Economics Textbook: Balance of Payments in Australia PDF

ocus questions and inquiries What is the balance of payments? What are the causes and effects of the current account trends? What are the causes and effects of the capital account trends? What is the significance of foreign debt and foreign investment? What is the significance of m...

ocus questions and inquiries What is the balance of payments? What are the causes and effects of the current account trends? What are the causes and effects of the capital account trends? What is the significance of foreign debt and foreign investment? What is the significance of movements within the balance of payments for particular groups? To provide a basis for answering such questions and carrying out such inquiries, this chapter will examine the following: how international transactions are recorded the recent trends in Australia's balance of payments the causes of such trends and their effects the specific groups in the economy that are affected by movements in the balance of payments why Australia has a foreign debt whether foreign investment is beneficial to Australia 4 The balance of payments A study of Australia's balance of payments examines how Australia records its international payments and policies that can be implemented to control balance of payments difficulties. Foreign debt and foreign investment are examined as two issues the government must deal with. Getty Images/xPACIFICA A nation uses its balance of payments account to track its overseas transactions and develop appropriate external policies. The efforts of nations to carefully monitor their receipts from exported commodities and their expenditure on imported commodities is not very different from those of a household keeping a watchful eye on the relationship between its income and its spending on goods and services. If income exceeds spending for a period of time, there will be an accumulation of savings. On the other hand, if spending exceeds income, savings will be depleted and the household may need to resort to borrowing to fund its activities. In much the same way, nations can accumulate foreign reserves or find themselves desperately in need of borrowing additional reserves. Floating exchange rates, different currencies and intervention by governments and central banks complicate the situation. 4.1 What is the balance of payments? Balance of payments: the summary of a nation's payments to, and receipts from, the rest of the world over a year Balance of trade: the difference between the value of exports and imports Capital and financial account: the record of the movement of capital funds between a nation and the rest of the world; made up of two sub-accounts: the capital account and the financial account Credits: payments received by a nation from the rest of the world Current account: the record of day-to-day financial transactions involving the trade of goods and services between a nation and the rest of the world Current account deficit: the amount by which credits in the current account are less than debits Current account surplus: the amount by which credits in the current account are greater than debits Debits: payments by a nation to the rest of the world CONCEPTS As we can see from the circular flow of income model (see Chapter 1), the sectors within our domestic economy undertake daily transactions that ultimately lead to interaction with the external sector. Apart from payments for traded goods, there are numerous other transactions that give rise to international monetary movements. In order to monitor the flow of financial transactions between Australia and the rest of the world, the Australian Bureau of Statistics divides the balance of payments into two accounts: the current account and the capital and financial account. The balance of payments is an accounting record of a country's international economic transactions. It provides information from which the relationship between the domestic and external sectors of the economy can be derived and analysed. KEY IDEA 4.1.1 Current account The current account includes day-to-day transactions for which payments are made or received. Australia's recent current account history is shown in Figure 4.1. The items within the current account can be categorised under four headings. 1 Goods: these are the 'visible' commodities that Australian producers sell to the rest of the world (exports; for example, wine, coal and wheat) and those that Australian importers buy from overseas producers (imports; for example, motor vehicles, electrical goods and chemicals). The balance of trade is the difference between the value of imports and the value of exports. 2 Services: these have been traditionally referred to as 'invisibles' because they represent transactions in which no visible item changes hands. The best example for this category is the enormous cost of shipping that must be met by Australians each year. Virtually all commodities shipped to and from Australia are carried by foreign vessels. Other examples include tourism, education, insurance and finance. 3 Net primary income: foreign investors derive income in the form of interest, dividends and royalties from their investments in Australia. This outflow of income appears as a debit in the current account. At the same time, Australians receive various forms of income from activities overseas. This appears as a credit on the current account. 