EXTERNAL

SECTOR
PRESENTED BY: CARLO EMMANUEL M CANLAS
Definition:
 The external sector of a country’s economy refers to all international
economic transactions between residents of the country (private and
public sector) and the rest of the world.

 The aggregate macroeconomic sector that contains everyone and

everything beyond the political boundaries of the domestic economy.

 Also known as foreign sector.

How does the domestic economy
relate to the external sector?
■ Trade in goods and services
-involves the exchange of products, commodities, or commerce between
individuals.  
- Imports are goods produced by the foreign sector and purchased by the
household, business or government in the domestic economy.
-Exports are goods produced by the domestic economy and purchased by
the foreign sector.
■ Capital access
- access of domestic companies or government on capital abroad.
■ Forex
- exchanging the currency of one country for another at prevailing exchange
rates.
How does the domestic economy
relate to the external sector?
■ Balance of Trade
- difference between the value of a country's exports and the
value of a country's imports for a given period.
- involves foreign exchange.
■ Foreign investment
- investors purchase an asset in a foreign country, resulting in the
cash flow consideration transferring from one country to the next.
Four-sector Economy
Contagion Effect
■ The domestic economy is increasingly connected to the external
sector through trade and capital flows, intensified with
globalization.
■ Increasing interdependence with the external sector also increases
the contagion effect.
■ Economic recession in US in 2008-2009
■ Asian Financial Crisis in 1997
How are transactions with the external sector
recorded?

■ Balance of Payments
- It serves as an accounting statement on the economic dealings
between residents of the country and non- residents.
- When a payment is received from a foreign country, it is a credit
transaction while payment to a foreign country is a debit transaction.
- The two components are the current account and the capital
account.
Current Account
- an account which records all the transactions relating to export and
import of goods and services and unilateral transfers during a given
period of time.
- contains the receipts and payments relating to all the transactions of
visible items, invisible items and unilateral transfers.
Main components are:
- Visible Trade
- Invisible Trade
Visible Trade
- exchange of physically tangible goods between countries, involving
the export, import, and re-export of goods at various stages of
production.

Invisible
  Trade
- involves the export and import of physically intangible items such as services.
- Example: Export and import of services, unilateral or unrequited transfers and
medical tourism
Capital account
- includes economic activities such as direct investment and
acquisitions of non-interest generating demand deposits and gold and
interest-bearing financial assets. In addition, all overseas asset
transactions are recorded in the Capital Account. 
- The main components of Capital Account are:
1. Borrowing and lending to and from abroad
2. Investments to and from abroad
3. Change in Foreign Exchange Reserves
The current account registered
a surplus of US$561 million
(equivalent to 0.5 percent of the
country's GDP) in Q4 2022, a
reversal of the US$3.7 billion
deficit (equivalent to -3.3
percent of the country’s GDP)
in Q4 2021. This development
resulted mainly from the
narrowing of the deficit in the
trade in goods account, combined
with the increase in net receipts
in the trade in services, primary
income, and the secondary
income accounts.
Systems of Foreign Exchange:

1. Fixed Exchange Rate System: Central Bank determines

the rate at which domestic currency is exchanged in to foreign currency.

2. Flexible Exchange Rate System: market determines the

the rate at which domestic currency is exchanged in to foreign currency.

3. Managed Exchange Rate System:  an exchange rate

that is generally allowed to adjust due to the interaction of supply and
demand in the foreign exchange market, but with occasional
intervention by government.
Advantages of Fixed Exchange Rate
System:
■ Certainty
■ Absence of speculation
■ Constraint on government policy
Disadvantages of Fixed Exchange Rate
System:
■ The economy may be unable to respond to shocks
■ Problems with reserves
■ Speculation
■ Deflation
■ Policy conflicts
Advantages of Flexible Exchange Rate
System:
■ Protection from external shocks
■ Lack of policy constraints
■ Correction of balance of payment deficits
Disadvantages of Flexible Exchange Rate
System:
■ Instability
■ Speculation
■ No constraints on domestic policy
Example of Managed Exchange Rate
System

Suppose, PH has adopted Managed Floating System

and the BSP wants to keep the exchange rate $1 =
Php 59.75 and let’s assume that the BSP is ready to
tolerate small fluctuations, like from 59.75 to 60.25.
References:
■ https://penpoin.com/external-sector/#
■ https://www.slideserve.com/willa/external-sector
■ https://unacademy.com/content/ssc/study-material/indian economy/external-
sector-of-india/#:~:text=...Read%20full ,Answer%3A%20Trade%2C%20oversea
s%20investment%2C%20budget%20deficits%2C%20the%20balance,falls%20wi
thin%20India%27s%20external%20sector
.
■ https://www.wallstreetmojo.com/circular-flow-of-income/
■ https://www.hdfcbank.com/personal/resources/learning-centre/pay/know-wh
at-is-foreign-exchange
■ https://www.amosweb.com/cgibin/awb_nav.pl?
s=wpd&c=dsp&k=foreign+sector