Chapter
25
IS
T
O
Balance of
Payments Account and
Exchange Rate
A
25.1
The Balance of Payments Account
(BOP Account)
25.2
Introduction to Exchange Rate
25.2.1
25.2.2
25.2.3
25.3
e-Learning Hub
A
R
25.1.1 Introduction to the BOP Account
25.1.2
Current Account
25.1.3
Capital and Financial Account
25.1.4Balance of Payments and Balance of
the BOP Account
Meaning of Exchange Rate
Types of Exchange Rate System
Changes in Exchange Rates
Effects of a Change in the Exchange Rate
25.3.1 Effects of a Change in the Exchange
Rate on Imports
25.3.2 Effects of a Change in the Exchange
Rate on Exports
25.4 The Linked Exchange Rate System in
Hong Kong
An economy records its external
economic transactions over time.
This is done by using the balance
of payments account.
As foreign currencies are needed
to make international transactions,
the exchange rate of a currency is
a major concern for trade.
In this chapter, we will introduce
the balance of payments account
and exchange rate. We will also
look into the effects of changes in
the exchange rate.
Chapter
25
25.1 The Balance of Payments Account
(BOP Account)
25.1.1 Introduction to the BOP Account
Brainstorm 25.1.1
Here are some figures from Hong Kong’s
balance of payments account in 2017.
1Have you heard of these components of
the balance of payments account?
2Scan the QR code and access the recent
figures for all the components.
Financial account −HK$75,843 million
Capital account −HK$645 million
Current account HK$123,900 million
(Figures as of June 2019)
Data
Explorer
IS
T
O
A balance of payments account (BOP account) systematically
summarises the balance of payments statistics of an economy. It records
the transactions of the economy with the rest of the world in a specific
period of time.
There are transactions made between local residents and foreign
residents from time to time. These external transactions are recorded in
the balance of payments account as credit or debit entries.
A
R
All receipts and obligations received from non-residents are
recorded on the credit (+) side.
All payments and liabilities to non-residents are recorded on the
debit (–) side.
In Hong Kong, economic
transactions with the Mainland
are treated as external
transactions and are recorded
in the balance of payments
account.
Receipts and obligations
received from non-residents
Credit (+)
Payments and liabilities
to non-residents
Debit (–)
transactions that involve a receipt (inflow) of
foreign exchange from other countries
transactions that involve a payment (outflow)
of foreign exchange to other countries
Table 25.1 Credit and debit sides of the BOP account
The balance of payments account consists of the current account and the
capital and financial account.
Exercise 25.1.1
Will the following be included in the calculation of the balance of payments of Hong Kong?
Put a tick (ü) in the correct box(es).
 receipts received by a Hong Kong resident from another Hong Kong resident
 payments from a Hong Kong resident to a non-Hong Kong resident
204
balance of payments account 國際收支平衡表 balance of payments 國際收支平衡 credit 貸方 debit 借方
Balance of Payments Account and Exchange Rate
25.1.2 Current Account
Brainstorm 25.1.2
1Imports of goods, exports of goods and balance of trade in goods are
important figures included in the calculation of the current account. Can you
describe the changes in these figures over the years according to the table
below?
Year
Imports of goods
(HK$ Million)
Exports of goods
(HK$ Million)
Balance of trade in goods
(HK$ Million)
2015
4,066,527
3,889,225
−177,302
2016
4,022,579
3,892,886
−129,693
2017
4,391,306
4,212,774
-178,532
(Figures as of June 2019. Source: Census and Statistics Department, HKSAR Government)
Data
Explorer
Scan the QR code and find out their latest values.
O
2
IS
T
The current account mainly records the flow of real resources to and
from abroad, including:
exports and imports of goods and services;
income receivable from and income payable abroad; and
current transfers to and from abroad.
A
R
A The four components of the current account
These external transactions are recorded under four main components
of the current account. They are goods, services, income and current
transfers.
a
Goods
Sub-classification of the main
components of the current
account is not required in the
curriculum.
The component of goods is also known as visible trade or
merchandise trade. It shows the values of exports and imports
of physical commodities. Total exports of goods is the sum of
domestic exports and re-exports.
Domestic exports refer to exported goods that are produced
locally.
Re-exports refer to goods that are imported to a country and
then exported to other countries.
Value of total
Value of domestic
Value of re-exports
=
+
exports of goods
exports of goods
of goods
current account 經常帳 visible trade 有形貿易 merchandise trade 商品貿易
Figure 25.1 Imports of goods are
recorded in the ‘goods’ component of
the current account.
205
Chapter
25
The value of exports of goods is recorded on the credit (+) side of
the account as local residents receive foreign exchange for exports.
On the other hand, the value of imports of goods is recorded on
the debit (–) side of the account as local residents pay foreign
exchange for imports.
Exports of goods
Credit (+)
Imports of goods
Debit (–)
value of watches exported from
Hong Kong to the United States
value of digital cameras imported
from Japan to Hong Kong
Table 25.2 Examples of exports and imports of goods of Hong Kong
recorded in the current account
O
The balance of visible trade is the difference between the values
of total exports of goods and imports of goods. It is sometimes
called ‘visible trade balance’, ‘balance of trade’ or ‘balance of trade
in goods’.
IS
T
Balance of
Value of total
Value of imports
=
−
visible trade exports of goods
of goods
The table below shows three possible outcomes:
Outcome
Balance of visible trade
= (Value of domestic exports of
goods + Value of re-exports of
goods) − Value of imports of
goods
Explanation
Visible trade
surplus
(Trade surplus)
•The value of total exports of goods is
greater than the value of imports of goods.
•The balance of visible trade is positive.
Visible trade
deficit
(Trade deficit)
•The value of total exports of goods is
smaller than the value of imports of goods.
•The balance of visible trade is negative.
Visible trade
balance
•The value of total exports of goods is equal
to the value of imports of goods.
•The balance of visible trade is zero.
A
R
206
Recall that the value of total
exports of goods includes
domestic exports and re-exports
of goods, therefore:
The Census and Statistics
Department has adopted the
‘change of ownership principle’
in the compilation of the
current account, as well as the
compilation of the GDP using
the expenditure approach. The
figures of exports and imports
of goods published in these
two statistics are therefore
different from those published
in the external merchandise
trade statistics, which are not
compiled using this principle.
For more details about the
‘change of ownership principle’,
please refer to Appendix 25.1.
balance of visible trade 有形貿易差額 visible trade balance 有形貿易差額；有形貿易平衡
visible trade surplus 有形貿易順差 visible trade deficit 有形貿易逆差
Balance of Payments Account and Exchange Rate
b
Services
The component of services is also known as invisible trade. It
shows the values of exports and imports of services.
Exports of services include services provided by local
residents to non-residents. When local residents receive
foreign exchange from exports of services, the value of
exports of services is recorded on the credit (+) side of the
account.
Imports of services include services provided by nonresidents to local residents. When local residents pay foreign
exchange for imported services, the value of imports of
services is recorded on the debit (−) side of the current
account.
Imports of services
Debit (–)
value of hotel services used by
a Canadian tourist during her
stay in Hong Kong
value of flight services of a
Korean airline used by a Hong
Kong businessman on a trip
from Hong Kong to Korea
IS
T
O
Exports of services
Credit (+)
Figure 25.2 The value of services
provided by local residents to nonresidents is recorded as exports of
services.
Table 25.3 Examples of exports and imports of services of Hong
Kong recorded in the current account
A
R
The balance of invisible trade is the difference between the
values of exports of services and imports of services. It is
sometimes called ‘invisible trade balance’ or ‘balance of trade in
services’.
Balance of
Value of exports Value of imports
=
−
invisible trade
of services
of services
The table below shows the three possible outcomes:
Outcome
Explanation
Invisible
trade surplus
•The value of exports of services is greater than
the value of imports of services.
•The balance of invisible trade is positive.
Invisible
trade deficit
•The value of exports of services is smaller than
the value of imports of services.
•The balance of invisible trade is negative.
Invisible
trade balance
•The value of exports of services is equal to the
value of imports of services.
•The balance of invisible trade is zero.
invisible trade 無形貿易 balance of invisible trade 無形貿易差額 invisible trade balance 無形貿易差額；無形貿易平衡
invisible trade surplus 無形貿易順差 invisible trade deficit 無形貿易逆差
207
Chapter
c
25
Income
The component of income is also known as external factor
income flows. It records income receivable from abroad and
income payable abroad. Examples of factor income include wages,
profits, dividends, interest and rent.
Income receivable from abroad is the income earned by local
residents from abroad for providing factors of production
to non-residents. It is recorded on the credit (+) side of the
account.
Income payable abroad is the income paid by local residents
for obtaining factors of production from non-residents. It is
recorded on the debit (−) side of the account.
Income payable abroad
Debit (–)
the dividend earned from holding
shares of an overseas company by
a Hong Kong resident
the wage paid by a Hong Kong
company to a resident of France for
her three-month employment
O
Income receivable from abroad
Credit (+)
According to the Census and
Statistics Department, the
term ‘primary income’ has
been adopted to replace the
former term ‘factor income’.
Correspondingly, the term
‘external primary income flows’
has been adopted to replace
‘external factor income flows’.
IS
T
Table 25.4 Examples of income receivable from abroad and income payable
abroad of Hong Kong recorded in the current account
A
R
The difference between income receivable from abroad and
income payable abroad is known as the net income from abroad
(or net factor income from abroad).
Net income from
Income receivable Income payable
=
−
abroad
from abroad
abroad
d
Current transfers
C urrent transfers records transactions of real and financial
resources between local residents and non-residents.
Current transfers are unilateral in nature. The resources are likely
to be consumed immediately or shortly after they are received. The
provider of the resources does not receive anything of equivalent
economic value in return.
208
According to the Census and
Statistics Department, the term
‘secondary income’ has been
adopted to replace the former
term ‘current transfers’.
external factor income flow 對外要素收益流動 net income from abroad 從外地所賺取的淨收益 current transfer 經常轉移
Balance of Payments Account and Exchange Rate
Current transfer received
from abroad
Credit (+)
Current transfer to abroad
Debit (–)
the remittance received by a
Hong Kong student from
a relative in Canada
the money and relief supplies
that the Hong Kong government
donates to victims of a typhoon
in the Philippines
Table 25.5 Examples of current transfers of Hong Kong recorded in the
current account
In the past
The difference between current transfers from abroad and
current transfers to abroad is known as the net current transfers.
A lecturer from the US has been
working in Hong Kong for 10
years. Which of the following
would be included in the
calculation of Hong Kong’s current
account balance?
Net current
Current transfers Current transfers
=
−
transfers
from abroad
to abroad
The current account balance
O
B
IS
T
The current account balance is calculated as the sum of visible trade
balance, invisible trade balance, net income from abroad and net
current transfers.
Current
Visible
Invisible
Net income Net current
+
account = trade + trade +
transfers
from abroad
balance balance balance
A
R
When the current account balance is positive, the current
account is said to be in surplus.
When the balance is negative, the current account is said to
be in deficit.
Exercise 25.1.2
(1)the money he gives to his
wife in Hong Kong
(2)the money he uses to buy
shares listed in the US stock
market
(3)the money he donates to a
charity organization in Africa
(4)the money he spends on
visiting his parents in the US
A.(1) and (2) only
B.(1) and (4) only
C.(2) and (3) only
D.(3) and (4) only
[HKDSE/2015/Paper 1/43]
(*Choose the correct option.)
1When the value of total exports of goods is greater than the value of imports of goods,
there is *(a visible/an invisible) trade *(surplus/deficit).
2When the value of imports of services is smaller than the value of exports of services,
there is *(a visible/an invisible) trade *(surplus/deficit).
3Identify whether the items listed are recorded as debit/credit in the current account.
Transfers to abroad
Imports of goods
Imports of services
Income receivable from abroad
Exports of services
Crebit (+)
Dedit (−)
Exports of goods
Income payable abroad
Transfers from abroad
net current transfer 經常轉移淨值 current account balance 經常帳差額
209
Chapter
25
Enrich
Yourself 25.1
An example of current account balance calculation
Refer to the following information of an economy.
Item
($ billion)
200
Re-exports of goods
500
Imports of goods
400
Exports of services
300
Imports of services
600
Income receivable from abroad
350
Income payable abroad
400
Current transfers from abroad
100
Current transfers to abroad
110
O
Domestic exports of goods
IS
T
The balance of visible trade, the balance of invisible
trade, the net (factor) income from abroad and the
net current transfers are calculated as follows:
A
R
Balance of visible trade
= Value of domestic exports of goods + Value of re-exports of goods
− Value of imports of goods
= $200 billion + $500 billion − $400 billion
= $300 billion
The balance of visible trade is $300 billion (i.e. visible trade surplus).
Balance of invisible trade
= Value of exports of services − Value of imports of services
= $300 billion − $600 billion
= −$300 billion
The balance of invisible trade is −$300 billion (i.e. invisible trade deficit)
Net (factor) income from abroad
= Income receivable from abroad − Income payable abroad
= $350 billion − $400 billion
= −$50 billion
There is a net (factor) income from abroad of −$50 billion (i.e. net income
outflow).
