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Updated: Nov. 29.,2006
Lecture Notes
ECON 622: ECONOMIC COST-BENEFIT ANALYSIS
Lecture Seven
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Cost of Foreign Exchange (EOCFX) and Shadow Price of
Non-Tradable Outlays (SPNTO)
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Definition of EOCFX and SPNTO
• These variables (EOCFX and SPNTO) are estimated to measure
the value of the distortions created when funds are sourced in the
capital market and used to purchase either tradable goods
(EOCFX), or non-traded goods (SPNTO).
• These actions are repeated many times for each project and are
identical for such actions across projects.
• It is efficient and to estimate these variables once for a country and
use the same values repeatedly as needed.
• To make the estimates general we do not include the specific
distortions on the particular traded or non-traded good. These
effects are included when we estimate the economic cost of the
specific item.
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Estimation of Economic Exchange Rate and Premium of Foreign Exchange under two situation:
1. Project already has raised funds e.g. foreign aid and spends them on traded goods.
2. Project raises funds in capital markets and spends funds on
a. Traded goods (Premium of Foreign Exchange)
b. Non-traded goods (Shadow price of non-traded outlays (SPNTO))
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• When the numeraire is the domestic currency at the domestic price level, the
foreign exchange effect of the change in the demand (or supply) of tradable
commodities must be converted into domestic currency.
• Conversion should take place at the “shadow exchange rate,” or economic price
of foreign exchange (Ee).
Cases:
1. Market Exchange Rate
• If there are no distortions on the demand or supply of tradable goods, and if the
exchange rate is determined by market forces, then the economic price of
foreign exchange is equal to the market exchange rate (Em).
Economic Cost of Foreign Exchange
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2. Trade Distortions
– Trade distortions will change the demand and/or supply of foreign
exchange such that the market exchange rate no longer measures
the economic price of foreign exchange. For example,
– Tariffs- lower the market demand for foreign exchange and cause Em
to be less than Ee
– Export Taxes - Decrease the market supply of foreign exchange and
cause the Em to be greater than Ee
– Export Subsidies - Increase the market supply of foreign exchange
and cause the Em to be less than Ee
3. Indirect taxes will impact the demand and supply of both traded and non-
traded goods
- Value added taxes
- Excise taxes
Economic Cost of Foreign Exchange (Cont’d)
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• All goods are divided into three types:
1. Importable
2. Exportable
3. Non-traded goods• Importable and Exportable goods are referred to as TRADABLE
GOODS.• Prices of TRADABLE GOODS are determined by international
markets and expressed in units of a foreign exchange currency.• Domestic prices of such goods are determined by multiplying
the internationally given import price PIw or the export price PE
W by the market exchange rate EM i.e. PD
I =EMPIw, PD
E=EMPEw
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• As the world prices of these goods are fixed their
domestic prices, and the quality domestically demanded
or domestically supplied of these will depend on the real
exchange rate (inflation =0)
• Their quantities can be expressed in units of foreign
exchange.
• Importable and Exportable goods can be aggregate to
make market for tradable goods.
• This market is also the market for Foreign Exchange.
• This market will determine the country’s real exchange
rate.
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Demand for Traded GoodsEquals Demand for Importable Goods plus Demand for Exportable Goods
Demand for Importable Demand for Exportable Demand for Traded
Goods Goods Goods
EM EM EM
DT=DI+DE
DI DE
Q (FX) Importable $FX Q (FX) Exportable $FX Q (FX) Traded
Because the world price of importable and exportable goods are given to country the demand for tradable goods is a function of the Real Exchange rate.
