I am struggling to understand the foreign exchange gap.
It is defined as being when a country's current account deficit it not matched by a capital inflows. However this doesn't make sense because in order for a country to run a current account deficit it must finance the deficit using capital inflows (a capital account surplus). So surely it is not possible to have current account deficit which isn't matched by capital inflows. Having a foreign exchange gap would mean the balance of payments wouldn't balance, which is impossible.
I would also like to know how it is possible for a country with a current account deficit ( such as the uk) to hold foreign currency reserves. Surely this is not possible if the spend all the foreign currency they receive from exports on buying imports?
Thank you for your time
Thank you for your query. It looks like you need to clarify the definitions of Balance of Payments, Current account and Capital Account. You may want to download a free pdf http://www.imf.org/external/pubs/cat/longres.aspx?sk=1559
published by the International Monetary Fund. The definitions are clear and will give you a starting point.