Topic 2 - Part 1: Australia's trade and financial flows Flashcards
How many ‘phases’ of change of Aus direction of trade have there been? (as in decades)
1950s, 1960s, 2000s, 2020s
How has Aus direction of trade changed over the past 4 phases of decades? (more specific, give reasons)
1950s: Mainly traded with the UK and other European countries, largely due to our historical ties with them, but eventually formed the EU trading bloc, and stopped trading with Aus
1960s: Japan became our largest export market, which was largely due to their strong EG during this time and thus demanded for more minerals and energy, which Aus was able to provide
2000s: In the 1990s, Japan’s trade begun to start shrinking because of Japans low EG and Aus increased focus on other markets in the region. In the early 2000s, exports to China began sustained period of rapid growth, which made China Aus’s largest trading partner, largely due to China’s increasing significance in the global economy and Aus being a commodity supplier, whilst Aus is a commodity demander
2020s: Likely to see further shifts towards rapidly-growing regional economies in Asia, Asian economies are expected to make up aa larger proportion of world trade in the 2020s
What is the balance of payments (BoP)?
Balance of Payments refer to the record of the transactions between Australia and the rest of the world during a given period
What is the current account?
The Current Account is part of the BoP that shows the receipts and payments for trade in goods and services, transfer payments and income flows between Aus and the rest of the world in a given time period. Here, the transactions are non-reversible
What are credits?
Inflow of money into Aus economy
What are debits?
Outflow of money from Aus economy
What are the two main parts to the Balance of Payments?
The current account (CA)
The capital and financial account (KFA)
What are the 5 components of the current account?
Net goods, Net services, Balance on goods and services, primary income, secondary income
How is the balance of the current account calculated?
Addition of the Net goods, Net services, Balance on goods and services, primary income, secondary income
What do net goods refer to?
Refers to the difference between what Australia receives for its exports and what it pays out for its imports of goods. Net goods = export receipts - import payments for goods
What are the 3 outcomes for the net goods?
Australia could be in a balance (X receipts = I payments)
Australia could be in a surplus (X receipts > I Payments)
Australia could be in a deficit (X receipts < I payments)
What are net services?
Refers to the services that are bought and sold without people receiving a ‘good’ in return (i,. transport , travel, insurance, telephone calls etc.). Net services = export receipts - import payments for services
What is the Balance on goods and services (BOGS)?
This refers to the amount that is derived from adding net goods and net services together
What is net primary income?
This refers to the earnings on investments (the income that is earned as a return from a factor of production). Covers interest on borrowings, profits and dividends. It is the difference between income flows into Aus and income flows out of Aus as earnings on investment.
Explain the idea of credits and debits on the net primary income
Debits: When foreigners invest in Aus, income in the form of rent, profits interest and dividends flows overseas
Credits: When Australians invest overseas, there is a flow of income back to Australia
What is net secondary income?
This refers to non-market transfers (Income that isn’t earned through a factor of production). Occurs when products or financial resources are provided without a specific good or service being provided in return.
What are examples of net secondary income?
Payouts in insurance claims, workers’ remittances (eg. foreign workers in Aus sending money overseas (remittance)), government pensions, unconditional aid to developing nation, pensions
What are considered debits on the CA? (6)
Imports of goods
Imports of services
Interest paid to foreign firms
Profits of foreign firms operating in Aus, including dividends
Payments to offshore employees by Aus firms
Non market transfers out of Aus
What are considered credits on the CA? (6)
Exports of goods
Exports of services
Interest received by Aus firms from overseas
Profits of Aus firms earned offshore, including dividends
Payment to offshore employees working in Aus
Non market transfers into Aus
What is the capital and financial account (KFA)?
The Capital and Financial Account (KFA) records the borrowing, lending, sales and purchase of assets between Australia and the rest of the world. These transactions are reversible (transactions can be undone in the future
(i.e. borrowings can be paid back, and assets that are bought can be sold again)
What is the capital account?
Refers to transfers in the form of tied aid, purchase and sale of non-financial assets. It also consists of ‘capital transfers’ and ‘purchase and sale of non-produced, non financial assets, foreign investment (conditional)
What are capital transfers?
Part of the capital account
refers to when a worker migrants in/out of a country, and bring their capital or bank account savings with them
What are purchase and sale of non produced, non financial assets?
Part of capital account
refers to purchase of things such as patents, copyrights, trademarks and franchises
What is the financial account?