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Supply of Traded Goods
Equals Domestic Supply of Importable Goods plus Domestic Supply of Exportable Goods
Domestic Supply Importable Domestic Supply Exportable Domestic Supply Traded
Goods Goods Goods EM S I EM SE EM ST=SI+SE
EM0 EM
0 EM0 DT
QSI QS
E QT Q(FX) Importable Q (FX) Exportable Q (FX) Tradable
Exchange rate determined by the demand and supply of tradable Goods
QDT=QS
T
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Demand for Foreign Exchange
An equivalent way to see how the exchange rate is determined as to draw the demand for imports and supply of exports
Importable Market Demand for Imports
P SImportable EM
_
EM0 EM
0
EM1 DImportable E1 DM
QIS Import QI
D Q Importable(QFx) QFXD
The demand for imports=Demand for importable goods-Supply of importable goods
Demand for Foreign Exchange=Demand for Imports
QFxD=QI
D-QIS
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Supply of Foreign Exchange
Exportable Market Imports and Exports
P SExportable
SX
_
EM0
_
EM1 E1
DM
DExportable
QED Export QE
S Q Exportable(QFx) QFXD/S
QFxS=QE
S-QED=Supply of Foreign Exchange =Supply of Exports=SX
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Total Economy=Market for Tradable Goods plus Market for Non-Tradable Goods
Tradable Goods Non-Tradable Goods
EM ST SNT
E0 PNT
DT DNT
QT
0 Q(FX) QNT0
• Because there is a given amount of capital and labor in country, GDP=Quantity Supplied of Tradable goods + Quantity Supplied of Non-tradable goods.
• Price of non-traded goods is fixed as the numeraire price in the economy (market equilibrium determined by relative prices).
• Real Exchange rate determined in traded goods market.• Real Exchange rate is the relative price of Traded to Non-Traded Goods.• Changes in exchange rate will cause the demand and supply of Non-Traded goods to
shift. This is the relative price effect on demand for a good.
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Full Employment and Equilibrium in Tradable and non-Tradable Goods Markets
Tradable Goods Non-Tradable Goods
EM ST0 SNT
E0 PNT
DT0 DNT
QT0 Q(FX) QNT
0
GDP=QT0+QNT
0 Full Employment
Should think of tradable Goods and Non-Tradable Goods as two large composite goods
QST=QD
T QSNT=QD
NT
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Economic Equilibrium
Importable Exportable Market for Foreign Exchange
EM SI SX
SE
E0
DI
DE DX
QSI QD
I QDE QS
E QFX0
Import Export
Equilibrium in Traded goods market also means that there is equilibrium in foreign exchange market.
QDI +QD
E =QDT
QSI+QS
E=QST
In equilibrium QDT=QS
T
Hence QDI+QD
E=QSI+QS
E QDI-QS
I=QSE-QD
E Imports=Exports
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Determination of Market Exchange RateNo Distortions
Exchange Rate: # of units of domestic currency per unit of Foreign Exchange
Quantity of foreign exchange US$
Ee=Em
S0fex
D0fex
Q0
Ee=Em
Em = Market Exchange Rate Ee
= Economic Exchange Rate
S0fex= Supply of foreign exchange as derived from supply of exports
D0fex=Demand for foreign exchange as derived from demand for imports
Ee = Ws * Em +Wd * Em
as Ws +Wd = 1 then
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Case One: Project already has funds from Foreign aid
• Import Tariff = Tm
Quantity of Foreign exchange Traded
Q0
D0
d1 QQ
Dt (net of tax)
s1
Dt+ project
m1Em0
E
S0
Exchange Rate
E0m(1+Tm)
Ee = Ws * Em +Wd * Em(1+Tm)
Determination of Exchange Rate with Distortions
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Case Two:• Export Subsidy = kx
D0
S0
S0+export subsidy
Quantity of Foreign exchange Traded
Exchange Rate
D0 + Project
Q0
s1QQ
d1
m1Em0
E
E0m(1+kx)
E1m(1+kx)
Ee = Ws * Em * (1+kx) + Wd*Em
Determination of Exchange Rate with Distortions
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Case Three:• Export Tax = tx
D0
S0+export tax
S0
Quantity of Foreign exchange Traded
Exchange Rate
D0 + Project
Q0
s1QQ
d1
m1Em0
E
E0m(1-tx)
E1m(1-tx)
Ee = Ws * Em * (1-tx) + Wd*Em
Determination of Exchange Rate with Distortions
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Case Four• Market Determined Exchange rate • Current Account in Equilibrium• Import Tariff = Tm
• Export Tax = tx
Ee = Ws *Em * (1-tx) + Wd * Em * (1+Tm)
Quantity of Foreign exchange Traded
Q0
D
d1
Q
Dt
G
F
Tariff
L
J
Export Tax
Qs1
Dp
m1Em0
E
St S
Exchange Rate
AB
H
Determination of Exchange Rate with Distortions
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Determination of Exchange Rate with Distortions and Capital Flows
Case Five:
• Market determined Exchange Rate
• Balance of Payments Deficit Sustained through Capital Inflows
• Import Tariff = Tm
• Export Tax = tx
Ee = Ws * Em * (1-tx) + Wd * Em * (1+Tm)
Quantity of Foreign Exchange Traded
Conclusion: No change in basic estimation procedure.