4 Net current transfers: these are movements of funds for which there is no reciprocal activity; for example, assets transferred by migrants, foreign aid, payment to international organisations such as the United Nations, and insurance payments. FIGURE 4.1 Australia's balance on current account 1990--2017 20122007200219971992 2017 --9 --6 --3 0 \% --9 --6 --3 0 \% Per cent of nominal GDP Trade balance Net income balance Current account balance Source: © Reserve Bank of Australia, 2001--2018. All rights reserved. Use either the Australian Bureau of Statistics website or the Reserve Bank of Australia website to locate the most recent statistical or graphic data showing the Australian current account balance. ECONOMICS DATA Australian Bureau of Statistics Reserve Bank of Australia Economists often measure the balance of payments figures as a percentage of GDP to enable comparisons to be made with previous years, and to evaluate the impact the foreign sector has on our economy. Figure 4.2 shows the current account balance (and imports, exports and balance on goods and services) as a percentage of GDP. Mar 1984 Mar 1987 Mar 1990 Mar 1993 Mar 1996 Mar 1999 Mar 2002 Mar 2005 Mar 2008 Mar 2011 Mar 2014 Mar 2017 0 --1 --2 --3 --4 --5 --6 --7 --8 Per cent of GDP, quarterly, s.a. FIGURE 4.2 Australia's current account balance as a percentage of GDP 1984--2017 4.1.2 Capital and financial account The capital and financial account includes the movement of capital funds between Australia and the rest of the world during a specified period of time. The funds are divided into three main categories: Capital account: this includes items classified as capital transfers of foreign aid and net capital brought into Australia by migrants. Financial account: this is divided into direct and portfolio investment categories and it records Australian investment abroad as well as foreign investment in Australia. Each form of investment is divided into debt and equity sub-classifications. Reserve assets: this refers to actions by the RBA in dealing with foreign currencies, plus government obligations with the International Monetary Fund (IMF). (Note: Errors and omissions include statistical errors and adjustments that enable the capital and financial account to balance the current account.) A capital and financial account deficit is the amount by which credits in the capital and financial account are less than debits; while a capital and financial account surplus is the amount by which credits in the capital and financial account are greater than debits. Use either the Australian Bureau of Statistics website or the Reserve Bank of Australia website to locate the most recent statistical data showing the Australian current account balance as a percentage of GDP. Australian Bureau of Statistics Reserve Bank of Australia ECONOMICS DATA Source: Australian Bureau of Statistics. Creative Commons (CC BY 2.5 AU) () t should be evident from Figure 4.3 that all payments made by the Australian economy to the rest of the world are debits to the Australian economy. On the other hand, all funds received from the rest of the world are considered credits to the Australian economy. The Australian Bureau of Statistics monitors the flow of funds on behalf of the government. In theory, with a floating exchange rate, any imbalance in the balance of payments will be corrected by a change in the exchange rate, thereby ensuring that the balance of payments will always balance. The aim of the accounting procedure is to offset any deficit with an equivalent surplus. For instance, as Figure 4.4 shows, a current account deficit is offset by an equivalent surplus on the capital account to give the balance of payments. Likewise, a current account surplus would be offset by a deficit on the capital account. It should be evident that movement of funds through the capital and financial account can achieve fine-tuning of the balance of payments. Figure 4.5 should help to clarify the procedure used for deriving the balance of payments. FIGURE 4.4 The derivation of the balance of payments =+ \+ \+ A debit on current account An equivalent surplus on capital and financial account Balance on goods and services Net income and net transfers Net capital transactions Net Reserve Bank capital transactions Net investment Transactions The introduction of a floating exchange rate allowed the Federal Government to divorce external policy from monetary and fiscal policies directed at aspects of our internal economy. In the days of fixed exchange rates, governments would adjust the exchange rate in their efforts to rectify internal problems such as inflation or unemployment. Frequently, the attempt to solve an internal imbalance would create an external imbalance. A floating exchange rate is, in theory, self-regulating and will find its own level according to the forces of supply and demand. Governments are now compelled to focus on monetary, fiscal, prices and incomes, and microeconomic reform policies to rectify any internal imbalance in the economy. Of course, as we noted earlier in Chapter 3, the float of Australia's dollar is not entirely without interference. Economists refer to it as a 'dirty' float because, over the years since the float, the RBA has sometimes intervened to bolster the value of the dollar. 4.2.1 The current account These days, governments are able to focus specifically on the economy's performance in the external sector and may introduce measures to address some particular aspect of external imbalance. For instance, a chronic current account deficit may lead to a variety of macroeconomic and microeconomic strategies. Macro-strategies may include fiscal policy measures aimed at stimulating export activity. Micro-strategies might include targeting specific firms and industries to encourage greater involvement in the external sector. Figure 4.10 on the next page shows Australia's recent balance of payments tables. Australia usually records a deficit in the current account matched by a surplus in the capital account. Use the Australian Bureau of Statistics website to locate the latest balance of payments figures for Australia. Australian Bureau of Statistics ECONOMICS DATA Of particular concern is the size of the current account deficit. This has shown a downward trend in recent years. Some of the major issues that affect the current account are listed below. Australia's main exports are commodities for which prices are determined by market factors of supply and demand. As a result, Australia is a price-taker, as our producers have little influence over world prices (except for coal and iron ore), and have to accept the prevailing world price. The fluctuating prices are reflected in the terms of trade. Australian exports are