Topic 2 Economics: Balance of Payments

balance of payments

a record of all financial transactions between Australia and the rest of the world over a period of one year

BOP as a measurement of economic health + stability

A consistent sur+ often signals a strong econ, while persistent deficits can signal dependency on the ROW or econ instability

BOP as a measure of global competitiveness:

It shows if a country's G, S, and financial assets are competitive internationally, as reflected in BOGS (X vs M).

BOP as an indicator of Lending/Borrowing Status:

Shows if a country is a net lender (investing abroad) or a net borrower (receiving foreign investment), influencing its financial position

BOP as an indicator of currency and investment

Large deficits or sur+es can signal econ strength or weakness, affecting currency value and attracting or deterring foreign investment.

Current account

tracks unilateral financial flows or money flows for non reversible Y, shows the receipts and payments for the trade in G and S over a period of 1 year

Money flowing in

Credit

Money flowing out

Debit

Trade flows

sum of export inflows and import outflows (of G and S)

Income flows

sum of returns on financial investments — income debits are paid out to overseas investors and income credits are received by Aus investors

Three categories in the CA

BOGS, primary Y, secondary Y

What does the goods category of the CA show

difference between the credits we receive from X and the debits we pay out for M of tangible G

What does the services category of the CA show

Services are the difference between what bought (imported) and sold (exported) with buyers receiving an intangible commodity

What is primary Y in the CA

income earned as a return from a FOP and individual’s personal income across national borders

Four FOP

• Wages

• Rent

• Interest

• Profit

What does the primary Y category ALSO cover

interest payments on borrowings, dividends on shares and returns on other foreign investments

Google in California pays quarterly dividends to Australian investors

credit as money flows into AUS, CA because non-reversible, PY as it’s a normal way of earning income

The export of Lamb to the USA

CA as it is a G, credit as we recieve money back, BOGS as it is an export

The purchase of $10 m of Microsoft shares by an Australian investor

KAFA as it is reversible, financial account as it is a form of portfolio investment, debit as the money flows out

The US$16 million standard fee earned by the Football Federation of Australia from its participation in the 2010 World Cup.

CA as non reversible, Primary Y as it is a normal source of income for FFA, credit as the money flows in

Australia Government donation towards famine relief in Africa

• CA as non reversible

• Secondary Y as not normal way to lose income

• Debit as money is flowing out

UK citizen who’s living in Darwin receives UK on-going pension payments in Pounds

CA as non reversible

Secondary Y as it is a pension payment

Credit as money flows into the econ

The Australian Government contributes $10 Billion to the IMF to help that organisation provide emergency loans to the European Central Bank to manage the Euro crisis

KAFA as contributing = lending as the IMF is expected to pay back the funds once the crisis has ended

• Financial account as it is a debt asset

• Debit as the money is flowing out

Australia forgives a prior commercial loan to Papua New Guinea

• Debit as the money flows into the economy

• Capital account as the Aus govt is forgiving the loan hence also in KAFA

Costs of end of season overseas exhibition trip by AFL AllStar team

Current account as non reversible

Debit as money is going out

Services as intangible

The payment for new Mercedes vehicles from Germany by a car dealership in Perth

• CA as non reversible

• BOGS as it is a Good

• Credit as money is flowing into the econ

The reinvestment of profits of Westpac Banking Corp into its London subsidiary

• KAFA as reversible

• Financial account as direct investment

• Debit as money goes out

An unpaid invoice, treated as an overdraft, owed by an Australian subsidiary to its British parent company

KAFA as it is a debt being repaid

Financial acct as a part of direct investment as an overdraft is a loan given to an australian subsidary (subsidary = direct as there is ownership)

Credit as we got a loan

New Zealand workers remit portion of their wages to families back home

CA as non-reversible
Secondary income (special case)
Debit as the money is flowing out of the economy

Donald Trump (US) invests in another Trump golf resort on the Gold Coast

Credit as we are receiving the money
Direct invesment (financial acct)
KAFA

What is Secondary income

technical account for where ‘all the other payments go’

Characteristics of the Secondary Y

• There are no specific reciprocal payments in return eg charity payments

• Little importance on the BOPS figures due to its small size

• If it’s reversible, but not a G or S, but is not a normal way to earn income, it is secondary income

