Chapter 12

BALANCE OF PAYMENT
&
FOREIGN EXCHANGE RATE
Balance of Payment

 Statement of systematic records of all economic transaction between one country and
the rest of the world in a given period of time.

 Shows the detailed of the total payments made by one country to other nations and the
total receipts received by it.

 Refer to difference between the total value of goods and services imported and
exported over a given period of time
A.1) Trade balance (balance of visible trade)
= values of goods exported – value of goods imported

Example:
-Export of cars
-Imports of machines

A.2) Service balance (balance of invisible trade)

= value of services exported- values of services imported

Examples:
-Banking
-Insurance
-Tourist spending
-Net property income from abroad
B) Net income balance (net factor payment)
-Difference between income receipts from abroad and income payments to
residents abroad

Example of income receipts from abroad:

(i) salary or income received from residents working abroad
(ii) profit, dividends comes from direct investment & portfolio investment
-Usually shown (+) sign as it is credit items in the current account.

Example of income payments to residents abroad:

(i) salary paid to foreign residents working in the country
(ii) Dividends and profit remittances.
-Usually shown a (-) sign as it is a debit items.
C) Current transfers
-Unilateral transfer from one country to another in a forms of;
(i) gifts
(ii) military aids
(iii) donations and financial aid by the government, private or individual

Current Acct = A.1 + A.2 + B + C

E) Capital account
- Show the net change in the physical or financial asset ownership of a nation
- Example foreign direct investment (FDI)
- Two types of transactions;
(i) private= all types of investment
(ii) official = government official transaction consist of loans to and from foreign official
agencies.

F) Financial account
- Show the change in international ownership of shares properties, bank deposit, gov securities,
loan etc.
- This acct included buying and selling of assets.

Balance on Capital & Financial = E + F

H) Errors and omissions
- Use to balance items to bring the final BOP.

Overall Acct = Current Acct + Capital & Financial Acct + Errors &
Omissions

i) Official reserve account

• Consist of government gold and foreign currency reserves as well as government
reserves with the international monetary fund (IMF) and the special drawing rights
(SDR).
• CB will buy RM in exchange market to support the RM (not drastically depreciation).
• Reserve can be used to finance the deficit in any part of the BOP.
The effect of exports and imports on the economy

 Feedback effects on trading (Kesan maklum balas perdagangan)

 E.g: An increase in Malaysia's GDP will stimulate an increase in domestic
consumption. Therefore, the demand for imported products as a production
input will increase and ultimately increase the economic activity of other
countries.
 Feedback effects on pricing ( Kesan maklum balas harga)
 E.g: Japan's domestic economy was struck by inflation, which resulted in an
increase in goods prices for export. If Malaysia imports their products,
Malaysia's domestic goods prices will also increase.
 Inflation can be effect to import or export.
 Exchange Rate

 Exchange rate – the ratio at which 2 currencies are traded.

 The price of one currency in terms of another (Direct quote or Indirect quote).
 The exchange rate is set through:
 the government offering its currency in a fixed exchange system or
 the interaction between supply and demand in the foreign exchange market under a floating
exchange rate system.
 Foreign exchange market – refers to the interaction between demand & supply of currencies
– due to 2 main activities
 i.e international trade & international investment (FDI & Portfolio Investment).
• Exchange rate is determined by the interaction of DD & SS of currency in the foreign
exchange market.

• Direct quote – a foreign exchange rate quoted as the domestic currency per unit of the foreign
currency.

• In other words, it involves quoting in fixed units of foreign currency against variable amounts
of the domestic currency.

• Example : in Malaysia, a direct quote for the US$ would be RM4.20 = 1US$.

• The difference between supply of Ringgit (RM) and supply of money.

• Supply of RM – means the total amount of RM in the foreign exchange market,
subjected to exchange with foreign currencies.