Refers to the inflows (credits) and outflows (debits) related to transactions in foreign financial assets and liabilities
What are the 5 parts of the financial account?
Foreign Direct Investment
Portfolio investment
Financial derivatives
Other investments
Reserve assets
What does foreign direct investment refer to?
Refers to the establishing a new business overseas or purchasing a controlling stake in an existing business (greater than 10% of shares)
What does portfolio investment refer to?
buying of land, shares or other marketable securities in existing companies
What do financial derivatives refer to?
financial assets whose value is normally derived from the performance of specific assets, interest rates, exchange rates or indices.
What are reserve assets?
financial assets controlled by the central authorities for financing or regulating payment imbalances. For example; monetary gold, Special Drawing Rights and foreign exchange
What is considered ‘other investments’ in the financial account?
residual category that captures transactions not classified as direct investment, portfolio investment, financial derivatives or reserve assets.
Includes trade credits, loans including financial leases, currency and deposits, all other transactions
What are net errors and omissions, and what is the purpose of it?
Refers to statistical discrepancies. It is included because under a floating exchange rate system, the current account and the capital and financial account always balance to zero (i.e. the Balance of payments = 0)
Does the current account and financial account add up to zero together?
Yes
What are the links between key BoP categories? (3)
CA and KFA will always add up to zero altogether, where a deficit on CA equals to an equivalent surplus on KFA
Meanwhile, a surplus on CA equals to an equivalent deficit on KFA
A KFA surplus will result in a larger deficit on the net primary income. This is because foreign financial flows that come into Aus must earn some return for its owners, which result in a debit on the NPY account
How does floating the $A ensure that there is a balance on the BoP?
Under a floating exchange rate, supply of $A = demand for $A
Therefore;
Imports + income debits + capital outflow = exports + income credits + capital inflow
which can be rearranged into:
Imports - Exports + income debits - income credits = Capital inflow - capital outflow
Leading to:
Deficit on CA = surplus on the KFA
What are two ways that financial inflows can create debits on the primary income category of the CA?
International borrowing (foreign debt): requires regular interest payments or servicing costs, recorded as debits on NPY
Foreign investment (foreign equity): requires returns on the equity investment, such as rent, dividends, profits which are recorded as debits on NPY
Would high levels of KFA surpluses result in widening CAD? If so, why
Because there are increased servicing costs associated with increasing foreign liabilities
What does CAD stand for?
Current Account Deficit
What is Australia’s average CAD in 2000s?
4.6%
What is the trend in CAD since 1980?
Trend is that Aus CAD is among the highest in the industrialised world , cycling between 3-6% GDP since 1980
What are cyclical factors?
Factors which vary with the level of eco activity, i.e. changes in global demand for commodities, Australia’s ToT, value of exchange rate
What are structural factors?
Factors which are underlying or persistent influences on the balance of payments
I.e. structures of export base, international competitiveness of exports, level of national savings
What are they cyclical factors which have an effect on BOGS? (4)
Movements in the exchange rates
Terms of Trade
Level of domestic eco growth
Changes in the IBC
How do movements in the exchange rates affect the BOGS?
Affects the IC of Aus X and relative price of g+s that Aus imports
Depreciations decrease foreign currency price of Aus exports, increasing IC of Aus X on world markets, it also discourages consumers from purchasing imports, leading to a surplus in the BOGS
What is an example of BOGS being affected by the exchange rates?
BOGS went into surplus in 2008-09 after $A experienced sharp depreciation due to deteriorating global outlook, reaching 7-year low of $US 0.62 in late 2008
How do terms of trade impact the BOGS?
If TOT increases, there is an improvement on BOGS –> decrease in CAD
If TOT deteriorates, there is a deterioration of BOGS –> increase in CAD
Higher TOT reflects increased demand for Aus X –> increased demand for $A –> appreciation of e/r –> Weakened IC of Aus non-commodity X
What are terms of trade (ToT)?
Terms of trade measures the relative movements in the price of an economy’s imports and exports over a period of time
Calculated by price of exports/price of imports
What is an example of TOT impacting BOGS
(Theoretically) Increase in TOT (doubling) since the 2000s due to the global commodities boom –> X receives higher prices –> Increased X revenue –> improved BOG –> Appreciation –> Decreased IC –> partially offsetting benefits of rising TOT by decreasing BOGs a bit
How does level of domestic EG affect the BOGS?
