Causes And Effects Of Fluctuations In Australia's External Stability
Q27: Analyse the causes and effects of fluctuations in Australia’s external stability.
External stability is an aim of government policy that seeks to promote sustainability on the external accounts so that Australia can service its foreign liabilities in the medium to long run and avoid currency volatility. The main causes of fluctuations in external stability include changes in the current account and net foreign liabilities, which, if not managed appropriately, can result in detrimental effects for Australia’s exchange rate and credit rating. Currently, Australia’s current account deficit sits at 2.9% of GDP, having averaged close to 4.5% since 2004. Australia’s net foreign liabilities in 2012-13 were 56.3% of GDP, with net foreign equity representing 3.8% of GDP and net foreign debt representing 52.5% of GDP. However, …show more content…
Australia’s persistent current account deficit and recent growth in net foreign liabilities are yet to cause concern, as they are considered to be providing productive investment, expanding economic activity in the process.
The Current Account Deficit (CAD) is recorded when the debits in the current account (imports and income payments to overseas) are greater than the credits (exports and income payments from overseas). Historically, Australia has suffered from a lack of international competitiveness and poor terms of trade, due to its geographical isolation and the composition of its exports, primary commodities. However, globalisation, rising commodity prices and the rapid industrialization of China have effectively negated these concerns. In the past three years the size of Australia’s current account deficit has tended to fluctuate for
three different reasons. Firstly, the surplus on the goods and services balance has fallen, reflected by the decline in the merchandise trade surplus from $13,807 million in 2011-12 to $1,415 million in 2012-13. This is due to a slowdown in export growth and income, and a rise in import spending, especially on capital goods, to invest in increasing productive capacity in the mining and resource sector of the economy. Secondly, net services has recorded a deficit, which has been exacerbated because of the decline in competitiveness caused by the appreciation of the $A. The net services deficit increased from -$6920 million in 2010-11 to -$11902 million in 2012-13. Finally, the deficit on the net primary income account, which almost accounts for the entire current account deficit, remained large, growing by 14% between 2010-11 and 2012-13. Since then, low global interest rates have helped to reduce the deficit. The combination of these factors have caused an increase in the current account deficit recorded at -$47,654 million in 2012-13.
Net foreign liabilities are equal to Australia’s financial obligations (foreign debt plus foreign equity) to the rest of the world minus the rest of the world’s financial obligations to Australia. In recent years, Australia’s net foreign debt has grown steadily while net foreign equity fluctuated during the GFC ($849.5 billion in 2009-10) and has fallen since ($54.7 billion 2012-13). The current account deficit is financed primarily through inflows of foreign capital, which are in the form of debt and equity borrowings from abroad. Hence, the growth in foreign debt can be attributed to the large CAD, which recently rose again due to falling commodity prices. Yet in June 2013, the debt-servicing ratio, a reliable measure of an economy’s capacity to service its foreign debt, was 6.2%, its lowest level since 1982, reflecting the combination of low global interest rates and strong export growth. Net foreign equity, the smaller of the two components, is also in a good position, having been high as a result of foreign investment in the minerals and resources sector and Australia’s AAA credit rating (maintaining investor confidence), but now falling. This has been due to the overall growth in Australia’s investments overseas and the overall growth of countries’ liabilities to Australia. Between 2000-01 and 2012-13, Australian ownership of equity overseas rose from $295 billion to $709 billion, while Australian loans to overseas grew from $198 billion to $695 billion. However in the long term, Australia must be wary of the growth in net foreign liabilities as a structural problem. There is a risk of falling into the debt trap scenario, as seen during the GFC when the Government was forced to provide a temporary blanket guarantee for all overseas loans.
Fluctuations in Australia’s major external stability indicators can cause severe changes in investor confidence, which is reflected in Australia’s exchange rate. Since each of the categories within the Balance of Payments, the Current Account and the Capital and Financial Account, make up the demand (credits) and supply (debits) of the $A, it directly effects Australia’s terms of trade and international competitiveness. It is expected that if a country is recording a current account deficit the tendency will be for its exchange rate to depreciate over time since import spending exceeds export income. It seems that the mining boom has delayed the onset of this effect, with the $A reaching a high of US$1.11 in 2011 to decline to US$0.87 at the beginning of February 2014. This depreciation has increased international competitiveness for suffering industries such as manufacturing and tourism, recording profit growth of only 0.9% in the non-mining sector in 2012, and helped them to maintain employment levels. While, the sustained appreciation of the $A has led to a multispeed economy in some areas, it helped to maintain consumer confidence during a volatile period in the global economy. Australia is one of the shrinking numbers of advanced economies to have retained their AAA credit rating, with European countries suffering from the sovereign debt crisis and America still recovering from the GFC. Thus, Australia’s external stability has had a huge impact upon the success of Australia’s recovery from the GFC.
