Chapter 4- Aus Trade and Financial Flows

Question 1

What percentage of what we produce do we export and what percentage of GDP do we import?

Answer 1

25%

Question 2

Define the direction and composition of trade.

Answer 2

The direction of trade is the countries to which a country exports goods and where it imports from, whereas the composition of trade is the study of the goods and services that make up a countries X and M.

Question 3

Outline trends in the direction of trade.

Answer 3

China has become Australia’s dominant trading partner in the past decade.
Aus X to Chn increased from 5.8% - 36.1% in 1990-2019 and M from 4.4%-24.5% of total M.
South Korea and ASEAN countries have also become more important.
Meanwhile, key X markets for Aus in previous decades – Japan, UK and Europe – have declined in importance.
E.g Japan - (26.5%-15.8%)X and (15.6%-7%)M 1990-2019
EU - (16.9%-5.8%)X and (26.1%-17.6%)M 1990-2019
US - (13.1%-3.9%)X and (23.4%-10.6%)M 1990-2019

Question 4

In what industries does Australia have a comparative advantage in and why?

Answer 4

Commodities due to Aus vast natural resources.

E.g. wheat, wool, beef, iron ore, coal and gold.

Question 5

What percentage of current Aus X earnings came from agriculture and mineral exports?

Answer 5

2/3

Question 6

Outline changes in Aus composition of X from 1990-current with reasons.

Answer 6

Increase in minerals and metals. from 33%-54% of total X due to Aus comparative advantage and current high commodity prices following China’s growth, the mining boom in 2005 and the Brazilian mining disaster in 2019.

Decline in rural area (agriculture) from 23%-10% due to large fluctuations in prices and increased protectionist policies for agricultural X. Also recent more extreme weather patterns has reduced output in the sector.

Manufacturing slight decline from 13%-9% due to overseas competition from China and other emerging and advanced economies.
Services remain at 20%, other increased (8%-11%)

Total X $470billion (2019-2020). Increase from $403b in 2018-2019.

Question 7

Outline changes in Aus composition of M from 1980-2019 with reasons.
What is Aus total M in 2020?

Answer 7

Part-finished intermediate goods and services have both fallen slightly, (39.7%-31.8%) and (23.3%-22.2%) respectively.
Consumer goods have increased. (14.4%-27.9%).

These changes can be explained by shift away from large-scale manufacturing in Australia, especially with the gradual reduction of tariffs and local content rules.

In 2019–20, Australia’s total M were valued at $399 billion. Intermediate goods accounted for $120 billion, followed by consumption goods ($97 billion) and capital goods ($77 billion).

Question 8

Outline trends in Australia’s financial flows since 1990 giving reasons.

Answer 8

The level of foreign investment in Aus and investment overseas by Australians has doubled in the past decade, and has been rising rapidly since the 1980’s.

This is because international capital markets opened up, exchange rates were floated, and technological changes made it easier to shift finance between countries since the 1970s.

Foreign investment into Aus 1990-2020:
Direct: $106,636m-$1,087,936m
Portfolio: $145,942m-$1,898,068m

Foreign investment from Aus 1990-2020:
Direct: $44,715m-$862,115m
Portfolio: $22,702m-$1,234,346m

Question 9

Why has there been an increase in portfolio investment into Aus compared to direct investment since the deregulation of the financial market?

Answer 9

Prior to the deregulation of the financial sector, most financial flows came into Australia in the form of direct investment as it brought benefits of job creation and technology transfer. Portfolio investment was not as important, as the level of overseas purchase of shares was small and overseas loans were not common.

After removal of restrictions on financial flows, Aus saw the benefit of attracting the growing flows of finance into the economy, injecting money into Australian companies through loans and share purchases.

Question 10

Why is Australia a net capital importer?

What are the reasons for this?

Answer 10

Because the level of foreign investment into Aus consistently remains above the level of Aus investment overseas.
This is because Aus has low levels of domestic savings so Aus must rely on financial flows from overseas.

Question 11

Outline trends in Aus net foreign liabilities since 2000.

Answer 11

Reduction in short-term debt and equity as a percentage of GDP. Approx. (15%-5%) and (10%- -10%) respectively.

Increase in long-term debt from approx. 23%-52%, 2000-2020.

Question 12

Define the BOP.

Answer 12

Record of the transactions between Aus and rest of the world during given period, consisting of the current account (CA) and the capital and financial account (CAFA).

Question 13

Define the current account.

Answer 13

Part of BOP that shows the receipts and payments for trade in G&S, transfer payments, and Y flows between Aus and the rest of the world in given time period. Non-reversible transactions.

Question 14

What are all the sections in the current account.

Answer 14

Goods - X, M, net goods
Services - service credit, service debits, net services
BOGS

Primary Y - credits, debits, NPY
Secondary Y - credit, debits, net secondary Y

Balance on CA

Question 15

Outline how net goods are calculated?

Answer 15

Difference between what Aus receives for its X and pays out for its M for goods.

Either in balance, surplus (receipts exceed payments) X>M, deficit (where payments exceed receipts) M>X

Question 16

Outline net services and how it’s calculated?

Answer 16

Services bought and sold without receiving “good” e.g. transport, travel, insurance.
Calculated by adding service credits - what Aus sells (inflows) to service debit - what Aus buys (outflows).

Question 17

How is BOGS calculated. What was the BOGS in 2019-2020?

Answer 17

Net goods + net services.

$77.4b surplus in 2019-2020.

Question 18

Define NPY and how it’s calculated.

Answer 18

Refers to earnings on I, i.e. Y earned from a factor of production. Covers interest payments, foreign investment and Y in the form of rent, profit, interests and dividends.
Consists of credits and debits.
Calculated by adding credits+debits.

