Foreign Investment

Question 1

What is the importance of foreign investment?

Answer 1

Australia has always relied on net inflow of foreign investment to develop its economy and to supplement its domestic savings.
The CAD and capital and financial account surplus occurs because Australia’s total investment exceeds its savings and we imports savings from the rest of the world.

Question 2

What is Australia’s net international investment position?

Answer 2

Australia’s net international investment position records the stock or level of foreign investment into Australia (FIA) and the level of Australian investment abroad (AIA).

Question 3

Describe what foreign liabilities and foreign assets are. Use examples.

Answer 3

Foreign investment into Australia is referred to as foreign liabilities while Australian investment abroad is known as foreign assets.
-A liability is something you owe.
-An asset is something you own.
E.g. If a US firm invests in the Australian share market= liability.
If an Australian firm buys shares in an overseas company= asset.

Question 4

As of June 2016, what did Australia’s net IIP stand at?

Answer 4

As of June 2016, Australia’s foreign liabilities stood at $3,213 billion and its foreign assets amounted to $2,177 billion. Therefore, Australia’s net international investment position was $1,036 billion. This was composed for net debt totaling $1,044 billion and net equity totaling $-8 billion.

Question 5

When are foreign liabilities created?

Answer 5

Foreign liabilities are created when Australian residents borrow money from overseas or sell assets, such as shares, to foreign residents. (Foreign investment= inflow of money).

Question 6

When are foreign assets created?

Answer 6

Foreign assets are created when Australian residents lend money to foreign residents or purchase foreign assets. (Investment abroad= outflow of money).

Question 7

Over the past 35 years what has increased faster; the rate of GDP or foreign investment into and out of Australia?

Answer 7

Over the past 35 years both foreign investment into Australia and foreign investment abroad have increased at greater rates than the rate of GDP.

Question 8

How do we determine Australia’s net international investment position (IIP)?

Answer 8

If we subtract Australia’s foreign assets from foreign liabilities, we are left with Australia’s net international investment position (IIP).

Question 9

What has happened to Australia’s net foreign liabilities over time?

Answer 9

Australia’s net foreign liabilities have increased over time, from around 47% of GDP in 1991, to 56% in 2015.

Question 10

What is the difference between foreign debt and foreign equity?

Answer 10

Foreign debt is borrowing (or lending if it is in assets). If Australian residents (households/governments/firms) borrow from overseas this increases foreign debt.
Foreign equity is wen Australian residents sell assets (or buy) to overseas residents. This increases foreign equity liabilities.

Question 11

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

Answer 11

Foreign liabilities represent foreign investment into Australia. Australia’s net foreign liabilities have increased over time from 43% of GDP in 1990 to 56% of GDP in 2016. As Australia’s economy grown, it relies on foreign investment.

Question 12

Why is foreign debt more popular than foreign equity?

Answer 12

Foreign debt has risen from 40% of GDP in 2001 to 64% of GDP in 2016. Equity has fallen from 9% of GDP in 2001 to -0.5% of GDP in 2016. This is because borrowing provides a far more flexible and prudent (safe) approach then selling ownership of one’s assets.

Question 13

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

Answer 13

The financial account records foreign investment INTO and OUT of Australia. When foreign residents incest in Australia, this increases our foreign liabilities. The income flows associated with foreign liabilities are recorded in the current account (as interest, profits) resulting in a large CAD. When Australian residents invest overseas, this increases Australia’s foreign assets. Australia’s foreign liabilities are greater then its foreign assets.

Question 14

Describe Australia’s liabilities in terms of its savings and investment position.

Answer 14

Australia uses foreign capital (and therefore has liabilities -> from the borrowed money) not because its national savings ratio is low, but because its investment ration is high. In the past decade, the national savings rate in Australia has averaged 22% (higher than the OECD average). Australia’s investment ratio, however, is higher than the OECD average- creating a savings gap that is filled by foreign savings.

Question 15

Explain why the level of public debt has risen since 2008.

Answer 15

Prior to 2008, the government’s share of foreign debt had been falling over time as the government was running budget surpluses. Since 2008-2009, the government has been in deficit and has had to borrow as government spending was greater than government revenue (impact of GFC).

Question 16

Why does Australia have a large foreign debt?

