Foreign Investment

Question 1

Foreign liability Definition

Answer 1

• An obligation, debt or responsibility owed to someone
• Foreign investment = Foreign Liabilities -> foreign equity + foreign debt
• foreign equity

Question 2

Foreign Debt

Answer 2

• Refers to the borrowings of governments, individuals and the private sector from overseas residents.
• Liability because original sum must be paid back plus interest payments.
• Australia has a large foreign debt bill because of low savings pool and large funds needed to finance our investment projects.
• The media dramatise debt as a national crisis, however this is not a concern.
• This debt is used for projects which increase the nation’s production, output employment and living standards.
• Foreign debt is also referred to as external debt.
• Debt includes borrowing (of individuals), debentures (of companies) and bonds (of governments).

Question 3

GFD

Answer 3

• Gross Foreign Debt

- Total of Australia’s borrowings

Question 4

NFD

Answer 4

Net Foreign Debt is GFD minus lending to overseas residents and is hence a better indicator of Australia’s debt position.

Question 5

Foreign Investment into Australia

Answer 5

• Is the stock of financial assets in Australia owned by foreign residents.
• May be in the form of shares owned in a company, the actual ownership of a company or giving a company to the government a loan (debentures and bonds).
• These bonds and debentures are foreign debt.
• Foreign investment is a liability because Australia must pay back interest on the debt investments and dividends and profits on the equity investments.

Question 6

Direct Investment:

Answer 6

• Is investment into an overseas or Australian company or even a takeover of a company
• where the investment is large enough to have a significant degree of ownership into the company (more than 10%).
• Once more than 10% ownership is claimed, you have a say in how the company is run and operated. In 2011, this comprised of 22% of foreign investment.

Question 7

Portfolio Investment:

Answer 7

Investments which do not give you a say in a company’s operations.

This includes the exchange of shares, debentures and bonds between Australian and overseas residents.

In 2011, this comprised of 57% of total investment.

Question 8

Other investment:

Answer 8

Loans to individuals, fixed term deposits, currency exchanges and gold exchanges between countries.

21% of total investment.

Question 9

Explain the relationship between the current account outcome and foreign liabilities.

Answer 9

The foreign liabilities that are all contained within the Balance of Payments all are situated in the financial account.

Foreign liabilities are credits because when Australia borrows we are receiving money to use and when foreigners invest in our companies, they are injecting funds into our economy.

We do have to pay back the loans with interest and pay dividends to foreign investment; these are recorded as debits in the current account (income section).

The relationship between the CAD and foreign liabilities is that the more debt and equity we acquire, the more interest and dividends we must pay back and hence the income deficit will get larger and hence the CAD will get larger.

Some worry that these income payments will drain the economy and will cause an unsustained CAD.

This is incorrect as Australia borrows funds to increase its production and future profits, which always has an income and goods deficit.

Hence, the KAS fuels the CAD.

Question 10

Account for the extent of and recent trends in Australia’s foreign investment

Answer 10

• Has grown over the past 20 years.
• Therefore total foreign investment is a surplus in the financial account.
• Portfolio investment is the dominant type of foreign investment in Australia accounting for nearly 60% of the total.
• Most foreign investment is in the form of debt securities (65%) with equity comprising the other 35%.
• Debt is more popular than equity because Australia would rather borrow money and still have ownership of assets rather than sell a portion of their assets and have less control in operations.
• Mining has the highest level of foreign ownership (equity) and hence the most direct foreign investment. The finance industry borrows heavily because of Australia’s low savings pool.
• This foreign investment comes from the USA and the UK who are the two biggest sources for Australia.
  These two countries are large investors and are the largest investors in our economy (totalling to 52%)

Question 11

Experts believe that Australia is perfect platform for investment due to the following

Answer 11

• Australia is the most resilient economy in the world
• AAA credit rating
• GDP and productivity rates are higher than the average of other developed countries
• Abundance of natural resources
• Stable political environment
• Highly skilled workforce
• Good IT and infrastructure
• Competitive business costs
• High standard of living

Question 12

Account for the extent of and recent trends in Australia’s foreign debt.

Answer 12

• Largest part of our foreign investment.
• Most of this debt is private debt
• Australia had debt because we prefer to borrow rather than sell overseas. Australia is also a country with a low savings pool that is not sufficient enough to finance the countries investment requirements.
• Therefore we must obtain the funds from overseas.
  Private debt is considered to be far more superior to public debt in that it is acquired with a profit motive as the major driving force.
• Private debt is more likely to result in increased investment and therefore to increased future income.
• Government debt on the other hand, could result in a burden on future generations if it is used to fund current consumption rather than public infrastructure.
• Government debt about 25%

Question 13

Benefits and cost of foreign debt

Answer 13

• When borrowing is used for investment, living standards rise.
• Wealth is assets minus liabilities. Australia’s foreign debt is rising but so is our wealth. Wealth in terms of assets owned include buildings, livestock, machinery,
  equipment and financial assets (shares).
• Australia has debt to expand Australian industries through increased production, output and employment which leads to economic growth and higher standards of living.
• Australia’s debt is mostly private debt which is a benefit because there is a profit motive behind it.
• The key is to ensure that debt is not excessive as a country would collapse if a recession hit and debt levels were too extreme.

Critics would argue the following:
-> Australia’s credit may be downgraded which means future borrowing will be subject to higher interest rates.

• > Higher interest payments lower a nation’s standard of living as more income must be diverted from consumption.
• > If the $AUD appreciates this will lead to higher interest payments.
• > If China goes through a recession and decreases exporting from Australia we will need to borrow more to finance our imports.
• > The terms of trade could deteriorate again reducing export income meaning we need to borrow to finance our imports.
• > In all of these instances, the opposite would occur is the $AUD went up, China improves or our terms of trade improves.

Question 14

Benefits and cost of Foreign Investment:

Answer 14

• Media often contradict themselves when that claim that foreign investment into the country is highly beneficial but our foreign debt is a major concern.
• This is ironic because foreign debt is the major component of foreign investment.
• Hence, a lot of the cost and benefits associated with foreign debt are the same with foreign investment.
• COSTS
• > Direct investment involves a loss of control and ownership of Australian resources.
• > Decision making can occur overseas without consideration of the interests of Australians and can lead to public hostility (e.g. Vegemite going offshore).
• > Dividend and profit payments flow overseas and out of the domestic economy creating a net leakage and adding to the net income deficit of the current account.

-> Some portfolio investment is short term and speculative.
Some investors only invest to make quick money and funds leave as quick as it arrived. This is no benefit to the economy.

• BENEFITS
• > Allows us to operate projects we would otherwise be incapable of running as we do not have the savings to fund these expensive operations.
• > Boosts domestic employment, production and income which leads to economic growth and increased standards of living.
• > New investment from overseas brings with it new ideas in management practices or introduces new technologies and knowledge that leads to increased productivity in the workforce.
• > Foreign investment provides funds to finance our CAD and helps us pay for our imports – specifically capital imports.