IB Economics SL 4.5 Exchange rates Question Bank

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Boom or bust

(1) The freely floating Australian dollar has been appreciating, creating winners and losers. Australian tourists overseas are getting bargain hotel rooms while some local exporters are suffering huge falls in demand. The appreciation of the Australian dollar gives a good reason to foreign students not to study in Australia. But as the Australian dollar continues to gain strength it seems that the economy is coping with the appreciating currency better than many economists expected.

(2) Australia's exports are dominated by minerals, energy and agricultural products, and all are enjoying record prices. Continued strong demand means that the exporters of these products have not needed to look for other markets. For example, coal and iron ore prices have more than doubled in the last two years, these commodity prices rising even more quickly than the appreciating currency.

(3) The Australian dollar is only one factor affecting exporters, and at the moment the strong economic growth of the Asian economies is adding to the increasing demand for Australian commodities.

(4) However, not everyone in Australia is happy. Service industries have not enjoyed an increase in the price of their output, nor have they enjoyed booming foreign demand. The problems with the appreciating Australian dollar are most evident in the fact that fewer students and tourists are coming to Australia. Manufacturers have a similar problem and are suffering from the results of the rising Australian dollar and increased domestic interest rates.
5 The higher Australian dollar has provided many indirect benefits. By making imported resources cheaper, it has reduced the inflationary pressures which were caused by the economic boom that gave consumers greater spending power. As a result, it allowed the Australian government to slow down the interest rate increases which it was imposing in order to tackle inflation.

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Argentina's currency keeps falling

(1) The year 2018 started badly for Argentina when the worst drought in 50 years negatively affected its export revenues from maize and soybeans, both important exports. The economy suffered several additional problems: a stronger United States dollar (US$), international investors selling Argentinian assets due to a lack of confidence in the economy, rising inflation from 25 % to nearly 50 % (Figure 1) and a significant depreciation of the peso, Argentina's currency (Figure 2).

(2) When Argentina's president was elected in 2015, inflation was at 25 %. He gave the central bank freedom to raise interest rates, which encouraged foreign investors to buy government bonds. The government had borrowed a lot of money from overseas to finance the persistent budget deficit, but by 2018, foreign investors were interested in other markets.

(3) As the peso was overvalued in 2015, it kept demand for imports high and made it hard for exports to compete. The current account deficit rose to more than 5 % of gross domestic product (GDP) but slowly narrowed in 2018, because the president allowed the peso to float freely.

(4) In May 2018, in an attempt to control the inflation rate and stop the fall in the peso's value, the Argentinian central bank raised interest rates to 40 %. In addition, it started selling foreign currency reserves. However, there were concerns that if the selling of foreign currency reserves continued, they would be depleted quickly. To address this concern, the president negotiated a US$50 billion loan from the International Monetary Fund (IMF). Yet the peso continued to fall. The IMF loan means that most of Argentina's debt-servicing requirements are covered until 2020. However, under IMF loan conditions, the budget deficit must be cut by postponing infrastructure projects, subsidies must be cut, and government jobs must be cut.

(5) A spokesperson from the IMF said "Argentina has a floating, market-determined exchange rate, and the IMF fully supports that. The exchange rate should continue to be determined by market forces."

(6) The peso's weakness causes imported oil prices to go up, further raising inflation. The falling real incomes of households combined with higher interest rates will affect the economy negatively, possibly leading to a recession. Interest rates will remain high for some time, discouraging investment. Economists expect Argentina to fall into recession, for the fifth time in a decade.

Gallas, G., 2018. Why confidence in Argentina's economy is dwindling. BBC, available at: https://www.bbc.co.uk/news/world-latin-america-44107630

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Text A - Overview of Uruguay

(1) With a population of only 3.5 million, Uruguay is one of the smallest nations in South America. Its membership of the MERCOSUR common market allows Uruguayan producers tariff-free access to 290 million consumers in Argentina, Brazil and Paraguay.

(2) Agriculture accounts for 8 % of Uruguay's gross domestic product (GDP) and 65 % of its export revenue. Exports have increased since the early 2000s, partly due to China's rising demand for commodities. In particular, Uruguay's soybean producers benefitted from significantly higher prices during the commodity boom. China is now Uruguay's most important export destination, with soybeans accounting for over 50 % of its exports to China.

