Foreign investment

Question 1

What is net international investment position?

Answer 1

The position we are left with when we subtract Australian foreign assets from our foreign liabilities (what we own – what we owe)

Question 2

What is a liability?

Answer 2

Something you owe

EG. A foreign resident investing in an Australian firm

Question 3

What is an asset?

Answer 3

Something you own

EG. An Australian resident purchasing shares in a US company

Question 4

Stats for June 2014 (foreign liabilities/assets and NIIP)

Answer 4

• Foreign liabilities = $2,609.7 billion
• Foreign assets = $1,745.5 billion
• Net international investment position = $864 billion (liabilities)

Question 5

What does foreign investment into Australia create?

Answer 5

Creates a foreign liability because we have to pay it back

Question 6

What does Australian investment abroad create?

Answer 6

A foreign asset because the money belongs to us and we will receive future payments.

Question 7

Australia’s net foreign liabilities (% of GDP)

Answer 7

55%

Question 8

What do foreign liabilities represent?

Answer 8

Represent foreign investment into Australia which has enabled Australia to develop and grow overtime, increasing our national income and standard of living

Question 9

What is foreign debt?

Answer 9

Australian residents borrowing from overseas

Question 10

What is foreign equity?

Answer 10

When Australian residents sell assets to overseas residents

Question 11

Stats in 2014 (foreign debt/equity)

Answer 11

• Net foreign liabilities = $2,609 billion
• Net debt = $1,692 billion
• Net equity = $917 billion

Question 12

Why does the level of Australia’s net foreign liabilities increase each year?

Answer 12

• This is because, as the economy grows, we require more foreign investment.
• Australia’s net foreign liabilities have increased from around 43% of GDP in 1990 to 55% of GDP in 2014
• Increased foreign investment, increases standard of living

Question 13

Why is foreign debt more popular than foreign equity?

Answer 13

• Most of our liabilities come from debt
• Net foreign debt has increased from 40% (2000) to 55% (2014), while net foreign equity has fallen from 10% to zero
• This is because borrowing provides a par more flexible and prudent (safe) approach than selling ownership of one’s assets

Question 14

What is the relationship between foreign liabilities recorded on the capital and financial account and the payment of these liabilities recorded on the current account?

Answer 14

• The financial account records foreign investment into and out of Australia
• Foreign investment increases our foreign liabilities
• The income flows associated with foreign investment liabilities (servicing costs) are recorded on the current account (interests and profits) and result in a large primary account deficit in Australia’s current account

Question 15

How do current account deficits reflect the gap between national investment and national savings?

Answer 15

• Higher foreign investment to substitute the lack of national savings leads to an increase in the nation’s capital stock.
• This will expand the economy’s productive capacity and provide for future income growth that will help service the current deficit.
• Therefore, running a current account deficit can lead to increasing a country’s national wealth and standard of living over time.

Question 16

Explain Australia’s liabilities in terms of its savings and investment positions

Answer 16

• As a nation, we have a small pool of savings funds and we require a large amount of investment.
• Therefore, we rely on foreign investment
• We use foreign capital, not because our domestic savings ratio is low, but because our investment ratio is high.
• In the past decade, the national savings rate in Australia averaged 22% (higher that the OECD average of 21%)
• Over the same period, the investment ratio averaged 27% (above the OECD average of 21%)

Question 17

What is foreign debt

Answer 17

The amount of money that Australian residents, both public and private, owe to the rest of the world

Question 18

How is net foreign debt a better indicator than gross foreign debt?

Answer 18

• Gross foreign debt is the total of Australia’s overseas borrowing.
• Net foreign debt is gross foreign debt minus our lending to overseas, giving us a better indication of our liabilities

Question 19

How much of our debt is private debt?

Answer 19

74%

Question 20

Government debt position before 2008

Answer 20

The government was running a budget surplus and repaying the debts

Question 21

What happened to the level of public debt after 2008?

Answer 21

• The government’s budget has been in deficit
• Due to the impact of the GFC
• This led to a contractionary period, causing the budget balance to automatically fall as spending rose and the government was forced to borrow funds
• As the economy recovers, the budget deficits fall and move into surplus enabling the government to pay back its debt

Question 22

Why has the interest payment burden reduced (as a % of export income) even though our foreign debt has increased?