210
Balance of Payments Account and Exchange Rate
Net current transfers
= Current transfers from abroad − Current transfers to abroad
= $100 billion − $110 billion
= −$10 billion
There is a net current transfers of −$10 billion.
The current account balance can be found by adding
up the balances above.
IS
T
O
Current account balance
= Balance of visible trade + Balance of invisible trade
+ Net (factor) income from abroad + Net current transfers
= $300 billion + ( −$300 billion) + ( −$50 billion) + ( −$10 billion)
= −$60 billion
There is a deficit of $60 billion in the current account.
Enrich
Yourself 25.2
A
R
Recording conventions used in the current account
The BOP account is recorded using a double-entry bookkeeping system.
The following table shows how each of the following transactions would be
recorded in the current account.
Current account
component
Goods
Services
Income
Current transfers
Transactions
Record in current
account
Exports of goods
Credit (+)
Imports of goods
Debit (–)
Exports of services
Credit (+)
Imports of services
Debit (–)
Income receivable from abroad
Credit (+)
Income payable abroad
Debit (–)
Current transfers from abroad
Credit (+)
Current transfers to abroad
Debit (–)
When the sum on the credit side is greater than the sum on the debit
side, there will be a current account surplus. If the sum on the credit
side is smaller than the sum on the debit side, there will be a current
account deficit.
211
Around Us
25.1
Hong Kong’s current account balance
The current account in Hong Kong comprises the goods and services
account, the primary income account and the secondary income
account. The goods and services account records the exports and
imports of goods and services, while the primary and secondary income
accounts record inflow and outflow of primary income and secondary
income.
The goods and services account
Goods
Imports of goods
Balance of
Credit (+)
Debit (−)
trade in goods
HK$ million
HK$ million
HK$ million
2015
3,889,225
4,066,527
−177,302
2016
3,892,886
4,022,579
−129,693
2017
4,212,774
4,391,306
−178,532
Year
O
Exports of goods
IS
T
(Figures as of June 2019. Source: Census and Statistics Department, HKSAR Government)
Both exports of goods and imports of goods increased from 2015 to
2017. Meanwhile, imports of goods were greater than exports of goods.
Hong Kong had a balance of trade in goods deficit in the above period.
A
R
Services
Major components of exports of services in Hong Kong include transport,
travel and financial services while major components of imports of
services include transport, travel and manufacturing services.
Exports of services
Imports of services
Balance of
Credit (+)
Debit (−)
trade in services
HK$ million
HK$ million
HK$ million
2015
808,948
574,345
234,603
2016
764,839
578,106
186,733
2017
812,937
605,506
207,431
Year
(Figures as of June 2019. Source: Census and Statistics Department, HKSAR Government)
Although imports of services increased from 2015 to 2017 from $574
billion to $606 billion, they were still smaller than exports of services
in the same period. As a result, Hong Kong had an balance of trade in
services surplus.
212
Skills Check
data
interpreting
The primary income account
Income receivable
Income payable
from abroad
abroad
Credit (+)
Debit (−)
HK$ million
HK$ million
HK$ million
2015
1,274,457
1,230,080
44,376
2016
1,273,534
1,210,941
62,593
2017
1,422,665
1,307,113
115,552
Year
Net primary income
from abroad
(Figures as of June 2019. Source: Census and Statistics Department, HKSAR Government)
Investment income has brought a substantial amount of income to Hong
Kong and the inflow of primary income is generally larger than the outflow.
Hong Kong has a net inflow of primary income from 2015 to 2017.
The secondary income account
O
Secondary income mainly includes remittances of foreign domestic helpers in
Hong Kong and donations of charitable organisations and the government.
Transfers to
abroad
abroad
Credit (+)
Debit (−)
HK$ million
HK$ million
HK$ million
2015
9,650
31,775
−22,124
2016
10,442
31,411
−20,969
2017
12,311
32,862
−20,551
A
R
Year
IS
T
Transfers from
Net secondary
income from abroad
(Figures as of June 2019. Source: Census and Statistics Department, HKSAR Government)
The outflow of secondary income is generally larger than the inflow.
The current account
Balance of trade Balance of trade
Year
Net primary
Net secondary
income from
income from
abroad
abroad
Current account
in goods
in services
balance
HK$ million
HK$ million
HK$ million
HK$ million
HK$ million
2015
−177,302
234,603
44,376
−22,124
79,553
2016
−129,693
186,733
62,593
−20,969
98,664
2017
−178,532
207,431
115,552
−20,551
123,900
(Figures as of June 2019. Source: Census and Statistics Department, HKSAR Government)
The current account balance is the sum of the above accounts.
Although the current account recorded a balance of trade in goods deficit
and net outflow in secondary income, Hong Kong still recorded an increasing
current account surplus from 2015 to 2017.
213
Chapter
25
25.1.3 Capital and Financial Account
Brainstorm 25.1.3
Scan the QR code and find out the latest figures in the capital and financial
account in Hong Kong.
Data
Explorer
The capital and financial account records external transactions in
capital transfers;
the acquisition or disposal of non-produced, non-financial assets;
and
financial assets and liabilities
O
between local residents and non-residents and shows how an economy’s
external transactions are financed.
IS
T
When capital inflow is larger than capital outflow, the net capital
inflow is positive. On the other hand, when capital inflow is smaller
than capital outflow, the net capital inflow is negative.
The capital and financial account includes the following:
A
R
capital account
financial account (which includes financial non-reserve assets and
reserve assets)
Sub-classification of the capital
and financial account is NOT
required in the curriculum.
For information about the
components of financial nonreserve assets, please refer to
Appendix 25.2.
A Capital account and financial non-reserve assets
External transactions that involve an inflow of capital are recorded on
the credit (+) side of the capital and financial account while an outflow
of capital is recorded on the debit (−) side of the account.
Inflow of capital
Credit (+)
Outflow of capital
Debit (–)
a company in Australia buying
the trademark of a company
in Hong Kong
a Hong Kong resident buying shares
issued by a listed company in the
United States
Table 25.6 Examples of inflow and outflow of capital of Hong Kong recorded in the
capital and financial account
214
capital and financial account 資本及金融帳
Balance of Payments Account and Exchange Rate
B
Reserve assets
The capital and financial account also records changes in reserve
assets. Reserve assets consist of gold and foreign exchange assets such as
foreign currency, deposits and bonds that are controlled by the monetary
authority of the economy. They are kept for financing deficits in the
balance of payments, or for intervention in foreign exchange markets to
affect the exchange rate.
‘Reserve assets’ are sometimes
referred to as ‘official reserves’
and ‘foreign exchange
reserves’.
When the central bank sells reserve assets (i.e. a decrease in
reserve assets), there will be a capital inflow and it is recorded on
the credit (+) side of the capital and financial account.
When the central bank buys reserve assets (i.e. an increase in
reserve assets), there will be a capital outflow and it is recorded on
the debit (−) side of the capital and financial account.
O
Example
IS
T
HKMA’s selling of US dollars for Hong Kong dollars in the
market is recorded on the credit (+) side of the account. On the
other hand, HKMA’s buying of US dollars using Hong Kong
dollars in the market is recorded on the debit (−) side of the
account.
A
R
When there is an increase in reserve assets, the net change in reserve
assets is positive. On the other hand, when there is a decrease in reserve
assets, the net change in reserve assets is negative.
Exercise 25.1.3
Identify whether each of the following transactions is an example of a ‘capital inflow’ or ‘capital
outflow’ of Hong Kong. Indicate whether they are ‘credit’ or ‘debit’ items of the capital and
financial account.
Transaction
a.A Hong Kong company buys a
property in Singapore.
Capital inflow / outflow
Credit / Debit
Capital outflow
Debit
b.A foreign investor buys a number of
shares of a Hong Kong company.
c.A Hong Kong resident borrows
money from a bank in the Mainland.
d.A Hong Kong company sells a
franchise to a company in Thailand.
official reserve 官方儲備
215
Chapter
25
Enrich
Yourself 25.3
Recording conventions used in the capital and
financial account
The following table shows how each of the following transactions would
be recorded in the capital and financial account.
Records in capital and
financial account
Disposal of non-produced, non-financial assets
Acquisition of non-produced, non-financial assets
Credit (+)
Debit (–)
Decreases in external assets
Increases in external assets
Credit (+)
Debit (–)
Increases in external liabilities
Decreases in external liabilities
Credit (+)
Debit (–)
Decreases in reserve assets
Increases in reserve assets
Credit (+)
Debit (–)
O
Transactions
IS
T
When the sum on the credit side is greater than the sum on the debit
side, there will be a capital and financial account surplus. If the sum on
the credit side is smaller than the sum on the debit side, there will be a
capital and financial account deficit.
A
R
Enrich
Yourself 25.4
Current transfers versus capital transfers
Donations can be current transfers or capital transfers. When is a
donation regarded as a current transfer and when is it regarded as a
capital transfer?

Donations as current transfers
If the resources involved in the
donations are likely to be consumed
immediately or shortly after they are
received, they are considered current
transfers.
For example, donations of relief
supplies like water and blankets are
consumed immediately or shortly after
being received by the people in need.
International transactions of this kind
are regarded as current transfers.
216

Donations as capital transfers
If the donations involve fixed assets
or things that are not consumed
immediately or in a short period
of time, they are considered capital
transfers.
Enrich
Yourself 25.5
Balance of Payments Account and Exchange Rate
How would different transactions affect the
balance of payment account?
The balance of payment account of Hong Kong records economic
transactions between Hong Kong and the rest of the world within a certain
period of time. The following table provides examples of transactions and
their effects on individual components of the balance of payments account.
A Hong Kong investor purchased
a house in Japan.
Included
(credit)
IS
T
A Hong Kong investor received
rental income from his property in
Thailand.
Included
(debit)
A foreign investor bought shares
issued by a listed company in
Hong Kong.
A
R
A foreign investor bought shares
of a listed company in Hong Kong
from another foreign investor.
Explanation
Capital and financial
account
(outflow of capital for
acquiring assets)
O
Transaction
Included /
Not included in
the calculation of
BOP
Included
(credit)
Not included
Current account
(inflow of primary
income)
Capital and financial
account
(inflow of capital for
acquiring financial
assets)
Not a transaction
between a resident and
a non-resident of Hong
Kong.
A foreign investor received
dividends from a listed company
in Hong Kong
Included
(debit)
Current account
(outflow of primary
income)
A foreign resident purchased a life
insurance policy from an insurance
company in Hong Kong.
Included
(credit)
Current account
(exports of services)
A foreign domestic helper earned
a salary from working in Hong
Kong for three years.
Not included
A foreign domestic helper remitted
her savings to her children in the
Philippines.
Included
(debit)
Current account
(a current transfer to
abroad)
A tourist from South Korea bought
a pair of shoes in Hong Kong.
Included
(credit)
Current account
(exports of services)
A Hong Kong resident bought air
tickets from a European airline.
Included
(debit)
Current account
(imports of services)
Not a transaction
between a resident and
a non-resident of Hong
Kong.
217
Chapter
25
25.1.4 Balance of Payments and
Balance of the BOP Account
Brainstorm 25.1.4
‘The balance of payments is different from the balance of the BOP account.’
Do you agree? Why?
A Meaning of balance of payments
The balance of payments (BOP) is equal to the sum of the balance
of the current account and the balance of the capital and financial
account (excluding changes in reserve assets).
O
Balance of
Balance of current Balance of capital and financial account
=
+
payments (BOP)
account
(excluding changes in reserve assets)
IS
T
Since all international transactions are recorded on either the credit
side (receipts) or the debit side (payments), BOP can be regarded as the
difference between total credits and total debits. It can be in surplus,
deficit or balance.
Outcome
Balance of
payments
surplus
218
A
R
The table below shows the three possible outcomes for the balance of
payments:
Explanation
It occurs when an economy’s total receipts exceed its
total payments in international transactions (total
credits > total debits).
Balance of
payments deficit
It occurs when an economy’s total receipts are less
than its total payments in international transactions
(total credits < total debits).
Balanced balance
of payments
It occurs when an economy’s total receipts are equal
to its total payments in international transactions
(total credits = total debits).
balance of payments 國際收支差額 balance of payments surplus 國際收支盈餘
balance of payments deficit 國際收支赤字
Balance of Payments Account and Exchange Rate
B
Meaning of balance of the BOP account
Note that the balance of payments and the balance of the BOP account
are different.
The balance of payments refers to the difference between total credits
and total debits (excluding changes in reserve assets), which may not be
zero.
The balance of payments account is an account recording the
transactions that is always balanced in the accounting sense. The sum
of all credit entries is equal to the sum of all debit entries in a complete
balance of payments account (i.e. including changes in reserve assets).
The balance of the BOP account is zero. Therefore, the current account
balance should be equal to the capital and financial account balance but
with an opposite sign.
IS
T
O
Balance of the BOP account = Current account balance + Capital and financial
account balance
0 = Current account balance + Capital and financial
account balance
Current account balance = − Capital and financial account balance
In the past
A
R
Therefore, when there is a balance of payments surplus or deficit, there
will be a change in reserve assets by the exact amount so that the balance
of the BOP account will be zero.