Influences the BOGS balance by affecting demand for imports
An upturn in domestic business cycle results in higher disposable income, leading to higher consumption and imports, worsening the BOGS
What is an example of the level of domestic EG affecting the BOGS?
High growth in household disposable income levels during commodities boom –> worsening BOGS performaance due to an increase in import spending despite rising TOT
How do changes in IBC impact the BOGS?
It impacts the BOGS by affecting the demand for Aus X. A slow down in global EG and weaker growth in Aus regional trading partners –> reduced demand –> worsening BOGS
What is an example as to how the IBC impacts the BOGS
Australia’s challenge in the late 2010s is to find new export markets at a time when growth remains sluggish in most of the world
What are the structural factors that affect the BOGS? (3)
Australia having a narrow export base
Poor infrastructure; Aus suffers from infrastructure bottlenecks which are considered supply side capacity constraints, Examples of poor infrastructure can be urban congestion (traffic), lack of high-frequency transit systems, lack of complete national high speed broadband
Shortage of skilled labour –> higher wages –> increased business cost –> hinders IC and export growth
How does Aus having a narrow export base influence the BOGS?
Exports are heavily weighted towards primary commodities, and we only have a comparative advantage in products like minerals and agriculture, and lacks IC in manufacturing, having to import high value added consumer and capital goods. Thus BOGS tends to be in deficit rather than surplus, as we have to pay a lot more for imports than export revenues
What are the cyclical factors affecting Net primary income (NPY)
Valuation effect (exchange rates)
Global and domestic interest rates
Domestic business cycle
How does the valuation effect/exchange rate affect NPY?
Movement in e/r will alter the $A value of debt denominated in foreign currencies.
Appreciation will decrease $A value of debt denominated in foreign currencies, decreasing thee value of debt service –> reduced value of NPY outflows, and improves the NPY deficit
Depreciation increases $A value of debt denominated in foreign currencies, increasing value of interest repayments and worsening NPY deficit
What are the effects of global and domestic i/r on NPY
Servicing costs on foreign debt set by an i/r, changes to the i/r will impact cost of servicing debt. A decline in Aus and global i/r rates to record low levels in recent years reduced the cost of debt servicing (in net terms; $24.3bn in 2015-16)
What are the effects of the domestic business cycle on NPY?
Performance of domestic business cycle influences equity servicing costs (repaying the foreign entities who have invested into us). Strong domestic growth results in a rise in domestic company profits, and these profits are redistributed to shareholders
A large proportion of dividends flow out of Aus as payments to overseas shareholders, specially since approx 40% of Aus share market is foreign owned
What is the structural factor affecting Aus NPY
Savings and investments gap
How does the savings and investments gap affect the NPY?
Savings investment gap means that we borrow from overseas to meet our investment needs, leading to debt/equity servicing costs
Increased foreign liabilities creates future servicing obligations in the form of interest payments and dividends which are recorded as outflows on NPY account
What is the trend in international borrowing and why?
Net foreign debt rising faster than GDP, currently at 63.8% of GDP in June 2016, compared to 6.3% in 1980 and 34% in 1990. Aus external debt accounted for 115.3% of country’s nominal GDP in 2021, ultimately indicating an increase in international borrowing
this is because international borrowing allows for access to a wide range of credit sources as well as access to cheaper credit sources
What are the four trends in size and composition of Aus BoP that are outlined in the syllabus?
international competitiveness, terms of trade, international borrowing, foreign investment
What is the trend in foreign investment into Aus and why?
The trend is that foreign investment into Aus is slowly rising. This is seen in FDI in net inflows as a % of GDP increasing from 2.7% in 1990 to a peak of 7% in 2004, before reaching 4.3% in 2018 (as there was a crash to -3.6% in 2005 during GFC)
Net foreign equity also increased from $24bn in 1980, before peaking at $81bn
This is largely due to the increases/stability in Aus EG, which make Aus a good place to invest in.
What are the pros and cons (2 of each) of international borrowing?
Pros:
Access to wide range of credit sources
Access to cheaper credit sources
Cons:
Worsens NPY account in CAD
Possibility of debt cycle (further loans to service debt) and external instability
What are the two pros and cons of foreign investment into Aus?
Pros:
Increases economic growth due to investment in capital goods
Access to new technologies and ideas
Cons:
Worsens NPY account in CAD
Increase vulnerability to speculation on share markets (portfolio investment)
What are the two pros and cons of a rise in TOT?
