Balance of payments Paper 2

IBDP Economics  HL – The global economy – Balance of payments -Paper 2 Exam Style Practice Questions

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Balance of payments Paper 2? 

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Exam Style Question for IBDP Economics HL- Balance of payments -Paper 2

Current account deficit poses a challenge to Pakistan’s economy

  1. The president of Pakistan has expressed his concern at the significant increase in Pakistan’s current account deficit. The current account deficit grew to US$12.12 billion in the fiscal year of 2016/17 compared to US$4.86 billion in 2015/16. The deficit was caused by rising imports and falling exports. The increasing current account deficit may result in Pakistan having to request a new International Monetary Fund (IMF) loan to fund the deficit. To avoid this, the president is proposing that the importing of luxury, non-essential items needs to be reduced.

  2. The governor of Pakistan’s central bank agreed with the president’s concern. He said that the “rapidly growing current account deficit is the biggest challenge facing the country’s economy”. He agreed that the problem is made worse because many non-essential imports are being purchased, which requires borrowing from abroad. However, he stressed that while rising non-essential imports are a problem, “32 % of imports are capital goods” and are necessary for the continued growth of small to medium enterprises (SMEs), agriculture, housing and construction.

  3. Central bank advisors have also recommended depreciating the rupee (Pakistan’s currency) to reduce the trade deficit. The value of the rupee is currently controlled through a managed exchange rate system. It has been suggested that the rupee is overvalued by as much as 20 %. However, the central bank governor claims that a “depreciation has a number of negative effects”.

  4. In 2016, Pakistan’s economic growth reached 5.3 %, its highest point for 10 years. The government has estimated that it will be 6 % in 2017. According to the central bank governor, loans to SMEs are currently only 7 to 8 % of all loans to businesses in Pakistan. He believes that if loans to SMEs were increased to 15 to 17 % of all loans to businesses in Pakistan, there would be even higher economic growth.

  5. Along with the current account deficit, fiscal policy decisions have also led to a significant budget deficit. The budget deficit increased in 2016, resulting in greater public debt. The central bank recommends the government’s debt to be limited to 60 % of gross domestic product (GDP).

Question

Explain the difference between a current account deficit and a budget deficit (paragraph [5]).

▶️Answer/Explanation
For an explanation that a current account deficit is when the net flow of money/value from trade in goods and services and income flows and/or transfers is negative AND an explanation that a budget deficit occurs when government spending is greater than government revenues.

Current account deficit poses a challenge to Pakistan’s economy

  1. The president of Pakistan has expressed his concern at the significant increase in Pakistan’s current account deficit. The current account deficit grew to US\($\)12.12 billion in the fiscal year of 2016/17 compared to US\($\)4.86 billion in 2015/16. The deficit was caused by rising imports and falling exports. The increasing current account deficit may result in Pakistan having to request a new International Monetary Fund (IMF) loan to fund the deficit. To avoid this, the president is proposing that the importing of luxury, non-essential items needs to be reduced.

  2. The governor of Pakistan’s central bank agreed with the president’s concern. He said that the “rapidly growing current account deficit is the biggest challenge facing the country’s economy”. He agreed that the problem is made worse because many non-essential imports are being purchased, which requires borrowing from abroad. However, he stressed that while rising non-essential imports are a problem, “32 % of imports are capital goods” and are necessary for the continued growth of small to medium enterprises (SMEs), agriculture, housing and construction.

  3. Central bank advisors have also recommended depreciating the rupee (Pakistan’s currency) to reduce the trade deficit. The value of the rupee is currently controlled through a managed exchange rate system. It has been suggested that the rupee is overvalued by as much as 20 %. However, the central bank governor claims that a “depreciation has a number of negative effects”.

  4. In 2016, Pakistan’s economic growth reached 5.3 %, its highest point for 10 years. The government has estimated that it will be 6 % in 2017. According to the central bank governor, loans to SMEs are currently only 7 to 8 % of all loans to businesses in Pakistan. He believes that if loans to SMEs were increased to 15 to 17 % of all loans to businesses in Pakistan, there would be even higher economic growth.

