Economics of Australia - Financial Flows and Balance of Payments PDF

> australia exports slightly more than it imports which is roughly 25% > China now accounts for One 3rd of China's exports and this rate has risen substantially in accordance to 2000 which displayed an export rate of 4.4. this pattern has also been displayed through the massive growth in imports wh...

> australia exports slightly more than it imports which is roughly 25% > China now accounts for One 3rd of China's exports and this rate has risen substantially in accordance to 2000 which displayed an export rate of 4.4. this pattern has also been displayed through the massive growth in imports which are now at a rate of 20% and above indicating a massive reliance on china both import and export wise. > trade has also increased with other nations in asia such as indonesia, Vietnam and singapore which hold a comparative advantage in production. > the main focus of the Australian economy in terms of exports are considered to be in the primary sector, these happen to be agriculture and minerals. Some examples being gold and iron in terms of minerals and beef, wheat and wool in terms of agriculture.(these collectively make up 80% of exports) > In comparison to 1999 the composition of exports has changed tremendously, as agriculture and farming have subsequently decreased due to the presence of comparative advantage in other nations allowing for goods to be produced far cheaper. > recent composition changes in australia's exports include > increase in mineral exports due to greater demand > reduced agricultural exports due to large fluctuations in the world price. > a decline in manufacturing ( a result of comparative advantage) Financial flows > What does financial flow even mean ? - it is the movement of money, particularly investments both domestically and internationally. > Financial flows were less important between 1950’s and 1970’s as there were several protectionist policies and limitations surrounding financial flows (all types of investments) > however, financial deregulation in 1970’s and 1980’s allowed for financial flows to grow rapidly, as international markets opened up, exchange rates were floated and technological changes made shifting money easier. Key terms of financial flows include >>>> > FDI (foreign direct investment) - long term investments that usually result in ownership of a company totalling past 10% > portfolio investment - refers to short term investments usually done for speculative and short term capital gains, such as small shareholdings in other forms of securities. > deregulation allowed portfolio investment to thrive because it mean that a far larger amount of people now have the ability to invest funds internationally, aso technology has made the process far easier and more convenient which reinforces portfolio investment, rather than FDI. > what is deregulation in regards to financial flows. > deregulation refers to the removal of government regulation, rules and restrictions in a market or economy. The effects of this are, > improved efficiency, consumer sovereignty > more competition amongst businesses > more innovation, technology > One major event was the 1983 float, this was when the market gained control of the value of the dollar rather than the RBA. - set by the laws of demand and supply - natural > Australia is a net importer - we receive more in investments than we invest into other economies Advantages Disadvantages ​ Transfers of technology ​ Loss of domestic ownership and management skills ​ Reliance of foreign ​ Access to forex markets investors and business ​ Creation of employment ​ The volatile nature of opportunities speculative portfolio investment Other terms > Debt borrowings: refers to foreign loans (makes up roughly 65% of total foreign liabilities) > Equity borrowings: refers to direct and portfolio investment (makes up roughly 35% of total foreign liabilities) Balance of payments (the hardest topic) > The balance of payments refers to the record of all financial transactions between Australia and the rest of the world. > the Balance of payments (BOP) usually track two flows  -​ Real flows (the flow of physical goods and services) -​ Financial flows (the flow of money, which is known as capital) > Balance of payment categories 1 - all money that flows into australia is known as (credit) 2- all money that flows out of australia is known as (debt) > The BOP is usually presented in two accounts 1- current accounts 2 - capital and financial account > Current accounts (non reversible) 1.​ Balance of goods: export (credits) and import (debits) of goods 2.​ Balance of services: export (credits) and import (debits) of services 3. Net Primary Income (NPY): the income and dividends received (credits) and paid (debits) on foreign loans, investments and foreign ownership (income from factors of production) 4. Net Secondary Income: current transfer payments involve small items such as insurance claims, unconditional foreign aid, pensions, etc. Note - when calculating current account, 1+2+3+4 = balance What makes up current account Goods (net goods) Services (net services) Balance on goods and services Net primary income (previously Net Income) Net secondary income (previously Net Current Transfers) Balance on current account The graph should look like this - Balance on the current account. Net goods + Net services Balance on goods and services + Net primary income + Net secondary income = Balance on current account Capital and financial accounts This account is concerned with financial assets and liabilities that flow into Australia, and out of australia. (reversible, an investor can withdrawal money from a project) 1 - This account is concerned with financial assets and liabilities (flowing into and out of Australia) 2. It includes money flowing from: international borrowing, lending and the purchase of assets (such as shares and real estate) Capital - refers to movement of money (not capital goods) What do capital goods consist of ? > (capital transfers) foreign aid, debt forgiveness, > (Non produced goods) - trademarks, patents, and franchises. More components of financial accounts, > direct investment -( more than 10 percent shares ownership of a company) > portfolio investment - (buying or selling land, shares over (10 percent) > financial derivatives - purchase of financial assets, where value is determined by demand in that moment in time (futures) > reserve assets - transactions of RBA stored money used for stabilising markets and making contributions to international organisations. > Other investments - a category for left over transactions, trade credits > What are net errors and omissions?  -​ This refers to the statistical discrepancies on the Capital and Financial Account. It is a balancing item often added to the account figure to ensure that BOP sums to 0 Example question - How would the items on your sheet be recorded on the BoP? Example: An Australian car dealer purchases Mazda cars to sell. Answer: Mazda cars coming into Australia are IMPORTs. So the money flows OUT of Australia. This is a goods debit. 0 - 0 means that the rate of inflows is equal to the rate of outflows in a year. current account + KAFA + net errors and omissions = 0 So what are the links between the two categories of BOP, which are known as (current accounts) and (capital and financial accounts) > there is a shortfall of investments(small total amount of investments) hence a need for foreign investment. > when financial flows come into australia they are recorded as, credit on the Capital and financial accounts(KAFA) > when foreign investors get dividends from australia, it is known as a debt on the NPY credit account.  Note - Whenever we borrow money from overseas, it is labelled as credit on (KaFa) - capital and financial accounts, as technically it is an inflow. > this therefore means that the debt on (KAFA) will be larger than credit) as we will have to pay back interest or dividends with the borrowed funds. How are the topics of current account and capital and financial accounts interlinked/connected ? > Australia has a very low rate of domestic investment therefore leading, (due to lack of population) therefore meaning that Australia is in need of immense investments. > these investments received are known as credit on capital and financial accounts (KAFA) > however, the money leaves the country in the form of dividends and interest which results in a debts for CA - reducing net primary income What about receiving investments ? > when we borrow money from overseas, it is known as credit on KAFA - scenario B Why? > this is because credit refers to money coming in, which in this case is true and because KAFA, conditional transfers (foreign aid grants) + debt forgiveness) + KAFA refers to non produced - assets such as intellectual property + trademark. Also, the FA part refers to derivatives, portfolio investment and direct investment. Therefore meaning that an investment from overseas in scenario B is categorised as KAFA, or FA. So how is the link between CA and KAFA evident in international borrowing and foreign investment ?? International borrowing > The borrowed funds as seen as credit in terms of KAFA, as it is money flowing into australia > - the repayment costs for the debt, are known as debit on NPY - (CA) > So a high rate of foreign borrowing will create a deficit for that nation as the rate of money that will leave is larger than the amount of money that will enter the nation. > a deficit on the entire current account is known as CAD - meaning current account deficit Foreign investment > Foreign investors, invest into australia through forms of buying land, buying shares and buying portions of company’s (if over 10% then it is FDI) > for this investment, foreign investors receive rent, dividends and profit. > The foreign investment is recorded as credit on KAFA > the returns of the investment for investors, are known as debts on NPY (CA) Leading to a deficit on NPY (cad) There are 3 potential downsides to CAD CAD - that is the current account deficit (when the current account is in the minus due to more exports than imports. 1.​- exchange rates decrease- leads to decrease in exchange rate as a loss in investor confidence can result in a reduced demand for the australian dollar and therefore lead to the price of the australian dollar dropping 2.​Balance of payments constraint - when the economy cannot undergo economic growth due to the fact that the higher growth rates require an increase in imports which can only be achieved with a normal CA. This therefore limits the performance of the economy forcing them to a point where CAD is sustainable for growth. 3.​Monetary changes - this is when Australia has to develop a tighter stance on its monetary policy in order to ensure (short term) in order to increase imports and try to deteriorate the element of CAD. Exchange rate Define - Exchange rate refers to the price of one currency in comparison to another. Why is it important ? They are asset price (treated like an asset or stock) and because they determine import and export rates between nations. For example, if the exchange rate is too high a nation might not choose to trade with that nation. In Australia - exchange rates are identified using the indirect method which is when we convert from one currency to another. On the contrary, (overseas market) Direct is when we calculate how much of a currency we need to use in order to buy one unit of foreign currency. So, How much aud to buy one unit of usd - $A 1.27 = $US 1.00 How do we determine exchange rates? > floating - this is when the factors of supply and demand determine the price of a currency, there is no government intervention. It is purely decided by the public. > - dirty float - this is when there is some sort of government intervention in order to ensure that the exchange rate is steady and does not fluctuate to the point where it can limit exports and imports for nations. > flexible peg - this is a fixed exchange rate between two nations, so this means that the rate does not change as it is agreed beforehand between two countries. > fixed or managed - this is a rate set by the government’s central bank in order to effectively control exchange rates, meaning that there is no intervention of supply and demand. Exchange rates are determined in two ways -​ Bilateral - this refers to the normal process of converting a currency into a foreign currency -​ Trade weight index - A measure of the (Aud) against a basket of currencies that we regularly trade with. -​ > Each currency is weighted according to their importance in our trade. > the index includes 21 counties that we trade with and it must account for at least 90% of trade. > the TWI, is accurate as it takes into account Australia’s balance of payments performance over time. > limitations -​ The weightings are only based on the volumes of trade, regardless of the currency in which exports and imports take place. Increasing in purchasing power means - Appreciation Decrease in purchasing power means - Depreciation