Pros:
Rise in TOT index indicates a favorable movement in the TOT, leads to smaller deficit or greater surplus in BOGS, improve CAD
A given volume of exports buys a greater quantity of imports than the previous years; same volume of imports financeable by a smaller volume of exports
Cons:
A fall in the TOT between two consecutive years indicates a deterioration or unfavorable movement in the TOT, worsen CAD and BOGS position
A given volume of exports buys a smaller volume of imports than previously; same volume of imports financeable by a greater volume of exports
What is the general trend of the TOT in Aus?
TOT has been in decline since WWII, but is especially seen in recent decades where there was a fall from 96.1% in 2012 to 80.5% in 2016. However, really recently, it has leapt to 103.6% in 2018 and reached a peak of 135% in 2021-22
What is International competitiveness determined by?
Price factors and non-price factors
What are the links between IC and BOP?
If IC increased, country’s export revenue increases improving our CAD, as well as less NPY debits as a country doesn’t need to borrow that much anymore and so less foreign liabilities and vice versa
What are 4 issues with having a high CAD?
Growth of foreign liabilities
Increased servicing costs
Increased volatility for exchange rates
Constraint on future EG
How does a high CAD contribute to growth of foreign liabilities?
CAD requires financial inflow on KFA account, which would involve borrowing from overseas or through selling equity, which would involve increasing our foreign liabilities
How does having a high CAD lead to increased servicing costs?
Leads to larger outflows on NPY as foreign debt and equity must be serviced through interest payments and returns on payments –> worsening CAD
How does a high CAD increase volatility for e/r
Undermines confidence of overseas investors in the Aus economy as there is constricted EG
How does a high CAD constrain future EG?
Higher levels of EG increases imports and thus deteriorates CAD
Is Australia’s high CAD sustainable? Give reasons
Aus has been warned that the CA may become a long term risk, because changes in eco conditions such as loss of Chinese export markets or rise in global i/r –> High CADs –> sustained CADs make AUs dependent on continuing financial inflows to fund servicing costs
At this point, Aus has a high foreign debt and high debt servicing costs
Why does Aus have a high level of foreign liabilities?
Because it is seen as a profitable investment destination
How to calculate net foreign liabilities?
Net foreign debt + Net foreign equity
What was Australia’s net foreign debt in 2021
Aus net foreign debt was just above $1.16 trillion in 2021
What is the increase in exports to China from 2000 to 2021?
Increase from 4.4% of exports –> 38.8% in 2021
What is the decline in exports to Japan from 2000 to 2021?
Decreased from 17.3% in 2000 to 10% in 2021
How has exports with the US changed from 1990 to 2021?
In 1990 - Trade towards the US was 11.6%, however this decreased to 5.3% in 2021
Explain the changes in exports by destination from 2000 to 2020
This is significant as it describes the fall of exports towards Japan despite having a high export level prior to 2000s, which is largely due to the Japanese economy growing strongly in the 1960s and thus demanding minerals and energy increasingly rapidly, in which Aus was able to respond to this opportunity through increasing exports with them, and thus Japan became Aus largest export market, however this declined since the 1990s as Japan continued to have weak EG, and Aus started to shift their focus onto other markets in the region
In the early 2000s, exports to China began rapidly growing which has led to China being Australia’s largest trading partner (I+X) by 2007. This idea is seen in the increasing of China’s annual share of exports. This was largely due to Australia’s natural endowment in iron ore, in which China consumed massive quantities of.
What kind of industries did Aus traditionally rely on? I.e. which industry does Aus have a comparative advantage in?
In commodities, minerals and vast natural resources
What percentage of export earnings are from agricultural and mineral exports?
2/3
How has agricultural exports changed?
Agricultural export have dropped to 13% of a proportion of Aus trade over recent years
What are some reasons for th change in the decline of agricultural exports as part of Aus trade?
Largely attributed to large fluctuations in world prices as well as trade protection policies such as CAP in the EU
Why have exports of minerals and metals increased in importance?
Due to thee global commodities boom in the decade after 2003, high commodity prices are positive in the MT and LT due to rapid growth of developing economies such as China and India
What is the change in exports of resources from 1997 - 2021?
Has been an increase from around 25bn in 1997 to 57bn in 2021
How has the value of exports of services changed from 1997 to 2020 to 2021
10bn in 1997 to 21-22bn in 2020–> 16bn in 2021
How has the value of manufacturing changed from 1997 to 2021
5bn in 1997, 10bn in 2021
Why is Aus trying to shift away from providing exports of minerals and commodities to services
This is because a majority of Aus workforce is in services, and is a growing industry. Furthrmore, the export of commodities is finite and there is a belief that as economies want to become more environmentally sustainable, they will move away from commodities such as minerals and move towards other exports which would mean that Aus export economy would be crushed if this happens, as they mainly rely on exports of minerals
What is the growth in iron ore exports in 2004/5 to 2020/21?
