AUSTRALIA’S BALANCE OF PAYMENTS

BALANCE OF PAYMENTS is the record of the transactions between Australia and the rest of the world
during a given period, consisting of the current account and the capital and financial account.

STRUCTURE

● Single most important economic indicator of relationship between AUS and global economy
● Summarises how resources flow between AUS and trading partners
● Money flowing in is referred to as credit, money flowing out is debit
○ Eg. money derived from an export is a credit on the balance of payments, money spent
on imports is a debit (credit entries are considered positive transactions, debit entries are
negative)
● Every single transaction is entered twice - both as a credit and a debit - allowing the total sum of
the CUR + KAFA to equal zero
○ The two entries are: the economic transaction (ie. the import, export, aid, investment,
etc.) and the actual movement of cash for the economic transaction (ie. the actual
payment of the import, receipt for export, etc.)

Current Account, debits and credits

Current Account = NET FLOW OF MONEY

● Records value of flow of g/s + income between AUS + rest of world; covers external transactions
that are not reversible
● ‘Current’ - g/s + income traded will be consumed/received in the current period (within the
quarter)

BOGS is the difference between what AUS receives for its exports and what it pays for imports
● NET GOODS - The difference between what Australia receives for its exports and what it pays
out for its imports of goods. → Surplus of $152.4B in 22/23
● NET SERVICES - Services that are bought and sold without people receiving a “good” (transport,
travel, education) → Deficit of $13.6B in 22/23
● BALANCE ON G/S (BOGS) is the amount derived by adding net goods + net services together
○ Surplus of $138.8B 22/23
○ Went into surplus for the first time since 2011 in 2017

NET PRIMARY INCOME refers to exchanges regarding returns on investment (rent, interest and
dividends)
● Outgoing returns are debits and incoming returns are credits
● Deficit of $108.7B 22/23
NET SECONDARY INCOME refers to non-market transfers (not earned through FOPs, of little
importance to BOP):
● Income AUS residents earn from the govt (workers remittance, insurance claims, pensions),
minus what they pay to the rest of the world
● AUS provides resources without anything being provided in return (eg. emergency foreign aid)
● Deficit of $1.2B in 22/23

BALANCE ON CURRENT ACCOUNT refers to the addition of BOGS, NPI + NSI

● Surplus of $28.9B 22/23

Capital and Financial Account

KAFA = NET CHANGE IN OWNERSHIP OF ASSETS + LIABILITIES

● Records the transfers/payments that are due to changes in ownership of assets (borrowing,
lending, sales and purchases of assets between AUS + rest of world); reversible transactions

CAPITAL ACCOUNT - consists of two main components:

1. Capital transfers - conditional foreign aid grants (linked to specific projects) and debt
forgiveness
2. Transactions of non-produced, non-financial assets (IP: patents, copyrights, trademarks,
etc)
● Deficit of $0.9B 22/23

FINANCIAL ACCOUNT shows transactions that involve a change of ownership of AUS assets + liabilities
1. Foreign direct investment (purchase of 10% or more of a company)
2. Portfolio investment (short-term; shares, debt securities)
3. Financial derivatives (financial instruments, the price of which is determined by the value
of another asset - eg. currency, interest rates)
4. Reserve assets (like monetary gold)
5. Other investment (trade credits, loans)
○ Until recent years, AUS has consistently recorded a positive financial account balance →
rise in AUS liabilities to rest of world higher than liabilities of rest of world to AUS
● This means AUS has effectively drawn on the savings of the rest of the
world to finance a deficit on its current account

Balance on capital and financial account

● Adding the two together should be approximately equal to the deficit on the current account
● ie. BOP = current account + capital and financial account + net errors and omissions* = 0
*Net errors and omissions are statistical discrepancies, as it is difficult to account for every single
transaction made between every Australian and the rest of the world, included to ensure the BOP sums to
0

LINKS BETWEEN KEY BALANCE OF PAYMENTS CATEGORIES

● The two accounts add to zero, representing a ‘balance of payments’