(3) Uruguay's real GDP increased by an average of 5.39 % per year from 2005 to 2014. However, the economy slowed considerably when the commodity boom ended in 2015. It slowed further because of decreased regional demand when the largest members of MERCOSUR, Argentina and Brazil, faced a recession in 2017. Uruguay's real GDP grew on average by 1.04 % per year from 2015 to 2018.

(4) With the increasing importance of China and the European Union (EU) as export markets, Uruguay has managed to reduce its dependency on MERCOSUR. However, attempts to diversify its exports away from agriculture have not been successful. The end of the commodity boom contributed to a fall in export revenue and the depreciation of the peso (Uruguay's currency). The currency has lost over 25\% of its value since 2015.

(5) Inflation stayed at a relatively high rate of 8 % in 2018 due to the weaker currency. The unemployment rate also increased to 7.9 % as a result of the economic slowdown. The higher cost of living and the lower rates of employment could inhibit efforts to reduce inequality and poverty levels.

(6) Despite rising inflation and unemployment, Uruguay's minimal corruption, abundant natural resources and access to a large common market continue to attract foreign direct investment (FDI). Investments in the paper and wood industries have made forestry one of the country's fastest growing industries. Increased FDI inflows have also prevented the peso from depreciating further.
Text B - The EU-MERCOSUR free trade agreement

(1) The EU and MERCOSUR are finalizing the terms of a free trade agreement, which would enable Uruguay to increase its exports to the 27 EU member states. The EU currently buys 11 % of all Uruguayan exports, mostly animal products, paper, vegetables and wood.

(2) Once the free trade agreement comes into effect, almost all agricultural and industrial tariffs between the EU and MERCOSUR will be removed. The imports of beef, poultry and sugar will not be included in the list of tariff-free products but will be subject to very large quotas. This will allow increased exports of these products to EU countries.

(3) The free trade agreement may cause bankruptcies in the manufacturing sector and higher structural unemployment in Uruguay. EU exports to Uruguay largely consist of manufactured goods, such as chemicals, machinery, transport equipment and plastics, which are in high demand despite the current tariffs of up to 35 %.

(4) One third of FDI into Uruguay comes from the EU. Anticipation of the free trade agreement has led to more EU investments in Uruguay's forestry sector. Environmental organizations have warned that the free trade agreement could be a threat to sustainability as South American forests are cleared to create land for cattle farming, paper and wood production. The deforestation might also disrupt water sources that supply rural villages, depriving the villagers of clean water.
Text C — Uruguay seeks trade agreements outside MERCOSUR

(1) Members of MERCOSUR have differing views on trade policies. Brazil, Paraguay and Uruguay believe in trade liberalization and want to increase competition through a reduction of the common external tariff. On the other hand, Argentina wants to maintain the high external tariff to protect industries from cheap imports from China and to avoid prolonging its current recession.

(2) Uruguay has expressed its desire to seek trade agreements apart from MERCOSUR, which is prohibited by the common market's rules. If Uruguay pursues separate bilateral agreements, it is likely to lose its MERCOSUR membership and the benefits of any existing free trade agreement.

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Japan in first trade gap since 1963

(1) Japan's current account surplus fell 85.5 % in November 2011 from a year earlier to 138.5 billion Japanese yen (Japan's currency) ( $ 1.80 billion), the Ministry of Finance said. In 2011, Japan recorded its first deficit in its balance of trade in goods since 1963.

(2) The appreciation of the Japanese yen against the dollar has reduced Japan's current account surplus. The Japanese yen gained 8.5 % against the dollar in the 12 months since January 2011. The currency has acquired a new and unusual status as a safe haven, reinforced by the eurozone debt crisis since international investors are concerned about the single European currency.

(3) It is estimated that a 1 % gain in the Japanese yen could reduce the export volumes by 0.34 %, slowing down growth for a country that has relied on overseas demand to maintain its recovery from March 2011's earthquake. To stop the trade in goods deficit from getting worse, the world economy would have to grow by 4 % and the value of the Japanese yen would have to fall by 5 %. It is unlikely that this will happen.

