On question 18 of the capital market and expectations reading, it says that we can expect higher foreign exchange rates for a country with a higher current account surplus.
My understanding: larger current account surplus = more net exports = higher rates = lower FX = more exports
Can someone please explain? the solutions don’t go into detail …
What do you mean by ‘rates’?
Basically, a CA surplus means you have more demand for your currency relative to other currencies, so the currency appreciates to close the gap. Unless you’re China.
A larger current account surplus implies high net exports. But remember that the suplus also implies reduced imports which doesn’t require the borrowing of foreign currency to meet deficits (since it’s a surplus) thus reducing the demand for foreign currency relative to the home currency. Thus foreign currency depreciates and the home currency appreciates.
Also remember that a CA surplus is simply the nations savings minus its investment. Savings > Investment => Higher rates of interest in the nation => FX flows into the nation’s currency which makes the home currency appreciate => Selling foreign currency.which depreciates it.