○ The deficit on the CUR account is equal to the surplus on KAFA and vice versa
● The floating Australian dollar plays the role of ensuring this balance → equilibrium occurs when:
ie. when supply of A$ = demand for A$, then
M(imports) + Y(income) debits + K(capital) outflow = X(exports) + Y(income) credits + K(capital) inflow, so
deficit/surplus on current account = surplus/deficit on capital + financial
● Strongest link between the CA and KAFA is seen on the NPI
○ KAFA surplus results in deficit on NPI (incoming foreign financial flows presuppose future
debits on NPI)
● Over a period of time, high KAFA surpluses will result in a widening CUR deficit → may lead to
‘debt trap’, where an economy borrows from overseas just to pay the interest on its existing debt
● AUS’ historically low savings makes it necessary to attract a large inflow on FA → historically
blamed on AUS’ lack of international competitiveness (led to implementation of micro reform), but
recently there is focus on the savings-investment gap as the cause of AUS’ external imbalances
(low savings result in a need for capital inflow to fund investment within AUS)

TRENDS IN THE SIZE AND COMPETITION OF AUSTRALIA’S BALANCE OF PAYMENTS

● AUS moved from a consistent CAD to a CAS in 2019, mainly aided by a surplus in BOGs which
became surplus since 2016 ($12B) and an increase in national savings, which has outstripped
investment since 2019
● In the four decades prior to 2010s, consistent CAD averaged -4% of GDP
● Reached record -6.6% GDP in 2007-08 → shown sustained improvement since
○ Largely due to BOGs going from an average deficit until 2017 to a surplus of 5.5% of
GDP by 2023
■ CAD + BOGS peaked at -1% and 3% of GDP in 2008 as demand for resources
during GFC went up
○ Additionally, the net income deficit has narrowed in years prior to COVID as AUS
repayments increased as global interest rates declined → after COVID narrowed further
○ NPI historically averages -3% of GDP -- improved in 2021 to -1.1% as a result of stopping
outbound dividends during COVID, then worsened by 2024 to -4.3% with their
resumption
● 2021-22:
○ Exports grew 34% because of CHI’s demand for iron ore whilst lower growth reduced
demand for imports → huge trade surplus of $136B
○ Net services went into deficit as overseas travel by Australians resumed → CAS surplus
of $50B (3.2% GDP) was achieved despite a large NPI deficit of $83B as more dividends
and profits were sent overseas
● 2022-23 CUR account recorded its 4th consecutive surplus, the first since 1972, $29B at 1.1% of
GDP
○ Improvement during COVID was driven by strong commodity prices and a larger
contraction in imports than exports due to increasing interest rates, seeing the trade
balance improve to $159B
○ BUT NPI reduced as world interest rates rose → -$108B, causing the CAS to drop
 ○ Short-term nature is reflected in forecast of CAD of -2.5% of GDP in 2023-24 (weaker
commodity prices, high debt servicing costs in rising i rates)

Date Trend Reason

2 Record deficit (6.6% of GDP)

007–08 (averaged 4% prior to 2010s)

2018/19- Record surplus - Strong commodity prices

2022/23 - Low global interest rates
- Larger contraction in imports than exports
- Sustained by a further surge in commodity prices that ended
in 2023

2023/24 CA deficit of 0.8% - Short term nature of those factors

- Weaker commodity prices
- Higher debt servicing costs → rising interest rates

Australia’s current account balance moves in cycles, influenced by both cyclical (eg. changes in global
demand for commodities, value of exchange rate) and structural (structure of AUS’ export base,
international competitiveness, level of national savings) factors

International competitiveness, terms of trade, international borrowing, foreign investment

BOGS/TRADE BALANCE
● Improving trend in recent years, consistently in surplus since 2016-17, averaging 3.4% GDP
● Reflects strong growth in income from AUS resources and energy exports
● Surplus of $138.8B 2022-23 highest on record, reflecting elevated commodity prices, strong
activity in travel + tourism and return of international students to AUS cities