When there is a balance of payments surplus:
 Reserve assets will increase by the amount of the surplus.
When there is a balance of payments deficit:
 Reserve assets will decrease by the amount of the deficit.
The following table shows the
information about the balance of
payments of a country:
Visible trade
Invisible trade
Capital inflow
Capital outflow
$ million
20
X
70
50
Suppose the foreign exchange
reserves of the country increase by
$30 million. What is the value of
X?
A. −70
B. −10
C.+10
D. +70
[HKDSE/2016/Paper 1/43]
When there is a balanced balance of payments:
 the reserve assets will remain unchanged.
Exercise 25.1.4
(*Choose the correct option.)
Complete the table below.
Transaction
total credits
Balance of payment
total debits
total credits < total debits
total credits > total debits
Net change in reserve assets
zero
deficit
*(positive/zero/negative)
*(positive/zero/negative)
219
Chapter
25
Enrich
Yourself 25.6
An example of balance of payments calculation
Refer to the following information about an economy. Most of the
figures come from Enrich Yourself 25.1.
Item
Debit
($ billion)
Skills Check
400
300
600
350
400
100
110
450
O
Domestic exports of goods
Re-exports of goods
Imports of goods
Exports of services
Imports of services
Income receivable from abroad
Income payable abroad
Current transfers from abroad
Current transfers to abroad
Capital transfers received from non-residents
Capital transfers paid to non-residents
Disposal of non-produced, non-financial
assets
Acquisition of non-produced, non-financial
assets
All inward investment
All outward investment
Total
Credit
($ billion)
200
500
400
IS
T
250
100
750
A
R
2,900
1,250
3,260
To calculate the balance of payments, we can follow the steps below.
1. A
dd up all the amounts on the credit side (excluding changes in
reserve assets) and we get $2,900 billion.
2. A
dd up all the amounts on the debit side (excluding changes in
reserve assets) and we get $3,260 billion.
3. T he difference between the two sums is the balance of payments. In
this case, there is a balance of payments deficit of $360 billion.
A balance of payments deficit (surplus) would result in a fall (rise) in
reserve assets by the same amount. As a result, the amount of reserve
assets will decrease by $360 billion and this will be recorded on the
credit side. In this way, the balance of payments account is balanced.
Item
Decrease in reserve assets
Total
220
Credit
($ billion)
Debit
($ billion)
360
3,260
3,260
data
interpreting
Around Us
25.2
Balance of payments of Hong Kong
The table below shows information about the balance of payments of Hong
Kong in 2017 (as of June 2019).
(HK$ million)
123,900
−178,532
207,431
115,552
−20,551
−76,488
−645
−75,843
174,666
186,887
264,159
61,763
−338,144
−250,509
−47,413
250,509 (surplus)
O
Current account
Goods
Services
Primary income
Secondary income
Capital and financial account
Capital account
Financial account
Financial non-reserve assets
Direct investment
Portfolio investment
Financial derivatives
Other investment
Reserve assets
Net errors and omissions
Overall balance of payments
IS
T
(There may be a slight discrepancy between the sums of individual items and the total due to rounding.)
(Source: Census and Statistics Department, HKSAR Government)
Current account
A
R
There was a current account surplus of about HK$124 billion along with a
balance of trade deficit of about HK$179 billion. It is normal to see a balance
of trade deficit because Hong Kong lacks natural resources and relies heavily
on imports. The large surplus in invisible trade shows the importance of the
services sector to the Hong Kong economy.
Capital and financial account
There was a capital and financial account deficit of about HK$76 billion along
with a deficit in the capital account and a positive value in financial nonreserve assets.
Net errors and omissions
In principle, the sum of the current account balance and capital and financial
account balance is zero. Nevertheless, there may be discrepancies in the
figures for various reasons. To adjust the sum of the balances to zero, the item
‘net errors and omissions’ is included in the balance of payments account.
Overall balance of payments
There was a balance of payments surplus (an increase in official reserves) of
about HK$250.5 billion. Theoretically, the balance of payments is the sum of
the current account balance and the capital account balance plus the net
change in financial non-reserve assets. In practice, we need to add in the
amount of net errors and omissions to get the actual balance of payments.
221
Revision Corner
25.1
Guided practice
1.In which of the following situations might a fiscal surplus and a trade surplus decrease at the same time?
A.
B.
C.
D.
a tariff imposed on imports
a decrease in the salaries tax rate
an increase in money supply
an increase in the income tax rate
(*Choose the correct option.)
Approaching the question
Recall the meaning of fiscal surplus and trade surplus.
•Fiscal surplus: the situation in which the
is greater than the
.
•Trade surplus: the situation in which the value of
is greater than the value of
.
O
Think about how each of the situations would affect fiscal surplus and trade surplus.
Option A:An import tariff would *(increase/decrease) imports. The trade surplus would *(increase/decrease).
IS
T
Option B:Decreasing the salaries tax rate might decrease government revenue, which would *(increase/decrease)
the fiscal surplus. People’s disposable income and expenditure on imports would *(increase/decrease).
The trade surplus would *(increase/decrease).
Option C:Increasing money supply would *(increase/decrease) the nominal interest rate, which would boost
national income. With an increase in national income, tax revenue and imports would *(increase/
A
R
decrease). The fiscal surplus would *(increase/decrease) and the trade surplus would *(increase/decrease).
Option D:A rise in the income tax rate would reduce people’s disposable income. Their expenditure on imports
would *(increase/decrease). The trade surplus would *(increase/decrease).
2.The following table shows some information about the balance of payments of Country A.
Item
Imports of goods
Exports of goods
Imports of services
Exports of services
Net factor income from abroad
Net current transfers
Net change in reserve assets
$ million
800
1,200
2,000
2,500
300
−900
−500
According to the above data, which of the following statements is CORRECT?
A. The balance of the current account is −$300 million.
B.The balance of the capital and financial account (excluding changes in reserve assets)
is −$800 million.
C. The balance of payments surplus is $500 million.
D. The GDP of the economy is greater than its GNI.
222
Balance of Payments Account and Exchange Rate
Approaching the question
(*Choose the correct option.)
Calculate the current account balance, the capital and financial account balance (excluding changes in reserve
assets) and the balance of payments.
Recall the relationship between GDP and GNI.
Analyse which option is correct.
Option A:Balance of current account =
Option B:
•Balance of current account + Balance of capital and financial account (excluding changes in reserve assets)
= Net change in reserve assets
•
+ Balance of capital and financial account (excluding changes in reserve assets)
=
•
Balance of capital and financial account (excluding changes in reserve assets) =
O
Option C:As there is *(an increase/a decrease) in reserve assets, the balance of payments is in *(deficit/surplus).
Option D:GNI = GDP *(+/−) Net factor income from abroad. As net factor income from abroad is positive, GNI is
Learning Focus
Topic/Key point
IS
T
*(greater/smaller) than GDP.
HKDSE
Paper 1
Paper 2
Whether and how a given
transaction affects the current
account
2019 Q44
2017 Q41
2015 Q43
2014 Q43
2012 Q40
2017 Q12c (4)
2016 Q13bi (6)
2015 Q12a (2)
2012 Q5b (3)
Meaning of trade surplus and
deficit
2017 Q39
2016 40
2012 Q31
2019 Q12aii (3)
Current account
(main components:
goods, services,
income and current
transfers)
A
R
Brief introduction to the balance of payments account
Meaning of current account
surplus and deficit
Capital and
financial account
Whether and how a given
transaction affects the capital
and financial account
2013 Q6a (1)
2019 Q44
2013 Q6b (3)
Meaning and role of foreign and
official reserves in the balance
of payments accounting
Balance of
payments and
balance of the BOP
account
The balance of payments
is always balanced in the
accounting sense
Meaning of balance of payment
surplus and deficit
2016 Q43
Sample Paper Q38
2018 Q44
2015 Q44
2018 Q11 (2)
223
Chapter
25
25.2
Introduction to Exchange Rate
Brainstorm 25.2
1On the right are the names and symbols
of some currencies. Match the symbols
with the correct names.
2How many Hong Kong dollars do you
think are needed to exchange for one
unit of each of these currencies?
●
●
British pound
●
●
Renminbi
●
●
Euro
A
R
IS
T
O
Foreign exchange is the currency of another country. The foreign
exchange market is the market in which one currency is exchanged for
another. When making international transactions, buyers and sellers may
need to use foreign exchange as the medium of exchange.
Figure 25.3 A Hong Kong buyer exchanges Hong Kong dollars for British pounds to
pay for imported machines from Britain.
25.2.1 Meaning of Exchange Rate
An exchange rate is the price of a currency in terms of another
currency.
Table 25.17 shows the exchange rates of some major currencies on 17th
September 2018. For example, the exchange rate of the Hong Kong
dollar (HK$/HKD) against the British pound (£/GBP) was HK$1 =
£0.097. This means people had to use £0.097 to exchange for HK$1 on
that day.
224
foreign exchange 外匯 foreign exchange market 外匯市場 exchange rate 匯率
The demand for a currency is
actually a derived demand.
People demand currencies not
to consume them directly, but
to use them as a medium of
exchange in transactions.
Balance of Payments Account and Exchange Rate
HK dollar
(HKD)
US dollar
(USD)
British pound
(GBP)
Japanese yen
(JPY)
Euro
(EUR)
HKD 1 =
1
0.127
0.097
14.263
0.110
USD 1 =
7.847
1
0.764
111.926
0.860
GBP 1 =
10.265
1.308
1
146.412
1.124
JPY 1 =
0.070
0.009
0.007
1
0.008
EUR 1 =
9.129
1.163
0.889
130.207
1
(Source: xe.com, 17th September 2018)
Table 25.7 Exchange rates of major currencies
IS
T
£0.097 = HK$1
0.097
1
£
= HK$
0.097
0.097
£1 = HK$10.309
O
Mathematically, the exchange rate of the foreign currency against the
domestic currency is the reciprocal of the exchange rate of the domestic
currency against the foreign currency, for example,
25.2.2 Types of Exchange Rate System
Type of system
Floating
exchange rate
system
A
R
There are two main types of exchange rate systems used to determine the
value of domestic currency against other currencies. They are the floating
exchange rate system and the fixed exchange rate system.
Explanation
•It refers to the system where the exchange rate of a currency is
determined by the demand for and supply of that currency in the
foreign exchange market.
•A rise in the value of one currency in terms of another currency is called
currency appreciation.
•A fall in the value of one currency in terms of another currency is called
currency depreciation.
•It refers to the system where the government or the central bank of a
country fixes the exchange rate of its currency against other currencies
Fixed exchange
or the price of gold.
rate system
•When a government increases the value of its currency against another
(Pegged
currency, it is known as currency revaluation.
exchange rate
•When a government decreases the value of its currency against another
system)
currency, it is known as currency devaluation.
floating exchange rate system 浮動匯率制度 appreciation (浮動匯率制度下)升值 depreciation (浮動匯率制度下)貶值
fixed exchange rate system 固定匯率制度 pegged exchange rate 掛鈎匯率；釘住匯率 revaluation (固定匯率制度下)升值
devaluation (固定匯率制度下)貶值
225
Chapter
25
25.2.3 Changes in Exchange Rates
A Appreciation/Revaluation
When the domestic currency appreciates or is revalued, the exchange
value of the domestic currency in terms of the foreign currency rises.
This means that each unit of the domestic currency can be exchanged
for more of the foreign currency. It also means more units of the foreign
currency are required to ‘buy’ one unit of the domestic currency.
Example
If the Hong Kong dollar appreciates against the British pound, it
means each unit of the Hong Kong dollar can be exchanged for
more British pounds.
Exchange rate
1st January 20X8
HK$1 = £0.075
1st February 20X8
HK$1= £0.082
Skills Check
data
interpreting
O
Date
B
IS
T
Table 25.8 The Hong Kong dollar appreciates against the British pound.
Depreciation/Devaluation
When the domestic currency depreciates or is devalued, the exchange
value of the domestic currency in terms of the foreign currency falls. This
means that each unit of the domestic currency can be exchanged for less
of the foreign currency. It also means fewer units of the foreign currency
are required to ‘buy’ one unit of the domestic currency.
A
R
Example
As mentioned, the exchange
rate of the domestic currency in
terms of a foreign currency is
the reciprocal of the exchange
rate of the foreign currency in
terms of the domestic currency.
Therefore,
•an appreciation/a
revaluation of a currency
implies a depreciation/
devaluation of another
currency; and
•a depreciation/devaluation
of a currency implies an
appreciation/a revaluation
of another currency.
If the Hong Kong dollar depreciates against the British pound, it
means each unit of the Hong Kong dollar can be exchanged for
less of the British pounds.
Date
Exchange rate
1st January 20X8
HK$1= £0.082
1st February 20X8
HK$1 = £0.075
Table 25.9 The Hong Kong dollar depreciates against the British pound.
Exercise 25.2
(*Choose the correct option.)