  5. Along with the current account deficit, fiscal policy decisions have also led to a significant budget deficit. The budget deficit increased in 2016, resulting in greater public debt. The central bank recommends the government’s debt to be limited to 60 % of gross domestic product (GDP).

Question

Using information from the text/data and your knowledge of economics, discuss the effects of the increasing current account deficit on Pakistan’s economy.

▶️Answer/Explanation

Responses may include:

  • definition of current account deficit (paragraph [1]) / reference to (c).

Positive effects:

  • imports of capital can lead to increased economic growth in the long run (paragraph [2])
  • high imports of non-essential goods may indicate development and higher living standards (paragraph [1]) suggests consuming outside of PPC
  • Pakistan may have to depreciate the currency as advised by central bank. This will reduce the relative price of exports and may allow to improve Pakistan’s export competitiveness (paragraph [3]).

Negative effects:

  • may require “new IMF” loan and conditions that are attached regarding austerity (paragraph [1])
  • persistent trade deficit may compromise “decade high” economic growth (paragraph [4])
  • inflows on financial account increase, meaning foreign debt payments will increase and worsen current account deficit
  • downward pressure on the exchange rate requiring use of foreign exchange reserves to maintain managed float (paragraph [3])
  • may be forced to “depreciate” the rupee which will:
  • increase import prices and may cause cost-push inflation
  • reduce export revenues – Marshall-Lerner condition
  • IMF loans to finance current account deficit (paragraph [1]) will require interest payments that may worsen the budget deficit (paragraph [5])
  • foreign investors may be purchasing Pakistan assets to finance the deficit which could threaten sovereignty
  • current account deficit may worsen Pakistan’s credit rating
  • it may be unsustainable to finance the current account deficit by borrowing. If foreign investors lose confidence, there may be a rapid outflow of financial capital resulting in a rapid fall in the value of the rupee
  • fiscal policy (paragraph [5]) decisions may have to be addressed to help with the deficit. In this case, moving from expansionary to contractionary. This may reduce economic growth.

Turkey’s rising current account deficit

  1. According to forecasts from the International Monetary Fund (IMF), Turkey’s current account deficit is expected to rise from 4.4 % of gross domestic product (GDP) in 2016 to 5.6 % of GDP in 2017, with real GDP growth falling from 3.3 % in 2016 to 2.9 % in 2017. The current account deficit is perceived to be the biggest problem for Turkey’s economy. An international credit agency has reduced Turkey’s credit rating to “negative” because risks to the country’s credit profile have risen significantly in recent months.

  2. Economic activity has been further damaged by several factors, including political uncertainty, conflicts in neighbouring countries and trade protection by its trading partners. Turkey’s tourism revenues, which contribute 10 % to the country’s GDP, have fallen significantly due to security concerns related to terrorist attacks.

  3. The current account deficit has contributed to a massive depreciation of the Turkish lira (Turkey’s currency), which dropped by 20 % against the United States dollar (US\($\)) over the previous year. This is a significant problem for Turkey, which relies on a steady inflow of overseas investment to finance its current account deficit.

  4. Part of the problem is Turkey’s dependence on imports, especially energy. Higher import costs for energy will further worsen Turkey’s current account deficit and create further pressure on inflation (Figure 4).

  5. The Turkish government has blamed the currency collapse on speculators. The president of Turkey has asked Turkish citizens to help. There is approximately US\($\)140 billion worth of foreign currency being held in foreign currency savings accounts in Turkey. The president wants Turkish people to use their foreign currency saving to support the Turkish lira. However, Turkish citizens seem to have ignored his wishes, and bought US\($\)1 billion worth of foreign currency in September 2018.

  6. Analysts believe that the only solution to the falling value of the Turkish lira and the current account deficit is an increase in the official interest rate by the central bank. However, Turkey’s president has made it clear that he will not accept higher interest rates. In fact, he has demanded lower interest rates to stimulate the economy.

