Analyse the effects of Australia's ongoing high current account deficit (CAD) on the Australian economy.

The current account deficit (CAD) represents the excess of debits in the current account in comparison to the credits; that is, the excess of money going out to imports and income payments to abroad in comparison to the money coming in from exports and income payments from abroad. Recent figures record the CAD at -2.6% (as a percentage of GDP) for the year 2011. Australia has recorded a CAD for many years. In the 1970's and 1980's, the CAD averaged 1.1% and 4.3% respectively. This rapid shift in CAD caused alarm and prompted a number of structural reforms to restore the competitiveness of the Australian economy. Since the 1980's, the CAD has moved in a range of 3%-6%, averaging 4.0% in the 90's and 4.6% in the 2000s. While the CAD has remained at the same level since the 1980's, this level is among the highest of all advanced economies. An ongoing high CAD has a number of severe risks for an economy. These risks include: Increase in foreign liabilities Increased servicing costs Increased volatility for exchange rates Sudden loss of international investor confidence Constraint on future economic growth (contractionary fiscal policy)

Over a period of time, a high CAD will contribute to an increase in the level of foreign liabilities. A deficit on the current account implies a surplus on the capital and financial account (in the form of borrowing from overseas resulting in foreign debt, or selling property/companies resulting in foreign equity). This may result in lenders becoming more reluctant to investing/lending in Australia. High levels of foreign liabilities result in increased servicing costs, which lead to larger outflows on the net primary income account, worsening the CAD. Foreign debt must be serviced through interest payments, and profits must returned on foreign equity investment. Higher levels of foreign debt can result in foreign lenders demanding a 'risk premium' on loans, forcing up interest rates. High CAD deficits may also undermine the confidence of overseas investors in the Australian economy. By reducing the demand for $AUD, this would result in a depreciation of the $AUD

In the long term, an ongoing high level of CAD deficit may act as a speed limit on economic growth. Higher levels of economic growth generally involve an increase in imports (due to more disposable income) and a deterioration of the CAD. Economies with a CAD problem are therefore forced to limit economic growth (through contractionary economic policies) at which the CAD is sustainable. This is known as the balance of payments constraint. An ongoing high level of CAD deficit may also result in a sudden loss of international investor confidence. This would result in a major financial crisis, as highlighted by the 1997 Asian financial crisis, which was triggered by Thailand's high CAD of -8% in 1996. In this way, countries with a high CAD's are more vulnerable to shifts in investor sentiment. However, a high CAD does have some potential benefits. Borrowing from overseas can increase investment and help the economy grow faster. Generally, the high CAD deficit does pose a severe problem to Australia, and may lead Australia into a major financial crisis, as seen in the 1997 Asian financial crisis. Consumer sentiment may shift at any time, and Australia must take action to narrow the CAD deficit. However, at the moment, the commodities boom and high exchange rate of the $AUD is allowing Australia to finance its foreign liabilities, and the increased investment into the commodity sector will lead to high returns.