Balance of Payments and Current Account

1.

describe the structure of Australia's balance of payments

The Balance of Payments records all economic transactions between Australia and
the rest of the world.

The BOP consists of the current account and the capital and financial
account.

The BOP records transactions as a double entry recording system for every
credit there is a corresponding debit.
Credit entries are recorded as a + (plus) on the BOP and represent a flow
of funds into the country
Debit entries are recorded as a - (minus) on the BOP and represent a flow
of funds out of the country

In theory, the current account deficit should be balanced out by and equal capital
and financial account surplus. However, due to statistical errors and omissions,
this is rarely the case, so a net error omissions category is included to account
for this difference.

Current Account
The Current Account records transactions involving:
Goods
Services
Primary income
Current transfers (secondary income).
Goods

Includes exports (such as coal, gold, iron ore and wheat) and exports (such as
cars, computers and aircraft)
Net goods (also called the trade balance) are used to show the difference
between goods credits and goods debits. Net goods can be in a surplus or deficit.
Put simply:
Net goods = goods credits goods debits
Services

Involves transactions such as transport, banking, insurance, tourism and

education.
Put simply:
Net services = service credits service debits

Balance on Goods and Services

Australias CAD is largely determined by the balance on goods and services
(BOGS) and therefore:
A surplus in the BOGS will reduce the CAD
A deficit in the BOGS will increase the CAD
The BOGS can be expressed as:
BOGS = net goods + net services

Income
Income refers to earnings on investment (rent, wages, interest, profit)
Involves interest payments on borrowings and returns on other foreign
investments (e.g. dividends)
It does not include investment by foreigners into Australia (equity or debt); this is
recorded in the financial account
It covers income in the form of rent profits and dividends that flow overseas the
largest income section of the current account
Net income is the largest contributor to the CAD
Net income deficit depends on the result from the past inflow of foreign
capital
Income debits depend on past inflow of foreign savings which have been
determined by the presence of profitable opportunities in Australia (confidence in
Australias economy)
Income credits have grown rapidly in recent years resulting in an increase in
Australias overseas assets and still a larger amount of income debits
Net income can be expressed by:
Net income = income credits income debits
Current transfers (secondary income)

One way payments mainly by government as well as non-government sectors

(e.g. charities) in the form of gifts, welfare and foreign aid.
This does not include capital investment, which is recorded in the capital
account.
They have little significance in the overall size of the CAD

The Balance on the Current Account

Balance on current account = net goods + net services + net income + net current
transfers

Capital account

The capital account comprises of capital transfers and disposal of nonproduced, non-financial assets.
Capital transfers include migrant funds (e.g. people moving from the UK to
Australia) and types of aid funds related to fixed capital formation (e.g.
funds for roads and infrastructure in Haiti). Also includes debt forgiveness,
meaning a country no longer has to repay debts, which is the equivalent of
a capital transfers debit.
non-produced, non-financial assets refer to intangible assets such as
patents, copyrights, trademarks and franchises.
The capital account generally records a surplus, mainly due to net migration.

Financial account

The Financial account comprises of transactions of ownership of Australias

foreign financial assets and liabilities.
Credit entries involve net inflow of money into Australia. e.g. borrowing by
Australians, foreign investment in Australia.
Debit entries involve net outflow of money from Australia. e.g. repaying
loans, foreigners borrowing from Australia (not common).
The financial account records a surplus when Australian liabilities to foreign
countries exceeds Australias claim on foreign countries.

2.

explain the concept of the Current Account Deficit (CAD)

A CAD (current account deficit) occurs when the money flows of export receipts,
service credits, inflowing income and current transfers are less than the money flows
of import payments, service debits and outflowing income and current transfers
overseas. So, if total debits are greater than total credits there is a CAD.
The current account deficit can be described as the difference between domestic
savings and foreign investment.
Net income is the main contributor to our current account deficit.
Australia has recorded a general current account deficit (CAD) since the 1920s which
has seen an increase into the 21st century and has persisted into 2014.
3.

explain the reasons for Australias CAD

Australia tends to record a CAD in order to sustain our desirable rate of economic
growth and the high standard of living we enjoy today.
To do this, Australia needs to attract foreign investment/lending in order to allow for the
level of domestic investment that would be possible with domestic savings alone. This
therefore benefits the Australian economy provided this investment generates a higher
return than the cost of servicing our foreign liabilities.
A short term CAD indicates strong economic growth and rising living standards.
A long term CAD however can be a problem in being attractive to foreign investors or
lenders if it is not carefully and properly financed.
4.

account for the recent trends in Australias current account

5.

explain the implications of Australias CAD

A short term CAD can be interpreted to indicate strong economic growth and rising
living standards, as it means more funds are being demanded to finance an increasing
level of investment.
A long term CAD however (such as Australias), can be a problem in being attractive to
foreign investors or lenders if it is not carefully and properly financed.