Macroeconomic policy, consisting of monetary and fiscal policy, significantly influences Australia’s external stability. Australia’s comparatively high cash rate of 2.5%, when compared to 0.25% in the US and 0.75% in the EU attracts foreign investment. The recent growth of investment in the resource sector, which is estimated to be 83% foreign owned, has resulted in a worsening of the CAD as Australia is forced to service the profit and interest earned on these investments, which recorded a deficit of $47.7 billion in 2012-13. However, the effects of contractionary fiscal policy have helped to reduce the effect of Australia’s savings and investment gap. This way domestic equity will be able to fund domestic investment instead of having to rely on overseas borrowing, which in turn harms Australia’s external stability. Similarly, compulsory superannuation, requiring employees to set aside 9% of their earnings for when they retire, is helping to address this problem. It is expected to rise to 12% by 2019, reducing the long-term pressure on Australia’s sustained CAD. Yet, in recent years Australia’s sustained CAD has not been a major objective of Government policy as they have largely accepted the Pitchford Thesis, or the ‘consenting adults’ view. When this is combined with Australia’s strong medium to long term export prospects and increasing household savings, it is evident why this is so.
Microeconomic policy can be used to address structural problems causing Australia’s external imbalances. These policies include measures to reduce capacity restraints in the economy by improving infrastructure, such as the additional $11.6 billion for Infrastructure Growth Package. Likewise, the Australian Government has provided a $200 million boost to the Export Finance and Insurance Corporation’s capital base, and a $50 million boost to the Export Market Development Grants Program to help more small-medium sized businesses access export markets, in turn enhancing efficiency and productivity, while improving Australia’s trade imbalance. It is important that structural factors continue to be managed as they provide the foundations for Australia’s future economic performance.
The main indicators of Australia’s external stability, the current account deficit and net foreign liabilities, appear to be in a viable position at this time. As long as the government continues to address structural issues, such as the savings and investment gap, and foreign borrowing is used for productive investment to expand economic activity, growth will exceed trend and the servicing costs will be able to be covered. These actions will have a positive effect upon Australia’s domestic economy, promising continued and sustained economic growth into the future.
External stability is an aim of government policy that seeks to promote sustainability on the external accounts so that Australia can service its foreign liabilities in the medium to long run and avoid currency volatility. The main causes of fluctuations in external stability include changes in the current account and net foreign liabilities, which, if not managed appropriately, can result in detrimental effects for Australia’s exchange rate and credit rating. Currently, Australia’s current account deficit sits at 2.9% of GDP, having averaged close to 4.5% since 2004. Australia’s net foreign liabilities in 2012-13 were 56.3% of GDP, with net foreign equity representing 3.8% of GDP and net foreign debt representing 52.5% of GDP. However, …show more content…
Australia’s persistent current account deficit and recent growth in net foreign liabilities are yet to cause concern, as they are considered to be providing productive investment, expanding economic activity in the process.
The Current Account Deficit (CAD) is recorded when the debits in the current account (imports and income payments to overseas) are greater than the credits (exports and income payments from overseas). Historically, Australia has suffered from a lack of international competitiveness and poor terms of trade, due to its geographical isolation and the composition of its exports, primary commodities. However, globalisation, rising commodity prices and the rapid industrialization of China have effectively negated these concerns. In the past three years the size of Australia’s current account deficit has tended to fluctuate for
three different reasons. Firstly, the surplus on the goods and services balance has fallen, reflected by the decline in the merchandise trade surplus from $13,807 million in 2011-12 to $1,415 million in 2012-13. This is due to a slowdown in export growth and income, and a rise in import spending, especially on capital goods, to invest in increasing productive capacity in the mining and resource sector of the economy. Secondly, net services has recorded a deficit, which has been exacerbated because of the decline in competitiveness caused by the appreciation of the $A. The net services deficit increased from -$6920 million in 2010-11 to -$11902 million in 2012-13. Finally, the deficit on the net primary income account, which almost accounts for the entire current account deficit, remained large, growing by 14% between 2010-11 and 2012-13. Since then, low global interest rates have helped to reduce the deficit. The combination of these factors have caused an increase in the current account deficit recorded at -$47,654 million in 2012-13.
