Topic 2 Flashcards
Direct investment
establish company, or purchase sustained proportion of shares in existing comp. (10% more). Its long term, with investor intending to manage biz
Portfolio investment
loans, other securities, smaller share holdings. Shorter term more speculative
Net foreign liabilities
net foreign debt + net foreign equity
Balance of Payments
record of financial transactions between Australian residents and the rest of the world during a given period, consisting of the current account and the capital and financial account
Current Account
shows the receipts and payments for trade in goods and services, income flows and non- market transfers in a given time period (1 year) These are non-reversible transactions.
Balance on goods and services (BOGS)
the amount that is derived by adding net goods and net Can be indicator of economic performance, i.e (X – M) component of Aggregate Demand.
Net Primary Income (AKA income)
covers earnings on investments and are debt servicing costs. It covers interest payments and returns on other foreign investments through dividends, profits and income. This component is the major component of Australia’s persistent current account deficit
Net Secondary Income (AKA current transfers)
non-market transfers; when products or financial resources are provided w/out a specific product provided in return, relatively small/technical.
Capital and Financial Account
records the borrowing, lending, sales and purchases of assets between Australia and the rest of the world. These transactions are reversible.
Capital account
consists of 2 parts
capital transfers- conditional foreign aid
purchase and sale of non produced + non financial assets- intellectual property rights
Financial account
Australia’s transactions in financial assets and liabilties
Direct Investment
Portfolio Investment
Financial Derivatives (Options, futures, swaps)
Other Investments (trades, loans, currency, deposits, financial leases, etc)
Reserve Assets (gold, exchange)
Supply of $A is represented by
▪ Payments for imports of G&S (M)
▪ Primary and secondary income/transfers to overseas (Y debits)
▪ Capital and financial outflow (K outflow)
Demand for $A is represented by
▪ Receipts for exports of goods and services (X)
▪ Primary and secondary income/transfers from overseas (Y credits)
▪ Capital and financial inflow (K inflow)
how Financial inflows can create debits in two ways
- International Borrowing (Debt): requires regular repayments. The payments after the repayment of the principal (original amount borrowed) shows up on the NPY.
- Foreign Investment (Equity): requires rent, dividends and profit. Investment goes into the KAFA because it is transferable. Dividends/rent/profit go into the NPY
cyclical factors
go up and down with business cycle
structural factor
underlying or persistent
Terms of trade
ratio of the export price index to import price index
relationship between prices aus receives for its x and its prices it pays for m
Terms of trade formula
(X price index / I price index) x 100
BOP constraint
the extent to which an economy’s capacity to grow is constrained by the need to prevent CAD worsening
Exchange rate
the price of Australia’s currency in terms of another currency
Trade Weighted Index
A measure of the value of the AUD against a basket of currencies of major trading partners. Weighted according to the significance of Aus’s trade flows.
Fixed rates
government determines exchange rate for a period of time
***Another way is to change rate ‘officially’, so its closer to market value (devalue/revalue)
• Advantages
o Certainty of short term value of the exchange rate
o Eases volatility (aiding exporters, importers, investors and policy makers)
• Disadvantages
o Encourage speculation
o RBA needs to hold large foreign exchange reserves
***unsustainable as they exhaust a country’s foreign currency and gold/ silver reserves
o Does not react to external structural changes
Managed rates (dirty float)
government intervenes to influence rate or set rate for short periods
• RBA ‘pegs’ value each day (depending on current market forces)
• Advantages
o More flexibles
o Eases volatility (aiding exporters, importers, investors and policy makers)
• Disadvantages
o May lead to drift away from what rate should be – overvalued/undervalued rate
o RBA needs to hold large foreign exchange reserves
• ***unsustainable as they exhaust a country’s foreign currency and gold/ silver reserves
Flexible/ floating (clean float)
market forces of S/D determine exchange rate
• Advantages
o Increase international competitiveness
o Price determined by the market which reflects on factors including economic growth, unemployment, BOP and inflation