6.

recognize that there are different views as to the significance of Australias CAD

Some economists are critical of Australias CAD and argue that the CAD and the debt
and equity flows that underpin it are evidence that Australia has been living beyond its
means and that it has had to attract additional foreign debt or equity to service its
obligations to other countries. They also argue that this increases our vulnerability to
change is confidence from foreign investments as well as malfunctions in the global
credit market, such as those experienced during the GFC.
The other (and arguably more common view) is that a CAD is not a problem and is
actually sustainable as long as it generates an income flow sufficient to finance any
debt servicing costs and increase domestic economic activity and standards of living.
Foreign Liabilities
7.

explain the concept of foreign liabilities i.e. foreign investment and foreign debt

Foreign liabilities are defined as the extent to which overseas investors have a claim
over Australian assets.
An asset is simply something a company owns and is of value.
Foreign investment is the stock of financial assets in Australia owned by foreign
residents.
Foreign investment takes three forms:
Direct investment Capital investment in an enterprise, involving at least
10% ownership and enabling significant management control over the key
policies of the enterprise.
This type of investment is generally intended to be more long-term.
Accounts for 25% of total foreign investment in Australia.
Portfolio investment Any other private, non-direct investment. Includes
equity securities, debt securities (bonds) money market instruments and
financial derivatives. This
This type of investment is generally more short-term and speculative.
Accounts for 58% of total foreign investment in Australia.
Other investment liabilities Includes financial assets controlled and
available for use by the RBA for BOP needs and financial derivatives.
Accounts for 17% of total foreign investment in Australia.
Foreign equity is the total value of Australian assets owned by foreigners.
Foreign debt is the total amount of money Australia owes to foreigners.
Gross foreign debt is the total amount of money owed by Australians to overseas
countries.
Net foreign debt is simply gross foreign debt less the value of financial assets held
by Australians from other countries.
The seriousness of the problem of debt repayment can be determined with the Debt
Service Burden formula:

DSB =

Interest payable on foreign debt

100
Goods and service credits

The higher the debt service burden value, the bigger a problem debt servicing is.

8.

explain the relationship between the current account outcome and foreign
liabilities

Foreign investment is needed to fund Australias current account deficit.

The CAD must be financed by capital inflow. Capital inflow can be in the form of debt
or equity, vast majority in Australia is debt because equity investment requires a
transfer of ownership and is therefore not attractive to entrepreneurs. Increases in
foreign liabilities will lead to future periods of higher interest payments on debt, and
higher dividend payments on equity. These will contribute to future net incomes
deficits and reinforces the CAD.
9.

account for the extent of and recent trends in Australias foreign investment and
foreign debt

10. assess

the benefits and costs of foreign investment and foreign debt to Australia.

The benefits of Australias foreign investment are:

1. Boosts employment, economic development and growth. Increases capital
stock.
2. Boosts technological innovation and research capacity. This will ensure that
Australia has newer and better goods and services.
3. Creates new industry and employment opportunities.
4. Due to multiplier effect will increase national income and standard of living.
5. Creates better products and services.
6. Finances deficiency in national savings over national investment.
The costs of Australias foreign investment are:
1. Dividend repatriation and debt servicing can have a negative effect on the BOP.
2. Leads to domestic industry employment rationalization restructure of business
results in loss of jobs.
3. Creates social instability by selling off domestic assets (Australians arent
happy and fear our future)

4. Excessive investment can result in negative investor sentiment and a lower AUD
on world currency markets.
5. Overseas control over Australian owned assets (Australians arent happy).

The benefits of Australias foreign debt are:

1.
2.
3.
4.

Most debt is owned by the private sector, whose sole purpose is making profit.
Debt as a % of GDP has stabilized, making it sustainable to repay.
The debt servicing burden has fallen in the past decade.
Debt is being used to expand Australian industries, which results in increased
economic growth and higher standards of living.

The costs of Australias foreign debt are:

1. Australias credit ratings may be downgraded which means that future
borrowing will be subject to higher interest rates.
2. Higher interest payments lower a nations standard of living as more income
must be diverted from consumption
3. If the terms of trade deteriorate export income will be reduced so that the
burden of the debt increases.
4. If the AUD depreciates, the cost of servicing our debt increases, meaning more
money will be diverted from consumption and lower standards of living occur.
5. If trading partners growth declines, our export income decreases yet we still
need to allocate the same amount of money to service the debt.