mainly demand-price elastic because there are substitutes readily available on the world market. This causes the prices of many Australian exports to fluctuate considerably over time. In addition, our agricultural production is affected by floods and droughts, resulting in fluctuating levels of production. Australia is a price-taker for imports, because of the small size of our domestic market. As a result, we are unable to exert influence over prices paid for imports. Australia could be said to be a dependent economy; that is, a country that is a price- taker for both imports and exports. A dependent economy is highly subject to cyclical fluctuations in the world economy. he Index of International Competitiveness, which compares changes in domestic price, measures the international competitiveness of a country and its cost levels with those of other countries, allowing for exchange rate movements. Competitiveness is determined by the price and quality of goods compared with those of other nations. If the prices of goods produced in Australia increase relative to the prices of goods produced FIGURE 4.10 Australia's balance of payments 2014--15 to 2015--16 Amounts are in A\$ million Current account 2014--15 2015--16 Goods Credits 255 525 243 934 Debits --269 796 --271 761 Balance --14 271 --27 827 Services Credits 63 128 67 922 Debits --71 827 --76 993 Balance --8 699 --9 071 Balance on goods and services --22 970 --36 898 Primary Income Credits 52 795 55 808 Debits --85 903 --90 003 Balance --33 108 --34 199 Secondary Income Credits 8 338 8 630 Debits --10 467 --10 362 Balance --2 129 --1 732 Balance on current account --58 207 --72 828 Capital and financial account 2014--15 2015--16 Capital account Financial Account Net capital transfers --519 --531 Net acquisition/disposal of non-pro- duced, non-financial assets 12 0 Balance on capital account 2 167 2 075 Direct investment 37 498 55 242 Portfolio investment 50 579 --4 322 Financial derivatives 2 364 --12 248 Other investment 39 687 --35 368 Reserve assets 2 122 2 394 Balance on financial account 52 875 76 435 Balance on capital & financial account 52 356 75 904 Net errors and omissions 5 851 --3 076 Source: © Reserve Bank of Australia, 2001--2018. All rights reserved, based on ABS data. 9780170407014 Chapter 4 \| The balance of payments105 4.2.2 The capital and financial account DFAT -- International investment Australia Visit the DFAT -- International investment Australia web page and locate: 1 the amount of new foreign investment in Australia for one year 2 the countries from which foreign investment in Australia comes -- the top five at least 3 the industries that benefited most from foreign investment 4 the overseas countries in which Australians invest. ECONOMICS DATA Capital account: a record that includes capital transfers and the acquisition/ disposal of non-produced, non-financial assets between residents and non-residents Direct investment: the creation of new assets and liabilities in a foreign country, such as setting up a production facility or owning more than 10 per cent of a company's shares in a foreign country, giving the investor significant influence over the operation of the enterprise Financial account: a record that shows the inflows (credits) and outflows (debits) of debt and equity relating to Australia's external liabilities Portfolio investment: the purchase of less than 10 per cent of a company's shares in a foreign company to gain financial returns rather than to gain control of the business CONCEPTS The capital and financial account is the second part of the balance of payments figures in Australia. It is made up of two sub-accounts: the capital account and the financial account The capital account includes capital transfers and the acquisition/disposal of non- produced, non-financial assets between residents and non-residents. These include migrants' funds and types of aid funds related to fixed capital formation. The size of transactions in this account is very small and relatively insignificant. The financial account shows the inflows (credits) and outflows (debits) of debt and equity relating to foreign investment. This account is in surplus when the change in foreign investment in Australia exceeds the increase in Australia's investment overseas. A surplus in the financial account means that Australia literally draws on the savings of the rest of the world. The financial account has four components -- direct investment, portfolio investment, other investment and reserve assets. Direct investment is the creation of new assets and liabilities in a foreign country, such as setting up a new production plant, or buying more than 10 per cent of a company's shares in a foreign company. An example would be the opening of an H&M store in an Australian shopping centre. H&M is a Swedish brand and would be investing in Australia. Similarly, BHP Billiton invests in diamond mines in Mozambique, among its many foreign investments. 9780170407014 Chapter 4 \| The balance of payments101 The introduction of a floating exchange rate allowed the Federal Government to divorce external policy from monetary and fiscal policies directed at aspects of our internal economy. In the days of fixed exchange rates, governments would adjust the exchange rate in their efforts to rectify internal problems such as inflation or unemployment. Frequently, the attempt to solve an internal imbalance would create an external imbalance. A floating exchange rate is, in theory, self-regulating and will find its own level according to the forces of supply and demand. Governments are now compelled to focus on monetary, fiscal, prices and incomes, and microeconomic reform policies to rectify any internal imbalance in the economy. Of course, as we noted earlier in Chapter 3, the float of Australia's dollar is not entirely without interference. Economists refer to it as a 'dirty' float because, over the years since the float, the RBA has sometimes intervened to bolster the value of the dollar. 