Under a fixed exchange rate regime, a balance of payments surplus occurs when a country's exports of goods, services, and capital exceed its imports. This situation can have specific effects on the exchange rate:
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Pressure to Appreciate: A balance of payments surplus typically creates upward pressure on the currency value because more foreign currency is coming into the country than is going out. This influx of foreign currency from exports means that there is a higher demand for the domestic currency, which, under a flexible exchange rate, would lead to appreciation.
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Intervention by the Central Bank: However, under a fixed exchange rate regime, the central bank is committed to maintaining a specific exchange rate. To counteract the upwards pressure on the currency caused by the surplus, the central bank may intervene in the foreign exchange market. This can be done by selling the domestic currency and buying foreign currencies to maintain the fixed exchange rate.
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Foreign Currency Reserves: Persistent balance of payments surpluses would lead the central bank to accumulate foreign currency reserves. This is because, in order to maintain the fixed rate, the central bank will need to hold sufficient reserves to manage any fluctuations caused by the surplus.
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Adjustments in Economic Policy: If a surplus continues over time, the country may need to adjust its economic policies to either increase domestic demand for imports or reduce export competitiveness, to help align the balance of payments more closely with the fixed exchange rate.
In summary, while a balance of payments surplus would exert upward pressure on the exchange rate in a free-floating system, under a fixed exchange rate regime, the central bank intervenes to keep the exchange rate stable, often accumulating foreign reserves in the process.