.
25 countries of IMF members are using fixed exchange rate.

36. The relation between (FER) and (BOP)
countries which utilize Fixed Exchange Rate regime
when they face an inflation in local market, thus,
their demand for imports increases and the demand
for their exports decreases. Whereas foreign imports
will be cheaper than domestic production and
exports be more expensive than their counterparts
in other countries, the balance of payments deficit
increases.

37. Floating Exchange Rate
Central Bank allows the exchange rate to be determined
by market forces without any intervention or influence by
central bank
89 countries of IMF members are using Floating
Exchange Rate

38. Intermediate Exchange Rate
In between fixed exchange rate and floating exchange rate
The price of local currency increases or decreases depending on
the increasing or decreasing of another currency.
89 countries of IMF members are using intermediate exchange rate

39. References
- Carbaugh,R.,2011.Global economics,13th edition, south-western.
- Catão,L.,2018, Real Exchange Rates: What Money Can Buy, Finance &
Development, IMF.
- Kreinin,M., 2003. International Economics a policy approach, south-western.
- P.Daniels,J. and Vanhoosw,D.,2008.Intenational monetary and financial
economics, Pearson Education International.
-Sawyer,W. and L.Sprinkle, 2011. international economics, Pearson.