o Independent & effective monetary policy
o Consistent with trading partners
• Disadvantages
o Increase volatility
o Increase speculation
managed fixed peg
central bank changes the level of exchange rates each day depending on the market forces
^ in CAD
^ supply –> depreciation
^ CAFA
Appreciation
^M
= ^ CAD –> ^ supply –> depreciation
Describe Australias Trend from 1950-now
1950’s
UK: Due to colonial ties
UK joined EU
1960 -1970’s
Japan / US: due to high economic growth in Jap + demand for production inputs (minerals, energy products)
Japan suffer from AFC
1990 - 2000s
China: became largest trading partner (2007)
2010s
China / East Asia Pacific Region (ASEAN)
Future: South East Asia – India (^ 55% 2016-2017)
Composition of Australia’s exports
- Primary industries (commodiities) have always been the main focus of Australia’s exports (mining exports + agricultural = 2/3 of $X)
- Last 15 years - Mineral and energy exports + service (education & tourism) have increased in relative importance while agriculture + manufacturing has decreased
composition of Australia’s imports
intermediate goods
3 types of financial flows
- Speculative
- Foreign investment into Australia
- Borrowings by Australia which add to the foreign debt
• Australia: ‘net capital importer’ because:
o investment into Australia > than Australia investment overseas
o low level of domestic savings; relies on foreign investment
♣ Household savings rate: 2.5 (Jan 2019)
TNC affect KAFA trends
^ equity outflow and ^ debt inflow
***GFC ^ equity INFLOWs and V borrowing
Trends to Today
- Rate of growth in financial flows has been greater than growth in trade
- Portfolio investment (<10%) x 2 speed of FDI (> 10%) (since 1980s)
o Due to deregulation of financial market (1980)
-Floated exchange rates
-Technological advancements facilitated international financial flows
-Restrictions on capital movements removed
o Portfolio > FDI (2018)
Balance of payments structure
Current Account (Non - reversible) Balance on Goods and Services (+12%) Net Exports • Net Goods • Net Services
Net Primary Income (earnings on investment) • Interest • Dividend • Rent • Profits / Wages Net Secondary Income (non-market transfers) • Eg. unconditional foreign aid, sending money to relatives overseas, pension arrangements
Capital and Financial Account (Reversible)
Capital Account
• Non-commercial capital transfers (Foreign aid)
• Net acquisition / disposal of non-produced + non-financial assets (intellectual property)
Financial Account
• Direct Investment
• Portfolio Investment
• Financial Derivatives
• Other Investments
• Reserve Assets
Balance on Goods and Services
difference between exports and inmports
***BOGS = Total Exports – Total Imports = Net goods + Net Services
Net Primary Income
difference between income received from overseas and income paid overseas
Net Secondary Income
(non-market transfers)
Money transfer between countries
Eg. unconditional foreign aid, sending money to relatives overseas, pension arrangements
Capital Account
Non-commercial capital transfers (Foreign aid)
Net acquisition / disposal of non-produced + non-financial assets (intellectual property)
transfer of assets - migrants bringing wealth into country
selling of patents, copyrights, embassy land
Financial Account
Government and RBA transactions with the rest of the world eg
• Financial Derivatives
• Reserve Assets
Direct Investment/ Portfolio Investment and Other Investments
supply of aud =
demand of aud
(M-X) + (Y debits – Y credits) =
K inflow – K outflow
Deficit on the CA =
Surplus on the KAFA
Two measures of foreign debt
gross foreign debt ( total borrowings by australia residents from non residents)
net foreign debt (gross debt - australias holdign of foreign reserves/gold, overseas lendings made by australians)
**net foreign devbt is most accurate measure of external debt
Strongest link between CA/KAFA
primary income
Any foreign financial inflow (recorded on KAFA) that comes to Australia must earn some kind of return for its owner, earnings are debit (outflow) (recorded on the NPY in CA).
Financial inflows can create debits (2)
- International Borrowing (Debt): requires regular repayments. The payments after the repayment of the principal (original amount borrowed) shows up on the NPY
- Foreign Investment (Equity): requires rent, dividends and profit. Investment goes into the KAFA because it is transferable. Dividends/rent/profit go into the NPY
High level KAFA surplus/ widening of CAD (^foreign debt/ equity) may
debt trap: economy borrows more overseas to pay interest servicing costs on its existing foreign debt.