Question

Using information from the text/data and your knowledge of economics, discuss the implications of Turkey’s persistent current account deficit.

▶️Answer/Explanation

Responses may include:

  • Definition of current account deficit.

Economic analysis may include:

  • AD/AS theory.
  • Exchange rate market.
  • Elasticities.

To explore the impact on:

  • Current account is expected to grow to 5.6 % of GDP and is seen to be Turkey’s biggest economic problem (paragraph [1]).
  • Could become even worse if the current security and political problems continue and the tourism industry continues to suffer, affecting net exports negatively.
  • Causing a depreciation of the lira (paragraph [3]), which could worsen cost-push inflationary pressures (Figure 1).
  • The deficit has to be financed on the financial account of the balance of payments (paragraph [3]).
  • If the current account deficit is financed through FDI, it means greater foreign ownership of Turkish assets, which may be a threat to sovereignty.
  • Turkey is vulnerable to outflows of investment (paragraph [3]).
  • Turkey may need to increase interest rates to attract foreign savings (paragraph [6]) but this may further damage the economy through a possible fall in AD.
  • Turkey may need to borrow money to finance the current account deficit, leading to increased indebtedness.
  • The current account deficit may have contributed to the worsening in the credit rating (paragraph [1]), which will make it more difficult for Turkey to attract investment, and make it more costly to borrow.
  • Falling currency due to current account deficit will make it more expensive to repay debts.

South Korea’s current account surplus

  1. South Korea, Asia’s fourth-largest economy, has experienced a current account surplus since 2012. South Korea’s large working-age population, which tends to save a large portion of its income for retirement, contributes to the surplus. The South Korean government has expressed concerns about the impact of the high savings on domestic demand and the level of imports. However, it has been predicted that as the population ages the surplus will gradually disappear by 2042.

  2. The South Korean won (South Korea’s currency) recorded the second highest appreciation against the United States dollar (US\($\)) in 2017 among currencies of the G20* nations. The current account surplus, the improved economic conditions and the expectations of an interest rate rise have all helped increase the South Korean won’s value.

  3. The South Korean won officially operates under a floating exchange rate system, but the central bank would intervene if there were major fluctuations in the market that needed to be managed. The US is monitoring the exchange rate policy of South Korea due to the significant trade imbalance between the two countries. If the US identifies that a major trading partner like South Korea tries to limit an appreciation of its currency, then the US may consider tariffs to reduce the imbalance.

  4. South Korea’s financial account in the balance of payments recorded a deficit of US\($\)13 billion in 2018, as Koreans have invested extensively in other countries. Furthermore, foreigners have been reluctant to invest in South Korea due to the trade disputes and the potential of a trade war erupting between the US and China. The US and China are South Korea’s largest trading partners, and South Korea, with its export oriented economy (exports amount to 43 % of gross domestic product [GDP]), is sensitive to external demand shocks.

  5. South Korea’s domestic investment in key areas (such as manufacturing, construction and machinery) fell during 2018, and GDP grew by less than expected. Additionally, private consumption increased only by 0.3 % in 2018, the slowest growth for 4 years. There is also concern about the level of unemployment, especially the high rates of youth unemployment.

  6. Normally, in a situation of low growth, the central bank would implement expansionary monetary policy. However, the US Federal Reserve (the central bank of the US) and the European central bank are considering monetary tightening. If the South Korean central bank does not raise interest rates in line with the US and the European Union it runs the risk that the South Korean won may depreciate. Therefore, the South Korean government has begun discussions on using fiscal policy to help revive the job market and support domestic demand.

Question

List two components of the financial account (paragraph [4]).

▶️Answer/Explanation
Two components:
  • direct investment
  • portfolio investment
  • reserve assets.

South Korea’s current account surplus

  1. South Korea, Asia’s fourth-largest economy, has experienced a current account surplus since 2012. South Korea’s large working-age population, which tends to save a large portion of its income for retirement, contributes to the surplus. The South Korean government has expressed concerns about the impact of the high savings on domestic demand and the level of imports. However, it has been predicted that as the population ages the surplus will gradually disappear by 2042.

