Balance of Payments: Concepts

Question 1

Why does the balance of payments balance?

Answer 1

It is measured using a double-entry accounting system, so for every receipt of value, there is an equal loss of value. This means that the accounts always balance, and the total transactions on the BoP always add up to $0.

Question 2

What is the relationship between the current account and the KAFA?

Answer 2

1) In the current year, the CA and the KAFA always balance (due to the double-entry accounting system)
2) Inflows on the KAFA this year will worsen NPY in the CA in future years, due to increased servicing costs on foreign debt or equity

Question 3

How would an improvement in international competitiveness affect the BOGS?

Answer 3

Australian businesses would sell more exports, improving the BOGS

Question 4

The RBA raises interest rates. How would this affect the BOGS?

Answer 4

Higher interest rates would appreciate the AUD, worsening the BOGS

Question 5

Global interest rates fall. How would this affect the NPY?

Answer 5

Australians would pay less interest on foreign debt, improving NPY

Question 6

The terms of trade improves. How would this affect the BOGS?

Answer 6

Australians would receive more for the same quantity of exports, improving the BOGS

Question 7

The terms of trade improves. How would this affect the NPY?

Answer 7

Domestic firms that sell exports would make more profit, so dividend payments to foreigners would increase - worsening NPY

Question 8

Domestic growth is higher than growth of Australia’s trading partners. How would this affect the BOGS?

Answer 8

Incomes of Australians are rising faster, so import consumption will rise faster than exports - worsening the BOGS

Question 9

The exchange rate depreciates. How would this affect the BOGS?

Answer 9

Overall: the BOGS would improve due to improved international competitiveness

More specifically, the J-curve:
In the short-term, we still buy the same quantity of imports, but it costs more, so the BOGS worsens.
In the long-term, we adjust and buy fewer imports, and foreigners adjust and buy more of our exports, improving the BOGS

Question 10

The exchange rate depreciates. How would this affect NPI?

Answer 10

Dividends from investment overseas would be worth more in AUD, so NPI would improve.

The cost of interest on foreign debt would increase, so NPI would also worsen. But because most Australian debt is dollar-denominated (in AUD), it is unaffected by this.

Question 11

How has Australia’s BOGS changed over the past 10 years?

Answer 11

After consistently being in deficit for most of Australia’s history, the BOGS has improved since 2015 and reached a 7% surplus in 2022.

But it has fallen to 3.5% in 2024

Question 12

How has Australia’s NPY changed over the past 10 years?

Answer 12

NPY has remained in deficit: it fell from -1% of GDP in 2020, to -5.5% in 2023, but is now -3.5%

Question 13

How has Australia’s current account changed over the past 10 years?

Answer 13

After consistently being in deficit until 2019, the CA reached a surplus of 4% in 2021, but has fallen to 0% in 2024

(One way to remember this is 3.5% BOGS surplus - 3.5% NPY deficit)

Question 14

List 6 factors affecting Australia’s BOGS

Answer 14

1) Terms of trade
2) Export capacity
3) Exchange rate
4) Narrow vs diversified export base
5) Capital-intensive industries
6) Domestic vs global growth & demand

Question 15

List 4 factors affecting Australia’s NPI

Answer 15

1) Reduced reliance on foreign investment
2) Interest rates
3) Exchange rate
4) Domestic vs global growth

Question 16

List 3 factors affecting Australia’s KAFA

Answer 16

1) Business investment
2) Domestic savings
3) Fiscal policy

Question 17

How have the terms of trade affected Australia’s BOGS recently?

Answer 17

ToT have risen 50% since 2016 and are now higher than in the peak of the mining boom - improving the BOGS

Though ToT has fallen since 2023, worsening BOGS again

Question 18

How has export capacity affected Australia’s BOGS recently?

Answer 18

The mining investment boom (2005-2013) increased coal, iron and LNG export capacity (more mines and ports) - improving the BOGS

Question 19

How has the exchange rate affected Australia’s BOGS recently?

Answer 19

TWI has fallen by 18% since end of mining investment boom (2013) - improving the BOGS

Question 20

How has Australia’s export base affected Australia’s BOGS recently?

Answer 20

Australia relies on commodity exports (two thirds of all exports). While it’s usually bad to only export a small range of products, it has been good recently because commodity prices have spiked - improving the BOGS

Question 21

How has the capital intensity of Australian industry affected Australia’s BOGS recently?