4.2.1 The current account These days, governments are able to focus specifically on the economy's performance in the external sector and may introduce measures to address some particular aspect of external imbalance. For instance, a chronic current account deficit may lead to a variety of macroeconomic and microeconomic strategies. Macro-strategies may include fiscal policy measures aimed at stimulating export activity. Micro-strategies might include targeting specific firms and industries to encourage greater involvement in the external sector. Figure 4.10 on the next page shows Australia's recent balance of payments tables. Australia usually records a deficit in the current account matched by a surplus in the capital account. Use the Australian Bureau of Statistics website to locate the latest balance of payments figures for Australia. Australian Bureau of Statistics ECONOMICS DATA Of particular concern is the size of the current account deficit. This has shown a downward trend in recent years. Some of the major issues that affect the current account are listed below. Australia's main exports are commodities for which prices are determined by market factors of supply and demand. As a result, Australia is a price-taker, as our producers have little influence over world prices (except for coal and iron ore), and have to accept the prevailing world price. The fluctuating prices are reflected in the terms of trade. Australian exports are mainly demand-price elastic because there are substitutes readily available on the world market. This causes the prices of many Australian exports to fluctuate considerably over time. In addition, our agricultural production is affected by floods and droughts, resulting in fluctuating levels of production. Australia is a price-taker for imports, because of the small size of our domestic market. As a result, we are unable to exert influence over prices paid for imports. Australia could be said to be a dependent economy; that is, a country that is a price- taker for both imports and exports. A dependent economy is highly subject to cyclical fluctuations in the world economy. Economics for the Real World \| Units 3 & 4 9780170407014106 Portfolio investment is the purchase of shares in a foreign company amounting to less than 10 per cent of holdings in that company. Examples would include a foreign investor purchasing a million shares in Qantas, or a million shares in BHP Billiton. Other investment includes borrowing by a bank from an overseas financial institution, such as the ANZ Bank borrowing from Nomura Holdings (a Japanese financial institution). Reserve assets include RBA and government transactions involving foreign currencies and contributions to the IMF and the United Nations. This might occur when the RBA purchases Australian dollars in the foreign exchange market to smooth out the fluctuations in the exchange rate. 4.3 Foreign debt ECONOMICS CHALLENGE Changes in the balance of payments will affect various groups in Australia. Select one or more of the following groups and outline how movements within the balance of payments affect the group/s: importers exporters buyers overseas investors. Present your findings to the class using a PowerPoint presentation. Equity finance: company funds sourced from the selling of shares in a company Foreign debt: a debt owed by a nation to the rest of the world Gross foreign debt: the total of Australia's overseas borrowings Net foreign debt: gross foreign debt less Australian lending to overseas residents Private foreign debt: the part of Australia's foreign debt owed by private residents Public foreign debt: the part of Australia's foreign debt owed by the government CONCEPTS While certain costs can be identified with foreign debt, there are also potential benefits to be gained. The size of Australia's foreign debt would be a cause for concern if it were mainly caused by increased consumption rather than increased investment. KEY IDEA Economics for the Real World \| Units 3 & 4 9780170407014100 4.2 Balance of payments and the economy FIGURE 4.9 Australia's commodity prices RBA index of commodity prices SDR, 2015--16 average = 100 200 Index 150 100 50 0 200 Index 150 100 50 0 1987 1992 1997 2002 2007 2012 2017 Source: © Reserve Bank of Australia, 2001--2018. All rights reserved. External policy: measures taken by governments to influence activity in the current account or the capital account Fiscal policy: measures undertaken by governments in relation to raising revenue through taxation and determining the nature of government expenditure, aimed at influencing a nation's aggregate demand; can be discretionary or non-discretionary (automatic stabilisers) Macroeconomic strategy: measures undertaken by governments to influence broad variables in the economy, such as consumption or investment Microeconomic strategy: measures that focus on the operation of single decision- making units within the economy, such as the firm or the household Monetary policy: measures implemented through the Reserve Bank of Australia to bring about changes in aggregate demand by influencing money supply and interest rates CONCEPTS The balance of payments provides important information from which to derive and analyse the relationships between the domestic and external sectors of the economy. A government may choose to regulate an economy's external transactions by implementing a range of macroeconomic as well as microeconomic policy measures. KEY IDEA 112% verseas, or if overseas goods develop some non-price advantage over domestic goods, then Australia is said to have suffered a decline in international competitiveness. Such a decline reduces Australia's ability to export and increases our tendency to import, thus worsening the balance on merchandise trade. On the other hand, if Australian goods become more competitive, for price or non-price reasons, the balance on merchandise trade improves. The index is also affected by the exchange rate, with a depreciation resulting in a fall in the index, making Australian goods more competitive on world markets. Governments act to try to make Australia more competitive through prices and incomes policies; spending