trends in the size and composition of Australia’s Balance of Payments
• BOP indicator of economy’s health
o watched by financial markets and influences business confidence and financial investors
• Calculated as a % of GDP
o CAD been between 3-6% of GDP from 1980’s (3.10% of GDP in 2017)
• CAD result of 2 factors BOGS and NPI
o both affected by cyclical and structural factors
3 top aus competitiveness
financial market development
higher education and training
health and primary education
all top 10
BOGS clyclical factors 4
***major cyclical component of CAD Exchange rates (GFC: VM spending = ^ BOGS) International competitiveness (affected by relative interest rates, inflation rates, future expectations, demand for exports) • Changes in strength of AUD can influence level of X’s & M’s o Depreciation less imports & more exports = positive effect on BOGS • Higher TOT reflects ^ in demand for our exports and therefore = ^ demand for our dollar (causing an appreciation) o Improved TOT = same volume of X can buy more M iimproved BOGS (decreased CAD) o Weakens international competitiveness of our non-commodity exports
Terms of trade (2011 TOT BOOM 140 peak = ^ BOGS)
• ^TOT = X demand > M demand improve BOGS
o 2000’s: global commodities boom increased demand for Australia’s raw materials
o Received higher prices for X
o Rise of China and other low-cost economies flooded the world markets with low cost manufactured goods reduced import prices ^TOT
o ^92.7 (2018)
Domestic growth
High growth high demand for M (worsening CAD & BOGS)
• Mining boom (2003) high disposable incomes & high growth in investment poor BOGS performance
• Since GFC I v and household savings ^ (BOGS surplus)
International business cycle
High growth high demand for X (improving CAD & BOGS)
***Australia has been closely integrated with faster developing countries which has been key to economic success
BOGS STRUCTURAL FACTORs 4
Narrow Export Base
Primary industries (minerals and agriculture - 2/3 of export base)
• Contribute to large fluctuations in the BOGS from year to year
o Need to densify to reduce volatility (towards high growth sectors – ETM’s)
Capacity constraints
X volumes slow (eg. time lag constructing new mines, railway and shipping facilities)
• infrastructure bottlenecks lower X volumes = lower production
^ in global prices for agricultural X’s
more competitors from developing countries + increased protection to protect local industry
• Australia would benefit from diversifying its X base towards high growth
Climate Change
Demand from non-renewable resources to renewable resources lower demand for Australia minerals
• Important to diversify due to environment concerns Australia’s dependence on carbon intensive exports
Dutch Disease
growth in one export industry results in a higher exchange rate, and slowly chokes off other export industries as they lose their international competitiveness.
low TOT
V $ export / ^ import price
^ IC = ^ revenue BOGS
Net Primary Income
Cyclical Factors 3
Exchange rate Higher AUD means cheaper interest payments, improving CAD ***Valuation effect has little impacts: • over 60% of debt is denominated in AUD • Most foreign debt is ‘hedged’
Domestic/ Global interest rates
Changes to Interest rates impact the cost of servicing foreign debt
• Debits determined by rates of other countries, credits determined by domestic rate
Domestic business cycle
Strong growth ^dividends paid overseas ^CAD (eg. NPY debits)
Net Primary Income
Structural Factors 2
***major structural component of CAD
GFC: V profits + V IR + ^ savings = ^ NPY
Savings/investments gap Low saving base lots of investment required in Australia which cannot be provided domestically high foreign liabilities • GFC savings rate was 12.5% • 2.5% (Jan 2019) v overseas investment v NPY credits
Government Budget Deficit and Debt
Consequences of a high CAD 7
Growth of foreign liabilities
if the CAD rises to high or fast, foreign investors may become more reluctant to lend to lend/invest to Australia
Increased servicing costs
^ outflows in the primary income account deterioration of the CAD. ^ foreign liabilities = demand a risk premium (^ interest rates)
Increased volatility with exchange rates
high CAD may lead to an undermine in investor confidence v demand for AUD depreciation)
Constraint on future economic growth
High CAD = speed limit on economic growth. (since ^ growth generally ^ M and deterioration of the CAD)
BOP constraint
Must limit growth to level where CAD is sustainable
More contractionary policy
to reduce economics growth & reduce CAD in short term (tightening of fiscal and monetary policies)
Loss of international investor confidence
sudden shift in attitude of global markets can trigger economic crisis
evaluation of cad
- Due to Australia’s sustained economic growth financial markets are willing accept external imbalances + confident Australia’s natural resource wealth will continue strong export growth in future service its foreign liabilities
- Regardless, CAD is still a long-term risk – ongoing strain on external account takes Australia dependent on financial inflows to pay foreign liabilities.
