The object of research are the balances of payments of fife countries, the impact of changes in currency rate, borrowing rates and financial and monetary risks for performing within global economy.
The purpose of the study is to analyze theoretical approaches under Marshall-Lerner Condition and use the model for regulating the balance of payments in economies with different size and performance. The essay includes theoretical overview, methodological and practical aspects of national regulation of the balance of payments in countries with a developing economy and opposite industrialized nations. Empirical analysis is based on the dynamics, current condition and historical indicators of the balance of payments in Russia, United Kingdom, Australia, Poland and Slovak Republic. The following tasks helps to achieve the goal:
• explore and methodologically rethink the economic content, methods of analysis and measuring the balance of payments;
• to implementing Marshall-Lerner theoretical approaches for the measure elasticity of demand of the balance of payments;
• determine the criteria for the stability of the balance of payments in the analysed economies;
• analyse the state and investigate the dynamics of indicators of payment balances over time period Q4 2014-Q2 2017, identify the causes of instability of payment balances in different countries;
• summarize the experience of various countries in regulating the balance of payments and maintaining its stability;
• to study the interaction between the balance of payments and the exchange rate, to determine the role of the exchange rate in levelling the balance of payments;
• on this basis to develop conclusions how one country improving they deficit of the balance of payments, and why devaluation approach does not work for others.
The balance of payments – is the balance account of international operations when the value expressing the whole complex of world economic relations of the country in the form of the ratio of export and import of goods, services and capital. From an accounting point of view, the balance of payments is always in balance. But in its main sections either there is a surplus, if incomes exceed payments, or passive – if payments exceed revenues.
The state of the balance of payments for the period is closely related to the changes in the exchange rate. If the lost equilibrium of the balance of payments representing the disparity in the currency exchange market, it is possible to take control under BoP deficit through national currency market. In that situation the negative balance of payments of official expenditures means the excess of demand for foreign currency over its supply. The devaluation is the tool to achieve a zero balance of payments or decrease it deficit.
Devaluation and revaluation are traditional methods of monetary policy. Devaluation – the depreciation, means decrease of rate, of the national currency against a foreign currency or international currency units. That controlled change is based on the recalculation of the official exchange rate compared to the market rate. Revaluation – the rise in valuation of the national currency in relation to foreign currency or international currency units. Under conditions of floating exchange rates, they occur spontaneously day-by-day in the market, and only periodically exchange rate is officially controlled. The term “devaluation” in the modern sense means a relatively long and significant decrease in the market exchange rate.
The effect of devaluation on the deficit of the balance of payments can be described using a simplified model of Marshal-Lerner. In this model, the state of the balance of payments depends on the elasticities of demand for imports and export.
This model is based on the assumptions: The balance of goods and services is determined by the demand and supply of currency, in term of local and foreign prices for products are fixed. It is assumed that the price for local products not changes and does not affects the balance of payments. Thus, the balance of payments is mostly determined by the value of net exports. International trade is represented by two goods, one of which is exported, and the other is imported. Thus, ‘a devaluation will raise the current account only if the sum of import and export elasticities of demand is greater than One : (?X + ?M ; 1)’ .
Devaluation stimulates the export of goods only if the country has the export growing potential of competitive goods and services and have favourable situation on the world market. The devaluation objective in order of restrictive effect on imports, usually have a lag in time, or does not work, because the country often cannot drastically reduce the import of goods. In addition, not all countries have a successful import substitution policy. Moreover, when increasing the cost of imports, devaluation can lead to an increase in the cost of production of domestic goods, inflation and a loss of competitive advantages in foreign markets. Therefore, although it may give the country temporary advantages, it does not eliminate the causes of the balance of payments deficit in some cases.
In the financial account, for net value, a positive sign indicates a net flow from the domestic economy to the rest of the world (a lending to the rest of the world) and a negative sign, a net flow from the rest of the world to the domestic economy (i.e. a net borrowing from the rest of the world) .At the level of the sub items (investment abroad investment in the reporting economy etc.), a positive sign indicates an increase of the sub item under consideration and a negative sign a decrease.
To determinate years affected by decrease in currency rate, I prepared a comparison table of important indicators for each country, for investigated time period Q4 2014-Q2 2017. (Attachments 1-5, 6,7).