Question 19

Define NSY giving 4 examples.

Answer 19

Refers to non-market transfers, i.e. Y not earned through a factor of production. Occurs when products or financial resources are provided without a specific good or service being provided in return.

E.g. payouts on insurance claims, pensions received by residents from foreign countries, workers remittances and funds from Aus to aid developing nations.
Calculated by adding credits + debits.

Question 20

How is the balance on the CA calculated. What was the CA balance in 2019-2020?

Answer 20

BOGS+NPY+NSY.

35.8b surplus 2019-2020

Question 21

What does the KAFA record?

Answer 21

Records borrowing, lending, sales and purchases of assets between Aus and the rest of the world. (reversible)

Question 22

What is covered by the capital account? Give specific examples.

Answer 22

Consists of non-produced, non-financial assets.

Capital transfers: mainly ‘conditional’ foreign aid grants and debt forgiveness. May be in form of assistance to other countries to build up infrastructure or capital stock
Entries for the purchase and sale of non-produced, non-financial assets – mainly intellectual property rights e.g. patents, copyrights, trademarks and franchises.

Question 23

Define the financial account. Does Australia have a positive or negative financial account and what are the implications of this?

Answer 23

Transactions in foreign financial assets and liabilities. Credit entries represent net inflows, debit entries represent net outflows.
Australia has a positive financial account. This means the rise in Aus liabilities to the rest of the world is higher than the increase in liabilities of the rest of the world to Aus, i.e. Aus draws on the savings of the rest of the world to finance a deficit on its current account.

Question 24

What are the five main components in the financial account?

Answer 24

Direct investment, portfolio investment, financial derivatives, reserve assets and other investment.

Question 25

Differentiate between direct and portfolio investment.

Answer 25

Direct investment is foreign financial transactions to fund new investment or buy more than 10% in an existing company.
Portfolio investment is the buying of land, shares and other marketable securities in existing companies.

Question 26

Why is the net errors and omissions category added to the CAFA in the BOP?

Answer 26

Net errors and omissions added to the CAFA figure to ensure the BOP sums to zero under a floating XR system. Consists of statistical discrepancies.

Question 27

Under a floating XR system, what is the supply and demand of the $AUD represented by?

Answer 27

Supply = Payments for M + Y debits + Capital and financial (K) outflows.

Demand = Receipts for X + Y credits + K inflows.

Question 28

What is the effect of a KAFAS on NPY?

Answer 28

CAFAS will result in a larger deficit on the NPY.

This is because any foreign financial flow that comes to Aus will result in earnings moving overseas which are recorded as a debit (outflow) under the NPY.

Question 29

What is the current account balance as a % of GDP in 2019-2020? What are the reasons for this?

Answer 29

Surplus - 1.8% of GDP.

This is due to a large increase in commodity prices from the mining boom in 2003, the Brazilian mining disaster in 2019, extremely low global i/r and the growth of the Chinese economy.

Question 30

Name 4 cyclical factors that affect BOGS and why.

Answer 30

XR - affects international competitiveness. Lower XR increases demand for X and decreases demand for M improving BOGS.

TOT - improvement in TOT means same X can buy more M which will usually lead to an improvement in BOGS.

Domestic eco growth - upturn will lead to higher consumption and thus imports will increase worsening BOGS.

IBC - slowdown will reduce demand and growth in Aus trading partners decreasing demand for Aus X, worsening BOGS.

Question 31

Define terms of trade. How is it calculated?

Answer 31

Measures the relative movements in the prices of an economy’s M and X over a period of time. If X prices are increasing relative to M prices, Australia’s terms of trade will improve and vice versa.

TOT= X price index / M price index x 100.

Question 32

Why does Australia rely heavily on commodity X?

Answer 32

Low international competitiveness in manufacturing so Aus must rely on overseas imports for manufactured goods.
Isolation from major economies such as Europe and America increase transport prices and reduces Aus international competitiveness.

Question 33

Outline trends in the NPY. What is Aus current NPY stance?

Answer 33

Usually records deficit of 2-3% of GDP.

In 2019-2020 the NPYD was 2.0% of GDP.

Question 34

What are the cyclical factors that affect the NPY and why?

Answer 34

Exchange rate: Movements in the XR will alter AUD value of debt denominated in foreign currencies - valuation effect.
Depreciation will increase AUD value of debt in foreign countries, increasing Aus interest repayments and worsening the NPYD.

Global and domestic i/r: will impact cost of servicing debt. Lower i/r lower interest repayments.

Domestic biz cycle: growth in Aus economy leads to higher equity servicing costs.`

Question 35

What are the effects of the decline in Aus and global i/r on the NPYD and debt servicing costs?

Answer 35

Decreased debt servicing costs to $19.6b in 2019-2020 and reduced the NPYD.

Question 36

What percentage of shares in Aus are foreign owned. What are the implications of this on the NPY.

Answer 36

Approx. 40%.

This means with an increase in domestic eco growth, equity servicing costs would increase such as dividends and profits to overseas shareholders. This would increase the NPYD.

Question 37

What is the main structural characteristic in the Aus economy that has led to a NPYD?

Answer 37

Aus high saving-investment gap (4% GDP last few decades).

This is because Aus major X industry; minerals and resources, requires high levels of I so international borrowing occurs.
This increases Aus foreign liabilities increasing interest repayments (on debt) and dividends (equity) and increases NPYD.

Question 38

Outline the 6 main consequences of an high CAD.

Answer 38

1. Growth in foreign liabilities
2. Increased servicing costs
3. Increased XR volatility
4. Constraint on future eco growth
5. Possible contractionary eco policies.
6. Loss of international investor confidence.