Chapter 4 Australias trade and financial flows

The direction of Australian exports has shifted considerably in recent years from the US, Japan
and Europe towards China, Hong Kong and the ASEAN nations
Historically the composition of Australias exports has been agricultural; however this has declined
in recent years due to droughts, and high levels of foreign competitiveness and protection
In recent years the majority of our exports have been minerals, energies, manufacture and
servicing goods
In terms of imports, Australia mostly receives manufactured and capital goods. In recent years our
major importers have been the US, Japan and Asia
Financial flows
Australia is highly attractive to foreign investment
Foreign investment in Australia is two and a half times the value of Australian investment
overseas
Net capital importer Refers to a country which has more capital inflows then outflows (foreign
investment in Australia is greater than our overseas investments)
4.4 The balance of payments
Balance of payments The record of the transactions between Australia and the rest of the world
during a given period consisting of the current account and capital and
financial account
Debit All money flowing out of Australia on the balance of payments is a debit
represented by a negative
Credit All money flowing into Australia on the balance of payments is a credit
represented by a positive
The current account
Current account The current account is a record of all transactions between Australia and the
world of actual g/s and interest repayments on loans. The transactions on
the current account are non reversible
There are four aspects to the current account which include, net goods, services, income and current
transfers
Net goods Is the difference between the value of exports and the value of imports. There
are three possible outcomes on this account: if Australia's exports are greater
than imports there will be a surplus, if Australia's exports are equal to imports
there will be a balance or if Australia's exports are less than imports there will
be a deficit.
Net services The difference between the outflow and inflow of services to Australia.
Examples include tourism, insurance and travel.
Balance on g/s Amount derived by adding net services to net goods
Net income The difference between the profits earned by Australian owned securities
overseas and foreign owned Australian securities. When Australians invest
overseas the profits come back to Australia and vice versa for foreign
Australian interests
Net current transfers Occur when products or financial resources are provided without anything
provided in return, includes mostly gifts, donations and Australia's foreign aid
overseas. This area of account is mostly technical and very small and
insignificant compared to entire account
After all aspects have being worked out, they are added together to produce the balance on the
current account
EXAMPLE
Component Amount
Goods
Exports
Imports
Total

14
-16
-2
Services
Credits
Debits
Total

3
-6
-3
Balance on g/s -5
Income
Credits
Debits
Total

10
-13
-3
Current transfers
Credit
Debit
Total

1
-2
-1
Balance on CA -11 (-2 -5 -3 -1)
The capital and financial account
The capital and is a record of all international borrowing and lending transactions of Australias private
and public sectors
Capital account Consists of capital transfers including capital brought in or out by migrants,
aid to help other nations build capital and the sale and trade of non-produced
non-financial assets like patents and copyright.
Financial account Records all transactions of financial assets and liabilities. There are four
main aspects of the account including:
Direct investment Refers to the purchase of a substantial proportion of a companys shares
(greater than or equal to 10%) with the intent of managing or playing an
active part in the companys running
Portfolio investment Refers to short term investments in a company by foreigners for the purpose
of realizing a financial return
Other investment Trade items including; trade credits leases and foreign currency or other
assets which dont fit into either of the previous two categories
Reserve assets Refers to the transactions of the RBA which include its reserves of gold and
foreign currency

Component Amount
Capital account
Capital transfers
Credits
Debits
Other
Total


6
-2
-1
3
Financial account
Direct investment


Abroad
In Australia
Other
Reserve assets
Total
-9
15
-2
4
8
Balance on account 11

Last part of the BOP is the category of net errors and omissions, which is used to account for
statistical discrepancies on either account
There are a number of links between the current and financial accounts. The first is that the
surplus on the capital account (CFA) will equal the deficit on the current account thereby creating
equilibrium. This means that an increase in current account deficit (CAD) will lead to a rise in the
CFA.
In theory the Australian floating exchange system leads to this equilibrium









One of the strongest links between the two accounts can be seen on the net income part of the
current account
This is because any foreign financial inflow to Australia will produce some kind of return to its
owner (dividends etc) thus becoming a debit (outflow)
They create debits in two possible ways foreign financial inflows and outflows
4.5 Australia's balance of payments performance
Australia persistently has a large current account deficit, this is because Australia pays out more
for g/s and other incomes then it receives.
Other nations, such as China, Germany and Japan produce current account surpluses
The best way to measure CAD is as a proportion of GDP
The reasons why Australia produces a high CAD include
Loss of international competitiveness due to inflation and high labour costs
Deterioration of our terms of trade
High levels of domestic demand for imports
The costs of servicing our foreign debt
Current performance
On the current account our performance in g/s is affected by cyclical factors (e.g. minerals boom =
high exports)

Over 2008-09 the CAD began to fall as Australia's received much higher export revenues. In
addition our falling dollar increased our international competitiveness thereby raising our exports

High economic growth generally increases our CAD as we demand more imports

Net income deficit usually always remains high and stable; this is because the size of our foreign
liabilities and their associated servicing costs are structural factors that do not change from year to
year
4.6 Foreign liabilities and the balance of payments
Net foreign liabilities Reflect the total obligations of Australians to foreigners minus the total
obligations of foreigners to Australia
There are two components of foreign liabilities
Net foreign debt Is the total stock of loans owed by Australians to foreigners minus the total
stock of loans owed by foreigners to Australians.
Net foreign equity Is the total value of assets in land, shares and companies in foreign
ownership minus the total of overseas assets owned by Australians
Foreign owned Australian equity does not always constitute an outflow unless the equity is sold back
to Australians. If a USA firm sell Australian equity to a Canadian firm the funds transfer, no money
comes in or out of Australia but if the USA firm sells to an Australian firm the purchase cost goes to
the USA and is therefore an outflow
Australian capital borrowing from overseas, whilst an inflow, will lead to money being lost from the
economy due to the interest and servicing costs associated with a debt
Debt trap scenario This process starts with a high CAD, as Australia requires greater inflows, it
borrows capital from overseas. Whilst this borrowing lowers current CAD it
will increase it in the future as Australia is forced to pay servicing costs and
interest to those it borrowed from. Also known as passive accumulation of
debt