Refer to the table on the right.
a.The US dollar (US$) has *(appreciated/depreciated)
against the British pound (₤) during the period.
b.The same amount of British pounds can be
exchanged for *(more/less) US dollars.
226
Date
Exchange rate
1st January 20X8
US$1 = ₤0.65
1st February 20X8
US$1 = ₤0.61
Around Us
25.3
Exchange rates of the Hong Kong dollar
against some foreign currencies
We can buy foreign currencies with Hong Kong dollars or sell foreign
currencies for Hong Kong dollars at banks or money changers.
The following table shows how a bank normally displays the exchange rates
of foreign currencies to the Hong Kong dollar.
The ‘bid price’ shows how many Hong Kong dollars the bank is willing to pay
for 1 unit of foreign currency. The ‘ask price’ shows how many Hong Kong
dollars are required to pay for 1 unit of foreign currency at the bank.
US Dollar
Australian Dollar
Canadian Dollar
Euro
Bank sell
(the ‘bid price’)
(the ‘ask price’)
7.783
7.91
5.8677
6.0281
IS
T
Bank buy
O
Currency
5.9978
6.1675
9.0612
9.3118
Japanese Yen
0.07062
0.07275
Malaysian Ringgit
1.81916
2.11916
New Zealand Dollar
5.3525
5.5195
Philippine Peso
0.145
0.16
Pound Sterling
10.272
10.664
Renminbi
1.214
1.2456
Singapore Dollar
5.7715
5.943
Swiss Franc
7.7998
8.0125
Thai Baht
0.2306
0.2609
A
R
The difference between the ‘bid price’ and the ‘ask price’ is called the ‘bidask spread’. The bid-ask spread arises partly because there is transaction cost
involved in the buying or selling of foreign currencies.
227
Chapter
25
25.3 Effects of a Change in the
Exchange Rate
Brainstorm 25.3
Really? That’s
great!
O
2Scan the QR code
and watch a video to
learn more about the
effects of a change
in the exchange rate.
I will go on a study tour in
Europe this summer.
IS
T
1How do you think the
girl’s consumption
during the study
tour will be affected
by the change in the
exchange rate?
A
R
As mentioned in Chapter 17, changes in the exchange rate affect the
value of net exports. In this section, we will further discuss the effects of
a change in an exchange rate on:
import and export prices;
import and export volumes; and
the values of imports and exports (i.e. import expenditure and
export revenue).
In this section, we will use the following example to illustrate the effects
of a change in the exchange rate on imports and exports.
Date
Exchange rate
1st January 20X8
¥100 = HK$8
1st June 20X8
¥100 = HK$9
1st December 20X8
¥100 = HK$8.5
Table 25.10 Changes in the exchange rate of the Japanese yen
against the Hong Kong dollar
According to Table 25.10, the Japanese yen:
appreciated against the Hong Kong dollar in June; and
depreciated against the Hong Kong dollar in December.
228
The Hong Kong
dollar has
appreciated
against the euro
and the pound!
Going to Europe is
now cheaper!
Inspiring
Video
Balance of Payments Account and Exchange Rate
25.3.1 Effects of a Change in the
Exchange Rate on Imports
AEffects on the import price, the import volume
and the value of imports
(in terms of domestic currency)
aEffects on the import price
(in terms of the domestic currency)
Suppose a Hong Kong resident was going to buy a pair of
sunglasses imported from Japan. For simplicity, we assume that the
price of the sunglasses in Japanese yen remained at ¥5,000 over the
period from 1st January 20X8 to 1st December 20X8.
IS
T
O
Due to the change in the exchange rate between the Japanese yen
and the Hong Kong dollar, the price of the sunglasses in Hong
Kong dollars changed as follows:
Other things being constant,
the import price in terms of
the foreign currency remains
unchanged regardless of the
change in the exchange rate.
Date
Exchange rate
Price of the sunglasses
1st January 20X8
¥100 = HK$8
¥5,000 = HK$400
1st June 20X8
¥100 = HK$9
¥5,000 = HK$450
¥100 = HK$8.5
¥5,000 = HK$425
1st December 20X8
A
R
Table 25.11 Changes in the price of a pair of sunglasses in Hong Kong dollars
As shown in Table 25.11:
When the Japanese yen appreciated against the Hong Kong
dollar in June,
the price of the sunglasses in Hong Kong dollars
increased.
When the Japanese yen depreciated against the Hong Kong
dollar in December,
the price of the sunglasses in Hong Kong dollars
decreased.
To conclude,
an appreciation of the foreign currency (or a depreciation
of the domestic currency) will lead to a rise in the import
price in terms of the domestic currency; and
a depreciation of the foreign currency (or an appreciation
of the domestic currency) will lead to a fall in the import
price in terms of the domestic currency.
229
Chapter
25
bEffects on the import volume and the value of imports
(in terms of the domestic currency)
According to Table 25.11, when the Japanese yen appreciated
against the Hong Kong dollar in June, the price of the sunglasses
in terms of Hong Kong dollars increased.
i)
Effect on the import volume
By the law of demand, the quantity demanded of Japanese
sunglasses in Hong Kong would decrease from Q0 to Q1
when the price (in terms of Hong Kong dollars) increased.
Therefore, the import volume of the sunglasses would drop,
as shown in Figure 25.4.
Unit price (HK$)
Increase in expenditure
Decrease in expenditure
450
400
0
D
Q1
Q0
Quantity
Figure 25.4 When the Japanese yen
appreciated against the Hong Kong
dollar, the import price of Japanese
sunglasses in terms of Hong Kong
dollars would increase and Hong Kong’s
import volume would decrease.
IS
T
O
ii)Effect on the value of imports
(in terms of the domestic currency)
The effect of the change in the exchange rate on Hong
Kong’s import expenditure in terms of Hong Kong dollars
(i.e. HK$450 × Q1 − HK$400 × Q0) would be uncertain.
It would depend on the price elasticity of demand for the
sunglasses in Hong Kong.
Market for Japanese sunglasses
There are three possible outcomes:
•The percentage increase in the import
price would be smaller than the
percentage decrease in the quantity
demanded.
•The import expenditure in terms of
Hong Kong dollars would decrease.
A
R
1.Elastic
demand
(1<Ed<∞)
230
2.Inelastic
demand
(0<Ed<1)
•The percentage increase in the import
price would be greater than the
percentage decrease in the quantity
demanded.
•The import expenditure in terms of
Hong Kong dollars would increase.
3.Unitarily
elastic
demand
(Ed=1)
•The percentage increase in the import
price would be equal to the percentage
decrease in the quantity demanded.
•The import expenditure in terms of
Hong Kong dollars would remain
unchanged.
In the past
A country’s currency appreciates
against its trading partners’
currencies. If the country’s demand
for imports is
, the
appreciation of its currency will
lead to
in the total
import value (in terms of domestic
currency).
A. unitarily elastic … a rise
B.inelastic … a rise
C.elastic … a fall
D. inelastic … a fall
[HKDSE/2013/Paper 1/37]
Balance of Payments Account and Exchange Rate
BEffects on the import price, the import volume
and the value of imports
(in terms of the foreign currency)
aEffect on the import price
(in terms of the foreign currency)
Assume that the import price of the Japanese sunglasses in terms
of Japanese yen was not affected by any changes in the exchange
rate. The price of a pair of Japanese sunglasses remained at ¥5,000.
bEffects on the import volume and the value of imports
(in terms of the foreign currency)
IS
T
O
i)
Effects on the import volume
As mentioned before, an appreciation of the Japanese yen
against the Hong Kong dollar will result in a rise in the price
of the sunglasses in terms of Hong Kong dollars, leading to
a decrease in Hong Kong’s import volume of sunglasses.
A
R
As shown in Figure 25.5, with the unit price of the
sunglasses at ¥5,000:
the demand for the sunglasses would decrease;
the demand curve would shift to the left from
D0 to D1; and
the quantity demanded would decrease from Q0 to Q1.
Market for Japanese sunglasses
Unit price (¥)
Decrease in expenditure
5,000
D0
D1
0
Q1
Q0
Quantity
Figure 25.5 When the Japanese yen appreciated
against the Hong Kong dollar, the import price in
terms of Japanese yen would remain unchanged
and the demand for Japanese sunglasses would
decrease.
ii)Effects on the value of imports
(in terms of the foreign currency)
As a result, the import expenditure in terms of Japanese yen
would decrease by ¥5,000 × (Q0 − Q1).
231
Chapter
25
25.3.2 Effects of a Change in the
Exchange Rate on Exports
AEffects on the export price, the export volume
and the value of exports
(in terms of the foreign currency)
aEffects on the export price
(in terms of the foreign currency)
Suppose a Japanese resident was going to buy a watch exported
from Hong Kong. We assume that the price of the watch in
Hong Kong dollars remained at HK$100 over the period from 1st
January 20X8 to 1st December in 20X8.
Date
IS
T
O
Due to the change in the exchange rate between the Japanese yen
and the Hong Kong dollar, the price of the watch in Japanese yen
changed as follows:
Exchange rate
Price of the watch
1st January 20X8
¥100 = HK$8
¥1,250 = HK$100
1st June 20X8
¥100 = HK$9
¥1,111= HK$100
¥100 = HK$8.5
¥1,175= HK$100
1st December 20X8
A
R
Table 25.12 Changes in the price of a watch in Japanese yen
As shown in Table 25.12:
When the Japanese yen appreciated against the Hong Kong
dollar in June,
 the price of the watch in Japanese yen decreased.
When the Japanese yen depreciated against the Hong Kong
dollar in December,
 the price of the watch in Japanese yen increased.
To conclude,
an appreciation of the foreign currency (or a depreciation
of the domestic currency) will lead to a fall in the export
price in terms of the foreign currency.
a depreciation of the foreign currency (or an appreciation
of the domestic currency) will lead to a rise in the export
price in terms of the foreign currency.
232
Other things being constant,
the export price in terms of
the domestic currency remains
unchanged regardless of the
change in the exchange rate.
Balance of Payments Account and Exchange Rate
bEffects on the export volume and the value of exports
(in terms of the foreign currency)
As Table 25.12 shows, when the Japanese yen appreciated against
the Hong Kong dollar in June, the price of the watch in terms of
Japanese yen decreased.
i)
Effect on the export volume
By the law of demand, the quantity demanded of Hong
Kong watches in Japan would increase from Q0 to Q1 when
the price (in terms of Japanese yen) decreased. Therefore,
the export volume of the watches would increase, as shown
in Figure 25.6.
Gain in revenue
Unit price (¥)
Loss in revenue
1,250
1,111
D
0
Q0
Q1
Quantity
Figure 25.6 When the Japanese yen
appreciated against the Hong Kong
dollar, the export price of Hong Kong
watches in terms of Japanese yen would
decrease and Hong Kong’s export
volume would increase.
There are three possible outcomes:
1.Elastic
demand
(1<Ed<∞)
•The percentage decrease in the export
price would be smaller than the
percentage increase in the quantity
demanded.
•The export revenue in terms of Japanese
yen would increase.
A
R
IS
T
O
ii)
Effect on the value of exports
(in terms of the foreign currency)
The effect of the change in the exchange rate on Hong
Kong’s export revenue in terms of Japanese yen (i.e. ¥1,111
× Q1 − ¥1,250 × Q0) would be uncertain. It depends on the
price elasticity of demand for the watches in Japan.
Market for Hong Kong watches
2.Inelastic
demand
(0<Ed<1)
•The percentage decrease in the export
price would be greater than the
percentage increase in the quantity
demanded.
•The export revenue in terms of Japanese
yen would decrease.
3.Unitarily
elastic
demand
(Ed=1)
•The percentage decrease in the export
price would be equal to the percentage
increase in the quantity demanded.
•The export revenue in terms of Japanese
yen would remain unchanged.
233
Chapter
25
BEffects on the export price, the export volume
and the value of exports
(in terms of the domestic currency)
aEffect on the export price
(in terms of the domestic currency)
Assume that the export price of Hong Kong watches in terms
of Hong Kong dollars was not affected by any changes in the
exchange rate. The unit price of the watches remained at HK$100.
bEffects on the export volume and the value of exports
(in terms of the domestic currency)
Market for Hong Kong watches
IS
T
O
i)
Effect on the export volume
As mentioned before, the appreciation of the Japanese yen
against the Hong Kong dollar would result in a drop in the
price of the watches in terms of Japanese yen, leading to an
increase in Hong Kong’s export volume of watches.
A
R
As shown in Figure 25.7, with the unit price of the watches
at HK$100:
the demand for the watches would increase;
the demand curve would shift to the right from
D0 to D1; and
the quantity demanded would increase from Q0 to Q1.
ii)Effects on the value of exports
(in terms of the domestic currency)
As a result, the export revenue in terms of Hong Kong
dollars would increase by HK$100 × (Q1 − Q0).
Exercise 25.3
Unit price (HK$)
Gain in revenue
100
D1
D0
0
Q0
Q1
Figure 25.7 When the Japanese yen
appreciated against the Hong Kong
dollar, the export price in terms of Hong
Kong dollars would remain unchanged
and the demand for Hong Kong watches
would increase.
(*Choose the correct option.)
