Australian Balance of Payments - Performance Analysis and Evaluation

Australian Balance of Payments
Performance - Analysis and Evaluation
WACE Economics - Unit 3
Slideshow 5.2 (Updated Jan 2019)
© Andrew Tibbitt 2019

Relationship between Current Account Deficits and
Capital and Financial Account Surpluses
The balance of payments must balance overall.
Current account
balance +
Capital and
Financial account
balance
≡ ZERO
The current account balance and the capital and financial account balance,
therefore, mirror each other.
What is the direction of the causation? Probably both influence each other.
Current account
balance
Capital and
Financial account
balance
Current account
balance
Capital and
Financial account
balance

CAD caused by weaknesses in
structure of economy
Explanation:
Expenditure > Production
Lack of savings, too much
consumption
Poor productivity, too little
value added production
CFAS reflects strength of
economy
Explanation:
Investment > Savings
Resource rich (need for
investment finance)
Capital starved (insufficient
savings from our 25m
population)
Relationship between Current Account Deficits and
Capital and Financial Account Surpluses
Current
account
balance
Capital and
Financial
account
balance
Current
account
balance
Capital and
Financial
account
balance
Hypothesis 1 - Garnaut Thesis
CAD causes CFAS
Hypothesis 2 - Pitchford Thesis
CFAS causes CAD

There are links between Foreign Investment and the
Current Account

Australia almost always runs a Current Account Deficit
and Capital and Financial Account Surplus

Typically Australia has a Current Account Deficit and
Capital and Financial Account Surplus
This is because:
Australia has an investment-savings gap
(investing more on plant and equipment,
infrastructure and homes than the saving of
households, business and governments) so
savings of foreigners in the form of debt capital
and equity capital is needed to fill the gap).
Australians do save, but not enough to meet the
needs of a developed, resource-rich economy.
Australian’s aggregate expenditure
(consumption, planned investment, government
spending and net exports) exceeds national
output or incomes.

Current Account Performance
Source: IMF World Economic Outlook (October 2018)
Given the global nature of
the Australian economy the
Government and the
Reserve Bank do not set a
target level for the Current
Account Balance. Try to
avoid using judgemental
terms for movements in the
balance (such as worsening
or improvement) and use
neutral terms instead (such
widening and narrowing).

Since the float of the AUD in Dec 1983 the CAD has fluctuated
between -7% to -2% of GDP. The record deficit of just over 7% was
recorded in 2008. After the Global Financial Crisis the CAD has
narrowed (and is now about 2% of GDP)

Narrowing trend
Widening trend
- bigger fluctuations
Since the float of the AUD in Dec 1983 the CAD has fluctuated
between -7% to -2% of GDP. The record deficit of just over 7% was
recorded in 2008. After the Global Financial Crisis the CAD has
narrowed (and is now about 2% of GDP)

Reasons for the narrowing trend
Narrowing trend
Widening trend
- bigger fluctuations
End of the mining investment boom
(requiring lower levels of foreign
investment)
There is now a mining export boom
(demand strong from Asia, capacity
increased during investment boom)
Australian’s have increased
household savings since the GFC.
Banks are holding more liquid capital
for security reasons.
The government is undertaking
‘budget repair’
Companies are retaining more profits
rather than paying dividends
The Australian Dollar is below the
level during the mining investment
boom

So Australia has a negative International Investment
Position (IIP)
Total Foreign Liabilities rose due to the relative high CAD’s after 1983.
Since 2000 the negative IIP has been between 45% and 60% of GDP
Currently the IIP is about $1 trillion
Foreign debt exceeds the IIP because of positive net equity (due to
Australian multinationals and super-funds holdings of foreign shares)

The size of the investment-savings gap: The
extent to which Australian savings are sufficient
to meet the need for investment finance
Opportunities to earn profits: The potential to
earn profits by exploiting our ‘resource
endowment’ of minerals (iron ore) and energy
(LNG)
Sovereign risk: The degree of certainty foreign
investors have about future government
regulations and tax levels
Relative levels of interest rates: For example,
savers in Japan may be attracted to deposit
money in Australia to earn higher levels of
interest
Risk environment: Australia is not considered to
be a ‘safe haven’ in times of geopolitical
uncertainty
Factors affecting the Financial Account balance

Current Account Balance =
Trade Balance + Net Income Balance
The trade balance has fluctuated between -3% and +2% of GDP
The net income balance has fluctuated between -4% and -2% of GDP