St
Exchange Rate
H
Q
A
d1QQ
Dt
G
D
L J
s1
S
s0
F
K
MDP
B
Qd0
m1Em0E
N
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Economic Price of Foreign Exchange
Trade Distortions• An increase in demand for imported inputs will cause a (slight)
depreciation in the domestic currency, which in turn will cause a reduction in imports and an increase in exports
• The economic value of the foreign exchange required by a project is determined by the economic values of the forgone imports and increased exports
Example: The main trade distortions are tariffs on imported goods and taxes on exports. The economic price per unit of foreign exchange is
Ee = Ws * Em * (1-tx) + Wd * Em (1 + Tm)Where Ws = The proportion of an extra unit of foreign exchange that is
met by an increased supply of exports:
Wd = The proportion of an extra unit of foreign exchange that is met by a reduction in other imports:
s
s - d * (Qd/Qs)=Ws
s - d * (Qd/Qs)
- d * (Qd/Qs)=Wd
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Calculation of Foreign Exchange Premium
If the elasticity of foreign exchange supply (s) is equal to the elasticity of foreign exchange demand (d): s = - d
Then, a simple way to calculate the foreign exchange premium is:
Tariff Revenues + Export Subsidies - Export Taxes
Value of Imports + Value of ExportsFEP =
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Example for Indonesia (1991)
The Economic Cost of Foreign Exchange is calculated as follows:
Where:Ee = Economic exchange rateEm = Market exchange rate = 1,950.3 Rp/$1.0Ws = Weight on supply = 0.33Wd = Weight on demand = 0.67t x
adj = Weighted average rate of tax on price-responsive exports = 0.00157Tadj = Weighted average rate of tariff on price-responsive, non-re-
exported imports = 0.0919Therefore,Ee = 0.33 * 1,950.3 * (1-0.00157) + 0.67 * 1,950.3 * (1+0.0919) = 2,069.38Foreign Exchange Premium (FEP) = Ee/Em - 1 = 0.061
Note: The market exchange rate is obtained from International Financial Statistics, October 1992. Data for oil and non-oil imports and exports, and for re-exported imports, are from the Central Bureau of Statistics. Data for government imports are from the Quarterly Report of Balance of Payment, April 1992, Central Bank of Indonesia. Data for import duty and export tax are obtained from Ministry of Finance, Nota Keuangan 1992/93.
Ee = Ws * Em* (1 - t xadj) + Wd * Em * (1 + Tadj)
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Application of Foreign Exchange Premium
• To value tradable goods at economic prices, the CIF prices of importable goods, or the FOB prices of exportable goods should be converted into domestic prices using the economic exchange rate (Ee).
• Alternatively, this valuation at economic prices can be achieved by adding a foreign exchange premium [(Ee/Em) - 1] per unit of foreign exchange demanded (or supplied) by a project.
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Economic Cost of Foreign Exchange
Step1: Project Borrow 600 from Domestic Capital Market
Tradable Goods Non-Tradable Goods
EM ST0 SNT
400 200
E0 PNT
DT1 DT
0 DNT1 DNT
0
QT0 Q(FX) QNT
0
Assume: Demand for tradable goods is reduced by 400 and demand for Non- traded by 200. Total borrowing funds =Total reducing in demand for goods and services.