How it is seen from the statistical findings from https://stats.oecd.org, the quarter with highest BoP for Australia was Q4 2015, when high cost of AUD 1.389 per 1 USD. However, Australia starts softening local currency one year early, during the quarter 1 2015, when Australians Dollar (AUD) exchange rate to USD rise sharply from 1.169 to 1.271 and then increased significantly during next 4 quarters. Australia’s deficit decreased from 16190.90 Mln USD at Q2 2015 to 4,708.00 Mln USD at Q4 2016. In that quarter Australia’s goods export become greater than import, which changes from – 6364,1 mln USD to +4976,4 mln USD. The aim was achieved, first from the long time, and balance stay positive up to end of investigated period. Moreover, Services balance deficit dropped for 1,870.5 mln USD. Australia became attractive for local investors as a result of country’s good performance and lowered borrowing cost inside country. Thus, the net Financial account shows negative balance decrease to -3 130.0 mln USD in Q4 2016. However, this can be treated as a positive sign, because Net Direct Investment increased to -14 162.4 mln USD, which representing net borrowings from abroad. Based on funding, its concluded that deflation of AUD was successful, export of goods become positive and deficit of services reduced. However, the deflation us monetary instrument had a short-time negative effect for consumer prices, which increases for 0.7% and 0.5% during Q2 and Q3 2015. But inflation percentage change for same period for the previous year was not so dramatic – only 1.5%. As it was mentioned on the Marshal-Lerner theory, the currency deflation usually has a positive impact in long term, worsening BoP straight after approach, because of J-curve ‘delayed past-trough’ effect. In that example, the lag between drop of price of Australian goods for foreign consumers and increase in goods export was about 6 quarters (1,5 years).
The next investigated country is the United Kingdom. The high developed country shows slow GBP growth in past years. It is difficult to determinate impact of the pound exchange rate varying for native economy performance. First pound depreciation noticed in Q4 2014, with straight forward short-term Current Account’s improvement based in reducing goods balance deficit. However, the services surplus decreased at same time. Next pounds depreciation has during quarters 3 and 4 2016, which was results of Brexit referendum and unstabilized political situation in the country. The Q3 2016 shows negative ‘bounce’ in every indicators, such us drop of currency value, rise in goods deficit balance, rise in CA deficit, decrease in services surplus. However, the goods balance can’t be corelated to pound/dollar exchange rate only, because the UK’s main trade partners not USA, but EU and not-EU countries. Therefore, to see whole picture, goods and services balance can be represented by EU market and corelated to exchange GBP/EUR, as shown in graph below. How it seen, pound to euro rose during the Q4 2014- Q3 2016, and then dropped after referendum, and then softened until Q2 2018, which is like as GBP/USD currency exchange tendency. In that time goods deficit rise but services balances improved very slightly, if ignoring drop in performance for Q3 2016. The currency exchange rate has more corelating to Financial account and Net Direct Investment indicators. Very interesting finding is a Direct Investment increase to the country at Quarter 4 2016, such us -106 243.1 mln USD! Probably, because very low pounds exchange rate. Then that indicator shows quarter-by-quarter funds outflow from the UK. Overall, based on OERC.org statistical data comparison, the Great Britain’s currency devaluation has low impact on BoP balance deficit for investigated period. Thus, can conclude that UK’s products and services has too low elasticity of demand under Marshal-Lerner approach. Moreover, the strong rise in inflation in quarter to quarter basis confirm negative impact of deflation on consumers prices.
The Slovak Republic is representing the small developing country, with revers impact currency depreciation for CA . As a part of Europe Union, within EURO national currency and single trade market, the Slovak Republic performance is not strongly correlated to currency exchange rate. The countries main partners are Germany 21% and another countries EU (56%), UK-6%, Russia-2.3%, USA3.3% and China-2.2% of trade. The Slovak Republic has positive BoP in current account, as well as goods balance in the start of investigated period. But during the 3 years, the balance deficit increased to -969.3 mln USD. However, the goods and services export strongly performed over the import during all 3 years, going up and down quarter-by-quarter. But only at Q1 2017 when the EURO exchange rate rise against USD at maximum level of 0.938 EUR/USD, represents short-term negative impact for increased import cost, and dropped revenue in export. The devaluation has the complete pass-through effect, because car production can’t find substitution of imported vehicles parts, iron products and broadcasting equipment. Thus, balance been affected by raw material costs increase for local production, as a Slovak Republic mainly exporting cars and vehicles parts, video displays and rubber tires. That example illustrating the ‘The Pass-through Effect of a Devaluation’, under Marshall- Lerner condition. Therefore, these example means that import plus export elasticity on goods account is close to 1, and balance doesn’t affect, if currency price changes. However, the ‘bumping’ in local currency and worsening BoP has pushed up the consumer prices– from deflation index ‘-0.8’% (max at Q3 2016) , to inflation 2.8% max for Q2-2018.
