Chapter 6 The Foreign Exchange Market

Chapter 6 The Foreign Exchange Market
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Lead-in

The balance of payments (BOP)surplus of the Philippines narrowed by 28.5 percent to $448 million in March 2020 from $627 million in the same period last year amid the sharp drop in foreign portfolio investments as investors cashed in on their holdings amid the coronavirus disease 2019 or COVID-19 pandemic, according to the Bangko Sentral ng Pilipinas (BSP).

The BSP said the surplus reflected mainly the inflows arising from the BSP’s foreign exchange operations as well as income from its investments abroad and the national government’s foreign currency deposits.However, the inflows were partially offset by the foreign currency withdrawals made by the national government to pay its foreign currency debt obligations.

The BOP is the difference in total values between payments into and out of the country over a period.A surplus means more foreign exchange flowed into the country from exports, remittances from overseas Filipinos, business process outsourcing earnings and tourism receipts than what flowed out to pay for the importation of more goods, services and capital.

For the first quarter, the country booked a BOP deficit of $68 million, reversing the $3.8 billion surplus recorded in the same period last year.Data from the BSP showed that the country has recorded a net outflow of foreign portfolio investments that hot money or speculative funds amounting to $1.48 billion in the first quarter, a reversal of the $293.46 million net inflow recorded in the same quarter last year.The country’s trade deficit is narrowed by 27.1 percent to $7.54 billion in the first quarter from $10.34 billion in the same quarter last year.

Its exports decreased by 5.1 percent to $15.72 billion from January to March compared to $16.57 billion in the same period last year, while imports booked a double digit decline of 13.6 percent to $23.26 billion from $26.92 billion.According to the BSP, the BOP surplus in the first quarter reflects the all-time high gross international reserves (GIR)level of $88.86 billion as of end-March, equivalent to around 7.9 months’ worth of imports of goods and services and payments of primary income.

Source: MSN News, June 2, 2020, https://www.msn.com/en-ph/news/national/bop-surplus- narrows-in-march/ar-BB14VDkO

When studying open economies that trade with one another, we may find a major difference in the transactions between domestic and foreign residents as compared with those between residents of the same country, namely, different national currencies are usually involved.Factors determining how much domestic currency has to be given in exchange for a unit of foreign currency, the behavior of exchange rates and the impact of exchange-rate changes, are major fields of study in international economics and form the subject matter of later chapters of this book.

In this chapter, we look at some preliminary issues.We examine the various participants in the foreign exchange market and the basic forces that operate in the market.We then study the basic determinants of exchange-rate behavior.The chapter finishes by focusing on the relationship between the spot and forward exchange rate.