CYCLICAL FACTORS AFFECTING BOGS

● Exchange rate: depreciation decreases the price of AUS exports, increasing AUS’ int
competitiveness in world markets, and increases cost of imports, discouraging them and
improving BOGS
○ Depreciation following the decline of commodity prices since 2012 increased AUS int
competitiveness on non-mining exports
● Terms of trade (TOT): relationship between income received for exports and price paid for
imports. Improvement = the same volume of exports can purchase more imports (ie. export prices
increase relative to import prices) → improvement in BOGS + decrease in CAD

○ Since 2003, AUS has experienced its largest sustained TOT boom in its history, reflecting
impact in boom in prices for global commodities, whilst CHI and other low-cost emerging
 economies flooded world markets with low-cost manufactured goods, reducing import
prices
○ After beginning of global commodity prices boom, AUS experienced doubling of its TOT
○ 2011-2016 TOT declined by nearly 40% -- weaker world growth of just 3%, lower global
commodity prices due to EUR Sovereign Debt crisis, slow eco recovery in USA and
slower growth in CHI
○ BUT higher TOT means increased demand for AUS exports, causing appreciation of
exchange rate → weakens international competitiveness of AUS non-commodity exports,
partially offsetting the benefits of rising TOT (Dutch Disease)
● Economic growth rates:
○ DOMESTIC growth influences IMPORTS → upturn → higher imports, worsening BOGS
(but if this upturn is driven by increase in productive capacity that expands exports,
BOGS will improve in medium term - after mining boom 2003, BOGS worsened for
several years before its turnaround in 2010s).
○ GLOBAL growth influences EXPORTS → downturn reduces demand for AUS exports,
worsening BOGS. A key feature of AUS economic success in recent decades is its
relationship with faster-growing emerging economies.

STRUCTURAL FACTORS AFFECTING BOGS

● Narrow export base: minerals + ag account for ⅔ of AUS export earnings → high vulnerability to
changes in price and demand in these markets has lead to large BOGS fluctuations in recent
years
○ Until early 2000s, long-term downward trend in commodity prices, worsening AUS
BOGS, but increased global demand in 21st century made commodity exports far more
valuable → although there was volatility in TOT, it remained well above longer-term
averages, leading to sustained improvement in AUS’ trade performance
○ Recent decades’ upturn in ag prices - rural commodity prices rose by ⅓ between 2000
and 2010 - due to growing global food demand, rising incomes in the developing world,
rising prices for ag inputs like fertilisers, effect of war in UKR and impacts of climate
change reducing ag productivity
● Lack of international competitiveness: AUS lacks competitiveness in manufacturing and relies on
imports of value-added goods (consumer and capital goods) and exports without value-adding →
historically led to deficit in BOGS
○ Needs to diversify exports towards high-growth, high value-added sectors of global trade,
like elaborately transformed manufactures (ETMs)
○ Services exports provide the strongest growth opportunities, given AUS’ proximity to
emerging Asian economies → prior to COVID, AUS services exports reached peak
$96.6B in 2018/19 after a sustained period of double-digit growth for most of 2010s; fell
to $61.1B in 2021/22 before rebounding to $93.5B in 2022/23

THE PRIMARY INCOME ACCOUNT

● Between 2004/05 and 2019/20, NPI(net primary income) account typically recorded deficit of
2-3% GDP - deficit rose sharply to 4.9% GDP in 2022/23

