Reading 16 EOC 18 - Current Account and Currency

CFA Level III Economics
#1

So Q16 has country X and country Y. X is running a current account surplus, while Y is running a current account deficit, and the question says to pick the one that should have a strengthening currency based on the current account situation.

So my answer (which was wrong) was Y, and my reasoning was that since they are running a deficit, Foreign Direct Investment will be needed to come in and fill the deficit. The foreign investment increases demand for the country’s currency, and thus makes it appreciate. Ofc, I was wrong though, the one with the current account surplus is the one that should have an appreciating currency. Where am I going wrong with my reasoning?

Thanks

#2

Current account SURPLUS means the country is a net LENDER and a current account DEFICIT means a country is a net BORROWER. Surely you wont expect a country like Greece’s currency to appreciate (IF it was using its own currency Drachma).

#3

I’m acctualy also a bit confused by the answer given in CFAI. The reason is because the Saving-investment Imbalances can explain why a country might see it’s exchange rate rise as it experiences a current account deficit.

This is from section 4.6.9.4

"Suppose that an economy suddenly begins to expand rapidly, driven by a new government budget deficit or bullish entrepreneurs. If domestic savings do not change, there will be excess demand for capital as investment tries to exceed savings. The only way that investment can exceed savings in reality is for foreign savings to be used, since the accounts have to balance. But this solution requires a deficit on the current account of the balance of payments.

So, where does this deficit on the current account come from? Some of it may arise simply because imports are strong due to the buoyant economy or because exports are weak as companies focus on the domestic market. But if that is not enough, the exchange rate needs to rise. If capital flows are attracted to the country, either due to high interest rates or due to attractive expected returns on investments, then the exchange rate will indeed rise as needed."

Is there something I’m missing in their explanation? Are they saying that a strong economy with a current account deficit will see it’s exchange rate rise as a result of foreign investment?