ECS3703 EXAM PACK
2026
FOR ASSISTANCE CONTACT
EMAIL:
, lOMoARcPSD|31863004
SECTION A
Question 1
(a) Name and explain the items of the financial account of the
South African balance of payments
The financial account (previously referred to as the capital account) records
exchanges of international asset claims. For example, if a US bank buys a bond
issued by the South African government, a South African company purchases
shares in a British company or a foreign company establishes a controlling interest
in a local manufacturing concern, the value of these transactions will be reflected
in the financial account of the countries concerned.
the financial account does not record the stocks of the assets and liabilities.
It is the changes in foreign assets and liabilities that are shown in the balance of
payments. The three main subdivisions of the financial account are
1. Direct investment,
2. Portfolio investment
3. Other investment.
Direct investment refers to foreign investments in South Africa (changes in foreign
liabilities or inflows) and investments abroad by South African residents (changes
in foreign assets or outflows) where the companies or other organisations
concerned have a significant share of such investment.
The share should be significant in that there should be an intention to have a say
in the control or management of the investment, this is defined as at least a 10 per
cent share of the voting rights in the investment undertaking concerned.
Net direct investment (changes in foreign liabilities plus the changes in foreign
assets) was negative in 2004 and 2006, meaning that foreigners invested less in
South Africa than we invested abroad over this period.
However, the substantial net inflows of direct investment in 2008 indicate the
generally positive view of South Africa as a destination for foreign direct
investment.
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Portfolio investment is the purchase and sale of financial claims such as bonds,
treasury bills and equities. Unlike direct investments, there is no intention by the
investor to exercise any control over portfolio investments.
The justification for such investments is based purely on the expected financial
gain or return on investment.
Portfolio investments are notoriously fickle because changes in expected returns
may trigger speculative buying or selling activity. Other investment includes all
financial transactions that are not part of direct or portfolio investment or changes
in reserve assets.
The main item here is trade credit. For example, when a South African importer
purchases goods from a foreign supplier, he or she will usually be granted short-
term credit (representing an increase in foreign liabilities).
The local or foreign correspondent bank may arrange the credit. Similarly, a foreign
purchaser of goods exported by a South African company will normally obtain such
credit (an increase in foreign assets).
Direct foreign investment is generally considered to be a more desirable form of
foreign investment than portfolio investment because it demonstrates a stronger
commitment to invest over the longer term. It may thus have a more stable and
enduring positive effect on the domestic economy than the speculative “hot money”
flows.
It is generally agreed that speculative capital movements may prove to be
disruptive and difficult for the monetary authorities to counteract.
Besides its (hopefully positive) effects on employment, direct foreign investment
may also bring with it much needed transfers of scarce skills, technology and
innovations from abroad. These considerations are especially significant for a
small, open and developing economy such as that of South Africa.
b Describe the case for flexible exchange rates (no graphs required)
The case for fixed exchange rates
Less uncertainty
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Avoids day to day fluctuations that are likely to occur under flexible exchange rates.
Stabilising speculation
Speculation is likely to be destabilising under the flexible exchange rate system
than under fixed exchange rate system and less inflationary
Price discipline
Fixed exchange rates impose a price discipline not found in flexible exchange rate
system. A nation with high inflation is likely to face persistent deficit in its balance
of payment and loss of reserves under a fixed exchange rate system. Deficits and
losses cannot go on forever, the country will need to restrain its high inflation and
thus faces some price discipline.
2 a Explain (With the aid of two diagrams, using the IS/LM/BP
framework) the effectiveness of expansionary fiscal policies and easy
monetary policies in an open economy with flexible exchange rates
and perfect capital mobility
The IS-LM –BP model with flexible exchange rates and Perfect Capital mobility.
Monetary Policy is effective and Fiscal Policy ineffective.