on research and development, worker training and education; and assisting exporters through Austrade. Structural adjustment -- the shifting of resources from slow-growing sectors of the economy to fast-growing sectors -- began under the Hawke and Keating Labor Governments and is a continuing process designed to make Australia more competitive. Structural adjustment policies include industry plans; the lowering of tariffs and the development of free trade agreements; the establishment of global marketing plans through Austrade; the encouragement of research and development to improve technology; and the encouragement of sunrise industries (new high-technology industries). Structural adjustment has taken place in six areas of the economy: reform of labour, product and money markets; public and private sector borrowing; external debt reduction; import penetration and replacement; diversification of exports; and redirection of business investment. The sustained deficit in services, income and unrequited transfers is a problem for Australia. As only 3 per cent of cargoes are shipped in Australian-flagged vessels, shipping has a considerable negative effect on the services section of the current account. Australia usually has a large deficit in the income section. The main reason for this is the cost of servicing external debt. The current account deficit follows a cyclical pattern. It will increase when the economy grows at a rapid rate due to the increased spending on imports of both consumption and capital goods. When economic growth is at a more sustainable pace, the relative size of the current account deficit declines. The current account deficit is also affected by movements in the terms of trade, movements in the exchange rate, droughts, and the rate of economic growth elsewhere in the world. A current account deficit results in the accumulation of a large foreign debt, and a depreciation of the Australian dollar. Foreign debt will be discussed later in this chapter (see Section 4.3). A depreciation results from the decrease in demand relative to the supply of the Australian dollar on the foreign exchange markets. Governments can pursue policies to control the size of the current account deficit. Reducing demand for imports through tight monetary policy and moving towards domestic surplus in fiscal policy to reduce the rate of growth of aggregate demand will reduce imports. Moving resources into export industries through structural adjustment, increasing international competitiveness, and encouraging exports through government assistance may also assist reduction of the current account deficit. The government may place restrictions on foreign investment in Australia, thus controlling the cost of servicing the income section. Changes in both domestic and world economic growth cause a change in the size of the current account deficit. Usually, when domestic growth is higher than world growth, the current account deficit is likely to increase because spending on imports is likely to increase. A larger goods and services deficit results. If world growth is higher than domestic economic growth, export income will increase more quickly than import spending, leading to an improvement in the balance on goods and services. Capital account: a record that includes capital transfers and the acquisition/ disposal of non-produced, non-financial assets between residents and non-residents Direct investment: the creation of new assets and liabilities in a foreign country, such as setting up a production facility or owning more than 10 per cent of a company's shares in a foreign country, giving the investor significant influence over the operation of the enterprise Financial account: a record that shows the inflows (credits) and outflows (debits) of debt and equity relating to Australia's external liabilities Portfolio investment: the purchase of less than 10 per cent of a company's shares in a foreign company to gain financial returns rather than to gain control of the business CONCEPTS The capital and financial account is the second part of the balance of payments figures in Australia. It is made up of two sub-accounts: the capital account and the financial account The capital account includes capital transfers and the acquisition/disposal of non- produced, non-financial assets between residents and non-residents. These include migrants' funds and types of aid funds related to fixed capital formation. The size of transactions in this account is very small and relatively insignificant. The financial account shows the inflows (credits) and outflows (debits) of debt and equity relating to foreign investment. This account is in surplus when the change in foreign investment in Australia exceeds the increase in Australia's investment overseas. A surplus in the financial account means that Australia literally draws on the savings of the rest of the world. The financial account has four components -- direct investment, portfolio investment, other investment and reserve assets. Direct investment is the creation of new assets and liabilities in a foreign country, such as setting up a new production plant, or buying more than 10 per cent of a company's shares in a foreign company. An example would be the opening of an H&M store in an Australian shopping centre. H&M is a Swedish brand and would be investing in Australia. Similarly, BHP Billiton invests in diamond mines in Mozambique, among its many foreign investments. ortfolio investment is the purchase of shares in a foreign company amounting to less than 10 per cent of holdings in that company. Examples would include a foreign investor purchasing a million shares in Qantas, or a million shares in BHP Billiton. Other investment includes borrowing by a bank from an overseas financial institution, such as the ANZ Bank borrowing from Nomura Holdings (a Japanese financial institution). Reserve assets include RBA and government transactions involving foreign currencies and contributions to the IMF and the United Nations. This might occur when the RBA purchases Australian dollars in the foreign