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Step 2: Borrowed funds used to purchase 600 of traded goods
Tradable Goods Non-Tradable Goods
ST
0 SNT0
Eu
E0M PNT
DT2
DT DT
0 DNT1 DNT
0
QT1 QT
0 QT2 Q(Fx) QNT
1 QNT0
Suppose all 600 is spent on Traded goods hence demand for Traded good shift from DT1 to
DT2 .At the exchange rate of E0 there is now an excess demand of traded goods of QT
2-QT
0 or 200 and in the Non-traded goods market there is an excess supply of Non-traded goods of QNT
0-QNT1 or 200
600
400 200200
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Step 3: Exchange rate rises to E11 to reduce excess demand in Tradable goods market and excess supply in Non-Tradable goods market.
Tradable Goods Non-Tradable Goods
EM SNT1
ST0 SNT
0
E1
E0 PNT
80 120 DT2 120 80
DT1 DT
0 DNT
1 DNT2 D
NT0
QT
0 QT1 Q(FX) QNT
1QNT2QNT
0
Final Impact: Reduction in Tradable goods demand 400+120=520
Reduction in Non-Tradable goods demand 200-120=80
400 200
Assumption is that |TD| = 1.5 T
S
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Step 1:Equilibrium in Market for Foreign Exchange
Importable Exportable Market for Foreign Exchange EM SI SX
0
SX
1
300 100 300 100
E0 DI
0
DI1 DE
0 DM0
DE1 DM
1
QSIQDI
1 QDI0 QDE
1QDE0 QS
E QFX0
Imports Exports
Reducing in demand for Traded goods of 400 is assumed to reduce demand
for importable goods of 300 and a reduction in demand for exportable goods
by 100. Hence, reduction in demand for traded goods of 400 gets translated
into a reduction of demand by imports of 300 and an increase in supply
exports of 100.
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Step 2: Equilibrium in Market for Foreign Exchange
With the purchase of 600 of Traded goods (importable) there is an excess
demand for foreign exchange of QFxD-QFx
S or 200. Hence exchange rate must rise
to E1. This will cause the supply of export to increase by 100 and the demand for
import to decrease by 100.
Assumption that |ID| = x
S
100100
600
300 100
1E
0E
E XS0XS1
MD0
MD2MD1FXQ0
FXSQ
FXQ1FXDQ
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Financing of a Project by Borrowing from Abroad and Using Funds to Buy Traded Goods
Step 1: No impact on consumer demand due to borrowing from Abroad Step 2: More Foreign Exchange to purchase traded goods for Project
600
E
E0
Q
TS0 TBS 0
TD0
TPD 0
TQ0TQ1
Step 1Step 2
PNT
NTS0
NTD0
NTQ0
Traded Goods Non-Traded Goods
Change in supply of traded goods (foreign exchange) increased by 600 and Change in demand for foreign exchange increased by 600 with the Project
No Impact on Non-Traded
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Market for Foreign Exchange
600
FXS0 FXS1
FXMD
PFXMD
0Q 1Q
Step 1Step 2
FXQ
0E
E
No change in exchange rate as change in demand for FX
of 600 is offsetted by additional supply of FX of 600
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TABLE 1 CALCULATION OF ECONOMIC OPPORTUNITY COST OF FOREIGN EXCHANGE
600 of Project Funds Sourced in Capital Market And Spent on Tradables m
vt
m vh
Applicable m vt eis
Distortion Alone vh eia
Change Due To (exclusion for Capital Market investment Sourcing eis = 0.75)
Tradables Demand -400 vt = .20 n.a. -80 -20
Import Demand -300 m = .12 -36 -36 -36
Export Supply +100 - n.a. n.a. n.a. Nontradables Demand -200 vh = .05 n.a. -10 -2.5
Change Due To Real (exclusion for Exchange Rate investment Adjustment eia = 0.33)
Tradables Demand -120 vt = .20 n.a. -24 -16
Tradables Supply +80 - n.a. n.a. Import Demand -100 m = .12 -12 -12 -12
Export Supply +100 - n.a. n.a. Nontradables Demand +120 vh = .05 n.a. +6 +4
Nontradables Supply -80 - n.a. n.a. Total Distortion Costs (-), -48 -156 -82.5 Benefit (+) Distortion Cost/ Project Expend. .08 .26 .1375 = Premium on Tradables Outlays EOCFX/ 1.08 1.26 1.1375 Market Exchange Rate
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Estimation of Shadow Price of Non-Tradable Outlays (SPNTO)Financing of Project by Borrowing from Domestic Capital Market and
Used to Purchase Non-Traded Goods
Step 1: Projects Borrows 600 from Domestic Capital Market
400
E
QFX
TS0
TD1
TD0
TQ0
PNT
NTS0
NTD0
NTQ0
Traded Goods Non-Traded Goods
0E
200
NTD1
Assume: Demand for tradable goods is reduced by 400 and demand for Non-traded by 200. Total borrowing funds =Total reducing in demand for goods and services.