  2. The South Korean won (South Korea’s currency) recorded the second highest appreciation against the United States dollar (US\($\)) in 2017 among currencies of the G20* nations. The current account surplus, the improved economic conditions and the expectations of an interest rate rise have all helped increase the South Korean won’s value.

  3. The South Korean won officially operates under a floating exchange rate system, but the central bank would intervene if there were major fluctuations in the market that needed to be managed. The US is monitoring the exchange rate policy of South Korea due to the significant trade imbalance between the two countries. If the US identifies that a major trading partner like South Korea tries to limit an appreciation of its currency, then the US may consider tariffs to reduce the imbalance.

  4. South Korea’s financial account in the balance of payments recorded a deficit of US\($\)13 billion in 2018, as Koreans have invested extensively in other countries. Furthermore, foreigners have been reluctant to invest in South Korea due to the trade disputes and the potential of a trade war erupting between the US and China. The US and China are South Korea’s largest trading partners, and South Korea, with its export oriented economy (exports amount to 43 % of gross domestic product [GDP]), is sensitive to external demand shocks.

  5. South Korea’s domestic investment in key areas (such as manufacturing, construction and machinery) fell during 2018, and GDP grew by less than expected. Additionally, private consumption increased only by 0.3 % in 2018, the slowest growth for 4 years. There is also concern about the level of unemployment, especially the high rates of youth unemployment.

  6. Normally, in a situation of low growth, the central bank would implement expansionary monetary policy. However, the US Federal Reserve (the central bank of the US) and the European central bank are considering monetary tightening. If the South Korean central bank does not raise interest rates in line with the US and the European Union it runs the risk that the South Korean won may depreciate. Therefore, the South Korean government has begun discussions on using fiscal policy to help revive the job market and support domestic demand.

Question

Using an exchange rate diagram, explain how South Korea’s current account surplus could have “helped increase the South Korean won’s value” (paragraph [2]).

▶️Answer/Explanation
A foreign exchange diagram showing a shift of demand to the right, with an increase in price of the won.
AND
an explanation that as South Korean exports/inflows are greater than imports, foreigners are demanding won to pay for the South Korean products, which increases the price/value of the
won/resulting in an appreciation.
Alternative:
A foreign exchange diagram showing a shift of supply to the left, with an increase in price of the won.
AND
an explanation that as South Korean exports/inflows are greater than imports, South Koreans are importing less so supplying less won, which increases the price/value of the won/resulting in an appreciation.

South Korea’s current account surplus

  1. South Korea, Asia’s fourth-largest economy, has experienced a current account surplus since 2012. South Korea’s large working-age population, which tends to save a large portion of its income for retirement, contributes to the surplus. The South Korean government has expressed concerns about the impact of the high savings on domestic demand and the level of imports. However, it has been predicted that as the population ages the surplus will gradually disappear by 2042.

  2. The South Korean won (South Korea’s currency) recorded the second highest appreciation against the United States dollar (US$) in 2017 among currencies of the G20* nations. The current account surplus, the improved economic conditions and the expectations of an interest rate rise have all helped increase the South Korean won’s value.

  3. The South Korean won officially operates under a floating exchange rate system, but the central bank would intervene if there were major fluctuations in the market that needed to be managed. The US is monitoring the exchange rate policy of South Korea due to the significant trade imbalance between the two countries. If the US identifies that a major trading partner like South Korea tries to limit an appreciation of its currency, then the US may consider tariffs to reduce the imbalance.

  4. South Korea’s financial account in the balance of payments recorded a deficit of US$13 billion in 2018, as Koreans have invested extensively in other countries. Furthermore, foreigners have been reluctant to invest in South Korea due to the trade disputes and the potential of a trade war erupting between the US and China. The US and China are South Korea’s largest trading partners, and South Korea, with its export oriented economy (exports amount to 43 % of gross domestic product [GDP]), is sensitive to external demand shocks.