Answer 22

• The interest has fallen has fallen significantly over time
• This is due to world interest rates declining since 1990 (therefore reducing payments on loans)
• Australia’s export performance has improved
• By 2014, interest payments have fallen to just 7% of export income

Question 23

How long does it usually take for Australia to pay back it’s debt?

Answer 23

A large proportion of Australia’s debt is paid within a very short period of time

• In 2014, one third of the foreign debt was repaid within a year
• 70% was due to be paid within 5 years

Question 24

Explain why Australia’s foreign debt has increased, while foreign equity has fallen

Answer 24

• This reflects the accumulation of debt over time resulting from continued current account deficits
• Over the past decade, foreign equity has fallen, while foreign debt has increased.
• This is because Australian firms prefer to borrow rather than sell their assets
• This has resulted in an increase in foreign debt as a proportion of GDP

Question 25

Why is Australia better off than other countries which have similar sized foreign debt?

Answer 25

• Our private debt is a lot larger than our public debt
• Australia is one of a number of industrial economies with net foreign debt around 50% or more of GPD
• Government sector debt is only 25% of GDP
• Private sector debt is considered to be superior to government debt because it is more likely to lead to future income in order to service the debt
• Government debt could also result in a burden for future generations

Question 26

Why is the measurement of foreign debt as a % of GDP inaccurate?

Answer 26

• Foreign debt is a stock variable and reflects the accumulation of debt overtime
• GDP is a flow variable; it represents the increase in output for one year
• Measuring foreign debt as a proportion of GDP is therefore an inaccurate way of measuring its relative importance
• Foreign debt should be compared to another stock variable such as Australia’s total wealth

Question 27

Why is Australia’s net wealth is increasing?

Answer 27

• Australia’s foreign liabilities have increased overtime, as well as Australia’s assets measured in terms such as buildings, machinery and equipment, land, mineral resources, forest and financial assets.
• Australia’s assets (not foreign assets) have increased at a faster rate than liabilities, causing Australia’s net worth or wealth to rise overtime
• Since 2000, Australia’s liabilities have increased by $1,130 billion
• Total assets increased by $3,431 billion
• This means that Australia’s wealth over this time rose by $2,301
• Per capital wealth has also increased

Question 28

What are the potential costs with the growth in our foreign debt? (SIX)

Answer 28

• Australia’s credit rating may be downgraded which means that future borrowings will be subject to higher interest rates
• Higher interest payments lower nation’s standard of living as more income must be diverted from consumption to debt payments
• If the terms of trade deteriorate this will reduce export income so that the burden of debt increases
• If the $A depreciates, this will automatically increase the size of foreign currency denominated debt, further increasing interest payments. When we pay it back, the interest payments increase because the dollar isn’t strong
• If the growth rates of our trading partners fall, this will decrease our export income and increase the burden of the debt

Question 29

What are the circumstances where the burden of foreign might reduce?

Answer 29

• The terms of trade improve
• The $A appreciates
• World interest rates decline
• World economic growth increases
• If debt results in a higher rate of economic growth and a higher level of investment, the economy will gain.

Question 30

What is foreign investment?

Answer 30

Refers to the stock of financial assets in Australia owned by foreign residents, and financial transactions in the balance of payments which increase or decrease this stock.
- This occurs when a foreign individual or business decides to establish a new business in Australia or purchase property or shares in an Australian owned business

Question 31

What does foreign investment into Australia equal

Answer 31

Gross foreign debt + foreign equity

Question 32

Why do we rely on foreign capital?

Answer 32

• to boost domestic savings
• Australia is a small nation in terms of population
• We cannot raise enough savings to facilitate the development of its resources
• Enables Australia’s living standards and rate of economic development to be much higher

Question 33

Show how foreign investment in Australia has increased

Answer 33

Increased from $800 billion in 2000 to just over $2,6000 in 2014

Question 34

What are the types of foreign investment?

Answer 34

• Direct
• Portfolio
• Financial derivatives
• Other investment
• Reserve assets

Question 35

What are financial derivatives?