Net foreign liabilities are equal to Australia’s financial obligations (foreign debt plus foreign equity) to the rest of the world minus the rest of the world’s financial obligations to Australia. In recent years, Australia’s net foreign debt has grown steadily while net foreign equity fluctuated during the GFC ($849.5 billion in 2009-10) and has fallen since ($54.7 billion 2012-13). The current account deficit is financed primarily through inflows of foreign capital, which are in the form of debt and equity borrowings from abroad. Hence, the growth in foreign debt can be attributed to the large CAD, which recently rose again due to falling commodity prices. Yet in June 2013, the debt-servicing ratio, a reliable measure of an economy’s capacity to service its foreign debt, was 6.2%, its lowest level since 1982, reflecting the combination of low global interest rates and strong export growth. Net foreign equity, the smaller of the two components, is also in a good position, having been high as a result of foreign investment in the minerals and resources sector and Australia’s AAA credit rating (maintaining investor confidence), but now falling. This has been due to the overall growth in Australia’s investments overseas and the overall growth of countries’ liabilities to Australia. Between 2000-01 and 2012-13, Australian ownership of equity overseas rose from $295 billion to $709 billion, while Australian loans to overseas grew from $198 billion to $695 billion. However in the long term, Australia must be wary of the growth in net foreign liabilities as a structural problem. There is a risk of falling into the debt trap scenario, as seen during the GFC when the Government was forced to provide a temporary blanket guarantee for all overseas loans.
Fluctuations in Australia’s major external stability indicators can cause severe changes in investor confidence, which is reflected in Australia’s exchange rate. Since each of the categories within the Balance of Payments, the Current Account and the Capital and Financial Account, make up the demand (credits) and supply (debits) of the $A, it directly effects Australia’s terms of trade and international competitiveness. It is expected that if a country is recording a current account deficit the tendency will be for its exchange rate to depreciate over time since import spending exceeds export income. It seems that the mining boom has delayed the onset of this effect, with the $A reaching a high of US$1.11 in 2011 to decline to US$0.87 at the beginning of February 2014. This depreciation has increased international competitiveness for suffering industries such as manufacturing and tourism, recording profit growth of only 0.9% in the non-mining sector in 2012, and helped them to maintain employment levels. While, the sustained appreciation of the $A has led to a multispeed economy in some areas, it helped to maintain consumer confidence during a volatile period in the global economy. Australia is one of the shrinking numbers of advanced economies to have retained their AAA credit rating, with European countries suffering from the sovereign debt crisis and America still recovering from the GFC. Thus, Australia’s external stability has had a huge impact upon the success of Australia’s recovery from the GFC.
Macroeconomic policy, consisting of monetary and fiscal policy, significantly influences Australia’s external stability. Australia’s comparatively high cash rate of 2.5%, when compared to 0.25% in the US and 0.75% in the EU attracts foreign investment. The recent growth of investment in the resource sector, which is estimated to be 83% foreign owned, has resulted in a worsening of the CAD as Australia is forced to service the profit and interest earned on these investments, which recorded a deficit of $47.7 billion in 2012-13. However, the effects of contractionary fiscal policy have helped to reduce the effect of Australia’s savings and investment gap. This way domestic equity will be able to fund domestic investment instead of having to rely on overseas borrowing, which in turn harms Australia’s external stability. Similarly, compulsory superannuation, requiring employees to set aside 9% of their earnings for when they retire, is helping to address this problem. It is expected to rise to 12% by 2019, reducing the long-term pressure on Australia’s sustained CAD. Yet, in recent years Australia’s sustained CAD has not been a major objective of Government policy as they have largely accepted the Pitchford Thesis, or the ‘consenting adults’ view. When this is combined with Australia’s strong medium to long term export prospects and increasing household savings, it is evident why this is so.
Microeconomic policy can be used to address structural problems causing Australia’s external imbalances. These policies include measures to reduce capacity restraints in the economy by improving infrastructure, such as the additional $11.6 billion for Infrastructure Growth Package. Likewise, the Australian Government has provided a $200 million boost to the Export Finance and Insurance Corporation’s capital base, and a $50 million boost to the Export Market Development Grants Program to help more small-medium sized businesses access export markets, in turn enhancing efficiency and productivity, while improving Australia’s trade imbalance. It is important that structural factors continue to be managed as they provide the foundations for Australia’s future economic performance.
The main indicators of Australia’s external stability, the current account deficit and net foreign liabilities, appear to be in a viable position at this time. As long as the government continues to address structural issues, such as the savings and investment gap, and foreign borrowing is used for productive investment to expand economic activity, growth will exceed trend and the servicing costs will be able to be covered. These actions will have a positive effect upon Australia’s domestic economy, promising continued and sustained economic growth into the future.