Answer 16

The reason why Australia has a large foreign debt is that Australia must use foreign savings to fund its national investment since its domestic savings are insufficient.

Question 17

What are all of Australia’s net foreign liabilities in the form of?

Answer 17

Currently, all of Australia’s net foreign liabilities is in the form of foreign debt.

Question 18

What is foreign debt?

Answer 18

Foreign debt is the amount of money that Australian residents, both public and private, owe the rest of the world.

Question 19

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

Answer 19

Net foreign debt is gross foreign debt minus Australian borrowing to overseas resident. Net foreign debt takes into account what Australia is OWED by foreign countries. Net foreign debt is currently around $1,044 billion.

Question 20

What was happening to the public debt level belonging to the government up until 2008? Why?

Answer 20

The public debt level belonging to the government has been falling up until 2008. This is because the government has been running budget surpluses and repaying all the debt.

Question 21

Is most of Australia’s foreign debt private or government?

Answer 21

Most of Australia’s foreign debt is private (76%).

The government’s share is 24%.

Question 22

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

Answer 22

This is because world interest rates declined over this period, reducing payment on leans. Additionally, Australia’s export performance has improved. By 2016, interest payments had fallen to 7% of export income.

Question 23

Why is Australia better off than other industrial economies with similar sized foreign debts?

Answer 23

Most of Australia’s foreign debt is PRIVATE debt (76%). The government’s share is 24%. Private debt is more likely to result in increased investment and therefore to increase future income to service the debt. This is because private debt is incurred with the profit motive as the guiding hand. A large government debt can be worse as it has to be paid back with taxpayer money and it is incurred for the purpose of welfare payments etc. (not to make profit). Also, a large proportion of Australia’s foreign debt is paid within a relatively short period of time.

Question 24

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

Answer 24

An important point to be aware of is that foreign debt is a stock variable -it represents the ACCUMULATION of debt over time, whereas GDP is a flow variable -it represents the increase in output from ONE YEAR TO THE NEXT. Measuring foreign debt as a proportion to GDP is therefore an inaccurate way to measure its relative importance. Foreign debt should be compared with another stock variable such as Australia’s total wealth.

Question 25

Explain why Australia’s net wealth is actually increasing.

Answer 25

Australia’s national balance sheet show that while Australia’s foreign liabilities have increased over time, so also has Australia’s assets measured in terms such as buildings, machinery and equipment, land, mineral resources, and financial assets with the rest of the world. Australia’s assets have increased at a faster rate than liabilities, so Australia’s net wealth/worth has been rising over time.

Since 2000, Australia’s liabilities increased by $2 trillion but total assets increased by $5.3 trillion. This means that Australia’s wealth over this time rose by $3.3 trillion.

Question 26

Under what circumstances might the foreign debt burden actually reduce?

Answer 26

• The terms of trade improve.
• The AUD appreciates
• World interest rates decline
• World growth rates increase

Question 27

What are pssible coasts associated with the growth in our debt?

Answer 27

• Australia’s credit rating may be downgraded which means that future borrowing may be subject to higher interest rates.
• Higher interest payment lower a nation’s standard of living as more income must be diverted from consumption.
• If the ToT deteriorate this will reduce export income so that the burden of debt increases.
• If the AUD depreciates this will automatically increase the size of the foreign currency denominated debt further increasing interest repayments.
• If the growth rates of our trading partners fall this will decrease our export income and increase the burden of the debt.

Question 28

What does foreign investment in Australia refer to?

Answer 28

Foreign investment in Australia refers to the stock of financial assets in Australia that are owned by foreign residents/businesses/governments and financial transactions in the BOP which increase or decrease this stock.

Question 29

Where are foreign investment flows recorded?

Answer 29

Foreign investment flows are recorded in the financial account of the balance of payments

Question 30

Why is Australia a net capital importer?

Answer 30

Australia has always been a net capital importer as we are a small nation in terms of population and can’t raise enough savings to facilitate the development of our resources.
-> Savings investment gap.

Question 31

List the four types of foreign investment?

Answer 31

Foreign direct investment.
Portfolio investment.
Financial derivatives.
Other investment.
Reserve assets.

Question 32

What is foreign direct investment?