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Step 2: Borrowed Funds from Domestic Capital Market Used to Purchase 600 of Non-Traded Goods
400
E
QFX
TS0
TD1
TD0
TQ0
PNT
NTS0
NTD0
NTQ0
Traded Goods Non-Traded Goods
0E
200
NTD1
NTD2
400
NTQ1NTQ2
600
Suppose all 600 is spent on Non-Traded goods. Hence demand for Non-Traded goods shifts from D1
NT to D2NT. At an exchange rate of E0
M there is an excess supply of Traded goods of 400 (Q0
T-Q1T) and an excess demand for Non-
Traded goods of 400 (Q2NT-Q0
NT) .
TQ1
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Step 3: Exchange Rate Falls to Increase Demand for Traded Goods and Reduce Supply of Traded Goods Tradable Goods
400
E
QFX
TS0
TD1
TD0
TQ0
PNT
NTS0
NTD0
NTQ0
Traded Goods Non-Traded Goods
0E
200
NTD1
400
NTQ1NTQ2TQ1
240 160 160 240
NTS1
NTQ3
NTD2
NTD3
Final EquilibriumDemand for traded goods has decreased by - 400 + 240 = -160Demand for non-traded goods has decreased by -200 - 240 = -440 Total= -600
2E
Assumption is that |TD| = 1.5 T
S
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Step 1:Equilibrium in Market for Foreign Exchange Markets
Importable Exportable Market for Foreign Exchange EM SI SX
0
SX
1
300 100 300 100
E0 DI
0
DI1 DE
0 DM0
DE1 DM
1
QSIQDI
1 QDI0 QDE
1QDE0 QS
E QFX0
Imports Exports
Reducing in demand for Traded goods of 400 from 600 of raising funds in
capital market is assumed to reduce demand for importable goods of 300 and
a reduction in demand for exportable goods by 100. Hence, reduction in
demand for traded goods of 400 gets translated into a reduction of demand by
imports of 300 and an increase in supply exports of 100.