Answer 21

Australia usually imports lots of machinery for mining industries - but the amount of capital being imported has fallen since the end of the mining boom - improving the BOGS

Question 22

How has the level of economic growth in Australia vs the rest of the world affected Australia’s BOGS recently?

Answer 22

Australia recovered faster than the global economy from the pandemic - worsening the BOGS.

Border closures also hit service exports too - worsening the BOGS

Question 23

How has Australia’s reliance on foreign investment affected Australia’s NPY recently?

Answer 23

Australia has been a net provider of investment since 2019, meaning net foreign liabilities are gradually improving. This means Australia is paying less in interest and receiving more dividends than we used to - improving NPY.

Question 24

How have interest rates affected Australia’s NPY recently?

Answer 24

Interest rates in most countries were at record lows, reducing interest costs on Australia’s foreign debt and improving NPY.

BUT they have recently been rising, worsening NPY

Question 25

How have exchange rates affected Australia’s NPY recently?

Answer 25

The TWI has fallen by 18% since end of mining investment boom (2013), meaning dividends on assets overseas are worth more in AUD - improving NPY.

While the depreciation could also make interest more expensive and worsen NPI, 90% of Australia’s foreign debt is dollar denominated so is unaffected by the exchange rate

Question 26

How has the level of economic growth in Australia vs the rest of the world affected Australia’s NPI recently?

Answer 26

Strong profits (especially in the mining sector) have increased dividend payments - worsening NPI

Question 27

How has the level of business investment affected Australia’s KAFA recently?

Answer 27

Business investment has been falling since the mining boom, and fell further during the covid pandemic - reducing KAFA inflows

Question 28

How has the level of domestic savings affected Australia’s KAFA recently?

Answer 28

Household savings rose in the pandemic, meaning firms can borrow from domestic banks and need less foreign loans - reducing financial inflows

Superannuation savings also continue to grow over time - increasing foreign outflows

Question 29

How has the Australian Government’s fiscal policy affected Australia’s KAFA recently?

Answer 29

The Government has been in deficit since 2008 (so borrowing more every year), and then made a record $291b stimulus in response to the pandemic. Much of this debt is foreign debt - increasing financial inflows

Question 30

What are the reasons net foreign liabilities are bad?

Answer 30

1) Debt accumulation cycle
2) Higher interset rates
3) Exposure to loss of investor confidence
4) Exposure to balance of payments crisis
5) Balance of payments contraint

Question 31

Why does NFL cause a debt accumulation cycle?

Answer 31

Two reasons:

1) If you have a CAD, it means you are receiving foreign investment (KAFA surplus). So a CAD every year means you keep adding to your foreign debt.
2) Also, having a CAD means you have foreign investment (KAFA surplus). This will create interest costs, and lead to an even bigger CAD and even more borrowing in the future.

Question 32

Why does NFL expose the economy to a possible loss of investor confidence?

Answer 32

A CAD or NFL indicates the country is reliant on foreign investment. So if for any reason foreigners became reluctant to invest in the economy, firms would no longer be able to get the funds they need for investment - leading to a sudden drop in economic growth.

Question 33

Why does NFL expose the economy to a possible balance of payments crisis?

Answer 33

If a country consistently has a CAD, it will have accumulated foreign debt. If the currency falls, the country may find it much harder to repay the debt (worsening foreign investor confidence and causing a further depreciation).

As a result, firms may default on their foreign debt (causing business closure). And the government may struggle with debt repayments, meaning it might be unable to also fund basic services (e.g. welfare, health care) or a fiscal stimulus

Question 34

Why does NFL cause a balance of payments constraint?

Answer 34

Economic growth can cause the CAD to get worse (due to increased import spending). So the government may now need to slow down growth (with contractionary fiscal and monetary policy) in order to prevent a worsening of the CAD

Question 35

Why might NFL be considered beneficial?

Answer 35

A CAD indicates the country is receiving foreign investment on the KAFA. This can be beneficial because it fills the savings-investment gap and allows firms to expand and drive economic growth.

The Pitchford Thesis also argues that a CAD isn’t even risky as long as the debt was borrowed by rational businesses that are confident they will be able to repay, (but not if the debt was borrowed by the government)