Answer 32

Foreign direct investment occurs wen a foreign investor establishes a new business or acquires 10% or more of an Australian enterprise.
E.g. The establishment of Australian branches of multinational companies or joint ventures between Australian and foreign companies.
-Direct investment is thus associated with either ownership and/or control of Australian enterprises and resources.
-FDI’s account for 26% of total foreign investment.

Question 33

What is portfolio investment?

Answer 33

Portfolio investment refers to all other foreign investment that is not direct investment. In other words, when an overseas firm purchases less than 10% of the shares of an Australian company.
E.g. The purchase of property and/or shares in Australian companies as well as the purchase of government bonds by foreign superannuation or pension funds.
-Portfolio investment makes up 51% of total foreign investment.

Question 34

What are financial derivatives?

Answer 34

Financial derivatives are linked to a specific financial instrument or indicator, or to a particular commodity.

Question 35

What is other investment?

Answer 35

Other investment is a residual group that comprises many different kinds of investment.

Question 36

What are reserve assets?

Answer 36

Reserve assets are those external financial assets controlled by the Reserve Banks or the Australian Treasury for use in financing payment imbalances or intervention in foreign exchange markets.

Question 37

What are the target industries for the highest level of foreign investment?

Answer 37

• Mining 40%
• Manufacturing 12%
• Real estate activities 9%
• Finance and insurance 8%
• Wholesale and retail trade 7%

Question 38

What countries that are the greatest source of foreign investment into Australia?

Answer 38

United States- 24%
United Kingdom -10%
Japan -12%

Question 39

Why us Australia a popular target for foreign investment?

Answer 39

• The Australian economy represents a secure and safe haven for financial capital.
• The Australian economy is well-placed in terms of the fast-growing economies of east and south east Asia.
• In past decades, the Australian economy has been outperforming most OECD economies, including the US -> has contributed tot eh large inflow of foreign investment.
• Australian interest rates higher= attracts portfolio investors chasing high returns.
• Have a well developed and regulated financial market which offers low risk returns.
• Are a resource rich nation which depends on international investment to supplement its own domestic savings to enable it to develop its vast mineral and energy resources.

Question 40

What is the difference and relationship between foreign investment and ‘investment’?

Answer 40

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

Question 41

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

Answer 41

Being a component of aggregate demand, investment increases the level of economic activity, employment and national income. So, an increase in investment will shift the aggregate demand curve the right.
Investment also expands the productive capacity of the economy by increasing the stock of physical capital- in other words, it moves the economy’s PPC outwards. This means that an increase in investment will also shift the aggregate supply curve to the right.

Question 42

What would happen in the Australian economy if the flow of foreign investment funds declined?

Answer 42

If the funds from foreign investment were to fall, then Australia’s standard of living would decline since less goods and services (as imports) could be consumed.
Australia’s economic growth would decline because there would be insufficient savings to finance the economy’s capital needs.

Question 43

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

Answer 43

• Foreign investment increases the economy’s infrastructure, and by increasing the capital-labor ratio, productivity rises.
• Development of industry and resources.
• Australia’s current account is in deficit because imports of goods, services and income payments far exceed the export of goods and services and income receipts.
• A large surplus on the capital and financial account is required to finance the CAD.

Question 44

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

Answer 44

Argued that foreign control might conflict with government economic policy, and the profits would be siphoned back to the parent company.

Question 45

Why was the equity that dominated in the 1970’s seen as ‘evil’?

Answer 45

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

Question 46

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

Answer 46

As long as the foreign investment boosts Australia’s future productive capacity, then the servicing of the debt does not impose a problem.
However, a debt trap could occur if the economy was no longer growing and expanding.

Question 47

What is the advantage of direct investment and why is portfolio investment less advantageous?

Answer 47

Foreign investment in the form of portfolio investment can be short term and speculative, and therefore may be destabilising.
While direct investment has the advantage of being fairly long term, portfolio investment could be withdrawn at any time and is more short term and speculative.

Question 48

What factors influence the level of portfolio investment?

Answer 48

• The general state of the economy, the level of interest rates, government stability and performance of the share market are all factors affecting short term capital movements.
• Portfolio investment is a function of short term profitability and is highly sensitive to relative interest rates.
• The interest rate differential between Australia and the rest of the world plays an important role in the movement of portfolio investment in and out of the Australian economy.
• When interest rates in Australia rise relative to the rest of the world, then capital inflow in the form of portfolio investment increases.