EXTENDED RESPONSE QUESTION

Analyse the main causes of recent trends in Australia’s balance of

payments.

Introduction
 What’s BOP (components)
 What’s current account à what are NPI and net secondary income
 Link between current account and capital & financial account
Body 1 – recent CAS
 General trends (past CAD + recent CAS)
 Growing trade surplus (BOGS) à China demand (covid recovery) + iron
ore price
 Iron ore has been trading above $US 100 a tonne since May and
reached a 12 year high (in Australian dollar terms) of over $200
per tonne in December 2020.
 Favourable terms of trade (BOGS) à commodity prices à recent
increase
 Australia’s terms of trade improved by around 8% between Jan 2019 and
July 2019 just before heading to CAS, increasing by 8.3% over the 2019
calendar year.
 Improving NPI balance (NPI) à superannuation funds
 Closing saving-investment gap (NPI) à domestic savings exceed domestic
investment + Changing capital flows (brief)
 Effects of CAS
Body 2 – recent KAD (capital flows and liabilities)
 Changes in the capital flows + debt à NIIP rates à KAD financed by
CAS
 Ownership of Australian companies
Body 3 – previous CAD
 Growth of Australia relative to world (GFC + mining boom)
 The saving – investment gap à driving KAS to fund investments
 Build up of net foreign liabilities à effect on NPI
 Effects of CAD
Conclusion

Refined PLAN
1. CAS causes
 Demand for commodities (mainly China) à cyclical
Recent growing BOGS largely sourced by continued strong iron ore, coal and
natural gas prices.
China’s sustained demand following its covid recovery led to iron ore trading
above $US100 a tonne from May 2020 reaching over $US200 a tonne in Dec
2020 (12 year high).
The coal export prices rose by 73.6 per cent between Dec 2021- Dec 2022 à
BOGS surplus reaching new highs of 38.9bn in Sep 2021 à contribute to CAS
of 23.9bn (4.4% of GDP) Sep 2021à contribute to 2021-22 BOGS surplus of
135.9bn
Gas export prices rising by 117 per cent during 2022 à
June quarter 2022 BOGS surplus reached 43.1bn (highest on record)
September quarter 2022 BOGS 31.4bn
December quarter 2022 BOGS 40.9bn
Higher CASs lead to increased currency stability and reduced exposure to
financial crisis.
 Favourable Terms of Trade (TOT) à cyclical
The terms of trade represent the ratio between a country’s export prices and
import prices.
Over past 3 years, improvements in Au TOT driven by commodity prices helped
push the BOGS into surplus
During 2022 TOT rose by 9.8 per cent
In 2021 TOT index rose from 103 in January to 128 in December – a 24 per cent
increase. The greatest ever increase in TOT was 26 per cent in second quarter
2021.
Strong iron ore prices pushed up the export price index while import price
index fell in 2021.
During 2020 TOT rose by 1.5 per cent and in 2019 it rose by 8.3 per cent.
Strong trade surpluses, to some degree offset the declining levels of aggregate
demand that have accompanied the COVID pandemic.
 Improving net primary income balance until 2022 à cyclical
NPI balance has been improving with low OS interest rates with reduced
interest payments and increased dividends payments.
 The growth in Au super fund assets has pushed Australia’s net equity position
from a net liability to a net asset position. Combined with low OS interest rates
the NPI deficit fell from 62.1bn during 2018-19 to 40.6bn in 2019-20 and a
record low of 17.5bn in 2020-21leading to CAS rising to a record high 70bn
(3.4% of GDP)
Rising interest payments on foreign debt and strong dividend payments to
non-residents on portfolio lead to record high deficit of 30.4bn in Sep quarter
2022 slowing CAS to only 754m. However, it fell to 26.4bn in Dec quarter 2022
helping CAS rise back to 14.1bn.

 Closing savings – investment gap à structural

Australia’s level of national savings now exceeds our level of domestic
investment.
At the end of 2019 investment flows stood at 454bn while domestic savings
had reached 463bn à Net foreign investment had fallen to -9.5b
Closing SI gap means more money available for funding investments which
translates to less borrowing and investment from abroad which reduces debt
servicing costs and profit and interest payments where the excess budget
could be spent on the economy instead or fund more investments.
2. CAD causes
Australia historically ran a CAD of on average
 The savings – investment gap à structural
The savings – investment gap has led to the build-up of the net foreign
liabilities.
Australia’s net foreign liabilities (consisting of net foreign debt and net foreign
equity) grew from $170 billion (46% of GDP) in 1989-90 to $517billion (60% of
GDP) during 2004 – 05 and $1047 billion (around 63% of GDP) by 2015- 16.
A CAD is a sign of faster growth in Au however,
Sustained CAD has led to higher debt servicing costs and dividend payment to
overseas shareholders. This reduce the government’s disposable income which
could otherwise be invested in infrastructure or consumer spending, hindering
economic growth.
Persistent CADs may be a sign of profit maximizing decision by firms where
they import intermediate goods and raw material to increase chances of
export competitiveness in the future.
 Narrow export base à structural
Australia has an export mainly based on minerals and fuel which account for
51% of its export value in 2018-19.
 Global economic cycle à cyclical
Prior to the CAS, Australia’s CAD fell from -72.6bn (-4.6% of GDP) in 2015-16 to
29.5bn (-1.7% of GDP) in 2016-17 largely due to an increase in BOGS following
rise in the value of mineral and fuel and export revenue.
 CAD then rose back to -54.1bn (-2.9% of GDP) following global economic cycle
with a large NPI deficit of 59.1bn.
Large increases in investment into the mining sector and demand for imports
and larger trade deficit until 2008.
 Mining – boom growth/TOT à cyclical
Growth in Au import of capital goods and FDI investment for mining.
Terms of trade grew by 45% between 2005 and 2011
Terms of trade fell by 10.2% in 2014-2015
 Depreciation of Au dollar re-GFC à cyclical
Massive depreciation of 33 per cent in AU dollar against US dollar and high
demand from China (due to its fiscal stimulus in response to GFC) caused a
massive turnaround in CAD.
CAD fell from -74bn (-6.6% of GDP) in 2007-08 to -38.8bn (-3.4% of GDP) in
2008-09 due to BOGS going into surplus of 7.6bn compared to -24.5bn and a
reduced NPY deficit.
3. KAFA deficit recently
 Net capital inflows
Net capital inflows to the Australian economy averaged around 4.5% of GDP in
the 15 years to 2019 with FDI averaging 3% of GDP.
The main structural influence driving KAFA deficit is the closing savings
investment gap with Australia’s level of national saving now exceeding our
level of domestic savings with.
These changes affected our net foreign debt and NIIP falling to 859.9bn
(around 37% of GDP) with a net foreign equity of -299.4bn and net foreign
debt of 1,159bn in Dec 2022. This means our offshore investments exceeds
foreigners by around 7% of GDP now.
This NIIP peaked at 60% of GDP in GFC and declined to below to 50% by the
end of 2019.
The changes in the KAFA are mainly due to the growth in the superannuation
pool.
An improved net foreign equity helps reduce NPY deficit by reducing dividend
and profit payments relative to receives. This also eliminate the need for
further borrowing, reducing exposure to global interest rate fluctuations by
reducing future interest payments.