(4) With their rapidly aging and decreasing population, Japanese firms face severe challenges and have little choice but to look abroad for growth. The Japanese yen's appreciation to record highs against the euro and relative strength against the US dollar has led to a boom in outward foreign direct investment (FDI). Exporters are transferring their operations from Japan to other economies, where parts and labour costs are lower.

(5) Japan's current account surplus could move into a deficit sooner than 2015 if more companies shift production abroad to combat losses from a strong Japanese yen. In 2011 Japanese firms purchased a record number of firms across the rest of Asia. Worldwide the number of Japanese purchases reached 455, only just short of its record of 463 in 1990.

(6) Japanese firms are also acquiring shares in natural resource companies. Mitsubishi spent more than $ 5 billion buying a quarter of mining giant Anglo-American's Chilean copper unit, and trading group Itochu bought a $ 1 billion stake in a US oil and gas firm.

(7) The Japanese Prime Minister has encouraged the trend. "We will take advantage of the appreciating Japanese yen to support Japanese companies in purchasing foreign companies and acquiring resource interests," he said.

(8) However, Japanese authorities have signalled there are concerns about a further appreciation of the Japanese yen. The central bank said last month that it plans to increase the funds available for currency intervention.

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Latvia to join the eurozone monetary union

(1) Latvia will become the 18th country to adopt the euro after being approved for membership by the European Commission. The country has met the criteria for eurozone membership, including low inflation, low long-term interest rates, a stable exchange rate, low public debt and low budget deficits.

(2) Latvia joined the European Union (EU) customs union in 2004. This resulted in a large increase in the availability of credit and strong economic growth in Latvia. However, the 2008 global financial crisis resulted in the collapse of one of its leading banks and massive economic instability. Economic output fell by about 20 % and Latvia had to accept a bailout (loans) from the International Monetary Fund (IMF) and the EU.

(3) Latvia kept the lat (the Latvian currency) pegged to the euro throughout the crisis. At the time, some economists argued that devaluation would have been a better way to improve the economy. However, Latvia followed the path of other countries such as Greece and Ireland, and chose to improve competitiveness through austerity measures. This involved increasing direct taxes and cutting government spending and public sector wages.

(4) By late 2010, the economy was growing again and Latvia had repaid the loans to the IMF and the EU. In 2012, the economy expanded by 5.6 %, the fastest of any country in the EU, although output was still 12 % below its pre-crisis peak. In addition unemployment was falling, but it remained high at 12.4 %.

(5) For Latvia, which shares a border with Russia, the attraction of the euro is about economics and security. Entering the eurozone in January 2014 is part of a process of shifting away from the influence of Russia, and following its northern neighbour Estonia which joined the eurozone in 2011. Lithuania hopes to join the eurozone in 2015.

(6) Public support for joining the eurozone has been low. Evidence from one survey suggests that a small majority of Latvia's population opposes membership, fearing that prices will rise and Latvians will be drawn into the problems facing Europe's struggling economies.

(7) Nonetheless, there are signs that support is growing. The Latvian prime minister said that "switching to the euro will help economic growth and bring increased foreign investment. Unlike countries that can afford to ignore the euro and additional integration, Latvia cannot easily stand on its own. This is good news, not only for Latvia, but also for the eurozone. It shows that there is still confidence in the single currency".
www.theguardian.com, 16 July 2013]

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The Australian dollar

(1) The Australian dollar is very strong against the United States (US) dollar and has reached its highest value against the British pound and the euro since 1992.

(2) The world demand for coal, iron ore, and natural gas is rapidly increasing. Australia has these resources in abundance. This has led to an extraordinary boom in the construction of new mining facilities in Australia that is likely to run for at least 10 years. It has had a huge effect on domestic economic growth and has also threatened inflation.

(3) With its stable economic outlook and high interest rates, Australia has proved to be a magnet for foreign investors since 2002, and this has had a significant impact on the exchange rate. The global surge in foreign direct investment and portfolio investment is a sign of international confidence in the economy but it has come at a cost, and with risks. The rise of the exchange rate has created hardships for domestic exporters of goods and services other than resources, and the tourist industry.