63 Mt of iron ore (04/05) –> 205Mt in 2020/21
What is the change in total exports of iron ore as a % of exports?
15.5% in 2001 to 57% in 2011
Why have iron ore exports increased?
This is largely due to China’s strong EG, and their growing infrastructure –> demand for minerals such as iron ore and coal –> purchase from Aus
What is the change in LNG exports from 04/05 to 2020/21
3Mt in 2004/5 to 18Mt in 2020/21
What is the trend in coal exports in the recent decade?
It has stagnated at around 100Mt
What is the trend in composition of Aus imports?
Shar of capital goods has remained largeely unchangd at around 20% of total imports, imports of consumer goods have risen from the 1990s from 17.7% to 26%, imports of intermediate goods and services have fallen slightly
What was the total value of Aus imports in 2021/22
$459bn
How much of imports were intrmediate goods? (I.e. how much)
$171bn
How much of imports were consumer goods (I.e. how much)
$119 billion
How much of imports were capital goods (I.e. how much)
$89bn
Why did exports to the EU decline from 1990 to 2021 and why?
Declined from 10.9% of total exports in 1990 to 3.8% in 2021. This was largely due to the EU forming the trade bloc EU which utilised a lot of protection –> decreased exports
What is the trend with exports to Japan and why?
In the 1960s, Jap economy was growing strongly and demanded minerals and energy, and thus we exported a lot towards them because we had a good factor endowment in them. However it started declining around 1990 from 23.9% to 10% in 2020, as a result of Japan’s weak growth and AUs increased focus on other markets in the region
What is the trend with export to China and why?
In the early 2000s, exports to China had a rapid growth which since 2007 has made China Australia’s largest trading partner (in both I and X). This was largely due to their large infrastructure projects which required iron ore (which was provided by Aus), in fact in 2021, China accounted for 80% of exports of Iron ore from Aus. However, it was not only exports of iron ore which made China our greatest trading partner, but also meat and many more goods. We also consume large quantities of China’s manufactured products in which they have a comparative advantage in. All of which results in the shift from 4.4% of total exports to China in 2000 to 38.8% in 2021, and 5.7% of imports from China in 2000 to 24% of imports in 2021
What is the growth in minerals and metals from 2020/21 to 2021/22
Changed from $301 bn to $415bn
What is the trend in services exports from 2018/19 to 2021/22
2018/19: 97 bn
2021/22: 60 bn
Is Aus the largest recipient of FDI in 2021?
No, it is the 15th largest recipient
What is the trend in the level of financial flows in and out of Aus
Level of foreign investment both in and out has more than doubled in the past decade, rising rapidly since the 1980s
What have caused the changes in the composition of financial flows?
Prior to the deregulation of the financial sector, most financial flows came into Australia in the form of direct investment
Removal of restriction on financial flows increased the levels of non-direct investment
Following the deregulation of the financial sector and floating of $A in the 1980s:
Foreign investment inflows grew rapidly, and rate of growth of portfolio investment was significantly faster than growth of FDI, and investment overseas is greater than 100x what it was in 1980
What is foreign direct investment (FDI)
refers to the movement of funds between economies for the purpose of establishing a new company or buying a substantial proportion of shares in an existing company (10% or more)
How much of total investment does FDI account for?
Accoutns for 26% of total investment in 2021
WHat is foreign portfolio investment (FPI)
refers to the short-term movement of funds between economies for loans or the purchase of small share holdings (less than 10% of the total value of the company) and includes equity/debt securities
How much of total investment does FPI account for in 2021?
Accounted for 47%
What does it mean by Australia being a neet capital importer?
Level of foreign investment in Australia consistently remaining well above level of investment abroad. Reflects the historically low level of domestic savings – reliance on overseas financial flows to make up for shortfall between savings and investment remains a feature today
What are the two major investment destination and source?
US (25.5%), UK (17.4%)
What are the 3 largest stocks of FDI in Aus industry (in other words, which industries receive most FDI and how much)?
Mining ($360bn)
real estate ($136bn)
Financial and insurance activities ($123bn)
As of 2021