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Step 2:Equilibrium in Market for Foreign Exchange Markets
100300
MD0
MD1
200 200
FXQ0
2E
0E
XS1
XS0
Market for Foreign Exchange
With the purchase of 600 of non-traded goods there is an excess supply of 200 of foreign exchange. Hence exchange rate must fall to E2
M . This will cause the supply of exports to fall by 200 and the demand for imports to increase by 200.Foreign Exchange Market EquilibriumStep 1: Reduction in demand for imports 300 Increase in Supply for exports 100Step 2: Increase in demand for imports 200 Reduction in Supply for exports 300Net Impact: Demand for Imports reduced by 100 Supply of Export reduced by 100 Total = 200
E
FXQ
Assumption that |ID| = x
S
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TABLE 2 CALCULATION OF SHADOW PRICE OF NONTRADABLES OUTLAYS 600 of Project Funds Sourced in Capital Market And Spent on Nontradables
m
vt
m vh
Applicable m vt eis
Distortion Alone vh eia
Change Due To (exclusion for Capital Market investment Sourcing eis = 0.75)
Tradables Demand -400 vt = .2 n.a. -80 -20
Import Demand -300 m = .12 -36 -36 -36
Export Supply +100 - n.a. n.a. n.a. Nontradables Demand -200 vh = .05 n.a. -10 -2.5
Change Due To Real (exclusion for Exchange Rate investment Adjustment eia = 0.33)
Tradables Demand +240 vt = .2 n.a. +48 +32
Tradables Supply -160 - n.a. n.a. n.a. Import Demand +200 m = .12 +24 +24 +24
Export Supply -200 - n.a. n.a. n.a. Nontradables Demand -240 vh = .05 n.a. -12 -8
Nontradables Supply +160 - n.a. n.a. n.a. Total Distortion Costs (-), -12 -66 -10.5 Benefit (+) Distortion Cost/Project Expend. .02 .11 .0175 = Premium in Nontradables Outlays Shadow Price of Nontradables Outlays 1.02 1.11 1.0175
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Financing the Project by Borrowing from Abroad and Using Funds to Buy Non-Traded Goods
• Step 1: No impact on consumer demand due to borrowing from abroad.
• Step 2: More foreign exchange available to purchase traded goods by others.
Change in demand for traded goods is increased by 360, change in demand for non-traded goods is decreased by 360.
Traded
S0T
S0T+BF
D0I
600
360 240
Q0T
S0NT
S1NT
D0NT
600
240 360
PNT
D2NT
Non-Traded
D1NT
E0
E1
E
Q
E
Q
Assumption is that |TD| = 1.5 T
S
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Market for Foreign Exchange
SXFX
SXFX
DMFX
600
300 300
Q0T
PNT
E0
E1
E
QFX
600 excess supply of FX from foreign borrowing results in falling
real exchange rate to E1. This will cause the demand for imports
to rise by 300 and the supply of export to fall by 300.
Assumption that |ID| = x
S
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TABLE 3 CALCULATION OF SHADOW PRICE OF NONTRADABLES OUTLAYS
600 of Project Funds Sourced Abroad And Spent on Non-Tradables m
v t
m vh
Applicable m v t eis Distortion Alone v h eia
Change Due To (exclusion for Capital Market investment Sourcing eis = 0.75) n.a. n.a. n.a.
Change Due To Real (exclusion for Exchange Rate investment Adjustment eia = 0.33)
Tradables Demand +360 vt = .2 n.a. +72 +48
Tradables Supply -240 - n.a. n.a. Import Demand +300 m = .12 +36 +36 +36 Export Supply +300 - n.a. n.a. Nontradables Demand -360 vh = .05 n.a. -18 -12
Nontradables Supply +240 - n.a. n.a. Total Distortion Costs ( -), +36 +90 +72 Benefit (+) Distortion Cost/ Project Expend. -.06 -.15 -.12 = Premium on Nontradables Outlays Shadow Price of Nontradable Outlays 0.94 0.85 0.88
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• s1 = share of project funds sourced by displacing the demand for importables,
• s2 = share of project funds sourced by displacing the demand for exportables,
• s3 = share of project funds sourced by displacing the demand for nontradables,