  • Income not earned through a FOP

Examples of secondary Y

1. Payments of insurance claims across national boundaries 

2. Govt donations for Foreign Aid to help developing nations

3. Monthly pension payments to foreigners/migrants

4. Cross border tax payments and refunds 

5. Foreign workers’ earning remittances

   • Note: If Govt Foreign Aid ‘donations’ are used to build capital in a developing nation, then this money is not included in the secondary income category, but in the K&F account

Capital and financial flows

record of all international capital flows, the sum of all financial investment borrowing and lending transactions between Aus and the rest of the world for a period of one year

Hot money

money which is rapidly moved from country to country (or investment to investment) to get the best returns (or to avoid losses)

What is the KAFA concerned with

• Concerned with financial flows of assets and liabilities — the money flows from international borrowing, lending and purchases of assets shares, real estate and bonds over a one year period

  • Transactions that create assets or liabilities go into the K&F account

Key distinction of the KAFA

They are reversible

Capital account

the sum of financial investment borrowing and lending transactions between Australia and the rest of the world

The debits and credits are not directly for investment purposes.

Examples of things that wld go in the capital acct

1. Permanent migrants moving their lump sum assets/pension proceeds from house sales

2. Forgiveness of prior loans 

   • Debit: AUS forgives loan

   • Credit: Foreigner forgives AUS

3. Foreign aid payment to build a developing nation’s capital stock (bridges, infrastructure, etc) IMPORTANT

Purchase of non producing, non financial assets such as rights to sell intellectual propertypatents, copyrights, franchise rights, artwork

What does the financial acct show

shows Aus transactions of foreign financial assets and liabilities with the rest of the world

What is the financial acct concerned with

• Concerned with profit making 

• Size of financial account can change drastically from one period to another 

• Dependant on a range of factors within domestic and international economies

  • Can result in an enormous amount of money flows

• Only the repayment of the principle amount of money borrowed is recorded on this account

Components of the Financial acct

FDI, FPI, financial derivatives, other investment, reserve assets, errors and omissions

FDI

Covers cross border foreign financial transactions to fund new investment opportunities in Australia or overseas

• includes ownership

• Buying >10% shares and bonds

FPI

Buying and selling of non-controlling interests in marketable financial assets, like shares (<10%) and bonds

• Portfolio investments are usually the most liquid

• Investment is usually for capital gain or income stream return

Financial derivatives

movements of financial derivatives associated with foreign assets

other investment

a residual category that captures all the opposing transactions for every other category (just to make the process double entry)

reserve assets (RBA)

Foreign financial assets that are available to and controlled by the central bank for financing or regulating payments imbalances

• Monetary gold, special drawing rights, foreign exchange held by reserve banks

• An increase in reserve assets is treated as a minus (a debit)

errors and omissions

covers statistical discrepancies

• Rounding errors

• Always go in the KAFA

• It is included because under a floating exchange rate system, the balance of payments would always balance to zero  

3 links in the BOP

BOP = 0
K flows in in the KAF links to PY in CA

↑ in K inflows over the long term → we produce more G for exports, or produce more G for which we will ↑ EOS

BOP = 0 meaning

• Current Acct (CA) + Cap & Financial Acct (KFA) = Zero

CA & KFA are equal in size, but are opposite in sign due to the Floating Exchange Rate

2/ K flows in in the KAF links to PY in CA

• Investment flowing through the financial acct requires the investment returns to be provided to the investor. 

  • Investment returns are recorded in the PY component of the CA

  • ↑ in overseas savings coming in via the Financial account results in increased debt servicing costs in the primary Y category of the CA

    • If foreigners own more Aus assets, Aus owes more interest and dividends

Trends in global interest rates

• The trend in interest rates affects the trend in: 

  • PY Credits earnt from overseas due to changes in the global interest rate 

  • PY Debits from trends in CR when foreign investors earn interest in Aus

    • Higher net foreign liabilities mean more interest and dividend payments to foreign investors.

↑ in K_INFLOWS over the long term → we produce more G for exports, or produce more G for which we will ↑ EOS

• Ongoing financial account surpluses lead to rising net foreign liabilities (foreign debt + equity).

• BOGS will improve 

• We export more or import less

• Capital goes to BOGS

international investment position

net of Australians investing in foreign debt and equity and foreigners investing in Australian debt and equity