Fiscal Policy
i
LM
6.25
5.0 E’ BP
E
IS’
IS
0 Yn Yf
3|Page
2026
FOR ASSISTANCE CONTACT
EMAIL:
, lOMoARcPSD|31863004
SECTION A
Question 1
(a) Name and explain the items of the financial account of the
South African balance of payments
The financial account (previously referred to as the capital account) records
exchanges of international asset claims. For example, if a US bank buys a bond
issued by the South African government, a South African company purchases
shares in a British company or a foreign company establishes a controlling interest
in a local manufacturing concern, the value of these transactions will be reflected
in the financial account of the countries concerned.
the financial account does not record the stocks of the assets and liabilities.
It is the changes in foreign assets and liabilities that are shown in the balance of
payments. The three main subdivisions of the financial account are
1. Direct investment,
2. Portfolio investment
3. Other investment.
Direct investment refers to foreign investments in South Africa (changes in foreign
liabilities or inflows) and investments abroad by South African residents (changes
in foreign assets or outflows) where the companies or other organisations
concerned have a significant share of such investment.
The share should be significant in that there should be an intention to have a say
in the control or management of the investment, this is defined as at least a 10 per
cent share of the voting rights in the investment undertaking concerned.
Net direct investment (changes in foreign liabilities plus the changes in foreign
assets) was negative in 2004 and 2006, meaning that foreigners invested less in
South Africa than we invested abroad over this period.
However, the substantial net inflows of direct investment in 2008 indicate the
generally positive view of South Africa as a destination for foreign direct
investment.
1|Page
, lOMoARcPSD|31863004
Portfolio investment is the purchase and sale of financial claims such as bonds,
treasury bills and equities. Unlike direct investments, there is no intention by the
investor to exercise any control over portfolio investments.
The justification for such investments is based purely on the expected financial
gain or return on investment.
Portfolio investments are notoriously fickle because changes in expected returns
may trigger speculative buying or selling activity. Other investment includes all
financial transactions that are not part of direct or portfolio investment or changes
in reserve assets.
The main item here is trade credit. For example, when a South African importer
purchases goods from a foreign supplier, he or she will usually be granted short-
term credit (representing an increase in foreign liabilities).
The local or foreign correspondent bank may arrange the credit. Similarly, a foreign
purchaser of goods exported by a South African company will normally obtain such
credit (an increase in foreign assets).
Direct foreign investment is generally considered to be a more desirable form of
foreign investment than portfolio investment because it demonstrates a stronger
commitment to invest over the longer term. It may thus have a more stable and
enduring positive effect on the domestic economy than the speculative “hot money”
flows.
It is generally agreed that speculative capital movements may prove to be
disruptive and difficult for the monetary authorities to counteract.
Besides its (hopefully positive) effects on employment, direct foreign investment
may also bring with it much needed transfers of scarce skills, technology and
innovations from abroad. These considerations are especially significant for a
small, open and developing economy such as that of South Africa.
b Describe the case for flexible exchange rates (no graphs required)
The case for fixed exchange rates
Less uncertainty
2|Page
, lOMoARcPSD|31863004
Avoids day to day fluctuations that are likely to occur under flexible exchange rates.
Stabilising speculation
Speculation is likely to be destabilising under the flexible exchange rate system
than under fixed exchange rate system and less inflationary
Price discipline
Fixed exchange rates impose a price discipline not found in flexible exchange rate
system. A nation with high inflation is likely to face persistent deficit in its balance
of payment and loss of reserves under a fixed exchange rate system. Deficits and
losses cannot go on forever, the country will need to restrain its high inflation and
thus faces some price discipline.
2 a Explain (With the aid of two diagrams, using the IS/LM/BP
framework) the effectiveness of expansionary fiscal policies and easy
monetary policies in an open economy with flexible exchange rates
and perfect capital mobility
The IS-LM –BP model with flexible exchange rates and Perfect Capital mobility.
Monetary Policy is effective and Fiscal Policy ineffective.
Fiscal Policy
i
LM
6.25
5.0 E’ BP
E
IS’
IS
0 Yn Yf
3|Page
