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How a country’s balances of payment directly affect the exchange rate

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How a country’s balances of payment directly affect the exchange rate

The balance of payment affects the exchange country’s exchange rates through its impacts on demand and supply. For instance, when the exports of a given country are higher than the imports, the demand for the goods of such a state is high, and subsequently, its currency exchange rates also increase. On the other hand, if the import is higher than the exports, the demand for the goods of such a country is low, and hence its currency exchange rates decrease, and therefore, the country’s currency losses value.

Reasons why companies located outside of their home country

Companies operating overseas enjoy foreign investment opportunities; many countries encourage foreign investment in their country through various incentives such as tax incentives, especially for international companies investing in their region. Further, companies investing in foreign counties enjoy the improved infrastructure and other benefits that favor the growth of the business.

A company may invest in oversee for both resource and market seeking. For instance, most companies find it cheap to invest in foreign countries due to affordable access to factors of products in a foreign country. Furthermore, the availability of overseas markets where firms can sell their products also encourages foreign investments.

Companies may invest in a foreign county for efficient seeking. For instance, in countries where technology for production is very high compared to the product technology level at home country, most of the firms move to oversees to broaden their production as it improves its competition level and the market that the firm can control.

Explain how the balance of payments is balanced. What pays for a current account deficit or a capital account surplus.

The balance of payments of any given country is always balanced because every credit that appears in the current account, it must be a corresponding debit arising in the capital account. In other words, every entry in the debit side attracts similar entry on the credit side, and hence the balance of payments remains balanced.

A deficit in the current account is offset by a surplus from the capital account of the country. For instance, if a county imports a product, it must export financial assets to pay for the imported products, and this is paid from the capital account.

On the other hand, a surplus in the current account is always offset by the deficit in the country’s capital account to balance the balance of payments. For instance, if a county exports its products, this is recorded as a surplus in the current account. To offset such surplus appearing in the balance of payment a country must import financial assets from the foreign country that received the exports. Hence the value capital assets introduced equals to the value of goods exported.

Explain the relationship between interest rates and exchange rates

Several factors affect the exchange rates of a country. Interest rates are one of the factors affecting the country’s exchange rates. Higher interest rates in any given country increase the value of the country’s exchange rates as it increases the value of the country’s currency relatively compared to the value of the currency of other countries with low-interest rates. In other words, the interest rate is an indicator of the country’s currency value compared to other countries’ currencies. Thus, the interest rates at the international level determine the value of the country’s exchange rates. Hence, an increase in the country’s interest rates results in to increase in the amount of its currency at international exchange rates and verse versa.

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