Date
Exchange rate
1st January 20X8
US$1 = ₤0.65
1st March 20X8
US$1 = ₤0.63
a.The US dollar (US$) *(appreciated/depreciated) against the British pound (₤) during the
period.
b. The price of goods imported from the US to Britain (in terms of British pounds)
*(increased/decreased).
c. The volume of goods imported from the US to Britain would *(increase/decrease).
234
Quantity
Balance of Payments Account and Exchange Rate
Enrich
Yourself 25.7
Summary of the effects of a depreciation of the
foreign currency
Effects on imports
When there is a depreciation of the foreign currency (or an appreciation
of the domestic currency):
Effect
In terms of the
foreign currency
In terms of the
domestic currency
Import price
Import volume
remains unchanged
decreases
Value of imports
increases
increases
O
uncertain
(depends on the price
elasticity of demand)
IS
T
The table below shows the effects on the value of imports (i.e. import
expenditure) in terms of the domestic currency under different price
elasticities of demand for imports:
1 < Ed < ∞
0 < Ed < 1
Increase in expenditure
<
A
R
Unit price
(in terms of the
domestic currency)
P0
P1
D
Ed = 1
Decrease in expenditure
Unit price
(in terms of the
domestic currency)
>
P0
Unit price
(in terms of the
domestic currency)
=
P0
P1
P1
D
D
0
Q0
Q1
Quantity
•% decrease in the import
price < % increase in the
quantity demanded
•import expenditure in terms
of the domestic currency
increases
0
Q0 Q1
Quantity
•% decrease in the import
price > % increase in the
quantity demanded
•import expenditure in terms
of the domestic currency
decreases
0
Q0
Q1 Quantity
•% decrease in the import
price = % increase in the
quantity demanded
•import expenditure in terms
of the domestic currency
remains unchanged
235
Chapter
25
Effects on exports
When there is a depreciation of the foreign currency (or an appreciation
of the domestic currency):
Effect
In terms of the
foreign currency
Export price
Export volume
increases
In terms of the
domestic currency
remains unchanged
decreases
uncertain
(depends on the price
elasticity of demand)
Value of exports
decreases
O
The table below shows the effects on the value of exports (i.e. export
revenue) in terms of the foreign currency under different price
elasticities of demand for exports:
0 < Ed < 1
IS
T
1 < Ed < ∞
Gain in revenue
Unit price
(in terms of the
foreign currency)
Loss in revenue
Unit price
(in terms of the
foreign currency)
<
Ed = 1
Unit price
(in terms of the
foreign currency)
>
=
P1
A
R
P1
P0
•% increase in the export
price < % decrease in the
quantity demanded
•export revenue in terms
of the foreign currency
decreases
•% increase in the export
price > % decrease in the
quantity demanded
•export revenue in terms
of the domestic currency
increases
P1
P0
0
236
D
Q1
Q0 Quantity
P0
D
D
0
Q1
Q0 Quantity
0
Q1
Q0 Quantity
•% increase in the export
price = % decrease in the
quantity demanded
•export revenue in terms
of the domestic currency
remains unchanged
Around Us
25.4
Exchange rate between the Renminbi
and the Hong Kong dollar
Since Hong Kong has adopted a linked exchange rate system, any
revaluation or devaluation of the Renminbi against the US dollar will also
affect the exchange rate between the Renminbi and the Hong Kong
dollar.
2005 – 2014
After the reform of the Renminbi exchange rate regime in 2005, the
value of the Renminbi against the Hong Kong dollar rose. The revaluation
pushed up prices in Hong Kong and increased the purchasing power of
tourists from the Mainland.
2015 – 2016
A
R
2017 – 2018
IS
T
O
On 11 August 2015, the People’s Bank of China announced a
modification in its exchange rate regime and devalued the Renminbi.
The exchange rate between the Renminbi and the Hong Kong dollar was
¥1 = HK$1.2150 in August 2015 and became ¥1 = HK$1.1199 in
December 2016. The amount of Renminbi deposits in Hong Kong
dropped from ¥979 billion in August 2015 to ¥547 billion in December
2016.
Since the US dollar depreciated against other major currencies in 2017,
the value of the Renminbi increased against the Hong Kong dollar again.
The market expected that the value of the Renminbi would continue to
increase against the Hong Kong dollar as the Mainland economy would
continue to grow and the determination of the exchange rate would
become more market-driven.
RMB/HKD
1.35
1.3
1.25
1.2
1.15
1.1
1.05
1
0.95
0.9
2005 2006
Exchange rate between the Renminbi and the Hong Kong dollar
2007 2008
2009 2010
2011
2012 2013 2014 2015 2016 2017
2018
Year
(Source: Census and Statistics Department, HKSAR Government)
237
Revision Corner
25.2
Guided practice
1.
Date
Exchange rate
January 201X
A$1 = HK$6.8
February 201X
A$1 = HK$7.1
The above change in the exchange rate between the Hong Kong dollar (HK$) and the Australian dollar (A$)
will result in
A.
B.
C.
D.
a drop in the number of tourists from Australia to Hong Kong.
a drop in Hong Kong’s import volume from Australia.
a drop in the price (in terms of HK$) of Hong Kong’s exports to Australia.
a drop in the total value (in terms of HK$) of Hong Kong’s exports to Australia.
Approaching the question
(*Choose the correct option.)
O
Determine which currency has appreciated and which currency has depreciated against the other.
The
 has appreciated against the

IS
T
as each unit of the Australian dollar can be exchanged for *(more/less) Hong Kong dollars.
Analyse the effects of the above change in the exchange rate.
Option A:With an appreciation of the
, purchases in Hong Kong
will be relatively *(cheaper/more expensive). This will result in a *(rise/drop) in the
number of tourists from Australia to Hong Kong.
A
R
Option B:A/An
of the Hong Kong dollar against the Australian
dollar will result in a *(rise/drop) in the price of imported goods in terms of Hong
Kong dollars, leading to a *(rise/drop) in Hong Kong’s import volume.
Option C:The price (in terms of Hong Kong dollars) of Hong Kong’s exports to Australia will
*(increase/decrease/remain unchanged).
Option D:As the price (in terms of Australian dollars) of Hong Kong’s exports to Australia
will *(increase/decrease), the quantity demanded will
.
With the price of exports in terms of Hong Kong dollars
,
a *(rise/drop) in the demand for the exports will result in a *(rise/drop) in the total
value (in terms of Hong Kong dollars) of Hong Kong’s exports to Australia.
238
Balance of Payments Account and Exchange Rate
2.The table below shows the change in the exchange rate of the Australian dollar (AUD) against the Hong
Kong dollar (HKD).
Date
Price of 1 unit of AUD
January 20X9
HKD 6.25
May 20X9
HKD 5.87
Suppose the price of Australian lobsters (in terms of AUD) did not change. With the aid of a diagram,
explain how the above change in the exchange rate would affect the total export value (in terms of AUD) of
Australian lobsters to Hong Kong.
(8 marks)
Approaching the question
Determine if the AUD
appreciated or depreciated
against the HKD. (1 mark)
O
(Hint: Would the price of Australian lobsters (in terms of HKD) change?)
(1 mark)
(Hint: How would Hong Kong’s demand for Australian lobsters change?)
(1 mark)
IS
T
Analyse the change in the
price of Australian lobsters
(in terms of HKD) and the
change in import volume
as well as the total export
value (in terms of AUD) of
Australian lobsters.
(4 marks)
(Hint: How would the total export value of Australian lobsters change?)
Indicate in the diagram the
Unit price
(in terms of AUD)
change in the total export
value of Australian lobsters
(in terms of AUD).
(3 marks)
Hints:
-indicate the movement along/shift
of a demand curve, if any
-indicate the effect on quantity
transacted
-indicate the change in export value
A
R
0
(2 marks)
Quantity of Australian
lobsters exported to
Hong Kong
Learning Focus
Topic/Key point
Effects of a
change in the
exchange rate
on imports
and exports
Effects of a change in the exchange rate
on import and export prices in terms of
domestic and foreign currencies, import
and export volumes, and values of
imports and exports in terms of domestic
and foreign currencies
HKDSE
Paper 1
Paper 2
2019 Q45
2018 Q45
2017 Q44
2016 Q44, 45
2014 Q42
2013 Q37
2012 Q39
Sample Paper Q40
2019 Q11c (8)
2018 Q12d (6)
2014 Q11a (7)
2012 Q8 (7)
Practice Paper Q10 (3)
239
Chapter
25
25.4 The Linked Exchange Rate System
in Hong Kong
Brainstorm 25.4
1Do you think the linked exchange rate system
is the only exchange rate system that Hong
Kong has ever adopted?
2Do you think the change in the exchange
rate shown in the picture would affect the
exchange rate of the Hong Kong dollar against
the euro?
IS
T
O
Hong Kong adopted the linked exchange rate system on 17th October
1983. Hong Kong’s linked exchange rate system is a Currency Board
System. Note-issuing banks can buy and sell Hong Kong dollars and
US dollars with the Exchange Fund at a fixed exchange rate of US$1 to
HK$7.8.
Features of Hong Kong’s linked exchange rate system are as follows:
A
R
1.Fixed exchange rate for the US dollar between the
note-issuing banks and the Exchange Fund
The Hong Kong Monetary Authority (HKMA) has authorised
the three note-issuing banks to issue Hong Kong dollar banknotes,
provided that they submit an equivalent amount of US dollars in
exchange for the Certificate of Indebtedness (CI) issued by the
Exchange Fund at a fixed rate of US$1 to HK$7.8.
Therefore, the Hong Kong dollar banknotes are fully backed by
US dollars held by the Exchange Fund. The note-issuing banks
can, if necessary, sell Hong Kong dollars to the Fund in return for
US dollars at the linked rate.
2.Relatively stable exchange rate between the Hong Kong
dollar and the US dollar
Under the linked exchange rate system, the exchange rate of the
Hong Kong dollar against the US dollar is relatively stable. This
reduces the foreign exchange risk faced by traders and international
investors.
In the past
Under the linked exchange rate
system of Hong Kong, which of
the following statements is correct?
A.The non-bank public can sell
their Hong Kong dollars to
the Hong Kong Monetary
Authority in exchange for US
dollars at any time.
B.It enables the Hong Kong
Monetary Authority to carry
out an expansionary monetary
policy to stimulate private
investment.
C.The market exchange rate
of the US Dollar against the
HK Dollar is fixed at US$1 =
HK$7.8.
D.There would be a downward
pressure on the consumer
price indices of Hong
Kong when the Renminbi
continuously depreciates
against the US Dollar.
240
linked exchange rate system 聯繫匯率制度 Currency Board System 貨幣發行局制度
Certificate of Indebtedness 負債證明書
[HKDSE/2017/Paper 1/45]
Balance of Payments Account and Exchange Rate
Figure 25.8 shows that the exchange rate between the Hong Kong
dollar and the US dollar has been very stable since the implementation
of the linked exchange rate system in October 1983.
USD/HKD
8
When reading line graphs
showing fluctuations of the
exchange rate, pay attention
to how the exchange rate is
quoted. Otherwise, the trend
may be interpreted wrongly. For
example, the exchange rate in
Figure 25.8 is quoted as ‘USD/
HKD’, meaning how many Hong
Kong dollars can be exchanged
for 1 US dollar. The rising trend
between 1975 and 1983 shows
that the US dollar appreciated.
If the exchange rate is quoted as
‘HKD/USD’, the trend becomes a
downward one.
7
6
5
0
1975
Year
2017
1983
(Source: Census and Statistics Department, HKSAR Government)
O
Figure 25.8 Exchange rate between the Hong Kong dollar and
the US dollar, 1975 – 2017
3.Fluctuations in the exchange rates of the US dollar and the
Hong Kong dollar are in phase
A
R
IS
T
The market exchange rate of the Hong Kong dollar against other
currencies is determined by demand and supply in the foreign exchange
market. However, under the linked exchange rate system, when the US
dollar depreciates (appreciates) against other currencies, the Hong
Kong dollar tends to depreciate (appreciate) against other currencies
as well. In other words, fluctuations in the exchange rates of the US
dollar and the Hong Kong dollar are in phase.
Unlike a fixed exchange rate system, the Hong Kong government does
not actively interfere with the foreign exchange market by controlling
the supply and demand of the currency in order to stabilise the
exchange rate under the linked exchange rate system.
Euro against the US dollar
Euro against the Hong Kong dollar
EUR/USD
EUR/HKD
10.0
1.25
1.23
9.8
1.21
9.6
1.19
9.4
1.17
9.2
0
Dec 2018 Feb
(Source: European Central Bank)
Mar
Apr
May
0
Dec 2018 Feb
(Source: European Central Bank)
Mar
Apr
May
Figure 25.9 The figures show that the changes in the exchange rate of the US dollar against the euro is in phase with
the changes in the exchange rate of the Hong Kong dollar against the euro.
241
Chapter
25
The table below briefly introduces the history of Hong Kong’s exchange
rate system.