(4) In the context of the resources boom, the high exchange rate helps to make the boom less inflationary. It also lowers the prices of imports for those consumers and businesses that buy them.

(5) Structural change is occurring in the Australian economy as domestic firms adjust to a high Australian dollar. It creates pressure for resources - capital and labour - to shift from manufacturing and service export industries to the expanding mining sector. The result is a change in Australia's comparative advantage.

(6) Everything suggests that the Australian dollar will stay strong, even as export prices increase. The huge spending on mining construction over the years will require a lot of foreign financial capital to flow into Australia, helping keep upward pressure on the exchange rate. and "Aussie Bond Appeal comes at cost", The West Australian, 27 January 2012]

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Text A — Overview of North Macedonia

(1) North Macedonia is a small, landlocked nation that shares borders with five countries, including Bulgaria and Greece. Bulgaria and Greece are members of the European Union (EU) common market, which North Macedonia hopes to join soon. Since the country began negotiating for EU membership, trade with the EU has increased rapidly and now accounts for 75 % of North Macedonia's exports and 62 % of its imports.

(2) Despite its small market, with a population of approximately 2 million, North Macedonia's proximity to the EU, low wages and expected entry into the common market have attracted foreign investors. Greece, its richest neighbour, was its third highest source of foreign investment in 2019. The lower cost of living also appeals to Greek tourists.

(3) EU companies have invested in the financial, telecommunication, energy and food processing industries in North Macedonia. Many of the most profitable companies are from the EU. If EU membership is granted, foreign direct investment (FDI) inflows may increase as firms located in North Macedonia will be allowed to bypass all custom checks and enjoy tariff-free trade within the common market. One particular challenge for North Macedonia, however, is that most of the profits of foreign companies are likely to be repatriated (sent back to the companies' home countries).

(4) In 2018, North Macedonia's export revenue was US $ 7.57 billion and its import expenditure was US$9.56 billion. The country's main exports are iron and steel, clothing and accessories, and food products. Food, livestock and consumer goods account for 33 % of imports while the remainder are machinery, petroleum and other materials needed for the industrial production process.

(5) The manufacturing sector, which now employs 31 % of the labour force, has gained more importance. The agricultural sector remains strong, contributes over 10 % of North Macedonia's gross domestic product (GDP) and employs about 16 % of the country's workforce.

(6) The unemployment rate decreased from over 30 % in 2010 to 17.3 % in 2019. However, youth unemployment is almost 40 %. Over 20 % of the population lives below the poverty line. Unemployment and poverty contribute to high rates of emigration. More than 20 % of the North Macedonian population have emigrated since 1994, mostly to the EU. As a member of the EU, North Macedonia will enjoy free movement of labour which will make it easy for its citizens to live and work in other EU countries.
Text B - North Macedonia's economic reforms

(1) To be considered for EU membership, North Macedonia implemented a series of supply-side policies to reform its economy. The EU imposes strict requirements for membership but provides financial assistance to countries preparing for membership. North Macedonia has received 633 million euros (the currency of the EU) to help with the reforms.

(2) Most of the supply-side policies seek to improve the international competitiveness of North Macedonia's industries. The authorities are increasing access to education and training for workers. The expansion of the transport network and other infrastructure is also expected to increase efficiency.

(3) Protection of the environment is also on the list of requirements for EU membership. North Macedonia aims to reduce its dependence on coal and to instead promote the use of solar, wind and hydropower technologies. These low-carbon energy sources would help decrease its air pollution, which is among the worst in Europe.

(4) The reforms, which started in 2014, have shown progress. Exports and manufacturing output are more diversified and more concentrated on high-value products. To attract FDI, North Macedonia maintains one of the lowest tax rates on corporate income in the region. The central bank also prevents the denar (North Macedonia's currency) from appreciating against the euro through managing foreign reserves. However, skill shortages and a mismatch of skills with those required by companies discourage foreign firms from investing. Important investment gaps in public infrastructure also remain.
Text C - North Macedonia's trade agreements
North Macedonia participates in five free trade agreements (FTAs), that together cover 95 % of its exports and 78 % of its imports. Most of its trade with the EU is already free but imports of wine, beef and fish products are still subject to quotas. North Macedonia is currently a net importer of agricultural and food products. All protectionist measures on EU products would be removed upon entry into the common market.