• f1 = fraction of a gap between the demand for imports and the supply of exports
that is closed by a movement along the demand function for imports as the
real
exchange rate adjusts to bring about equilibrium,
1 = fraction of a gap between the demand and the supply of tradables that is
closed by a movement along the demand function for tradables as the real
exchange rate adjusts to bring about equilibrium,
• gd = fraction of project funds effectively sourced in the domestic capital market
• gf = (1-gd) = fraction of project funds effectively sourced in the foreign capital
market
General expressions for premia on foreign exchange and shadow price of non-tradable outlays
Definitions:
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M = the uniform tariff rate on imports,
• vt = the rate of value added tax on domestic consumption of tradables,
• vh = the rate of value added tax on the domestic consumption of non-
tradables,
• Cs = share of reduced expenditure from the capital market sourcing of funds
that
are taxed by VAT, i.e. consumption. Cs = (1-eis)
• Ca = share of reduced expenditure from the adjustment of the exchange rate
that are taxed by VAT, i.e. consumption Ca = (1-eia)
• eis = share of reduced expenditure due to funds sourced through the capital
market that is excluded from the VAT base (i.e. investment)
• eis = share of reduced expenditure due to exchange rate adjustment that are
excluding from the VAT base (i.e. investment)
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TABLE 4 GENERAL EXPRESSIONS FOR PREMIA ON TRADABLES AND NONTRADABLES
(Project Funds Sourced 100% in Domestic Capital Market) With Uniform Import Tariff ( m) Alone:
Premium on Tradables = (s1 + f1s3)m
Numerical Check: .08 = [0.5 + 0.5(.33)](0.12) Premium on Nontradables = [s1 - f1(s1+s2)]m
Numerical Check: .02 = [0.5 - 0.5(.67)](0.12) With Uniform Import Tariff ( m) Plus Value Added Taxes (vt and vh)
(No Credit For Investment Goods) Premium on Tradables = (s1 + f1s3)m + (s1+s2)vt + s3vh + 1s3(vt-vh)
Numerical Check: = .08 + (.67)(0.2) + .33(0.05) + 0.6(.33)(0.15) .26 = .08 + .1333 + .0167 + .03 Premium on Nontradables = [s1-f1(s1+s2)m] + (s1+s2)vt + s3vh - 1(s1+s2)(vt-vh)
Numerical Check = .02 + .1333 + .0167 - (.6)(.67)(0.15) .11 = .02 + .133 + .0167 - .06 With Uniform Import Tariff ( m) Plus Value Added Taxes (vt and vh)
With Credit for Investment Goods Premium on Tradables: = [(s1+f1s3)m] + cs[(s1+s2)vt+s3vh] + ca[1s3(vt-vh)]
Numerical Check: = .08 + (.25)[.1333+.0167)] + (.67)(.03) .1375 = .08 + .0375 + .02 Premium on Nontradables: = [s1f1(s1+s2)]m + cs[(s1+s2)vt+s3vh]
- ca[1(s1+s2)(vt-vh)]
Numerical Check: = .02 + (.25)(.1333+.0167) -.67[.6(.67)(.15)] .0175 = .02 + .0375 - .04 Note: cs = (1-eis)
ca = (1-eia)
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TABLE 5 GENERAL EXPRESSIONS FOR PREMIA ON
TRADABLES AND NONTRADABLES (Project Funds Sourced 100% Abroad)
With Uniform Import Tariff (m) Alone Premium on Tradables = zero Premium on Nontradables = -f1m Numerical check -.06 = -(.5)(.12) With Uniform Import Tariff ( (m) Plus Value Added Taxes (vt and vh) (No Credit For Investment) Premium on Tradables = zero Premium on Nontradables = -f1m - 1(vt-vh) Numerical Check -.15 = -(.5)(.12) - (.6)(.15) With Uniform Import Tariff (m) Plus Value-Added Taxes (vt and vh) With Credit For Investment Premium on Tradables = zero Premium on Nontradables = -f1m - ca1(vt-vh) Numerical Check -.12 = -(.5)(.12) - (.67)(.6)(.15) Note: cs = (1-eis)
ca = (1-eia)
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TABLE 6 WEIGHTED AVERAGE PREMIA WITH “STANDARD”
CAPITAL MARKET SOURCING gd = fraction of project funds effectively sourced in the domestic capital market