Exchange rate
Reference rate
system
Silver
Silver dollars as a legal tender
1863 – 1935
Standard
•£1 = HK$16
(December 1935 – November
December 1935 – Pegged to the
1967)
June 1972
British pound
•£1 = HK$14.55
(November 1967 – June 1972)
•US$1 = HK$5.65
Pegged to the
( July 1972 – February 1973)
July 1972 –
US dollar at a •US$1 = HK$5.085
November 1974
fixed rate
(February 1973 – November
1974)
Exchange rates on selected dates:
•US$1 = HK$4.965
November 1974 –
Free floating
(25th November, 1974)
October 1983
•US$1 = HK$9.6
(24th September, 1983)
Linked
17th October, 1983
exchange rate US$1 = HK$7.8
– present
system
A
R
(Source: Hong Kong Monetary Authority)
IS
T
O
Period
Exercise 25.4
Determine if the following statements about the linked exchange rate system in Hong Kong
are correct or incorrect. Put a tick (ü) in the appropriate boxes.
Statement
a.The market exchange rate of the Hong Kong dollar
against the US dollar is fixed at a rate of US$1 to
HK$7.8 in the foreign exchange market.
b.The Hong Kong dollar banknotes have to be fully
backed by a basket of major currencies in the
Exchange Fund.
c.Hong Kong’s import volume will increase when the
US dollar appreciates against other currencies.
242
Correct
Incorrect
Around Us
25.5
Convertibility Undertakings
The Hong Kong Monetary Authority introduced some refinements to
the operation of the linked exchange rate system in 2005. It introduced
convertibility undertakings on both the strong side and the weak side of
the linked rate.
•
Strong-side Convertibility Undertaking:
èThe Hong Kong Monetary Authority would buy US dollars from
the licensed banks at the rate of US$1 = HK$7.75
•
Weak-side Convertibility Undertaking:
èThe Hong Kong Monetary Authority would buy Hong Kong
dollars from the licensed banks at the rate of US$1 = HK$7.85
IS
T
O
The Hong Kong Monetary Authority has to keep a considerable amount
of reserves in order to maintain the linked exchange rate. It has to sell
US dollars and buy Hong Kong dollars when weak-side Convertibility
Undertaking is triggered. The linked exchange rate system cannot be
maintained if the Hong Kong Monetary Authority does not have enough
US dollars.
A
R
Convertibility Zone
7.70
7.75
7.80
7.85
7.90
To promote the smooth functioning of the Linked Exchange Rate System, the HKMA
may conduct any market operations which are consistent with Currency Board
principles (i.e. Hong Kong dollars and US dollars are linked and any changes in the
monetary base is to be matched by changes in foreign exchange reserves) within the
‘convertibility zone’ which is defined by the levels of the Convertibility Undertakings.
243
Revision Corner
25.3
Guided practice
Under the linked exchange rate system of Hong Kong, which of the following statements is CORRECT?
A. Hong Kong’s money supply is fully backed by the US dollar.
B. A trade surplus in the US will lead to a trade surplus in Hong Kong.
C.The Hong Kong Monetary Authority has fixed the market exchange rate of the Hong Kong
dollar against the US dollar at US$1 = HK$7.8.
D.Hong Kong’s import volume will decrease when the US dollar depreciates against other
currencies.
Approaching the question
(*Choose the correct option.)
Think about the features of the linked exchange rate system of Hong Kong.

Determine which option is correct.
Option A:
(i.e. cash in public circulation + bank
reserves) is backed by the US dollar.
O
•Only the
•All the three definitions of money supply in Hong Kong, i.e. M1, M2 and M3, *(include/
licensed banks.
IS
T
do not include) components other than the monetary base, e.g. demand deposits with
Option B:The trade balances of the US and Hong Kong are *(dependent on/independent of)
each other.
A
R
Option C:Only the official exchange rate between the HKMA and
is fixed at US$1 = HK$7.8.
Option D:Under the linked exchange rate system, when the US dollar depreciates against
other currencies, the Hong Kong dollar tends to *(appreciate/depreciate) against
other currencies. This will result in a *(rise/fall) in the price of imports in terms
of Hong Kong dollars, leading to *(an increase/a decrease) in Hong Kong’s import
volume.
Learning Focus
Topic/Key point
Brief introduction to the linked exchange rate system in
Hong Kong
244
HKDSE
Paper 1
2017 Q45
2015 Q42
2013 Q40
Paper 2
Balance of Payments Account and Exchange Rate
CONCEPT MAP
Balance of
payments account
Current account
■ Goods
■ Services
■ Income
■ Current transfers
Capital and
financial account
Balanced BOP
Total receipts =
Total payments
A
R
BOP surplus
Total receipts >
Total payments
IS
T
O
Balance of
payments (BOP)
Types of exchange rate system
■ Floating exchange rate system
■ Fixed exchange rate system
(Pegged exchange rate
system)
BOP deficit
Total receipts <
Total payments
Exchange rate
Changes in
exchange rates
Appreciation/
Revaluation
The linked exchange rate
system in Hong Kong
Depreciation/
Devaluation
Effects of a
change in the
exchange rate
245
Chapter
25
CHECKLIST
I am now able to …
 describe the major components of the balance of payments account;
 explain the meaning of balance of payments surplus (deficit);
 explain why the balance of payments account must be balanced;
 state the meaning of exchange rate;
 explain the meaning of appreciation and depreciation, and revaluation and devaluation;
 describe the effects of a change in the exchange rate on import and export prices and volume,
as well as on import expenditure and export revenue;
 describe the relationship between the linked exchange rate system and the currency issuing
system in Hong Kong.
IS
T
O
(Put a tick (ü) against the information that applies.)
GLOSSARY
A
R
appreciation (浮動匯率制度下)升值
balance of invisible trade 無形貿易差額
balance of payments 國際收支平衡；國際收支差額
balance of payments account 國際收支平衡表
balance of payments deficit 國際收支赤字
balance of payments surplus 國際收支盈餘
balance of visible trade 有形貿易差額
capital and financial account 資本及金融帳
Certificate of Indebtedness 負債證明書
credit 貸方
Currency Board System 貨幣發行局制度
current account 經常帳
current account balance 經常帳差額
current transfer 經常轉移
debit 借方
depreciation (浮動匯率制度下)貶值
devaluation (固定匯率制度下)貶值
exchange rate 匯率
external factor income flow 對外要素收益流動
fixed exchange rate system 固定匯率制度
246
A
floating exchange rate system
e-Word Bank
浮動匯率制度 foreign exchange 外匯
foreign exchange market 外匯市場
invisible trade balance
無形貿易差額；無形貿易平衡
invisible trade deficit 無形貿易逆差 invisible trade surplus 無形貿易順差 invisible trade 無形貿易
linked exchange rate system 聯繫匯率制度
merchandise trade 商品貿易 net current transfer 經常轉移淨值
net income from abroad 從外地所賺取的淨收益
official reserve 官方儲備
pegged exchange rate 掛鈎匯率；釘住匯率 revaluation (固定匯率制度下)升值
visible trade balance 有形貿易差額；有形貿易平衡
visible trade deficit 有形貿易逆差
visible trade surplus 有形貿易順差
visible trade 有形貿易 Balance of Payments Account and Exchange Rate
CHAPTER SUMMARY
Familiarising yourself with items in green is important for effective revision.
Paying attention to items in the
boxes is helpful for understanding the concept(s).
25.1The Balance of Payments Account
(BOP Account)
Make your
own notes
Introduction to the BOP account
A balance of payments account (BOP account) systematically
summarises the transactions of an economy with the rest of the world in
a specific period of time.
The credit (+) side
The debit (–) side
All receipts and obligations
received from non-residents are
recorded on the credit (+) side.
All payments and liabilities to
non-residents are recorded on the
debit (–) side.
the current account; and
In Hong Kong, economic transactions
with the Mainland are treated as external
transactions and are recorded in the BOP
account.
IS
T
The balance of payments account consists of:
O
the capital and financial account.
Current account
A
R
The current account mainly records the flow of real resources to and
from abroad, including exports and imports of goods and services;

income receivable from and income payable abroad; and current
transfers to and from abroad.
The four components of the current account: goods, services, income
and current transfers.
Goods (also known as visible trade or merchandise trade)
It shows the values of exports and imports of physical commodities.
Value of total
Value of domestic
Value of re-exports
=
+
exports of goods
exports of goods
of goods
The credit (+) side
The debit (–) side
The value of exports of goods is
recorded on the credit (+) side of
the account.
The value of imports of goods is
recorded on the debit (–) side of
the account.
247
Chapter
25
Balance of visible trade is sometimes called ‘visible trade balance’,

‘balance of trade’ or ‘balance of trade in goods’.
Balance of
Value of total
Value of imports
=
−
visible trade exports of goods
of goods
Three possible outcomes for the balance of visible trade:
•Value of total exports of goods >
Value of imports of goods
•The balance of visible trade is positive.
Visible trade
deficit
(Trade deficit)
•Value of total exports of goods <
Value of imports of goods
•The balance of visible trade is negative.
Visible trade
balance
•Value of total exports of goods =
Value of imports of goods
•The balance of visible trade is zero.
Services (also known as invisible trade)
O
Visible trade
surplus
(Trade surplus)
It shows the values of exports and imports of services.
The debit (–) side
IS
T
The credit (+) side
The value of exports of services
is recorded on the credit (+)
side of the account.
The value of imports of services
is recorded on the debit (−) side
of the account.
A
R
Balance of invisible trade is sometimes called ‘invisible trade

balance’, or ‘balance of trade in services’.
Balance of
Value of exports Value of imports
=
−
invisible trade
of services
of services
Three possible outcomes for the balance of invisible trade:
248
Invisible trade
surplus
•Value of exports of services >
Value of imports of services
•The balance of invisible trade is positive.
Invisible trade
deficit
•Value of exports of services <
Value of imports of services
•The balance of invisible trade is negative.
Invisible trade
balance
•Value of exports of services =
Value of imports of services
•The balance of invisible trade is zero.
Balance of Payments Account and Exchange Rate
Income (also known as external factor income flows)
It records income receivable from abroad (recorded on the credit (+)
side) and income payable abroad (recorded on the debit (−) side).
Net income from
Income receivable Income payable
=
−
abroad
from abroad
abroad
According to the Census and Statistics
Department, the term ‘primary income’
has been adopted to replace the former
term ‘factor income’.
Current transfers
It records transactions of real and financial resources between local
residents and non-residents.
Current transfers are unilateral in nature.
Current transfers received from abroad are recorded on the credit (+)
side of the account.

According to the Census and Statistics
Department, the term ‘secondary
income’ has been adopted to replace the
former term ‘current transfers’.
urrent transfers to abroad are recorded on the debit (−) side of the
C
account.
IS
T
The current account balance
O
Net current
Current transfers Current transfers
=
−
transfers
from abroad
to abroad
Current
Visible
Invisible Net income
Net current
account = trade + trade + from +
transfers
balance balance balance
abroad
A
R
When the current account balance is positive, the current account
is said to be in surplus.
When the balance is negative, the current account is said to be in
deficit.
Capital and financial account
The capital and financial account records external transactions in capital
transfers; the acquisition or disposal of non-produced, non-financial
assets and financial assets and liabilities between local residents and
non-residents and shows how an economy’s external transactions are
financed.
Net capital inflow
When capital inflow is larger than capital outflow, the net capital
inflow is positive.
When capital inflow is smaller than capital outflow, the net capital
inflow is negative.
Capital account and financial non-reserve assets
Inflow of capital is recorded on the credit (+) side of the account.

Outflow of capital is recorded on the debit (−) side of the account.
249
Chapter
25
Reserve assets
When there is an increase (a decrease) in reserve assets, i.e. the
central bank buys (sells) reserve assets, the net change in reserve
assets is positive (negative).
Balance of payments and balance of the BOP account
Meaning of balance of payments
Balance of
Balance of current Balance of capital and financial account
=
+
payments (BOP)
account
(excluding changes in reserve assets)
It can be in surplus (balance of payments surplus), deficit (balance of
payments deficit) or balance (balanced balance of payments).
Meaning of balance of the BOP account
O
The balance of payments may not be zero while the balance of

the BOP account is always zero.
= Current account balance + Capital and financial
account balance
0 = Current account balance + Capital and financial
account balance
Current account balance = − Capital and financial account balance
IS
T
Balance of the BOP account
A
R
When there is a balance of payments surplus or deficit, there will
be a change in reserve assets by the exact amount so that the
balance of the BOP account will be zero.
Balance of
payments surplus
Reserve assets
will increase by
the amount of the
surplus.
Balance of
payments deficit
Reserve assets
will decrease by
the amount of the
deficit.
Balanced balance
of payments
Reserve assets will
remain unchanged.
25.2 Introduction to Exchange Rate
Meaning of exchange rate
An exchange rate is the price of a currency in terms of another currency.
250
The exchange rate of the foreign
currency against the domestic currency
is the reciprocal of the exchange rate
of the domestic currency against the
foreign currency.
Balance of Payments Account and Exchange Rate
Types of exchange rate system
Floating exchange rate system
•The exchange rate of a
currency is determined by
the demand for and supply
of that currency in the
foreign exchange market.