Factors affecting the Trade Balance (Net Exports)
Factors affecting the Trade Balance can be:
Cyclical (i.e. linked to growth in Australia and in economies of our
trading partners). Cyclical factors relate to the demand-side of the
economy.
Structural (i.e. linked to the ways markets, or the economy as a
whole, operates). Structural factors relate to the supply-side of the
economy.
Special or shocks (i.e one-off events such as a drought or flood)
Source: Trading Economics

Cyclical factors affecting the Trade Balance
Changes in the rate of economic growth in Australia affects the level of
imports purchased (and influenced by the marginal propensity to import)
Changes in the rates of economic growth in our trading partners affects
the level of exports to them.
Since the Global Financial Crisis, growth in Australia has been lower
than growth in our our major trading partners, typically Asian economies.

Structural factors affecting the Trade Balance
The Investment-Savings gap - marginal propensity to save and level
of investment (see earlier slides)
International competitiveness (e.g. productivity growth, changes in
exchange rates, relative inflation rates)
Changes in the terms of trade
High marginal propensity to import - tendency to spend more than
we produce (National expenditure higher than national production)

Special or shock factors affecting the Trade Balance
Weather events (e.g. flood, fire and drought)
Interruption to supply (e.g. strikes, transport problems)

Factors affecting the Net Income Balance
Level of foreign liabilities: The higher the level of net foreign debt and foreign
equity the higher the outflows of interest, dividends and retained profits
Level of Interest rates: An increase in debt interest rates will increase income
outflows
Levels of profits of multinational businesses: The more profit earned by
overseas-owned businesses the higher the level of income outflows. (Note for
accounting purposes profit retained in Australia is assumed to have left
Australia and returned to Australia as foreign investment).
© Andrew Tibbitt 2019Source: RBA Chart Pack

Problems of a persistent current account deficit
Populist politics sees the trade deficits as a symptom of the unfairness
of globalisation such as income inequality, job losses and the decline in
real wages.
They attribute the trade deficits to unfair trade practices (e.g. Chinese
state subsidies and ‘theft’ of intellectual property) and the failings of the
World Trade Organisation to deal with these practices.
Protectionism in the form of sanctions and tariffs is seen as an easy
way of getting a better distribution of the gains from trade.
However, the inequities, job losses and wage stagnation are the result
of many factors from technological change and automation to
inadequacies in welfare and social security.
Protectionism will not solve the problems. Tariffs hit the very people
they are designed to protect (e.g. by raising the price of goods such as
cars and electrical goods) and also lead to retaliatory tariffs which hit
exporters (e.g. soya bean producers in the US)

Possible problems with a persistent current account
deficit
Build-up of debt: Debt has to be serviced (interest paid) and sustained
(regularly renewed).
Opportunity cost of incomes outflow: The money paid out in interest
could be spent better elsewhere, perhaps.
Debt trap: Can lead to a debt spiral where the money for interest
payments leads to more borrowing and more interest payments.
Build up of foreign ownership: Equity capital inflows potentially lead
to the loss of economic sovereignty and threaten national security
Increased vulnerability in next financial crisis: It may become harder
and more expensive to borrow
BUT…

Perhaps they are not problems in Australia’s case
IN AUSTRALIA
The levels of debt, interest payments and foreign ownership are relatively
low by world standards
Capital inflows can finance investment which increases the capacity of
economy to produce and export (e.g. LNG platforms, iron ore mines)
Most of the foreign debt is private sector debt. The borrowing was based,
presumably, on commercial judgements.
The floating exchange rate acts like a shock absorber controlling size of
Current Account Deficit.
Australia’s credit rating and exchange rate remain strong, showing
overseas investors are relaxed about having their capital invested in
Australia.
BUT THERE AGAIN THEY MIGHT BE IF…
Trade wars get out of hand and destroy the rules based trade system
There is another financial crisis upsetting financial and capital markets

Economic reform to promote
productivity growth
Increase national (domestic)
savings
Strengthen trade and investment
relationships with other countries
Accept situation as a fact of life
for strength of resource rich
economies
Appropriate
response?
This is not to say that nothing should be done that
helps narrow the current account deficit
Inappropriate
response?
Protectionism (as in US)
Reducing the value of the AUD
Deflating the economy to reduce
the level of imports
Restrict foreign investment flows
(apart from those that are clearly
against the national interest)

End of video slide show 5.2
See also Video 5.1
Structure of the Balance of Payments?

Australian Balance of Payments - Performance Analysis and Evaluation

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