  5. South Korea’s domestic investment in key areas (such as manufacturing, construction and machinery) fell during 2018, and GDP grew by less than expected. Additionally, private consumption increased only by 0.3 % in 2018, the slowest growth for 4 years. There is also concern about the level of unemployment, especially the high rates of youth unemployment.

  6. Normally, in a situation of low growth, the central bank would implement expansionary monetary policy. However, the US Federal Reserve (the central bank of the US) and the European central bank are considering monetary tightening. If the South Korean central bank does not raise interest rates in line with the US and the European Union it runs the risk that the South Korean won may depreciate. Therefore, the South Korean government has begun discussions on using fiscal policy to help revive the job market and support domestic demand.

Question

Using information from the text/data and your knowledge of economics, discuss the possible implications on South Korea’s economy of a current account surplus.

▶️Answer/Explanation

Responses may include:

  • Definition of current account surplus.

Economic analysis may include:

  • AD/AS theory
  • exchange rate market
  • balance of payments
  • economic growth.

To discuss:

  • Slowing domestic consumption (paragraph [5], slowest growth in 4 years), impact on AD, economic growth and employment opportunities, making it more difficult for unemployment issues (paragraph [5]).
  • Koreans investing overseas rather than domestically (paragraph [4]), but this may lead to inflow in the current account through primary income in the long run.
  • Insufficient domestic investment in key areas (paragraph [5]), limiting economic growth.
  • Encourages appreciation of the won (paragraph [2]), leading to imports cheaper, leading to lower imported inflation, exports more expensive/less competitive, may impact economic growth – important considering it is not growing as expected (paragraph [5]).
  • Appreciation of the won from current account surplus, in theory (paragraph [2]) should be self-correcting, but this does not apply to this case due to large working-age population contributing to the surplus (paragraph [1]).
  • Suggests that the current account surplus may have long-term consequences on the economy – until 2042 (paragraph [1]).
  • Domestic firms competing from cheaper imports suffer – due to the current account surplus encouraging an appreciation (paragraph [1]).
  • Persistent imbalances with trade partners may encourage protectionist measures from trade partners (paragraph [3]). This may lead to problems with exports, growth.
  • Current account surplus is influencing decisions made by government regarding policy which may conflict with other macro objectives.
  • Contractionary monetary policy (paragraph [6]) to avoid a depreciation will negatively impact on economic growth, but important to avoid issues of a current account surplus.

The Comprehensive and Progressive Agreement for Trans-Pacific
Partnership (CPTPP), Australia and Japan

  1. In 2018, Australia signed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP)*. The agreement creates the third largest free trade area in the world, covers nearly 500 million people and is worth more than US$12 trillion. The members of the agreement have stated that economic integration and free trade is important to help foster good political relations and inclusive growth for all nations.

  2. The trade agreement will aim to gradually eliminate most trade protection within the member countries. The agreement will see tariffs eliminated for Australian cheese and beef exports to Japan, and increased quotas for the export of rice to Japan from 4400 to 8400 tonnes. Nikkei Asian Review reported that “Fast-food restaurants in particular are embracing the import as a way to cut costs to cope with rising wages.” Additionally, Japanese food manufacturers will be able to lower production costs for rice-based meals and benefit from increased stability of input prices. The benefits from the agreement for Japan’s economy are projected to exceed US$70 billion, but some industries would be negatively affected.

  3. Japanese farmers are worried about the increase in imported food from Australia. Furthermore, the Japanese government is concerned about the effects of the CPTPP on Japan’s food self-sufficiency—Japan relies on other countries for over 60 % of its food. In response to these concerns the Japanese government has offered support for domestic farmers to diversify production into other crops. The government also plans to subsidize the rice farmers through the initial phase of lowering trade barriers.

