[HSC] Economist: 26 August — 1 September
The week in review.
Balance of Payments
Reserve Bank Deputy Director Guy Debelle gave a pertinent speech last week, discussing developments in Australia’s balance of payments. Australia’s current account has moved into a quarterly surplus for the first time since the June quarter of 1975 and the trade surplus is at its largest — as a percentage of GDP — since the 1950s. Furthermore, Australia’s net foreign liabilities (NFL) have been declining for the past decade and are at their lowest level since the early 2000s.
For almost all of its modern history, Australia has been a net importer of capital and run a current account deficit (CAD) — a byproduct of its saving and investment gap. Australia has a limited supply of savings — although the household saving ratio is not particularly dissimilar to other advanced economies. However, the share of investment in the Australian economy is significantly higher than many other advanced economies, due to Australia’s industry makeup and this drives a persistent CAD.
Through the 1980s, 1990s and 2000s, the CAD averaged around 4% of GDP, however, in the last four years the CAD has narrowed to be around 1% of GDP, with the quarterly surplus in June likely pushing the year-ended CAD below 0.5% of GDP. The recent narrowing is due to a shift in Australia’s trade balance, which averaged a deficit of -1.25% of GDP from 1980 through until 2015 and is now a surplus of more than 3% of GDP.
The large trade surplus is driven by a combination of factors. Firstly, high revenue from resource exports due to increases in both price and quantity and secondly, the end of the investment-phase of the Mining Boom, which has resulted in a decrease in the importation of capital goods. Services have also increased as a source of export revenue over time, with their share of total exports rising from 17% in the 1980s to 21% currently.
However, the large trade surplus has resulted in greater payments to shareholders in the form of dividends. Foreign ownership of the large mining companies that operate in Australia is approximately 75% and this has resulted in greater net income outflows, reducing the narrowing of the current account.
Another significant trend in Australia’s balance of payments is the reduction in net foreign liabilities (NFL). Australia’s net foreign liabilities peaked at 60% in 2009, however, lower current account deficits since then, have delivered lower net capital inflows and consequently seen NFL fall to only 50% of GDP currently.
The composition of Australia’s NFL has also changed. The Global Financial Crisis of 2008 saw an increase in the accumulation of Australian government bonds by those overseas, causing the public share of Australia’s total foreign debt liabilities to rise to almost 20%, as shown in the chart below.
Additionally, foreigners have traditionally owned more equity in Australian companies than Australians owned in foreign companies. However, this trend has reversed since 2013 largely due to superannuation funds choosing to invest in foreign equity. As a result, Australia now has a net foreign equity asset position of 7% of GDP — which combined with net foreign debt equivalent to 57% of GDP, returns the NFL figure of 50% of GDP.
Another factor supporting Australia’s external stability is that 68% of foreign liabilities are denominated in Australian dollars, a figure that increases to 85% after hedging. This means that,
“when the exchange rate depreciates, the value of net foreign liabilities actually declines rather than increasing.”
In turn, this reduces the potential for a negative valuation effect to accompany a depreciation, allowing the exchange rate to more effectively provide insulation against external shocks. The most likely source of such a shock is the ongoing trade war between the United States and China.
To conclude his speech, Guy Debelle remarked that,
“While Australia doesn’t have the exorbitant privilege of the US, the external accounts do not constitute a source of vulnerability and have become increasingly resilient over the past 30 years.”
The notion of the United States’ “exorbitant privilege” refers to their ability to service their external accounts using US dollars given its position as the reserve currency.
Further Reading
This series of weekly articles aims to compile the important economic news of the week into bite-sized summaries with HSC-specific takeaways.
You can expect a new article every Sunday at 6pm!
