HR Paper: Zambia Trade Tour Assignment - Currency Essay Example

Weeks 6 & 7 – Zambia Trade Tour Assignment
Worksheet

The exchange rate of a country measures the external value of the currency - HR Paper: Zambia Trade Tour Assignment introduction. To a country such as Zambia the market for foreign exchange is very important. Its own currency, the kwacha is not a hard currency and thus not universally accepted in payment of debt. Zambia relies on generating foreign currency from selling exports to enable it to finance imports. The macroeconomic situation such as the balance of payments position, employment and inflation are all influenced by a country’s exchange rate. Hence it becomes a key economic policy inconsistent.

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Step 1

What is your understanding of the terms below?
Exchange rate
The price of one compared to another countries currency. If you have one exchange rate i.e. USD = $1.00 and the Euro Dollar =$1.3087 you would get .31 cents for every US dollar. Fixed exchange rate

Is a rate system where the value of the currency against another currency remains exactly the same? In order for the rate to remain fixed governments have to hold large stocks of foreign exchange so they can interfere in order to hold the currency firm. (Bized, 2011) Floating exchange rate

Is a currency exchange rate that is determined by the sellers and the buyers that does not have government interference? (Bized, 2011) If a country has a floating exchange rate system the outside value of the currency is permitted to find its own value against other currencies. (Bized, 2011) Plot the value of the kwacha measured in terms of the US$ between: 1965 and 1980 and

1990 and 1998
Official and parallel exchange rates
1965
1980
1990
1998

Official exchange rate Local currency / US$, market rate, period average 0.71
0.79
30.29
1,861.61
Parallel market exchange rate (local currency / US$), period average
1.3
121.2

*Bized, 2011
Which particular exchange rate regime predominated in period 1 and which in period 2? Period 1
In 1990 the exchange rate regime was more predominate.
Period 2

In 1998 it appears that the Kwacha dominated as there is no data for the US$. Would you describe the change in the exchange rate of the kwacha between 1980 and 1995 as an appreciation or a depreciation? What is your reason for thinking this? I think the Kwacha appreciated in the exchange rate. My reasoning is due to the elevated dollar amount of the exchange is higher. Why did the government of Zambia want to maintain a fixed exchange rate for the kwacha? The countries government acted through its agent which was the Central Bank. (Bized, 2011) The government was following a policy of import exchange and industrialization at this time prior to 1991. (Bized, 2011) The Zambian government wanted control over the exchange rate. In 1964 the Zambian government adopted the fixed exchange rate regime with the British Pound which was the anchor. (Economics Association of Zambia, 2010) Using supply and demand analysis how a government could fix the value of the currency at an official exchange rate. Use the axes below to illustrate your analysis.

*Bized, 2011 During much of the period from Independence there has been a black market for dollars in Zambia. Would you expect a black market for dollars to develop in Zambia during a floating or fixed exchange rate regime? Why? Yes, in such a situation of a parallel or dual black market for foreign exchange usually develops with a fixed or floating exchange rate. Due to this black market foreign currency is usually bought illegally at an exchange rate which is far more than the actual exchange rate. (Bized, 2011) Calculate the % difference between the official exchange rate and the black market exchange rate and complete the table below. In which year is the % greatest? Why do you think this might be?

1970
1980
1991
1998
Official Exchange Rate
.71
.79
64.64
1,861.61
Black Market Exchange Rate

1.3
133.3

% difference
.71
.51
69.69
1,861.61
*Bized, 2001
It depends as there were no black market rates for the year 1970 & 1998 respectively. If we are comparing 1980 & 1991; than 1991 would have the greatest percentage difference. The dual rate in 1991 was a political motivated move due to the Copperbelt food riots. (Mungule, K., 2004) The dual-exchange rate regime was established as a two-tier system the official rate of K28/$1 was managed by a float initially at K40/$1. (Mungule, K., 2004) This system lasted about 1 year. Step 2

In 1992 when the government of President Chiluba introduced a floating exchange rate and abolished exchange controls there was considerable capital flight out of Zambia. What is meant by capital flight?