Answer 35

Linked to a specific financial instruments or indicator, or a particular commodity

Question 36

What is direct foreign investment?

Answer 36

• Occurs when a foreign investor establishes a new business or acquires 10% or more of an Australian enterprise.
• This 10% provides the foreign investor with a ‘significant influence’ over that enterprise.
• Examples include Australian branches of multinationals or joint ventures between Australian and foreign companies.
• FDIs account for 26% of total foreign investment

Question 37

What is portfolio investment?

Answer 37

The dominant type of foreign investment

• Accounts for 56% of foreign investment
• All other investment that is not direct investment
• When an overseas firm purchases less than 10% of the shares in an Australian company
• Does not result in foreign control of Australian enterprises
• EG. Purchases of property/shares or government bonds by foreign residents
• Comprises of both equity (35%) and debt securities (65%) (borrowing)

Question 38

What are reserve assets?

Answer 38

External financial assets controlled by the reserve bank or Australian Treasury

Question 39

What is other investment?

Answer 39

A residual group that comprises of many different kinds of investment

Question 40

What are the main influences on foreign investment into Australia?

Answer 40

• Profit expectations, interest rate differentials and political stability
• The Australian economy is well paced in terms of the fast growing economies of east and south-east Asia
• The past decade has seen the Australian economy out performing most of the OECD economies (including USA)
• Australian interest rates have been relatively higher than most other developed economies which attracts portfolio investment chasing high returns
• Australia has a well-developed and well regulated financial market which offers investors low risk returns

Question 41

What is the main industry that attracts foreign investment?

Answer 41

The mining industry - 37%

Question 42

Which countries provide the largest source of foreign investment into Australia

Answer 42

The Unites States
The United Kingdom
Japan

Question 43

What is the difference between investment and foreign investment?

Answer 43

• Investment refers to the creation of capital goods.
• Foreign investment is the flow of funds, some of which may be used to finance investment and some of which may be used for speculative purposes.

Question 44

How does investment expenditure influence both the level of demand and the level of supply in a nation?

Answer 44

• Investment expenditure is a component of aggregate demand
• It increases the level of economic activity, employment and national income (causing a shift of the aggregate demand supply curve to the right)
• Investment also expands the productive capacity of the economy by increasing the stock of physical capital (moves the PPF outwards)
• This means that investment will also shift the aggregate supply curve to the right

Question 45

What are the key productive benefits of foreign investment into Australia?

Answer 45

• Boosts GDP and employment

- It increases the economy’s infrastructure, and by increasing the capital to labour ratio, productivity rises.

Question 46

What are the effects of a decline in the flow of foreign investment in the Australian economy?

Answer 46

• Australia’s standard of living would decline since less goods and services (imports) could be consumed.
• Australia’s economic growth would decline, as there would be insufficient savings to finance the economy’s capital needs.

Question 47

What are the advantages to foreign direct investment as opposed to portfolio investment?

Answer 47

• Direct foreign investment brings with it new technology and managerial expertise
• Most of the foreign investment comes from the US, UK and Japan
• Their technological know-how and managerial skills can improve long-term efficiency
• Overseas firms establishing new subsidiaries will directly add to employment and contribute to increased taxation revenue for the government
• A large % if profits are also retained and invested back into the enterprise
• Foreign investment in the form of portfolio investment can be short term and speculative and therefore less advantageous

Question 48

What are the factors that influence the level of portfolio investment in the Australian economy?

Answer 48

• Portfolio investment is a function of short term profitability and is therefore highly sensitive to relative interest rates
• The interest rate differential between Australia and the rest of the world plays an important role
• When interest rates in Australia rise relative to the rest of the world, then capital inflow in the form of portfolio investment increases

Question 49

What is the main cost of foreign investment in the form of equity investment?

Answer 49

• When most of capital inflow was in the form of equity (1970s), the major concern was the ‘selling’ of Australian assets
• There was a fear that the profits would go back to the parent company

Question 50

Is it possible for Australia to fall into a ‘debt trap’?

Answer 50

• As long as foreign investment boosts Australia’s future productive capacity, then servicing the debt does not impose a problem