4.3.3 - Balance of payments, exchange rates and international competitiveness

The balance of payments records transactions between residents of one economy and the rest of the world over a period. Receipts are credits and payments are debits.

A current-account deficit must be matched by net financing, reserve changes and the other accounting entries, allowing for errors and omissions. For example, lower inward FDI or portfolio investment weakens the financial-account position, not the current account directly.

A current-account deficit means total current-account debits exceed credits; a surplus means credits exceed debits. The balance reflects trade, income and transfers, not exports and imports alone.

Diagnose the component, duration and size relative to GDP. A one-year deficit may reflect investment-related imports, whereas a persistent deficit linked to weak productivity suggests a deeper competitiveness problem.

To reduce an excessive surplus, the reverse adjustment may include currency appreciation, stronger domestic demand or investment, higher imports and policies that raise household consumption. Adjustment can be shared between surplus and deficit economies.

Use a policy mix matched to the cause: demand restraint addresses excessive import demand, while supply-side policy addresses weak long-run competitiveness.

Global trade imbalances are persistent current-account surpluses in some economies mirrored by deficits elsewhere. They link trade flows to international borrowing, lending and asset ownership.

Significance depends on duration, the balance as a share of GDP, reserve holdings, currency denomination, what financing funds and whether adjustment is orderly. Capital-goods imports that raise future capacity can make a deficit more sustainable than consumption financed by unstable short-term inflows.

An exchange rate is the price of one currency in terms of another. Regimes differ by how that price is determined and how strongly authorities commit to influence it.

A floating rate can still be influenced by interest rates or intervention; it is managed only when authorities deliberately steer it. A fixed rate may be adjusted officially but is not continuously market-clearing.

Intervention can be limited by finite reserves, speculative pressure and conflict with inflation, growth, employment or financial-stability goals. Interest-rate effects depend on relative rates, risk and expectations; QE does not mechanically set an exchange rate.

To support a falling peso against the dollar, a central bank can sell dollars and buy pesos. The transaction simultaneously increases demand for pesos and supplies dollars.

A floating currency appreciates when demand rises relative to supply and depreciates when demand falls or supply rises. Each factor works through trade or capital flows and expectations.

Both revaluation and appreciation mean that a currency buys more foreign currency. The difference is the exchange-rate regime and the cause of the rise.

If a floating rate moves from 1 domestic unit buying $0.80 to$0.90, it appreciates. If a government changes a fixed parity from $0.80 to$0.90, it revalues the currency.

Both devaluation and depreciation mean that a currency buys less foreign currency. The difference is whether the fall is an official parity decision or a market movement.

If a floating currency falls from $1.20 to$1.05 per domestic unit, it depreciates. If an authority lowers a fixed parity by the same amount, it devalues the currency.

A depreciation makes exports cheaper to foreign buyers and imports dearer domestically; appreciation reverses these price effects. Quantities, contracts, capacity and expectations determine the final outcome.

Appreciation tends to weaken net exports, growth and employment but lowers import costs and inflationary pressure. It can also make foreign assets cheaper for domestic investors.

A competitive depreciation or devaluation is an attempt to lower a currency to gain export price competitiveness and redirect demand towards domestic output, sometimes described as a beggar-thy-neighbour policy.

If many countries try to depreciate together, they cannot all improve relative competitiveness. Repeated intervention can create currency conflict, volatile capital flows, protectionism and weaker international cooperation.

International competitiveness is an economy's ability to sell goods and services in world markets on price and non-price terms while sustaining productive performance. The syllabus measures focus on relative, not absolute, performance.

If wages rise 3% while productivity rises 5%, unit labour cost tends to fall. If productivity falls with unchanged wages, unit labour cost tends to rise and firms may raise export prices.

The factors interact: high wages can coexist with strong competitiveness when productivity and non-price quality are high, while depreciation cannot repair weak infrastructure or unreliable products.

Assess goods and services separately and compare with trading partners. A domestic improvement is not a relative gain if competitors improve faster.

Infrastructure, health, innovation and reduced administrative delay can reinforce the specified policies by improving productive reliability and non-price performance.

Choose measures to match the diagnosed weakness and compare short-run price effects with long-run productivity and quality. A coordinated package may work better than an isolated subsidy or exchange-rate move.

An internationally competitive economy can sustain demand for its goods and services against foreign alternatives. Significance runs through exports, investment, productivity and employment, not ranking tables alone.

Benefits depend on productive capacity, income distribution, import content and environmental costs. Strong domestic demand, services or capital inflows can make a temporary trade deficit manageable, while export success based only on low wages may not raise living standards.