  4. The agreement is said to be worth more than US$37 billion to Australian agricultural exports. It is hoped that CPTPP and the falling value of the Australian dollar will help Australia to reduce its current account deficit, but some economists have argued that this can take a long time. According to some estimations, the short-run price elasticity of demand (PED) for Australian exports is 0.2 and the short-run PED for imports in Australia is 0.4. However, the long-run PED for Australian exports is 1.1 and the long-run PED for imports in Australia is 1.3.

  5. There have also been concerns about the CPTPP from trade unions in Australia. They argue that it deregulates the labour markets and gives corporations from other countries an ability to take legal action against governments for implementing laws that raise wages or protect the environment, if the foreign corporation can prove that the law hurt their commercial interests. One university lecturer said that the future costs to the taxpayer could be significant if foreign companies take the Australian government to court.

  6. The trade agreement would allow workers from other countries to work in Australia without employers being required to check if Australian citizens are available to fill the jobs before the migrant workers are employed. It is estimated this may risk 39 000 jobs in Australia. Furthermore, environmental activists have expressed concerns that the negative environmental and social effects of the agreement have not been well considered. This may lead to conflicts with Australia’s commitment to the United Nations’ Sustainable Development Goals.

Question

Using price elasticity of demand (PED) data from the text and the J-curve effect, explain the most likely impact of “the falling value of the Australian dollar” on Australia’s current account (paragraph [4]).

▶️Answer/Explanation

Answers may include:

  • explaining that in the SR PEDx+m is <1
  • due to time lags/contracts/relatively unresponsive to price changes, therefore, the depreciation will worsen the CA in the SR / improve in the LR
  • however, in the LR the PEDx+m>1 resulting in an improvement in the CA
  • SR PED=0.6 and LR PED=2.4

Text A — Overview of Vietnam

  1. Economic reforms in Vietnam during the past 30 years have led to rapid economic growth, which has transformed a poor nation into a lower middle-income economy. The percentage of the population with an income of less than US$1.90 a day declined from 38 % in 2002 to below 2 % in 2018.

  2. Vietnam used to be a food-insecure nation, in which many people sometimes lacked access to affordable food, but it is now a leading exporter of basic food commodities. It also aims to become an exporter of high quality and processed food products. However, agricultural production only accounts for 18 % of gross domestic product (GDP), although it uses 40 % of the land and employs 43 % of the labour force. Due to the growing rural population, land is often divided up between a greater number of farmers, causing some farms to become smaller. These farms have fewer opportunities to benefit from economies of scale and lower average costs of production.

  3. Vietnam’s rapid growth and industrialization, focused on export-oriented manufacturing, have had a harmful impact on the environment. Electricity consumption has tripled since 2010, growing faster than GDP. Electricity generation, which mainly uses fossil fuels, accounts for approximately 60 % of Vietnam’s carbon emissions. Demand for water continues to increase. Unsustainable exploitation of natural resources, such as land, fisheries, and timber, could negatively affect prospects for long-term growth. In addition, Vietnam’s primary sector is highly vulnerable to the climate and is therefore subject to supply shocks.

  4. Vietnam has signed several free trade agreements (FTAs). Its first FTA was a partnership with Japan in 2008. Both Vietnam and Japan are members of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which took effect at the beginning of 2019. These FTAs also promote inward foreign direct investment (FDI). In addition, Vietnam has introduced policies to attract foreign investment, such as tax incentives and spending on infrastructure.

  5. Japan is the biggest provider of foreign aid to Vietnam and the largest source of FDI. Japanese firms and aid agencies are jointly financing large-scale projects, including port infrastructure and a high-speed railway, which will reduce the Hanoi to Ho Chi Minh journey time from about 35 hours to under six hours. Other Japanese-funded aid projects are in the areas of health care, education, and the environment.

Text B — Trade and investment flows between Vietnam and Japan

  1. Japan imports seafood and consumer products such as textiles, leather shoes and processed foods from Vietnam, because Vietnam has a comparative advantage in such items. Conversely, Vietnam imports machinery, technology, and raw materials for production from Japan. Gradually barriers to trade are being removed. In 2020, Vietnam began exporting lychees (a luxury fruit) to Japan after five years of negotiations on quality standards. The improved access to the Japanese market has increased the number of consumers and the revenue earned by Vietnamese lychee farmers.