Capital flight is the movement of financial assets out of a country in response to an adverse domestic circumstance. (Bized, 2001) It can be explain as a large number of individuals and organizations exchange domestic currencies for US dollars in order to leave the countries. (Peng, pp. 102) Using supply and demand analysis explain the impact of capital flight on the value of the kwacha against the dollar. The real GDP averaged at about -0.6% per year and this performance was worse than the past 5 years. (Mungle, K. 2004) The gross domestic investment to GDP and the gross domestic savings to the GDP continued to decline. (Mungle, K. 2004) Zambia during this time accumulated a total debt of US$6.595 million at the end of 1995. (Mungle, K. 2004)

When a currency depreciates the fear is that it may lead to inflation. Why is this? When currency depreciates most time it does lead to inflation. Currency typically does not depreciate unless the prices of goods and services within an economy rise over a period of time. (Want2rich, 2011) This means the purchasing power of the country’s currency depreciates. (Want2rich, 2011) Plot the values of the exchange rate and the inflation rate between 1980 and 1998. Describe and explain the relationship between the two sets of data. Does it support the idea that depreciation could contribute to causing inflation? Yes, look at the period between 1989 and 1993, the consumer price index more than doubled in this time period. Measures of inflation

1980
1981
1982
1983
1984
1985
1986
1987

Inflation rate

55.83
47.05

Consumer Price Index (1995=100)
0.08
0.09
0.1
0.12
0.14
0.19
0.29
0.42

GDP deflator – period average (local currency) 1995=100
0.1122
0.1202
0.1276
0.1514
0.1791
0.2528
0.4601
0.7455

Measures of inflation
1988
1989
1990
1991
1992
1993
1994
1995

Inflation rate
51.00
123.40
107.02
93.21
169.05
188.05
53.61
34.2

Consumer Price Index (1995=100)
0.65
1.49
3.24
6.26
16.84
48.51
74.52
100

GDP deflator – period average (local currency) 1995=100
1.0026
1.8134
3.7427
7.2104
19.15
46.651
73.035
100

Measures of inflation
1996
1997
1998

Inflation rate
46.27
24.81

Consumer Price Index (1995=100)
146.27
182.56
234.94

GDP deflator – period average (local currency) 1995=100
124.31
156.51
192.82

*Bized, 2001
Step 3
A fall in the value of a currency will bring about a change in the prices of exports and imports. Changes in export and import prices will in turn cause changes in the quantity of exports and imports demanded and consequently the balance of payments of current account. Plot the data for the exchange rate of the kwacha and the current account balance. Can you find any evidence to support either of the following? Current account balance

1967
1968
1969
1970

Current account balance as % of GNP
1
0
25
6
Current account balance – IMF definition (Net Current prices US $) 14,000,000
-3,000,000
474,000,000
108,000,000

Official exchange rates
1967
1968
1969
1970

Official exchange rate
0.71
0.71
0.71
0.71

Current account balance
1971
1972
1973
1974

Current account balance as % of GNP
-15
-12
6
1
Current account balance – IMF definition (Net Current prices US $) -247,300,000
-209,000,000
129,300,000
15,200,000

Official exchange rates
1971
1972
1973
1974

Official exchange rate
0.71
0.71
0.65
0.64

Current account balance
1975
1976
1977
1978

Current account balance as % of GNP
-32
-5
-9
-11
Current account balance – IMF definition (Net Current prices US $) -721,600,000
-123,900,000
-216,400,000
-297,800,000

Official exchange rates
1975
1976
1977
1978

Official exchange rate
0.64
0.70
0.79
0.80

Current account balance
1979
1980
1981
1982

Current account balance as % of GNP
1
-15
-20
-19
Current account balance – IMF definition (Net Current prices US $) 37,100,000
-537,700,000
-779,800,000
-674,800,000

Official exchange rates
1979
1980
1981
1982

Official exchange rate
0.79
0.79
0.87
0.93

Current account balance
1983
1984
1985
1986

Current account balance as % of GNP
-6
-11
-16
-28
Current account balance – IMF definition (Net Current prices US $) -196,900,000
-261,100,000
-324,100,000
-375,100,000

Official exchange rates
1983
1984
1985
1986

Official exchange rate
1.26
1.81
3.14
7.79

Current account balance
1987
1988
1989
1990

Current account balance as % of GNP
-18
-8
-6
-13
Current account balance – IMF definition (Net Current prices US $) -347,100,000
-263,600,000
-221,800,000
-388,300,000