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Text A — Bangladesh: the economic role of women

(1) Bangladesh is a densely populated country in Asia. Its currency is the Bangladeshi taka (BDT). The annual rate of growth of gross domestic product (GDP) has steadily increased from 5.6 % in 2010 to 8.1 % in 2019. Absolute poverty has declined, but inequality has risen, partly due to higher unemployment rates for women than men. Moreover, the labour force participation rate for women is much lower than the rate for men. Over 80 % of the women's jobs are in the informal economy, and these jobs are low paid and insecure. Women need regular paid work, which not only raises household income but also improves economic well-being in terms of education and health.

(2) The structure of the economy is changing. The growth of cities is due to the expansion of the manufacturing sector, which now contributes a larger share to GDP than the agricultural sector. These changes have increased the number of women in the labour force. In particular, the growth of the ready-made garments (RMG) industry (mass-produced clothing) has given women the opportunity to move into formal employment. The RMG industry provides jobs for almost 4 million low-skilled and semi-skilled workers, accounting for over 40 % of total manufacturing employment. The majority of these jobs are being filled by women, with the result that the gap between the wages of men and women is gradually being reduced.

(3) There are concerns about working and safety conditions in the RMG factories. After an accident in a factory in 2013, reforms are being implemented, partly in response to criticisms from overseas retailers and consumers who purchase the garments. The minimum wage has been increased, inspections are carried out, and there are fewer small, unsafe factories.

(4) While working conditions are improving, such reforms raise the costs of manufacturing garments. Furthermore, the international garment market is becoming more competitive, putting pressure on Bangladeshi factories to reduce costs.

(5) The overseas demand for Bangladeshi garments had been rising strongly until 2019. However, demand has recently fallen, reducing firms' revenue. The reduction in revenue and the need to lower costs have forced certain firms to reduce the size of their labour force by dismissing some of their female workers.

(6) The number of ethically and environmentally concerned consumers is increasing globally. Rather than trying to lower costs, firms can be more successful if they produce "green ready-made garments" by implementing sustainable practices. About 100 garment factories in Bangladesh have already been certified as producers that meet specified environmental standards. In addition, global retailers and fashion brands are supporting recycling initiatives through the Circular Fashion Partnership.
Text B - Trade prospects for exports of ready-made garments (RMG)

(1) Exports of RMG account for over 84 % of Bangladesh's total exports. At present, Bangladesh is the world's second largest garment exporter after China. Bangladeshi exports could further increase as Chinese garments become more expensive due to rising wages in China.

(2) Bangladesh is designated as an Economically Least Developed Country (ELDC) and is therefore able to sell goods in Europe and China without any quotas or tariffs being imposed. However, Bangladesh will graduate from ELDC status by 2026 and will then no longer be eligible for preferential trade agreements. Moreover, the USA, which is the largest export market for Bangladeshi garments, has applied a 15 % tariff on imports from Bangladesh since 2013, citing concerns about working conditions in factories.
Text C - Role of foreign direct investment in the RMG sector

(1) Vietnam and Myanmar have significantly increased their garment exports to China due to foreign direct investment (FDI) from China. Chinese investors have set up factories that import raw materials from China and re-export the finished goods back to China.

(2) Consequently, to compete successfully in the huge Chinese market, Bangladesh needs to attract more FDI from China. Bangladesh is developing the required infrastructure, such as transport links. It is also necessary to diversify into expensive high-end fashion, market more aggressively, and use branding strategies.

(3) The funds from additional FDI would be helpful, because the relative contribution of Official Development Assistance (ODA) to Bangladesh's budget is declining. Furthermore, the foreign exchange obtained from foreign investors assists in financing the current account deficit.

*estimate

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South Africa's grain millers oppose corn tariff

(1) A battle is taking place between South African corn farmers and the corn millers who process corn. Grain South Africa (Grain SA) is the organization that represents the interests of corn farmers. It has asked the country's International Trade Administration Commission (ITAC) to protect local corn farmers from low global corn prices by imposing a tariff on corn imports.