exchange market to smooth out the fluctuations in the exchange rate. 4.3 Foreign debt ECONOMICS CHALLENGE Changes in the balance of payments will affect various groups in Australia. Select one or more of the following groups and outline how movements within the balance of payments affect the group/s: importers exporters buyers overseas investors. Present your findings to the class using a PowerPoint presentation. Equity finance: company funds sourced from the selling of shares in a company Foreign debt: a debt owed by a nation to the rest of the world Gross foreign debt: the total of Australia's overseas borrowings Net foreign debt: gross foreign debt less Australian lending to overseas residents Private foreign debt: the part of Australia's foreign debt owed by private residents Public foreign debt: the part of Australia's foreign debt owed by the government Australia's foreign debt has risen from relatively low levels in the 1970s of less than 10 per cent of GDP, to relatively high levels in the 1990s of about 40 per cent of GDP. By 2010, this had reached 51.7 per cent. Australia's net foreign debt expanded beyond A\$1 trillion for the first time on record in 2016, reaching 60 per cent of nominal GDP: see Figure 4.12. Net foreign debt in the December 2016 quarter came in at A\$1006 billion -- an increase of 2.8 per cent on the previous quarter's A\$971 billion. FIGURE 4.12 Australia's net foreign liabilities 2001--17, by type and percentage of GDP 2013200920052001 2017 --15 0 15 30 45 60 \% --15 0 15 30 45 60 \% \*Short-term debt includes debt with residual maturity of one year or less; long-term debt includes all other debt. Total Long-term debt\* Short-term debt\* Equity Source: RBA 1 Use Internet sources such as the Australian Bureau of Statistics, the RBA and other appropriate sites to find: a the latest value of Australia's gross and net foreign debt b the latest value of public foreign debt in Australia, and the percentage of net foreign debt this represents c foreign debt as a percentage of nominal GDP. 2 Compare the latest figures to those set out above. What changes can you observe? Australian Bureau of Statistics Reserve Bank of Australia ECONOMICS DATA Foreign debt is the debt owed by a nation as a whole to the external sector. Gross foreign debt is the total of Australia's overseas borrowings, and in 2018 was recorded as A\$2 005 834. Net foreign debt is Australia's gross debt less Australian lending to overseas residents, and is regarded as the best view of our debt situation. Public foreign debt is that part of Australia's foreign debt owed by the government, and over the past five years this has averaged 25 per cent of Australia's debt. Private foreign debt is thus about 75 per cent of the foreign debt of Australia. It is this debt that often results in increased investment and therefore in increased future income. Economics for the Real World \| Units 3 & 4 9780170407014108 4.3.1 Causes of the external debt The growth of the external debt can be attributed to a number of factors: a shortage of savings funds within the Australian economy and therefore a need to seek overseas funds heavy borrowing by the private sector at agreed interest rates regardless of industry performance, instead of using equity finance, where the return to investment dividend is dependent on industry performance and economic conditions depreciation of the Australian dollar high levels of domestic demand high interest rates within the Australia economy (especially during the 1990s) increasing globalisation as capital markets become more intertwined around the world. Most of Australia's external debt is written in terms of foreign currencies, particularly the US dollar. The depreciation of the Australian dollar relative to the US dollar in the mid-1980s, and in various periods since then, added further to the nation's debt problem. Every time the Australian dollar depreciated, Australian debtors had to find more dollars to meet their interest and loan repayments. The growing magnitude of external debt in recent years has meant that interest payments have become a significant contributing factor to Australia's current account deficit. Go to the Australian Debt Clock website. Use 30 minutes to answer the following. 1 Record the following at the start of the 30-minute period: a total government debt b total private debt c total household debt d personal debt e credit card debt. 2 Read the website. Would this site appear to be a government site or a privately operated site? What information did you use to determine this? 3 What does the graph show Australia's debt will be by 2026? 4 Go to the ASIC Credit Card Debt Clock website and note the credit card debt of Australians. How does this compare to the Australian Debt Clock figure for credit card debt? Are the figures the same or different? Why might there be a difference? Which one do you think would be more reliable? Why? 5 Return to the Australian Debt Clock website. At the end of 30 minutes, note the levels of debt for the same items in Question 1(a)--(e). 6 What do you notice about each debt category? Have they increased? Have any gone down? What might be some implications for Australia? Australian Debt Clock ASIC Credit Card Debt Clock igh foreign debt has a significant impact on the lives of Australians. These are as follows. Higher interest rates: interest rates must be relatively high to attract foreign investment to Australia. Governments and others must find extra money to pay the increased interest. The increased costs of interest are passed onto Australians through higher government charges and taxes. If the rate of interest is reduced to lower foreign investment, the demand for the Australian dollar will decrease, and hence depreciation of the dollar will occur. Such a depreciation increases the size of the foreign debt in domestic dollars. Taxation: in recent years, the government has given some tax relief to the workforce rather than wage rises. This is because wage rises will reduce the competitiveness of Australian goods and services. However, the increased