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ticity of Demand & Supply- According to Marshal Learner law depreciation in the exchange rate will only improve current account – if combined price elasticity of demand of export and Price elasticity of demand of import is greater than 1.

 

Profit margin- Often the companies don’t change their product price in foreign currency but adjust the exchange rate fluctuation in their profit margin thereby not affecting the balance of payment.

 

Global Demand- The global demand determines the opportunities for export on depreciating the currency. The sluggish global demand has not contributed much in increasing exports on a fall in sterling.

 

Let us now explore what has been the relation of Balance of payment and exchange rate for the last 10 years for UK. To show this we can use a simple graph.

 

As the chart shows that the deficit has increased enormously in the last few years. From the beginning of this century the deficit has increased and a link could be established to the relative rise in sterling. By looking at the graph we can see that in 2003 the sterling depreciated which led to a decrease in deficit. Also from mid-2007 the sterling depreciated leading to a decrease in balance of payment deficit. But form the beginning of 2009 sterling again started to appreciate which led to a decrease in the deficit. So by looking at the graph we can easily conclude that there is a significant relationship between the exchange rate and balance of payment. However, ceterus peribus, these are not the only factors that affect each other. As Montiel (1999) states that factors such as productivity, government spending, changes in the international environment and changes in commercial policies are important determinants of the real exchange rate. On the other hand, Balance of payment is affected by a number of reasons including tax receipts, savings and investment level, nature of exports and imports, and the sovereign capacity of lending and borrowing.

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