Another example of Europe Union country- Poland. The country shows good performance and GBP growth. It is still developing big country with huge potential, scope of natural and intellectual resources. The zloty devaluation against dollar and euro started in 2008 have positive impact for BoP Current account, when local goods and services became attractive for foreign consumer. At Q4 2014 we can see depreciation on zloty price from 3.374, and then currency sliding to 4.061 for 1 USD at Q1 2017. Thus, the countries ‘softening’ monetary policy, help country control goods balance and stimulate service surplus, quarter-by-quarter. Therefore, Poland become a strong service exporter, from 10 937.7 mln USD at Q1 2015 to 16 904.8 mln USD at Q2 2018. However, that example not representing a ‘devaluation’ of currency, but rather a ‘softening’ over time. Means, the Marshall-Lerner does not work for Poland for investigated period.
Most interesting example is Russia. The Russia’s main trading partners are USA, China, EU. The Russia exporting raw materials, energy, oil, gas – everything that other countries needs for production. Thus, Current Accounts reacting negatively for ruble devaluation against USD, because of worsening performance in Goods balance. At other hand, Services deficit reducing, because local suppliers trying to cut the costs in order to keep revenues. In Q1 2016 1 USD price rose to 74.646 ruble, leading to nearly 10 000 mln USD drop in goods balance surplus, and significant rise of Direct Investment for foreign economies. Despite the ruble depreciation riches 40% in Q4 2014-Q1 2016, the structure of production and trade remained almost unchanged. The revenues has depended from exchange rates for current period, but not expanding local business.
The Marshall-Lerner approach in example of Australia’s devaluation.
Consider an example of using devaluation as a method of influencing a country’s international operations. On Q1-2015, the AUD rate officially rise from 1.169 to 1.271 per 1 dollar. To determine the percentage of currency devaluation take this currency per unit, divide the exchange difference by the initial rate and multiply by 100. If we denote the old rate R1, and the new rate after devaluation R2, the formula for calculating the percentage of devaluation (D) can be represented as follows:
D =( (R1-R2)/R1)*100%
That means (1.169-1.271)/1.169*100%= -8.7% devaluation for Q1-2015.
And then again (1.285-1.379)/1.285*100%=-7.3% devaluation for Q3 2015.
In same time ,to calculate USD revaluation, exchange rate USD/AUR has :
(0.85-0.786)/0.85*100%=7.5% for Q1-2015
(0.77-0.72)/0.77*100%=6.4% revaluation of US dollar for Q3 2015.
Australian exporters benefited from the devaluation of their currency, since they received a devaluation premium of 8.75 (Q1-2015) and 7.3% six month later. When exchanging foreign currency (US dollar) to the local revenue. On the other hand. The importers, are losing out, as it is more expensive for them to buy payment currency by 7.5% and then 6.4%. Australian debtors win when paying off international debts with cheaper local currency, but will lose if foreign debt is expressed in US dollars.
Devaluation has contributed to higher prices and lower living standards for workers in UK, as inflation overdraw the salaries rise. For another hand, revaluation has increased unemployment in industries which not competitive against cheap foreign goods, as in Russia. Despite the ruble depreciation riches 40% in Q4 2014-Q1 2016, the structure of production and trade remained almost unchanged. The revenues depended from exchange rates for current period, but not expanding volume of local business. Competition between countries is increasing and GBP growth slows. Developing countries suffer losses from devaluations of major currencies, if not prepared for currencies war. However, the economists Eduardo Levi-Yeyati and Dany Rodrik have opinion that the tool of competitive devaluation is useful for developing countries and countries with clearly lagging sectors of the economy, poorly developed industries and institutions. Intentional devaluations in such countries can lead to a redistribution of resources in favor of deficient trade sectors, as a result of increase in gross profit, and attracting savings and investments.