Our net foreign debt to GDP ratio has increase significantly since the 1980s due to globalisation
In the long term the growth of Australia's debt could lead to debt sustainability issues. If the size of
debt rises faster than the increase in our GDP, the servicing costs and interest will take up an
increasing proportion of our total GDP thereby lowering our standard of living and lowering the level of
economic growth.
In addition if a countries debt rises too far it may pose repayment difficulties for that country lowering
their international credit rating.
Debt servicing ratio Is the proportion of export revenue used to make repayments on foreign debt
and is a common measure of the sustainability of Australia's debt level. A
country is better able to service its debt if it has a high volume of exports,
thereby earning more foreign currency
Australia pays more attention to the level of foreign debt then foreign equity as only a small proportion
of outflow results from our equities and represents less of an income drain
4.7 Issues and trends associated with the balance of payments
The structure of our export base
Export base Products a nation produces for exports
Australia has a narrow export base primarily focused on primary industry commodities (farming,
commodities).
This increases our CAD volatility as these goods are subject to large fluctuations
If our export demand is high this will lower CAD and vice versa for lower demand for our exports
Australia's narrow export base has been seen as an economic problem; as a lack of an export
base leads to significant swings in CAD and increases our import demand
As such Australia is trying to diversify its exports by moving into the production of manufactured
goods
In addition Australia is attempting to move from STMs to ETMs
Value add The amount of Fop input needed to produce and manufacture a product.
E.g. Computers are high value added as they are complex to produce
STM Simply transformed manufacturers are low value goods which are only
produced one or two steps beyond the raw material stage. E.g. socks,
singlets, steel
ETM Elaborately transformed manufacturers are highly complicated goods
produced far beyond a raw value stage. Such goods command high values
in export markets and include computers, car parts etc
Level of tariffs are being reduced by the government to increase the competitiveness internationally of
manufactured goods and ETMs
Export price index Shows the proportional change in exports over a period of time
Import price index Shows the proportional change in imports over a period of time
Terms of trade Measures the relative movements in the prices of an economies imports and
exports over time. The terms of trade is calculated as export price index over
import price index times 100




In the base year the terms of trade is equal (proportion of export change is equal to proportion of
import changes)
In the base year the terms of trade is improving (proportion of export change is greater than the
proportion of import changes
In the base year the terms of trade declining (proportion of export change is lower than the
proportion of import changes)
Terms of trade has a powerful influence on CAD. If the TOT lowers then the CAD will rise as
Australia will need to produce more in order to pay the same level for imports
Savings and foreign liabilities
Australia has one of the lowest levels of household savings in the developed world.

Over time, a lower national savings rate contributes to a higher level of foreign liabilities, because
Australia has to rely more on the savings of foreigners to fund local investment.

With a low level of national savings, Australia has an insufficient supply of funds for consumption
and investment spending. Instead, this is made up by borrowing from overseas or selling off
assets.

A higher level of foreign liabilities then contributes to an outflow of funds due to interest costs on
foreign debt and returning profits on foreign investment in Australia.

As the level of foreign liabilities rises, the deficit on the net income component of the current
account will grow.

The relationship between foreign debt and the CAD can also be affected by interest rates and
exchange rates. When interest rates overseas are low, as they were during the past decade, the
servicing costs of foreign debt are lower.

When interest rates overseas rise, the servicing costs of foreign debt increase.
4.8 The consequences of a high CAD
Over a period of time, sustaining a high current account deficit has significant impacts the Australian
economy and on the conduct of economic policy.
Some argue that the CAD and foreign debt can be beneficial because borrowing from overseas can
increase investment and help the economy to grow faster.
The risks involved with running a high CAD include
Increased volatility for exchange rates - high current account deficits may undermine the
confidence of overseas investors in the Australian economy thus reducing demand for
Australia's currency, which may result in a depreciation of the $A

Increased level of liabilities may lead to lenders becoming more reluctant to lend to Australia
or to invest in Australia, and decisions affecting the Australian economy will increasingly be
made by international businesses and not by Australians.

Increased servicing costs associated with high levels of foreign liabilities impose substantial
servicing costs, reflected by the large net income deficit on the CAD. Higher levels of foreign
debt can result in foreign lenders demanding a 'risk premium' on loans, forcing up interest
rates.

Constraint on future economic growth - in the longer term, the CAD acts as a speed limit on
economic growth. Higher levels of economic growth generally involve an increase in imports
and deterioration in the CAD. Economies with a CAD problem are therefore forced to limit
growth to the level at which the CAD is sustainable. This is known as the balance of
payments constraint.

A sudden loss of international investor confidence - during recent years, several countries
have experienced economic crises that have been triggered by a sudden loss of investor
confidence. This is often related to sustaining a high CAD.

More contractionary economic policy - if they find it necessary to reduce a high CAD in the
short term, governments will use tighter macroeconomic policies and an acceleration of micro
economic reform. In the short run, tighter fiscal and monetary policies will reduce economic
growth and contribute to a lower CAD.