Balance of Payments (BOP)

Balance of Payments (BOP)

• Definition: A record of all economic transactions between domestic and foreign residents, including individuals, firms, and the government.
• An economic transaction occurs when something of value is provided by one party to another.
• Transactions involve foreign exchange for goods or services.
• Exports and imports are the most common international transactions.
• Governments and financial markets use this to assess the relative performance of the economy.
• Changes in economic growth, inflation, terms of trade, and exchange rates impact this.
• Other economic transactions include income flow (wages, dividends, interest), transfers (foreign aid, migrant funds), and financial flows (foreign investment).
• The ABS publishes its statistics on a quarterly basis.

The Double-Entry System

• Every transaction is recorded with two equal and opposite entries, reflecting inflow and outflow.
• Each transaction has a matching credit and debit entry.
• Credit entry (positive entry): recorded when a domestic resident receive payment from a foreign resident, such as an export.
• The payment is recorded as a debit entry.
• Debit entry: recorded when a resident makes a payment to a foreign resident (e.g., import).
• The movement of currency will be recorded as a credit.

Scenario 1

• Australian firm purchases cars from Germany for $AUD 1 million.
• A Chinese firm purchases iron ore from an Australian Company (BHP) for $AUD 2 million.
• Offsetting transaction is recorded in the financial account.

Australia’s Balance of Payments

• The current account and the capital/financial account balances should be equal and opposite.
• Errors and discrepancies occur, with the ABS adding "Net errors and omissions" to balance.
• Australia typically has a current account deficit and a financial account surplus.
• This is due to a large primary income deficit from payments on foreign investment.
• Australia often has a trade surplus, but the current account shows a deficit when the income deficit is included.

The Current Account

• Records transactions between Australian residents and non-residents, involving goods, services, and income (primary & secondary).

Goods

• Trade of goods is the largest item in the current account (in absolute size).
• In the June quarter of 2024, good exports were $130 billion.
• Mining accounts for 72% of total goods exports (iron ore, coal, LNG, gold).
• In the June quarter of 2024, the goods trade account recorded a surplus of $19 billion.

Services

• Trade in services includes freight/shipping, travel by students and tourists, tourism, ICT, and financial services.
• Australia’s service exports are about 1/5 the size of good exports.
• Education and tourism dominate Australian services.

Income

• Primary income is the largest and mainly associated with foreign investment flows.
• Primary income is classified as compensation of employees (labour) and investment income (for the use of financial capital).
• Compensation of employees is wages and salaries to workers employed overseas.
• Investment income accounts for over 95% of income transactions.
• Residents get income payments from overseas investments (credits) and make income payments to foreign investors (debits).
• Two types of investment income: dividend payments for shares and interest income for loans.
• In the June quarter of 2024, Australia received $25 billion in investment income from overseas but paid out $40 billion.
• Total foreign investment in Australia exceeds investments abroad, resulting in net outflow of investment income.
• Superannuation is a reason for the current account deficit to be smaller than previously.
• Secondary income involves transactions where real or financial resources are provided, but nothing of economic value is received in return.
• Foreign aid, gifts, donations, and pensions are included in secondary income.

The Capital and Financial Account

• Capital account consists of capital transfers and acquisition/disposal of non-produced, non-financial assets and investment flow (migrant funds, aid funds, patents, copyrights, trademarks, slogans).
• Transactions in a capital account are small and insignificant, with a balance of under $1 billion.

Financial Account

• In this account, transactions are associated with changes in the ownership of Australia's foreign assets and liabilities (inward & outward foreign investment).
• Australia normally records a financial account surplus, relying on the net inflow of foreign investment.
• A financial account surplus means that foreigners purchase more Australian assets than Australians purchase overseas.
• A financial account deficit means that Australia lends its excess savings to the rest of the world (capital outflow).
• In the June quarter of 2024, Australia recorded an FA deficit of over $18 billion.
• Financial account transactions are classified by type of investment: direct, portfolio, other, and reserve assets.
• Foreign direct investment (productive): undertaken to gain a lasting interest in a foreign enterprise to exercise significant influence in its management.
• Foreign portfolio investment (financial) refers to investments made in securities, bonds, and other financial assets, which are short-term and speculative investments.
• An increase in domestic economic activity will increase imports and decrease the trade balance.
• An exchange rate depreciation will increase net exports and increase the trade balance.

Trends in the Current Account

• The CA deficit was $78 billion in 2016, with a surplus of $63 billion in > 2021.
• The net goods balance can fluctuate significantly.
• Services normally record a deficit (such as transport services).
• Between 2020-21, net services recorded a surplus due to travel restrictions.
• The net income category is always in deficit due to Australia's net inflow of foreign investment.
• Up until 2020, Australia had a CA surplus only once in the past 50 years (both investment & consumption fell, large decrease in imports).
• Balance on CA = Balance on G&S + Net Income

AUS CAB

• Typically runs from -3% to 3%.
• UK, in 2022, experiences a CAD and CAD decreased to -1% and in 2023, CAD was -6%.
• A increasing CAD in the USA has been increasing since 2020 at -2.2%.
• China remains in a CAS and has not dipped below 0%.

Factors Affecting the Trade Balance

• Determined by changes in exports & imports.
• The value of exports is determined by changes in the price.
• Commodities account for 85% of Australia's good exports.
• An increase in commodity prices will increase the value of AUS exports.
• An increase in domestic economic activity will increase imports, decreasing the trade balance.
• Movements in the exchange rate can also affect the trade balance by changing the price of exports and imports.

Factors Affecting the Income Balance

• It is usually less volatile compared to the trade balance.
• The income balance typically has a deficit, relies on a net inflow of financial capital to supplement domestic savings.
• The inflow of FI has developed the economy.
• Much of the foreign investment into Australia is in the form of foreign debt.
• During covid, the Australian economy contracted, less FI helped contribute to Australia's current account surplus.

The Savings- Investment Gap

• CA balance = trade balance + income balance
• CA surplus = a nation’s exports and income received from overseas exceeds the value of its imports + income paid to overseas.
• CA balance = difference between a country’s savings and investments (savings-investment gap).
• Australia is unable to generate enough savings to finance the investment needed to develop its economy
• Through drawing on foreign savings, investment and economic growth can grow.

The Significance of the Current Account Deficit

• A fast-growing economy experiences a current account deficit since its investment exceeds its savings.
• During a contraction or recession, investment will fall, and savings will rise.
• Australia’s CA balance will decrease if falling commodity prices decrease its expert value .

The Current Account Balanace Decrease

• Due to reduced international competitiveness.
• Increasing export prices and reduced competitiveness due to rise in domestic inflation.
• Increased national income due to a higher rate of economic growth.
• An increase in foreign investment will lead to a financial account deficit.
• A decline in national savings, with national savings being less than investment.

Interest Rate Differential (IRD)

• The difference between interest rates (cash rates) in Australian vs. overseas markets.
• Australian rate being 1.5% while other countries being 3%.
• The Australian IRD at -1.5%.
• Australia has a negative IRD, so is less attractive to other countries due to a lower interest rate

Liabilities and Assets

• Liabilities is taking on future debts (you will pay income in the future).
• Assets is an item of property that will later earn income like interest, dividends, stock returns.
• There is an immediate equal and opposite reaction

Formulas

• GDP = C + I + G(X-M)
• CAB= X-M + NI
• GNI= C + I + G(X-M) + NI
• GNI = C + I + G + CAB
• Y (income) = C + S
• S = GNI - C - G
• GNI = C + I + G + CAB
• CAB = GNI - C - G - I
• CAB = S- I
• S>I=+
• S