Official exchange rates
1987
1988
1989
1990

Official exchange rate
9.52
8.27
13.81
30.29

Current account balance
1991
1992
1993
1994

Current account balance as % of GNP
-17
-26
-16
-13
Current account balance – IMF definition (Net Current prices US $) -513,000,000
-752,900,000
-471,800,000
-397,800,000

Official exchange rates
1991
1992
1993
1994

Official exchange rate
64.64
172.21
452.76
669.37

Current account balance
1995
1996
1997
1998

Current account balance as % of GNP
-14
-14
-12
-16
Current account balance – IMF definition (Net Current prices US $)
-464,000,000
-426,000,000
-437,500,000
-513,000,000

Official exchange rates
1995
1996
1997
1998

Official exchange rate
857.23
1203.70
1333.81
..
*Bized, 2001

a) The idea that devaluation leads to an improvement in the balance of payments situation In 1990 the balance of payments due to the inflation was extremely in a deficit balance. b) The Marshall Lerner condition

This is a change in the exchange rate of a country’s currency which lead to improvement or decline of a country’s balance of payments. (Bized, 2001) Explain, using the concept of price elasticity of demand, how the exchange rate changing affects the balance of payments of current account. It is the percentage change in quantity demanded of a certain product divided by the percentage of change in the price. (Tutor2u, 2012) Changes in price and quantity always move in opposite directions, economists usually do not hassle by putting in the minus sign. (Tutor2u, 2012) Most economists are concerned with the co-efficient of elasticity of demand. (Tutor2u, 2012) Step 4

Suppose the members of the COMESA decided to form an economic union and introduce a single currency. You may find it helpful to review the COMESA case study in the trade tour and also look at the theory on the formation of Trading Blocs. Outline the advantages for a single regional currency and one outlining the disadvantages of such a currency to the economy of Zambia.

Advantages
Trading blocs have some advantage of keeping a single currency because of free trade. (Bized, 2001) Allowing free trade by lowering individual trade barriers is also an advantage of a single currency. (Bized, 2001) If the country’s currency is a hard currency it will be accepted by other countries as a form of payment. (Bized, 2001) Disadvantages

The impact of such trade barriers can have a negative impact as well. Trading blocs can create a trade diversion effect as well. (Bized, 2001) The kwacha is not considered a hard currency which is not universally accepted as a form of payment. (Bized, 2001) Could there ever be a world currency? Give the reasoning for your decision. Yes, I believe there could be a world currency. By the development of the Euro which is widely accepted in many countries as a form of payment. (Answers, 2006) Most world economies today depend on other nations for economic support and trade of some form. (Answers, 2006) To take a first step in global unification must be the incorporation and enforcement of a single world currency. (Answers, 2006)

References
Economics Association of Zambia, The Volatility of the Exchange Rate: A Case of the Zambian Kwacha, (2010), from www.eaz.org Mungule, K., The determinants of the real exchange rate in Zambia, The University of Zambia, (2004), from www.aerafrica.org Peng, Global, Student Edition, (2010)

Bized, Development Glossary (A-C), [ Biz/ed Virtual Developing Country ], (2001), from http://www.bized.co.uk/virtual/dc/resource/glos1.htm#c Want2rich, Understand Finance, Inflation: a worry for retail investors as it reduces investment options and return, (2011), from http://www.want2rich.com/2011/05/personal-finance/inflation-a-worry-for-retail-investors-as-it-reduces-investment-options-and-return/ Tutor2u, Essential guidance on economics exam technique: AS Markets & Market Systems, Price Elasticity of Demand, (2012), from www.tutor2u.net/economics.html Bized, COMESA, The Common Market for Southern and Eastern Africa (COMESA), (2001), from http://www.bized.co.uk/virtual/dc/trade/comesa/issue1.htm Bized, Introduction, (2001), from http://www.bized.co.uk/virtual/dc/works/ers.htm Answers, Yahoo, Will there ever be a one world currency? Or how about an end to currency?, (2006), from http://answers.yahoo.com/question/index?qid=1006041403652

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