CYCLICAL FACTORS AFFECTING NPI

● Domestic economic growth: strong growth → company profits rise, redistributed to shareholders -
in AUS, approx 40% of AUS public share market is foreign-owned, so large proportion of
 dividends flows out, meaning higher domestic profits increase equity servicing costs in the form of
dividend outflows, which then increase NPI deficit.
● Exchange rate: alters value of debt denominated in foreign currencies - the “valuation effect”.
Appreciation decreases A$ value of debt denominated in foreign currencies, decreasing debt
servicing costs and reducing NPI deficit. BUT this effect is limited as a large amount of AUS
foreign debt is ‘hedged’ (fixed exchange rate over course of loan), and a significant portion of
AUS’ debt is denominated in A$, so it is not affected by exchange rate movements.
● Changes in interest rates: When interest rates change, the cost of servicing foreign debt changes
- Australia’s sensitivity to global interest rates was reflected in the cost of debt servicing, which
doubled in 2022/23 from $18B to $33B as interest rates on debt rose sharply
○ BUT if i rates in AUS rise less than overseas, like US CR being higher than AUS, this
means AUS investors will invest in the US, earning higher returns, improving NPI

STRUCTURAL FACTORS AFFECTING NPI

The main reason Australia’s long-term net primary income is an underlying structural feature: gap
between savings and investment (AUS relies on foreign investment for growth)
● Overseas borrowing (foreign debt) or selling shares in AUS businesses (foreign equity) increases
foreign liabilities and creates future servicing costs
● HOWEVER, the growth in AUS’ investments overseas (due to large volume of superannuations
funds) results in inflows of earnings on those investments, improving NPI balance
● Australian households have twice as much debt as a proportion of their income as 20 years ago
● Household savings increased during COVID with fewer spending opportunities and govt support
payments, but this payments was not sustained with households spending when the economy
rebounded
● Similarly, when i rates rose to combat inflation, households saved less to cover the cost of living
● At the same time, AUS govt has substantially increased borrowings in last decades, further
detracting from national savings
● Govts can increase savings by: policies that increase the rate of compulsory super, tax incentives
on savings, reducing budget deficits, moving public sector into surplus through fiscal
consolidation

BOGS is the major cyclical component impacting CAD

NPI deficit is the main structural impact on CAD

Effects of these trends on Australia’s Balance of Payments

Consequences of a high Current Account Deficit

● IMF considers too high if over 4% in medium-long term or 6% in short term - risks of sustained
high CAD:
● Growth of foreign liabilities: high CAD presupposes financial inflow on KAFA (through debt +
equity financing), meaning lenders may become more reluctant to lend to/invest in AUS
● Increased servicing costs associated with high foreign liability leads to larger outflows on NPI,
worsening CAD. Debt servicing depends on the level of i rates in AUS and overseas, and profits
must be returned on foreign equity investment. Higher debt can result in foreign lenders
demanding a “risk premium” on loans, forcing up i rates
● Increased volatility of exchange rates - high CADs undermine the confidence of overseas
investors and, by reducing demand for AUS currency, may result in a depreciated of the AUS
dollar
 ● Constraint on future eco growth: CAD may limit future growth - high growth involves an increase
in imports and a deterioration in the CAD. Economies with a large CAD problem are therefore
forced to limit growth to the level at which the CAD is sustainable - known as the BOP
constraint.
● Contractionary economic policy - govts that find it necessary to reduce CAD use tighter
macroeconomic policies and accelerate microeconomic reform implementation, reducing growth
and lowering CAD
● Loss of international investor confidence - countries whose external imbalance appears
unsustainable are looked upon poorly by international investors. In recent years this has caused
crises in SRI + ARG, reflecting a loss in investor confidence due to its unsustainable debt levels.
Countries with high CADs + foreign debt are more vulnerable to shifts in investor sentiment.

Pitchford Thesis
If current account deficits were the result of savings and investment decisions by the private sector which
are not affected by distortions, then there is no cause for concern.

Australian Strategies for improving CAD:

● Save
○ Reduce the scale of savings investment gap by increasing the domestic savings pool
■ A secondary consequence of compulsory super
■ Whilst not all the funds are available in the domestic savings pool (some being
invested in foreign assets and loans) still makes a significant contribution.
● Increase domestic productivity
○ Further improve the trade balance by micro reform directed towards increasing
productivity,
■ development of Australian industry → substitute imports and generate exports →
negotiate free trade agreements → opportunity to increase net exports especially
in relation to agriculture and services