  2. Japanese firms invest in Vietnam, particularly in urban areas, because wages are low and they can export from Vietnam to other CPTPP members and to China and Indonesia. Panasonic, a Japanese multinational company (MNC), relocated a major factory, which manufactures refrigerators and washing machines, from Thailand to Vietnam in 2020. The construction of a coal-fired power plant is mainly funded by Japanese firms. The Japanese government is promoting further investment by subsidizing over 30 firms that are relocating from China to Vietnam. Most of these firms are food processors or producers of manufactured goods (for example, medical equipment).

Text C — Roles of the central bank in Vietnam

  1. The central bank in Vietnam has been lowering interest rates since mid-2019. However, it has kept the minimum reserve requirement at 3 % of commercial bank deposits, despite suggestions that this requirement could be lowered.

  2. The central bank also regulates the exchange rate of the dong (Vietnam’s currency). It actively intervenes in the foreign exchange market to stabilize the rate when necessary. In April 2020, there was downward pressure on the dong due to the lower interest rates and fewer foreign tourists. However, the central bank has a large amount of reserve assets, which were used to prevent the dong from depreciating.

Question

Using information from Table 1, calculate the change in the surplus on Vietnam’s balance of trade in goods with Japan between 2015 and 2019.

▶️Answer/Explanation

2015: (15 141 − 12 531)             2610
2019: (22 475 − 16 484)             5991

=  (US)\($\) 3381 million

The strong Thai baht

  1. Thailand’s currency, the Thai baht, ended 2019 at its highest value in more than six years. With a 7.8 % gain against the United States dollar (US$), it was the currency that appreciated the most among major Asian currencies.

  2. The Thai baht’s appreciation was caused by several factors. Many foreign investors are attracted by Thailand’s economic stability, high levels of foreign reserves, low inflation rate and low unemployment (Table 1). However, the inflation rate is below the central bank’s target.

  3. Initially, the central bank of Thailand (BoT) was not too concerned, as the strong Thai baht was helping Thai importers and those who had foreign debts. Additionally, Thai producers could afford to import new technology and capital equipment. An appreciating currency could also help improve the country’s terms of trade.

  4. However, a strong currency can have severe consequences on an export-oriented country like Thailand. Exports account for 65 % of gross domestic product (GDP), and in 2019 exports declined by 7 %. Additionally, the tourism industry, which makes up approximately 20 % of GDP and accounts for 16 % of employment, started to express concern. Economic growth in 2019 was 3 %, down from 4.1 % in 2018.

  5. Therefore, towards the end of 2019, the BoT implemented measures to prevent further appreciation of the Thai baht. The BoT reduced controls on capital outflows to make it easier for Thai citizens to move money abroad. Additionally, restrictions were placed on the amount of money foreigners could hold in Thai bank accounts.

  6. The BoT is considering further measures including the use of foreign reserves, a decrease in the interest rate, and imposing controls on capital inflows, to prevent speculative inflows. However, these controls may impact the country’s credibility and financial markets. Expansionary monetary policy may also increase household debt which, at 78.6 % of GDP, is among the highest in Asia.

  7. The BoT is concerned about using foreign reserves, as this may result in Thailand being labelled a currency manipulator* by the US. Currently, Thailand’s overall large current account surplus is the only requirement it meets to be labelled a currency manipulator. However, Thailand’s bilateral trade surplus with the US is currently US$19 billion, which means it is close to meeting a second requirement. Thailand wants to avoid being labelled a currency manipulator as the US may use trade protection in retaliation.

Question

Define the term current account surplus indicated in bold in the text (paragraph [7]).

▶️Answer/Explanation
An understanding that it is when the net flow of money from trade in goods and services and income flows/primary income  and/or (current) transfers/secondary income is positive.
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