•A rise (fall) in the value of
one currency in terms of
another currency is called
currency appreciation
(depreciation).
Fixed exchange rate system
(Pegged exchange rate system)
•The government or the central bank
of a country fixes the exchange
rate of its currency against other
currencies or the price of gold.
•When a government increases
(decreases) the value of its
currency against another currency,
it is known as currency revaluation
(devaluation).
Changes in exchange rates
O
Appreciation/revaluation: When the domestic currency appreciates/
is revalued, the exchange value of the domestic currency in terms of the
foreign currency rises.
IS
T
Depreciation/devaluation: When the domestic currency depreciates/is
devalued, the exchange value of the domestic currency in terms of the
foreign currency falls.
A depreciation (an appreciation) of
currency X against currency Y implies an
appreciation (a depreciation) of currency
Y against currency X.
25.3Effects of a Change in the
Exchange Rate
Effects of a change in the exchange rate on imports
A
R
When there is an appreciation of the foreign currency (or a depreciation
of the domestic currency):
Effect
Import price
In terms of the
domestic currency
In terms of the
foreign currency
increases
remains unchanged
Import volume
Value of
imports
decreases
uncertain
(depending on price
elasticity of demand)
decreases
When there is a depreciation of the foreign currency (or an appreciation
of the domestic currency):
Effect
Import price
Import volume
Value of
imports
In terms of the
domestic currency
In terms of the
foreign currency
decreases
remains unchanged
increases
uncertain
(depending on price
elasticity of demand)
increases
251
Chapter
25
Effects of a change in the exchange rate on exports
When there is an appreciation of the foreign currency (or a depreciation
of the domestic currency):
Effect
Export price
In terms of the
domestic currency
In terms of the
foreign currency
remains unchanged
decreases
Export volume
Value of
exports
increases
uncertain
(depending on price
elasticity of demand)
increases
When there is a depreciation of the foreign currency (or an appreciation
of the domestic currency):
Effect
Value of
exports
remains unchanged
increases
decreases
O
Export volume
In terms of the
foreign currency
IS
T
Export price
In terms of the
domestic currency
decreases
uncertain
(depending on price
elasticity of demand)
A
R
25.4The Linked Exchange Rate System in
Hong Kong
Under the linked exchange rate system, note-issuing banks can buy and
sell Hong Kong dollars and US dollars with the Exchange Fund at a
fixed exchange rate of US$1 to HK$7.8.
Features:
Fixed exchange rate for the US dollar between the note-issuing banks
and the Exchange Fund
Relatively stable exchange rate between the Hong Kong dollar and
the US dollar
Fluctuations in the exchange rates of the US dollar and the Hong
Kong dollar are in phase
252
The market exchange rate of the Hong
Kong dollar against the US dollar is not
fixed but is determined by the demand
and supply in the foreign exchange
market.
REVISION EXERCISE
Balance of Payments Account and Exchange Rate
Multiple Choice Questions
Choose the best answer.
3.The diagram below shows the aggregate demand
curve, the short run aggregate supply curve
and the long run aggregate supply curve of an
economy.
1.Refer to the following diagram.
Year-on-year
% change
Price level
LRAS
Value of total
exports of goods
SRAS
E
0
Value of imports
of goods
Year
From 20X3 to 20X4,
Suppose the economy initially operates at E and
there is a trade surplus. If the government raises
the income tax rate,
(1)the inflationary (output) gap will be widened
in the short run.
(2)the inflationary (output) gap will be narrowed
in the short run.
(3) the trade surplus will increase.
(4) the trade surplus will decrease.
IS
T
A.the economy suffered a visible trade deficit.
B. net exports decreased.
C.the values of imports of goods and total
exports of goods decreased.
D. the visible trade deficit worsened.
0
O
20X1 20X2 20X3 20X4 20X5
AD
Output level
2.In an open economy, there is a trade deficit and
the government has a budget deficit. If private
consumption expenditure decreases, which of the
following will most likely happen?
A
R
A.The trade deficit and the budget deficit will
improve.
B.The trade deficit and the budget deficit will
worsen.
C.The trade deficit will improve and the budget
deficit will worsen.
D.The trade deficit will worsen and the budget
deficit will improve.
A.
B.
C.
D.
(1) and (3) only
(1) and (4) only
(2) and (3) only
(2) and (4) only
4.Which of the following will be included in the
calculation of Hong Kong’s balance of invisible
trade?
A.A Hong Kong resident purchases a house in
the Mainland.
B.A Hong Kong resident buys a ticket to visit
Hong Kong Disneyland.
C.A Hong Kong resident buys some souvenirs
during his trip to Thailand.
D.A Hong Kong resident works in Germany for
6 months and earns an income.
253
25 EXERCISE
Chapter
REVISION
5.Refer to the following information about the
balance of payments of an economy in a certain
year.
Item
$ million
Domestic exports of goods
39
Re-exports of goods
23
Imports of goods
50
Exports of services
45
Imports of services
17
8.Suppose more and more foreign tourists spend
their holidays in Hong Kong. The increase in the
number of tourists would
(1) increase Hong Kong’s GDP.
(2) improve Hong Kong’s visible trade balance.
(3)improve Hong Kong’s current account
balance.
A.
B.
C.
D.
(1) and (2) only
(1) and (3) only
(2) and (3) only
(1), (2) and (3)
According to the above data, the economy has
Japan has imposed a departure tax of ¥1,000
per person since January 2019. The tax
is incorporated in the ticket charge. Both
Japanese residents and tourists are required to
pay the tax when leaving Japan by ship or by
plane.
9.Which of the following about the tourism industry
are CORRECT?
(1) It involves tertiary production only.
(2)It increases the net factor income from abroad
of a country.
(3)Its earnings are recorded in the current
account of a country.
(4)It increases the exports of services of a
country.
IS
T
6.
a visible trade surplus of $11 million.
an invisible trade surplus of $28 million.
a visible trade deficit of $12 million.
an invisible trade deficit of $62 million.
O
A.
B.
C.
D.
The imposition of the above departure tax will
lead to
A.
B.
C.
D.
A
R
(1) a decrease in export of services in Japan.
(2)a decrease in the invisible trade balance in
Japan.
(3) an increase in budget deficit in Japan.
(1) only
(1) and (2) only
(2) and (3) only
(1), (2) and (3)
7.Which of the following is included in the
calculation of Hong Kong’s current account
balance?
A.the money a Hong Kong charity donates to a
primary school in the Mainland
B.the money a US resident uses to purchase an
apartment in Hong Kong
C.the money an Australian investor uses to buy
shares of a Hong Kong listed company
D.the money a foreign travel agency uses to set
up a branch in Hong Kong
254
A.
B.
C.
D.
(1) and (2) only
(1) and (4) only
(2) and (3) only
(3) and (4) only
10.Suppose a Hong Kong resident leases his property
in the Mainland and remits the rental income to
Hong Kong. The rental income will
A.improve the balance of Hong Kong’s capital
and financial account.
B. improve Hong Kong’s balance of payments.
C.improve Hong Kong’s invisible trade balance.
D. lead to an increase in Hong Kong’s GDP.
Balance of Payments Account and Exchange Rate
11.The following table shows the items of the balance
of payments of an economy in a certain year.
$ million
Visible trade balance
200
Invisible trade balance
−150
Net factor income from abroad
−40
Net current transfers
100
Decrease in reserve assets
200
According to the above table, which of the
following statements are CORRECT?
A.
B.
C.
D.
(1) and (2) only
(1) and (3) only
(1), (3) and (4) only
(2), (3) and (4) only
12.I n which of the following situations will the
volume of Korean exports to Hong Kong decrease?
A
R
A. The Hong Kong economy is in recovery.
B. Hong Kong’s total value of imports decreases.
C.The US dollar appreciates against the Korean
won.
D.The Hong Kong dollar depreciates against the
Korean won.
13.
Exchange rate
5.97 HKD = 1 CAD
December 20X8
5.91 HKD = 1 CAD
The above change in the exchange rate between
the Hong Kong dollar (HKD) and the Canadian
dollar (CAD) would lead to
A.a decrease in the total value (in terms of HKD)
of Hong Kong exports to Canada.
B.a decrease in the total value (in terms of HKD)
of Canadian exports to Hong Kong.
C.an increase in the volume of Hong Kong
exports to Canada.
D.an increase in the total expenditure (in terms
of CAD) of Canada on goods imported from
Hong Kong.
15.Under the linked exchange rate system of Hong
Kong, which of the following situations would
result in an increase in the volume of Japanese
goods exported to Hong Kong?
IS
T
(1) The economy’s GDP is higher than its GNI.
(2)The economy’s current account is in surplus
of $50 million.
(3)The balance of payments deficit is $200
million.
(4)The economy’s capital and financial account
is in deficit of $310 million.
Date
January 20X8
O
Item
14.
Date
Exchange rate
1st June 20X8
1 GBP = 1.35 USD
1st December 20X8
1 GBP = 1.32 USD
Under the linked exchange rate system of Hong
Kong, the above change in the exchange rate
between the US dollar (USD) and the British
pound (GBP) would lead to
A.an increase in the number of British tourists
visiting Hong Kong.
B.an increase in the price of goods exported
from Hong Kong to Britain (in terms of Hong
Kong dollars).
C.a decrease in the volume of goods imported
from Britain to Hong Kong.
D.a decrease in the competitiveness of Hong
Kong’s exports to Britain.
(1)an appreciation of the Hong Kong dollar
against the Japanese yen
(2)a depreciation of the Hong Kong dollar
against the Japanese yen
(3)a depreciation of the Japanese yen against the
US dollar
A.
B.
C.
D.
(1) only
(2) only
(1) and (3) only
(2) and (3) only
16.Suppose Hong Kong’s demand for cars imported
from Britain is elastic. A depreciation of the Hong
Kong dollar against the British pound would
result in
(1)a decrease in Hong Kong’s expenditure on
cars imported from Britain (in terms of Hong
Kong dollars).
(2)an increase in the price of cars imported from
Britain (in terms of Hong Kong dollars).
(3)an increase in the price of cars imported from
Britain (in terms of British pounds).
A.
B.
C.
D.
(1) and (2) only
(1) and (3) only
(2) and (3) only
(1), (2) and (3)
255
25 EXERCISE
Chapter
REVISION
Date
Exchange rate
10 January 20X8
1 USD = 6.52 RMB
10 July 20X8
1 USD = 6.63 RMB
If China’s demand for imports is
,
the total value of China’s imports from the US (in
terms of Renminbi) would
.
A.
B.
C.
D.
perfectly inelastic … remain unchanged
elastic … decrease
inelastic … decrease
unitarily elastic … increase
A.The exchange rate of the Hong Kong dollar
against the US dollar in the foreign exchange
market is fixed.
B.The exchange rate of the Hong Kong dollar
against other currencies in the foreign
exchange market is fixed.
C.The monetary base of Hong Kong is fully
backed by US dollars.
D.The Hong Kong Monetary Authority does
not keep a large amount of foreign exchange
reserves.
IS
T
18.Mr. Chau sold 50,000 euro (EUR) for Hong Kong
dollars on 1st July and he bought euro with the
sum of Hong Kong dollars one month later at the
exchange rates shown in the table below.
19.W hich of the following statements about the
linked exchange rate system of Hong Kong is
CORRECT?
O
17.A change in the exchange rate between the US
dollar (USD) and the Renminbi (RMB) is shown
below:
Exchange rate
1st July
1 EUR = 9.11 HKD
1st August
1 EUR = 9.13 HKD
A.
B.
C.
D.
A
R
Mr. Chau
approximately
in the above transactions.
lost … 110 EUR
lost … 1,000 EUR
gained … 110 EUR
gained … 1,000 EUR
Short Questions
1.In an open economy, there is a trade deficit and the government has a budget deficit.
Explain whether an economic recovery of the economy’s trading partners helps improve
the trade deficit and the budget deficit.
(5 marks)
2.
Starting from 1 March 2017, the Hong Kong government
has relaxed visa restrictions for Cambodian workers,
investors and students. The first group of 1,000
Cambodian workers is expected to arrive in September.
Explain TWO components of the current account in the balance of payments of Cambodia
that may be affected by the above policy.
(4 marks)
256
Balance of Payments Account and Exchange Rate
3.Explain how Hong Kong’s current account will be affected by the following events and
state their effects on Hong Kong’s balance of payments.
(a) A Hong Kong resident watches a concert of his favourite singer in Taiwan. (3 marks)
(b) A pregnant woman from Japan gives birth in a hospital in Hong Kong.
(3 marks)
4.The table below shows the items in a country’s balance of payments account in a certain
year.
Item
$ billion
X
Current account balance
Balance of trade in goods
30
Balance of trade in services
50
Net factor income from abroad
2
Net current transfers
1
2
O
Capital and financial account balance
(excluding changes in reserve assets)
(a)Find the value of X. State whether the current account is in deficit or surplus.(2 marks)
IS
T
(b)Calculate the change in reserve assets. Is the balance of payments in surplus or deficit?
Explain.
(3 marks)
5.