Pitchford thesis
Pitchford thesis
aka consenting adults theroem
thesis stating that a large CAD is not a problem as due to a KAFAS, there are funds from overseas which supplement domestic funds to enable higher investment and hence economic growth
Exchange rate movements impact on 4
a) International competitiveness
b) Trade flows
c) Investment decisions
d) Inflation
measurement of relative exchange rates
to other individual currencies
Bilateral/cross exchange rates: Price of one currency in terms of another
Exchange occurs in Forex market where S/D (or government, in the case of fixed exchange rates) determine the price of one currency in terms of another
***A comparison to one country can be a misleading impression of the trends in AUD value (eg. U.S dollar declined significantly during 2000 and Australia’s rose)
Trade Weighted Index
• TWI: measure of value of $AUD against a basket of foreign currencies of major trading partners.
• Limitation of the TWI measurement of exchange rate movements:
o weighted according to volumes of trade REGARDLESS of currency in which export and import contracts are invoiced in (not as accurate)
♣ Most of our trade is in USD (¾ X and ½ M) AUD/USD is far more important than the weight it receives in the TWI *** US is not largest MTP
o Countries more prominent in Australia’s trade get a higher weighting and therefore higher influence on TWI. Countries weighted towards significance to the Australian economy (trade flows – China)
But shows lvl of competitivess
TWI figures
o Renminbi: 27.7%
o USD: 10.9%
increase/ decrease of TWI
^ twi = appreciation
v twi = deprecaition but ^IC
Demand of AUD
Consumers Demand for X • Changes in commodity prices and TOT • Global economic conditions • Intentional Competitiveness • Inflation • Taste & preference
Investors Size of financial inflows (^ = ^D): • Interest rates domestic/ overseas • Investor confidence • Investment opportunities
Speculators
• Speculation/ expectations for appreciation of AUD
Supply of AUD
Consumers Demand for M • Intentional Competitiveness • Taste & preference • Level of domestic income
Investors Size of financial outflows (^ = ^S) • Interest rates domestic/ overseas • Investor confidence • Investment opportunities
Speculators
• Speculation/ expectations for depreciation of AUD
factors causing appreciation
^ domestic IR /V overseas IR
^ dm investment opportunities / V OS investment opportunites
^ commidity prices / ^ TOT
^ IC
V inflation
^ Demand
expectation of appreciation
Australiia exchange rate system
- Prior 1976 – fixed exchange rate
- 1976 -1983 – ‘managed flexible peg’
- 1983 onwards – floating exchange system
Dirtying the float
RBA buys securities, increasing the supply of AUD, causing the AUD value to decrease and hence depreciation
Monetary policy decisions
High interest rates -> increased D for AUD
• Highly unusual for monetary policy to be used this way
exchange rate relationship w BOP
• Net outflow in CA (AUD supply) = net inflow in KAFA (AUD demand)
Thus, if CAD increases supply of AUD increases depreciation increase in KAFA
• BOP also influences exchange rate regarding perceptions (less/more willing to invest)
o IF CAD too high less willing to invest v demand for AUD
• ***Most significant exchange rate influence is how financial market react to BOP
Positive Effects of appreciation 4
- Greater purchasing power (Australian consumers can buy more goods with same level of income) = ^Living standards
- V interest servicing cost on Foreign debt (because Australians can buy more foreign currency with AUD reduces outflow on NPI (help reduce CAD in long term))
- v Inflationary pressures (as imports become cheaper reduces need) for RBA to use monetary policy
- Reduce $A value of foreign debt borrowed in foreign currency (valuation effect) + IR repayments = ^BOGS
Negative Effects of appreciation 6
• Exports more expensive decreased export income (deterioration of CAD)
• Lower import cost = ^ import spending = worsens CAD and decreases domestic production
• Lower export revenue + higher import receipts = reduce economic growth rate
• Makes foreign investment into Australia more expensive v financial flow (**might rise if speculators expect to keep appreciating)
• V value of foreign assets in Australian Dollar terms (valuation effect)
Lowers $A value of foreign INcome (credit) from abroad investments - deterioration in NPY and CAD
• Trade is important due to:
o 1. Our distance from the rest of the world
o 2. Amount of our output we cannot use
trade and protection
history - today
• Historically high protection, especially in manufacturing
o Low population necessitates protection as we cannot achieve the same economies of scale
• Protection phased out throughout the 70s
o Whitlam government cut tariffs by 25% across the board
• Protection today
o Australia has benefited from removal of barriers (25% since 1973)
o Assistance schemes such as the Export Market Development scheme are in use
o subsidies (agriculture) 2nd lowest in OECD