income as a result of tax cuts has resulted in increased consumer spending. Foreign debt decreases our export gains: when gross external debt reaches about 160 per cent of exports of goods and services, there is cause for concern. Given the level of Australia's gross external debt, a major danger point for Australia has been reached. Clearly, such danger points are arbitrary, and are not based on any scientific principle. Essentially, they reflect historical experience which suggests that, once a country's debt or debt-servicing level reaches a certain point, it becomes politically difficult to institute the policies needed to ensure the debt servicing and repayment. Tighter fiscal policy: if the government experiences a surplus budget that results in tight economic conditions, a decrease in services and a lowering of the standard of living, there is a danger that this will need to be followed by changes to monetary policy to kick start the economy. Increased foreign ownership: 23 per cent of agriculture, 52 per cent of mining, 55 per cent of manufacturing and 32 per cent of service industries in Australia are foreign owned. Such a high level of foreign ownership indicates that Australia has opted to borrow money as a source of investment. This also increases the servicing cost of the foreign debt, as profits and dividends are sent overseas. Q U E S T I O N S 1 What is the meaning of each of the following terms: gross foreign debt, net foreign debt, public foreign debt, private foreign debt? 2 What is the effect of a depreciation of the dollar on the foreign debt? 3 Explain how foreign debt affects each of the following areas: a import controls b export promotion c domestic economic policy d exchange rate policy e foreign investment f overseas borrowing. 4.3.3 Possible solutions to the external debt Some possible solutions to Australia's external debt problem include: an increase in domestic savings, so reducing Australia's need to borrow from overseas an improvement in the balance of goods and services trading balance, by making Australian exports more internationally competitive a decrease in domestic demand, but being careful not to contract the domestic economy too much appreciation of the Australian dollar, which effectively reduces the external debt and cost of debt servicing the encouragement of equity finance, by making it more attractive to overseas investors to invest in Australia; for example, by reducing barriers to foreign investment. The level of the external debt has been the subject of considerable debate among economists. Many economists have argued that Australia's net external debt is not a problem, particularly as it allows for more rapid economic growth through investment than might otherwise be available. Figure 4.13 identifies some of the key arguments put forward in the debate. Clearly it is difficult to hold a definitive opinion on this question. FIGURE 4.13 The external debt debate The debt is not a problem The debt is a problem The debt allows for increased economic growth possibilities without putting undue pressure on domestic interest rates. Debt servicing ratios indicate that Australia's income as a percentage of GDP is greater than the net interest payable. The economy is not vulnerable to external shocks as most of the debt is private sector debt and because much of the debt is in Australian dollars. Debt servicing is becoming a problem as the income component in the current account deficit has increased as a percentage of GDP. Increased borrowing costs are applied to Australian borrowers as the risk of lending is perceived by overseas lenders to increase with increased debt servicing. Increased exposure to external economic shocks occurs, as when the exchange rate declines, the value of the external debt increases. To reduce this impact, the RBA may be forced to increase interest rates to stabilise the currency and this may cause the domestic economy to contract. Q U E S T I O N S 1 Write a letter to the editor of a newspaper (no more than 300 words) outlining why Australia should or should not have such a high external debt. 2 The Howard Government (1996--2007) reduced its share of external debt as part of government policy. Is this good for Australia or should the money have been put into additional infrastructure and services for future generations? 3 Following the Global Financial Crisis of 2008--09, the Rudd and Gillard Governments borrowed from overseas and increased the level of government external debt. Can such borrowings be justified? Explain your answer..4 Foreign investment Foreign investment: funds invested in an economy by the rest of the world Foreign Investment Review Board (FIRB): a federal body established to examine foreign investment proposals CONCEPTS Foreign investment can be divided into two broad categories: direct investment and portfolio investment, also called indirect investment. Direct investment is said to be any capital invested in an enterprise that gives the investor significant influence over the operation of the enterprise. Officially, a 10 per cent or greater share of ownership is considered to be the threshold for determining 'significant influence'. Portfolio investment covers the acquisition by foreigners of shares in Australian enterprises. The principle here is that the foreigner acquiring the shares exerts no real influence over the operation of the Australian enterprise. In April 1976, the Australian Government established the Foreign Investment Review Board (FIRB), an advisory body created to monitor foreign investment. The functions of the board are to: examine proposals by foreign interests for investment in Australia and make recommendations to the government on these proposals advise the government on foreign investment matters generally foster awareness and understanding, both in Australia and abroad, of the government's policy work towards a high level of Australian equity participation in new investment projects provide guidance, where necessary, to foreign investors so that their proposals conform with government policy keep abreast