A change in the exchange rate between the euro (EUR) and the Hong Kong dollar (HKD) is
shown below:
Exchange rate
1st July 20X8
1 EUR = 9.13 HKD
1st August 20X8
1 EUR = 9.25 HKD
A
R
Date
Explain the effects of the above change in the exchange rate on
(a) the price of European red wine exported to Hong Kong (in terms of HKD). (2 marks)
(b) the total value of Hong Kong watches exported to Europe (in terms of HKD). (4 marks)
6.
Before the British people voted against staying in the European Union (EU), i.e. Brexit,
workers from the EU were free to work in Britain and vice versa. Brexit has shocked the
economies in Europe and the following table shows some views on Brexit:
British politicians:
Low-skilled EU workers should be
required to apply for a visa to work in
Britain.
British firm owners:
The new visa requirement for EU workers
affects most of the firms in the British
economy.
Global investors:
Political uncertainty in Britain increases
the risk of investment projects there.
EU officials:
British citizens may require a visa to visit
or to work in the EU countries.
Referring to the view of the EU officials, which TWO components of current account in the
balance of payments of Britain may be affected? Explain your answer.
(4 marks)
[HKDSE/2017/Paper 2/Q12(c)]
257
25 EXERCISE
Chapter
REVISION
Long Questions
With DRQ elements
1.The following table shows information about an economy.
Debit ($ million)
Credit ($ million)
Domestic exports of goods
100
Re-exports of goods
50
Imports of goods
80
Exports of services
200
Imports of services
100
Income receivable from abroad
Income payable abroad
400
150
Current transfers from abroad
Current transfers to abroad
200
50
(a) Calculate the following for the economy:
(i) balance of visible trade
(1 mark)
(ii) balance of invisible trade (1 mark)
O
(b) Explain whether the current account is in deficit or in surplus. (2 marks)
IS
T
(c)Suppose the capital and financial account balance (excluding changes in reserve assets)
is −$300 million. Calculate the balance of payments and state whether it is in deficit or
surplus. (2 marks)
2.A change in the exchange rate between the Hong Kong dollar (HKD) and the Renminbi
(RMB) is shown below:
A
R
Date
Exchange rate
September 20X2
HKD 1 = RMB 0.85
October 20X2
HKD 1 = RMB 0.80
(a)With the aid of a diagram, explain in what situation the above change in the exchange
rate would lead to an increase in the value of imports (in terms of HKD) from the
Mainland to Hong Kong.
(8 marks)
(b)How will the above change in the exchange rate affect the price (in terms of RMB) and
the quantity of goods and services exported to the Mainland from Hong Kong?
(3 marks)
(c)How will the above change in the exchange rate affect the number of Hong Kong
people visiting the Mainland?
(2 marks)
258
Balance of Payments Account and Exchange Rate
3.Hong Kong is an open economy. The change in the exchange rate would affect the Hong
Kong economy in different ways.
Source A:Effective exchange rate index (trade-weighted) for the Hong Kong dollar (HKD)
(January 2010 = 100)
Index
108
106
104
102
100
98
Jan
2017
Feb
2017
Mar
2017
Apr
2017
May Jun
2017 2017
Jul Aug
2017 2017
Sep
2017
Month
(Source: Census and Statistics Department, HKSAR Government)
O
*Note:The effective exchange rate index (EERI) for HKD is an index which
measures movements in the weighted average of the exchange rates
of HKD against the currencies of major trading partners of Hong
Kong. An increasing index means that HKD is getting stronger against
selected currencies.
IS
T
Source B:Information about the current account of the balance of payments of Hong
Kong
Goods (HK$ million)
Debit
Balance
945,336
−999,932
−54,596
A
R
2017 Q1
Credit
2017 Q2
995,555
−1,061,481
−65,926
2017 Q3
1,106,850
−1,121,315
−14,465
(Figures as of June 2019. Source: Census and Statistics Department,
HKSAR Government)
(a)With reference to Source A, explain how the above change in the exchange rate would
affect the total export value (in terms of Hong Kong dollars) of Hong Kong with the
aid of a diagram.
(7 marks)
(b) Discuss whether the data in Source B are consistent with your answer in (b). (3 marks)
(c)With reference to the sources and your own economic knowledge, explain how the
consumer price index would be affected by the change in the exchange rate. (3 marks)
259
25
Chapter
DRQ Level-up
Read the information and answer the questions that follow.
In February 2018, Cyril Ramaphosa, President of South Africa, announced that the
government would start a land redistribution programme to address the issue of
racial inequality in land ownership. It includes expropriation (徵收) of land without
compensation.
Source A: Opinions on the programme
White people make up 9% of the population, but they own 72% of the
farmland in South Africa. I think it’s fairer to redistribute the farmland.
Citizens
Our land may be seized by the South Africa government
without any compensation. Our property rights are not
protected. Maybe I should sell my land as soon as possible.
Topic
Explorer
Zimbabwe underwent
a similar land reform in
1980s, causing severe
consequences to the
Zimbabwean economy.
O
Investors
Credit rating
agency
(信貸評級機構)
IS
T
Investors are worried about the uncertainty regarding the land reform.
The economic growth of South Africa could be restrained by weak business
confidence.
If the land reform is done badly, which is quite likely to be the
case, the country’s agricultural exports may be adversely
affected.
A
R
Researchers
Source B: Monthly exchange rate of the rand (ZAR), currency of South Africa, against the
US dollar from December 2017 to September 2018, expressed in terms of how
many rands can be exchanged for 1 US dollar
USD/ZAR
Data
Reading
15
Pay attention to how
the exchange rate is
presented and the time
frame of the line graph.
14.5
14
13.5
13
12.5
12
11.5
Dec
2017
Jan
2018
Feb
2018
Mar
2018
Apr
2018
May
2018
Month
(Source: South African Reserve Bank)
260
Jun
2018
Jul
2018
Aug
2018
Sep
2018
Balance of Payments Account and Exchange Rate
Questions
(a)Referring to Source A, do you think the redistribution of the ownership of
farmland could improve equity in South Africa? Explain.
(2 marks)
R elevant concepts
(b)With reference to Source A, explain how the aggregate output and price level
of South Africa might be affected in the short run if the land reform weakens
business confidence.
(3 marks)
(b) AS-AD model
(a) equity
(c)exchange rate, total
value of exports
(d) balance of payments
(c) (i)With reference to Source B, describe the trend of the change in the US dollar
to rand exchange rate after the announcement of land reform.
(1 mark)
(ii)A ssume the prices of goods and services produced in the US remained
unchanged. Explain how the change in the exchange rate would affect the
total value of exports (in terms of US dollars) from the US to South Africa
with the aid of a diagram.
(7 marks)
A
R
IS
T
O
(d)Referring to Sources A and B and applying your economics knowledge, discuss
how the land reform is likely to affect the balance of payments of South Africa.
(3 marks)
261
Suggested answers — Chapter 25
Short Questions
1An economic recovery of the economy’s trading partners will raise the demand for exports of
the economy, resulting in an increase in exports. Holding imports constant, the trade deficit will
be improved. (2)
An economic recovery of the economy’s trading partners will raise the demand for exports
of the economy. Net exports will increase, resulting in an increase in aggregate demand. An
increase in national income will raise tax revenue. Holding government expenditure constant,
the budget deficit will be improved. (3)
2-Income: With more non-Hong Kong resident Cambodian workers working in Hong Kong,
income receivable from abroad will increase. (2)
-Current transfers: With more Cambodian workers becoming Hong Kong residents and
working in Hong Kong, more money will be remitted back to Cambodia. (2)
4 (a) X = $(30 + 50 + 2 + 1) billion = $83 billion (1)
There is a current account surplus. (1)
(b) Balance of payments = $(83 + 2) billion = $85 billion (1)
There is a balance of payments surplus. (1)
The reserve assets increase by $85 billion. (1)
O
3 (a) Imports of services will increase. (1)
This will reduce Hong Kong’s current account surplus (or enlarge its deficit). (1)
Hong Kong’s balance of payments will be worsened. (1)
(b) Exports of services will increase. (1)
This will enlarge Hong Kong’s current account surplus (or reduce its deficit). (1)
Hong Kong’s balance of payments will be improved. (1)
A
R
Long Questions
IS
T
5 (a)Assume that the price of European red wine (in terms of EUR) has not changed. As there is
an appreciation of the euro against the Hong Kong dollar, the price of European red wine
exported to Hong Kong (in terms of HKD) will increase. (2)
(b)The euro has appreciated against the HKD. Assuming the price of watches (in terms of HKD)
has not changed, the price of watches (in terms of the euro) will decrease. Europe will import
more Hong Kong watches. The demand for Hong Kong watches will increase. Quantity
transacted will increase and the total export value of Hong Kong watches (in terms of HKD)
will increase. (4)
1 (a) (i) Balance of visible trade = $(100 + 50 – 80) million = $70 million (1)
(ii) Balance of invisible trade = $(200 – 100) million = $100 million (1)
(b) Balance of current account = $(70 + 100 + 400 − 150 + 200 − 50) million = $570 million (1)
As the balance of current account is positive, the current account is in surplus. (1)
(c) Balance of payments = $(570 – 300) million = $270 million (1)
As the balance of payments is positive, the balance of payments is in surplus. (1)
2 (a) Verbal elaboration:
- There is an appreciation of the RMB against the HKD. (1)
-Assume that the price of imports from the Mainland (in terms of RMB) remains
unchanged. There will be a rise in the import price in terms of HKD and a drop in the
import volume. (1)
-If the demand for imports from the Mainland is inelastic, the percentage increase in price
is larger than the percentage decrease in quantity demanded. The value of imports from
the Mainland to Hong Kong (in terms of HKD) will increase. (3)
Illustrate in the diagram:
- price increases and quantity demanded decreases (1)
- increase in the value of imports > decrease in the value of imports (2)
(b)When there is an appreciation of the RMB against the HKD, assuming that the price of
exports from Hong Kong (in terms of HKD) remains unchanged, there will be a fall in the export price
in terms of RMB. The Mainland’s quantity demanded of the goods and services from Hong Kong will
increase, so the quantity of goods and services exported to the Mainland from Hong Kong will increase.
(3)
(c)Fewer Hong Kong people will visit the Mainland as the cost of the trip (in terms of HKD) will
increase when there is an appreciation of the RMB against the HKD. (2)
Unit price
(HK$)
P1
P0
+
−
0
Q1
D
Q0
Quantity
3 (a) Verbal elaboration:
-The Hong Kong dollar has depreciated against the currencies of its major trading partners.
Given the price of Hong Kong’s exports (in terms of HKD) did not change, the price of
Hong Kong’s exports (in terms of the foreign currencies) would decrease. Other countries
would import more of Hong Kong’s exports. (1)
-The demand for Hong Kong’s exports would increase. (1)
-The quantity transacted would increase. (1)
-The total export value of Hong Kong (in terms of HKD) would increase. (1)
Illustrate in the diagram:
- rightward shift of the demand curve (1)
- quantity transacted increases (1)
- total export value increases (1)
(b) Consistent. (1)
When the Hong Kong dollar depreciated against its major trading partners, exports of goods
increased in the above period. (2)
(c)The import prices (in terms of HKD) would increase when the Hong Kong dollar depreciated
against the currencies of its major trading partners. (1)
Many of the foodstuff and daily necessities consumed in Hong Kong are imported from other
countries. (1)
As a result, the consumer price index would increase. (1)
Unit price
(in terms of
HKD)
Increase in total
export value
P
D1
D0
0
Q1
Q0
Quantity of
Hong Kong’s
exports
DRQ Level-up
A
R
IS
T
O
(a)Yes. Redistribution of the ownership of farmland helped equalise income. The poor could earn
more return on capital while the rich would earn less return on capital. The income gap between
the rich and the poor could be narrowed. (2)
OR
No. Redistribution of the ownership of farmland could not equalise opportunity. The productivity
of the poor was not raised. (2)
OR
Any reasonable answer
(b)Investment expenditure would decrease. (1)
The aggregate demand would decrease. (1)
Both the aggregate output and the price level would decrease in the short run. (1)
(c) (i)The rand kept depreciating against the US dollar./The US dollar kept appreciating against the
rand. (1)
(ii) Verbal elaboration:
-The rand depreciated against the US dollar. Given the prices of US exports (in terms of US
dollars) remained unchanged, the prices of US exports (in terms of rand) would increase.
South Africa would buy fewer goods and services from the US. (1)
- The demand for US exports by South Africa would decrease. (1)
- The quantity transacted would decrease. (1)
- Total value of exports (in terms of US dollars) to South Africa would decrease. (1)
Illustrate in the diagram:
- leftward shift of the demand curve (1)
- quantity transacted decreases (1)
- correct position of the decrease in total value of exports (1)
(d)South Africa’s balance of payments will be worsened. Foreign investors may withdraw their
investments in South Africa because of weak business confidence, so capital will be likely to flow
out of the country. The exports of goods will decrease as agricultural exports may decrease if
the land reform is not successful. (3)
OR
Any reasonable answer
Unit price
(in terms of USD)
Decrease in total
export value
P
D1
0
Q1
Q0
D0
Quantity