o Local content rules
Export Market Development scheme
export incentive to provide financial and informational assistance for exporters by Aus trade
• Aims of reducing protection: 5
o Force domestic firms to become more internationally competitive
o Force domestic firms to become more efficient
Encourage resources to be more focused on Australia comparative advantage
o Australia has more access to goods and services in global market
o ^Living standard
o Promote structural change in economy (long-term produce what is globally demanded)
Australia/ New Zealand Closer Economic Relations Trade Agreement (CERTA)
Bilateral
• ^ trade, standardisation of laws, business practices and commercial structure
• Removal of all tariffs
• 8% annual increase in trade (average)
bilateral
between 2 countries
***Bilateral/multilateral have fewer eco wide benefits than other trade liberalisations – as agreements as complexity + cost
China Australia Free Trade Agreement (ChAFTA)
Bilateral
• Made 86% of goods tariff free, increasing to 96% after full implementation
o Trade diversion and inequality promotes globalisation
Multilateral
between more than 2 nations
Doha round WTO (free trade and reducing protection for agrilculture)
***Bilateral/multilateral have fewer eco wide benefits than other trade liberalisations – as agreements as complexity + cost
Associations of South East Asian Nations (AANZFTA)
- Agreed to v tariffs on 96% of Australia exports
* Covers 20% of Australian trade
Asia Pacific Economic Cooperation (APEC)
• Encouraged free trade (agreed not to exclude outside nations) Non-discriminatory tariff reduction
- Now acts as a forum for regional issues such as terrorism and climate change
- Decreased average tariff levels from 17% to 6% since 1994
- 44% of world trade
implications of Australia’s policies for individuals
Positive
• Consumers have greater variety, at lower prices
• Job opportunities increase in international competitive sectors
• Economic benefits of increased productivity
Higher quality of life
^ job opportunities in internationally competitive sectors
Negative
Closing/ restructuring/ cuts of local industries structural unemployment
^Y inequality (labour redudant firat)
implications of Australia’s policies for firms
Positive
• Lower tariffs = lower input costs for firms
• ^efficient: ^ need to innovate + ^ productivity
• ^ export volumes
• Reallocation of resources (aka microeconomic reform)
Negative
• Import competing industries go out of business
restructuring –> V profits
implications of Australia’s policies for gov
Positive
Sustainable eco growth should raise revenue
rev from more efficient firms
Negative
• Cutting tariffs = v government revenue (but not as much cuz tarriff rev is <1 % of gov budget)
• Political consequences- job losses
^ Government spending to assistance structural change, unemployment benefits and retaining programs
implications of Australia’s policies, other
pos
Long run = improve CAD as exports grow
neg
• Short term, lower living standards
CAD worsen due to increased demand for imports (cheaper without protection)
what happens when other countries put tariffs
Australia’s exports become less competitive and struggle to penetrate foreign markets.
what happens when other countries subsidies
subsidies their exports they ^ supply, and v price of those goods on global markets harder for Australia to compete
protection issues for aus
o high number of protectionist policies relating to agriculture (esp CAP difficult for Australian farmers to compete in global market) **ABARES 2012 stated if the Doha round were successful, Australian exports would increase by $9bn by 2020
o Firms in mining and resources sector face few barriers to trade due to high global demand + low tariffs.
o Manufacturers face high non-tariff barriers such as health regulations and licensing restrictions
• Service industries face many barriers to trade – mostly natural barriers (location, transport costs, language and cultural barriers). Government regulation of certain service industries (banking) has a significant impact
Future of Australian Economy
- Globalisation will affect structure of industry
- Past decade, hope to move towards manufacturing/servicing industries but due to China, commodities remained main industry
- Mining + energy exports grown a lot!
• Agriculture industry outlook – more optimistic o Rising middle class of Asia and low $A helped o But might decline due to lack of protection, impact of climate/water shortage and inefficient compared to other nations
• Manufacturing set to grow, but at slow rate
o $A will effect this (competitiveness)
• Service industry (75% eco activity) set to continue growing.
o Growth in health care, education, financial services, infrastructure, housing
• Australia can potentially grow in environmental services (enviro focused businesses)
formula: net foreign liabilities
net foreign liabilities = net foreign debt + net foreign equity
formula: terms of trade
export price index/ import price index x 100
