t is exporting less than importing. Thus, there is excess demand for foreign currency than the domestic currency and this lowers the exchange rate. (6 Factors That Influence Exchange Rates)
Consider that a foreign country's GDP has expanded compared to Singapore. As the foreign country's economy expands, it demand more goods and services from Singapore. This increases the demand for the Sing dollar and results in an appreciation of the currency against the foreign country's currency:
2
The demand curve for the Sing dollar shifts to the right and this results in a new equilibrium point where the exchange rate is. The Sing dollar has appreciated because the price of the currency in terms of the foreign currency has increases. Hence, it requires more foreign currency units to buy a given amount of the Sing dollar.
Balance of Payments
The balance of payments is an account of all monetary transactions between a country and the rest of the world. The two primary components of the balance of payments is the current account and the capital account. Changes in reserves of the central bank ensures that the balance of payments is indeed balanced.
The current account is associated with the trade balance. If the exports of a country rises, the current account improves and the country accumulates foreign currency.
The current account can be subdivided into 3 separate components:
Merchandise trade balance
Export of goods minus Import of goods (Understanding The Current Account In The Balance Of Payments)
Balance of services
Value of services exported minus value of services imported. (Understanding The Current Account In The Balance Of Payments)
Net unilateral transfers
Unilateral transfers from other countries minus unilateral transfers given by the domestic government, firms and residents to other countries. (Understanding The Current Account In The Balance Of Payments)
3
The capital account/financial account reflects net change in national ownership of assets and is a source of foreign currency by investors abroad who want to hold domestic assets.
A deficit in the current account can be entirely covered by a surplus in the capital account. However, if both accounts are in surplus, then there is excess supply of foreign currency which is accumulated by the domestic central bank and this affects the domestic money supply if the country is operating a fixed exchange rate.
However, if the country is using a flexible exchange rate system, the nominal exchange rate will adjust to equate the demand for foreign currency.
Analysis
This article states that Japan's trade balance turn worst in the month of May. This means that the country is exporting lesser than it is importing, generating a current account deficit. It then points to the negative effect it has on the nation's economic recovery.
When a nation is running a trade deficit, it is essentially spending more than what it is earning - a situation falling net exports. To finance a trade deficit the country has to borrow from abroad to finance its higher consumption at home. Thus, by running persistent and larger current account deficits, it is increasing its net indebtedness to the rest of the world. This is why the deteriorating t
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