of the activities of foreign-controlled businesses operating in Australia maintain liaison with state government authorities. The board is assisted by an executive that is part of the Treasury and has available to it advice from other Commonwealth and state government departments and authorities. The government's approach to foreign investment is to encourage foreign investment that is consistent with the interests of the community. The largest number of foreign investment proposals to the FIRB involve the purchase of real estate. Governments aim to channel foreign investment in the housing sector into activity that directly increases the supply of new housing ( for example, new development, home units, townhouses and so on) and to bring benefits to the building industry and its suppliers. Restrictive policy measures on already-developed real estate help reduce the possibility of excess demand in the housing market and aim to encourage the supply of new dwellings for The foreign debt is the amount of money that Australian residents, both public and private, owe to the rest of the world. Australia has always relied on a net inflow of foreign investment to develop its economy and to supplement its domestic savings. KEY IDEA urchase or rent, while maintaining stability of house prices and the affordability of housing for Australians. The FIRB's responsibilities are to: examine proposed investments that are subject to the Foreign Acquisitions and Takeovers Act 1975 (Cth) and supporting legislation, and to make recommendations to the Treasurer and other Treasury portfolio ministers on the national interest implications of these proposals provide advice on the operation of the foreign investment framework and related matters provide guidance to foreign persons and their representatives or agents on the operation of the foreign investment framework monitor and ensure compliance with the framework foster awareness and understanding, both in Australia and abroad, of Australia's policy on foreign investment. The FIRB's functions are advisory only. Responsibility for administration of the government's foreign investment policy and for making decisions on proposals rests with the Treasurer. Figure 4.14 shows the net capital inflow as a percentage of GDP. Equity finance has been outstripped by debt finance in recent years. Figure 4.15 shows the Australian industries attracting foreign direct investment. Clearly, mining, manufacturing, real estate, the financial and insurance industry, and wholesale and retail trade are the main beneficiaries of foreign direct investment. FIGURE 4.14 Australia's net capital inflows 2001--17, as a percentage of nominal GDP 20132009 2017 values are year to September quarter 20052001 2017 --4 --2 0 2 4 6 8 \% --4 --2 0 2 4 6 8 \% Debt Equity Total Source: © Reserve Bank of Australia, 2001--2018. All rights reserved, based on ABS data. It increases economic activity, employment and income. It expands the productive capacity of indus- tries and resources. It provides foreign exchange for purchase of imports that add to quality of life. It introduces new technology and manage- ment that help Australian industries operate more efficiently. It provides opportunities to access new markets. It leads to loss of ownership and control of industry and resources. Increasing external debt results in high debt servicing, which increases the income com- ponent of the current account. Portfolio foreign investment tends to be short- term and speculative. he UK and the USA have traditionally been the main sources of direct foreign investment in Australia. In recent years, they have been joined by Japan, China, Hong Kong and New Zealand. Much of Japanese direct investment has been in real estate, mining and tourism. The construction of tourist facilities to an international standard has led to the creation of employment opportunities for many Australians. Although much of the direct investment from the USA has focused on the manufacturing sector, there has been significant interest in recent years in mining, tourism, agriculture and real estate. Investors from the UK have concentrated mainly on the mining and manufacturing sectors. China has been interested in investing in the resource sector of the economy, given its demand for coal and iron ore in particular. As an open economy, Australia is exposed to many varying external economic pressures. Managers of the economy, aiming to achieve external viability while minimising disturbance to the domestic economy, need to take into account both theoretical and practical information to overcome problems such as increasing levels of external debt, volatile exchange rates, international prices and variable interest rates. Economic models demonstrate that trade can make everyone better off, but at times the rational economic solution is not clear in an interdependent economy because of domestic and international political and social pressures that intervene. Q U E S T I O N S 1 What do you think the role of foreign investment in Australia should be? 2 How is a foreign interest determined in Australia? 3 Is foreign investment beneficial or harmful to the Australian economy overall? Why? 4 Are joint ventures better for Australia than total foreign ownership of a project? Why? 5 Conduct a debate on the question: 'Should foreign investment be allowed in Australia?' 6 Examine Australia's current performance in the external sector. Do you agree with the policies that the government is implementing? ECONOMICS CHALLENGE Gather data about and test the following hypothesis: 'Economic growth in the Australian economy in recent decades must be attributed to foreign investment.' A suggested approach is as follows: 1 Conduct research to determine the levels of foreign investment, GDP per capita and domestic investment in the last ten years. 2 Tabulate the data. 3 Compare the trends and draw conclusions about the impact of foreign investment on Australian economic growth. 4 Consider the benefits derived from this investment and then the implications if this investment had not been available.