(2) South Africa's corn millers are opposing the request by Grain SA to implement the tariff on corn imports. The corn millers argue that a tariff will cause a burden for consumers and cattle farmers. In South Africa, corn is an essential food and also a source of feed for livestock.

(3) According to Reuters news service, South Africa is "Africa's largest corn producer and is relied upon by neighboring Sub-Saharan nations to [reinforce] their own corn supplies and feed their people." A drought in South Africa has dramatically increased the price of corn. In addition, the reduced supply has prompted the need for imports. "South Africa [has traditionally been] a net exporter of corn ... [but] for the second year in a row, [the economy] will become a net importer of corn." The need to import corn has shocked both the corn farmers and the government.

(4) The United States (US) is the world's largest corn producer. An unusually large harvest has increased US supply and more than halved the price of US corn to its current price of US$145 a ton. However, in South Africa, because of the drought, prices for domestically produced corn have more than doubled to reach an all-time high of US$348 a ton. The low import prices of US corn have made it very difficult for South African corn farmers to earn sufficient income to survive the drought, which is why they have asked ITAC for protection.

(5) However, a spokesperson for the corn millers said "we are strongly opposed to any attempt to apply a tariff. Why do we need protection for a commodity in which we are so self-sufficient?" However, Grain SA have claimed that corn farmers cannot compete with the big corn-exporting countries, such as the US and Mexico, because their governments are subsidizing corn farmers. According to Grain SA, South African farmers get almost no assistance. This is why they have requested that ITAC implement the tariff to protect corn farmers from these unfair trade practices.

(6) According to economists, South Africa will probably need to import about 970000 tons of corn this year and a further 3.8 million tons in the following 12 months. To make matters worse, the rand (South Africa's currency) has experienced a sharp depreciation against the US dollar. Combined, the need to import corn and the depreciation are likely to negatively impact South Africa's current account. Van Vuuren, http://www.bloomberg.com/news/articles/2016-02-21/grain-millers-oppose-south-african-corn-import-tariff-review, accessed 28 August 2016, used with permission of Bloomberg L.P. Copyright©2017. All rights reserved, and "South Africa's corn crop dilemma and the likely fixes: Braun," by Karen Braun, 8 April 2016, reuters.com, © 2016 reuters.com, http://www.reuters. com/article/us-safrica-maize-braun-corn-idUSKCN0X51QY. All rights reserved.]
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New Zealand dollar overvalued

(1) The New Zealand finance minister said the exchange rate of the New Zealand dollar (NZD), is "unsustainably high; it is somewhere between 10 % to 15 % overvalued".

(2) The NZD had been near its record high against the US dollar before weakening last week on slower inflation figures and a fall in dairy prices. The NZD has gained about 6 % so far this year.

(3) However, the finance minister said that New Zealand exporters had developed strength because of the high currency. "New Zealand is actually in reasonably good shape," he said. "We have had an export sector operating with a strong exchange rate now for five or six years and that has had an impact on efficiency."

(4) An economist said recently that the central bank might consider intervening in the currency market to achieve a depreciation in the value of the NZD.
5 The Reserve Bank (central bank) governor raised the official interest rate for the fourth time this year to 3.5 % at a time when other major economies have their rates at record low levels.

(6) He said that, "Encouragingly, the economy appears to be adjusting to the monetary policy tightening that has taken place since the start of the year. It is important that inflation expectations remain contained. This interest rate increase will help keep future average inflation near the 2 % target and ensure that the economic expansion can be sustained".

(7) New Zealand's economy is expected to grow at an annual pace of 3.7 % over 2014. New Zealand government figures showed a monthly trade (in goods) surplus of $ 247 million in June 2014 compared to $ 371 million in June 2013. The annual trade (in goods) balance turned to a surplus of $ 1.2 billion from a deficit of $ 819 million a year earlier.

(8) Global demand for New Zealand dairy products has been a key support for the country's exports over the past 18 months, though prices have dropped this year with increased supply.
> "Dollar dives after reserve bank lifts rate to 3.5 pc", The New Zealand Herald, 24 July 2014; and "NZ dollar slides to six-week low after rate hike", The New Zealand Herald, 24 July 2014]