• Supply of money – refers to the monetary policy exercise by the Central Bank.
Buyers & Sellers In The Foreign Exchange Rate Market
Between RM Malaysia & Dollar Australia

 Factors or Activities that Create Demand For Ringgit Malaysia (Supply Of AUD$)

i. Household, firms or Australian government that imports or buy goods & services from Malaysia.
ii. Australian tourist that visiting Malaysia.
iii. Australian investors buying shares, bonds & monetary instruments in Malaysia (portfolio
investment).
iv. Australian companies investing in Malaysia (FDI)
v. Speculator that expecting the fall in the value of AUD$ compared to Malaysian RM.
Buyers & Sellers In The Foreign Exchange Rate Market
Between RM Malaysia & Dollar Australia

 Factors or Activities that Create Demand For AUD$ (Supply of MYR)

i. Household, firms or Malaysian government that imports or buy goods & services from
Australia.
ii. Malaysian tourist that visiting Australia.
iii. Malaysian investors buying shares, bonds & monetary instruments in Australia.
iv. Malaysian companies investing in Australia.
v. Speculator that expecting the fall in the value of Malaysian RM compared to AUD$ .
Market Equilibrium of MYR and AUD$ Exchange

Figure 12.1: a) MYR exchange Figure 12.1: b) AUDS$ exchange

• indirect quote • Direct quote
• exchange rate in AUD$ • exchange rate in RM
• how much AUD$ for 1RM • how much RM for
1AUD$
 Figure 12.1 (a) and (b) show the foreign exchange demand and supply between the RM and the AUD$.
 When RM is demanded, the exchange rate is expressed in AUD$ per unit of RM.
 When AUD$ is demanded, the exchange rate is expressed in the RM per unit of the AUD$.
 When the amount of a currency demanded is equal to the amount supplied, the balance of the foreign exchange market
is reached at the level of the exchange rate agreed by the market.
• Suppose the exchange rate is RM3.50 = 1AUD$

• RM depreciates, AUD$ appreciates (at RM/AUD$ axis).

• Then, the price of goods in M’sia became relatively cheaper

compared to the price of goods in Australia.

• Australians will buy more M’sian goods (Australia will SS

more AUD$/Australia will demand more RM).

• M’sian exports will increase at the same time, M’sian will

import less from Australia, and M’sian imports will decrease.

• Market adjustment: Increase the quantity of AUD$ for every

unit RM1. Hence, SS of AUD$ will decrease, and DD for RM
will decrease (RM becomes more expensive than AUD$)

• RM will appreciate, and AUD$ will depreciate.

• Now, suppose the exchange rate is RM2.50 = 1AUD$

• RM appreciates, AUD$ depreciates (at RM/AUD$ axis).

• Then, the price of goods in M'sia became relatively expensive

compared to the price of goods in Australia.

• Malaysia will buy more Australian goods (Msia will SS more

RM/ Msia will DD more AUD$).

• Hence, Australian exports will increase; at the same time,

Australia will import less from M'sian, and Australia's imports
will decrease.

• Market adjustment: Increase the quantity of RM for every unit

1AUD$. Hence, SS of RM will decrease, and DD for AUD$
will decrease (RM becomes cheaper than AUD$).

• RM will depreciate, and AUD$ will appreciate.

 Relative Interest Rate

• Assuming the interest rate (r) in Malaysia is higher than r

in Thailand.

• It will attract more investors from Thailand to invest in

Malaysia (buying more securities in Malaysia).

• However, before the Thai people invest/ buy securities in

Malaysia, they must change Baht to RM. Hence, SS of
Baht increase from S1 to S2.

• An increase in r attracts Malaysian Firms and Households

to invest domestically. It will decrease DD for Baht from
DBaht0 to DBaht1.

• RM appreciates, and Baht depreciates.

 Relative Price Level

• Assuming the price in Malaysia is higher than in

Thailand.

• It will make Malaysia's products uncompetitive to

Thailand's. Malaysian products are more expensive
than Thai products.

• Malaysia's export decrease (low demand from

Thailand) will decrease SS for Baht from SS of Baht
increase from S0 to S1.

• Increasing Malaysia's prices increases the Malaysian

demand for Thailand's products. It will increase DD for
Baht from DBaht0 to DBaht1.

• RM depreciates, and Baht appreciates.