Question

. We have two countries, China and Nambia, with a fixed exchange rate trading at 1 yuan = 20 Nambian dollars (N$). Last year, China. bought 200 billion N$ worth of goods, services and financial assets from Nambia, while Nambia bought 5 billion yuan from the China. (4pts):

1. What is the value of the Chinese balance of payments deficit?

2. What is the value of the Nambian balance of payments surplus?

3. What will both the Chinese and Nambian governments do in response (keeping in mind there is a fixed exchange rate system in both countries)?

  

4. What effect will this have on domestic prices in China and Nambia?

Answer 1

a) China's BOP deficit = Imports - Exports = 200/20 billion yuan - 5 billion yuan = 5 billion yuan

b) Namibian BOP surplus = Exports - Imports = 200 billion N$ - 5 x 20 = 100 billion N$

c) China has a BOP deficit so it needs to devalue its currency to raise exports and reduce imports. Hence it will force its central bank to release more Yuan and buy Namibian Dollars in the market to devalue Yuan. This will bring down imports and increase exports so that the deficit is eliminated. Similarly, Namibian Central bank would buy Namibian Dollars and in turn release Chinese Yuan. This reduction in money supply revalue N$ so that imports are increased and exports are reduced.

d) Chinese prices in domestic market are expected to rise since there is an increase in money supply and an increase in GDP which stimulates aggregate spending. Namibian domestic prices are likely to fall as there is a monetary contraction.