gf = (1-gd) = fraction of project funds effectively sourced in the foreign capital market
PREMIA ON TRADABLES AND NONTRADABALES
Project Funds Sourced From: Both Markets gd = .7
Applicable Distortions Domestic Capital Market Foreign Capital Market gf = .3
m = .12
Project Funds Spent On Tradables .08 -0- .056 Nontradables .02 -.06 -.004 m = .12, vt = .20, vh = .05
Project Funds Spent On Tradables .26 -0- .182 Nontradables .11 -.15 .032 m = .12, vt = .20, vh = .05, eih = .75, eia = .33
Project Funds Spent On Tradables .1375 -0- .09625 Nontradables .0175 -.12 -.02375
TABLE 6 WEIGHTED AVERAGE PREMIA WITH “STANDARD”
CAPITAL MARKET SOURCING gd = fraction of project funds effectively sourced in the domestic capital market
gf = (1-gd) = fraction of project funds effectively sourced in the foreign capital market
PREMIA ON TRADABLES AND NONTRADABALES
Project Funds Sourced From: Both Markets gd = .7
Applicable Distortions Domestic Capital Market Foreign Capital Market gf = .3
m = .12
Project Funds Spent On Tradables .08 -0- .056 Nontradables .02 -.06 -.004 m = .12, vt = .20, vh = .05
Project Funds Spent On Tradables .26 -0- .182 Nontradables .11 -.15 .032 m = .12, vt = .20, vh = .05, eih = .75, eia = .33
Project Funds Spent On Tradables .1375 -0- .09625 Nontradables .0175 -.12 -.02375
48
A Case of South Africa
• A General Equilibrium Analysis
• Take into account:
- project funds sourced from the capital market (62.5% from displaced investment, 11.5% from household saving and 26.0% from foreign savings).
- all distortions in import tariff, subsidy, value-added tax, and other indirect taxes.
49
Table 1 Impact of Capital Extraction and Spending on Project Inputs in South Africa
Capital Sourcing and Spending Importables Exportables Non-Traded Domestic Funds a) Project Demands for Importables +100.0
Displacement (K-Market) -39.0 -24.0 -37.0 Effect of Real Exch Rate on Demand -8.4 -6.9 +15.3 Effect of Real Exch Rate on Supply +7.6 +14.1 -21.7 Excess Demand for Goods +45.0 -45.0 0 Domestic Funds b) Project Demands for Exportables +100.0
Displacement (K-Market) -39.0 -24.0 -37.0 Effect of Real Exch Rate on Demand -8.4 -6.9 +15.3 Effect of Real Exch Rate on Supply +7.6 +14.1 -21.7 Excess Demand for Goods -55.0 +55.0 0 Domestic Funds c) Project Demands for Non-Tradables +100.0
Displacement (K-Market) -39.0 -24.0 -37.0 Effect of Real Exch Rate on Demand +14.3 +11.8 -26.1 Effect of Real Exch Rate on Supply - 12.9 -24.0 +36.9 Excess Demand for Goods -11.8 +11.8 0 Funds Borrowed from Abroad d) Project Demands for Non-Tradeables +100.0
Displacement (K-Market) - - - Effect of Real Exch Rate on Demand +22.7 +18.8 -41.5 Effect of Real Exch Rate on Supply -20.4 -38.1 +58.5 Excess Demand for Goods +43.1 +56.0 0
50
Table 2 Externalities Generated from Project Funds Sourced from Domestic Markets and
Spent on Importables
Capital Sourcing and Spending Importables Exportables Non-Traded Domestic funds a) Project Demands for Importables +100.0
Displacement (K-Market) -39.0 -24.0 -37.0 Effect of Real Exch Rate on Demand -8.4 -6.9 +15.3 Effect of Real Exch Rate on Supply +7.6 +14.1 -21.7 Excess Demand for Goods +45.0 -45.0 0 Externalities: 8.21% Import Tariffs = (45-100)*3.6% = -1.98% Production Subsidies = -(-45)*0.6% = + 0.27% VAT = [(-39-24)*0.156 + (-8.4-6.9)*0.804]*11.36% +[(-37)*0.156 + (15.3)*0.804]*6.54% = - 2.09% Other Indirect Taxes = (-39-24-8.4-6.9)*5.63% = - 4.41%
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Table 3 Summary of Externality
(Percentage)
Funds Drawn from Funds Spent on Funds Spent on Tradables Non-Traded
Domestic Capital Source Foreign Capital Source Capital Market Weights (Domestic: 74%, Foreign: 26%)
-8.21 -3.06
0 +5.15 -6.08 -0.93