Foreign Investment Exam

Define foreign investment (FI)

Refers to the flows of financial capital into and out of the Australian economy associated with the purchase and sale of financial assets. It is the stock of Australian foreign assets and liabilities, and financial transactions, recorded in the Financial Account of the BoP, that change this stock.

Stock

Represents a share of ownership in a company.

State the trend in Australia's outward and inward foreign investments

Australia has throughout its history had more inward foreign investment than outward.

Define investment

The purchase of capital goods

Describe foreign assets (AIA)

The stock of financial assets owned by Australian residents, in the form of debt or equity E.g Australia’s ownership of shares in Microsoft and loans from Bankwest to Microsoft. This is a capital outflow. When foreigners invest more in Australia, it increases Australia’s liabilities.

Describe foreign liability (FIA)

Stock of Australian financial assets owned by non-residents, usually in the form of foreign debt or foreign equity. E.g. A US company builds a data centre in Sydney. This is a capital inflow. When Australians invest more in foreign countries, it increases Australia’s foreign assets.

Define foreign direct investment

Foreign direct investment (FDI) involves the foreign company/investor gaining 10% or more of ownership rights. e.g. US investor buying more than 10% of shares in an Australian mining company.

Define foreign portfolio investment

Foreign portfolio investment involves the foreign company/investor gaining 10% or less of ownership rights e.g US investor buying less than 10% of shares in an Australian mining company.

Define foreign equity

Relates to a country’s buying of foreign assets and selling of domestic assets

Define foreign debt

Amount of money that Australians (public and private sectors) owe to the rest of the world.

Define net foreign equity

Provides a measure of the foreign ownership of Australian enterprises (through share holdings) and Australian ownership of foreign enterprises.

Define net foreign debt

Measures Australia’s total borrowings from overseas and overseas borrowings from Australia.

Define net international investment position

NIIP (Net Foreign Liabilities): Net foreign equity + Net foreign debt. If negative, more assets abroad than foreign entities own in Australia (no longer a liability)

Define capital inflow

Money flowing into Australia and is recorded as a credit in the Financial Account.

Define capital inflow

Money flowing out of Australia and is recorded as a debit in the Financial Account.

Differentiate between equity and debt.

Equity represents the sale or purchase of Australian shares to/from overseas, whereas debt represents the borrowing/lending of money to/from overseas.

Describe the main sources of FI

Foreign investment comes from foreign direct investment (FDI) and foreign portfolio investment. Foreign direct investment (FDI) involves the foreign company or investor gaining significant ownership rights in an Australian business, where ownership of 10% or more is considered significant. Foreign portfolio investment includes all forms of borrowing and all forms of equity investment where less than 10% ownership is purchased and is generally short term and speculative.

Describe the main sources of industry recipients of FI.

Australia’s abundant mineral resources and high levels of infrastructure have attracted foreign direct investment. Foreign portfolio investment is usually in the form of borrowing or loans, with the accumulation of this debt known as foreign debt. A large proportion of foreign portfolio investment is undertaken by financial institutions to provide funding for Australia’s housing market.

Identify factors that influence FI into Australia in recent times.

Australia has, for most of its history, been a financial capital importer, and the inflow of foreign capital fills Australia’s negative savings‑investment gap. Foreign investments are influenced by factors such as increase profit expectations, increase in interest differentials, expansion in Australia’s economic activity, and an increase in commodity prices.

Explain the effect of FDI (equity) on the Balance of Payments.

Incr in foreign investment into Australia - FIA (in the form of direct investment-equity) →

credit in the financial account → surplus in the capital and financial account or an incr in

the balance of the capital and financial account → dividends have to be made to overseas

residents → incr debit from the income category of the current account→ decr in income

balance or an incr in income deficit → CAD or a decr CAB

Explain the effect of FPI (debt) on the Balance of Payment

Incr in foreign investment into Australia - FIA ( in the form of portfolio investment-debt) → credit in the financial account → surplus on the capital and financial account or an incr in the balance of the capital and financial account → make interest payments → debit on the income category of the current account → decrease in income balance or an incr in income deficit → CAD or a decr CAB.

Explain the effect of AIA on the Balance of Payments.

Incr in Australian investment - AIA (buying overseas assets) → debit in the financial account → decr surplus in the capital and financial account or a decr in the balance of the capital and financial account → dividends received by Australian residents → credit into the income category of the current account→ incr income balance or a decr in income deficit → CAS or incr CAB.

Foreign investment–induced appreciation of the AUD

With an inflow of foreign investment into Australia, the value of the AUD will appreciate. With an appreciation, imports become cheaper, and exports are less competitive and CAD will incr or the current account balance will decr.

Outline the positive effects of FI

Supplements Australia’s low levels of savings, increased GDP, employment opportunities, technology transfer, human capital development, provides taxation revenue to the government, increased productivity, market diversification and tax incentives

Explain the effect of FI on Australia’s low level of savings

Due to Australia’s low levels of savings, investment increases into Australia. With an influx of foreign investment into Australia, labour is required to work on imported capital equipment. This boosts employment and increases economic growth for a country.

Explain the effect of FI on increased GDP

Foreign Direct Investment (FDI) can significantly boost a country’s

economic development by injecting capital into the economy. This capital can be

used to build infrastructure, improve public services, and stimulate other sectors of

the economy. For example, FDI can lead to the construction of new factories, roads,

and schools, which in turn can create a more conducive environment for business

operations and economic growth.

Explain the effect of FI on employment opportunities

One of the most direct benefits of FDI is job creation.

When foreign companies set up operations in a host country, they often need to hire

local employees. The has an overall multiplier effect on the economy raising living

standards and net wealth (over time).This not only reduces unemployment but also

increases the income levels of the local population, leading to higher purchasing

power and overall economic improvement.

Explain the effect of FI on technology transfer

FDI often involves the transfer of technology from the investor

to the host country. This can include advanced machinery, production techniques,

and management practices. Such technology transfers can enhance the productivity

and efficiency of local industries, helping them to compete more effectively in the

global market.

Explain the effect on human capital development

Foreign investment can lead to the development of

human capital by providing training and development opportunities for the local

workforce. Employees gain new skills and knowledge, which can improve their

productivity and career prospects. This development of human resources is crucial

for the long-term economic growth of the host country.

Explain the effect of FI on taxation revenue to the government

More foreign companies such as MNCs investing in Australia provides more company tax to the government.

Explain the effect of FI on increased productivity

The introduction of new technologies and management

practices through FDI can lead to significant improvements in productivity. Foreign

companies often bring with them best practices and innovations that can be adopted

by local firms, leading to overall productivity gains in the economy.

Explain the effect of FI on market diversification

For investors, FDI provides an opportunity to enter new

markets and diversify their business operations. This can reduce the risk associated

with relying on a single market and open up new revenue streams. For the host

country, it means increased competition and a wider variety of goods and services

available to consumers.

Explain the effect off FI on tax incentives

Many countries offer tax incentives to attract foreign investors.

These can include reduced tax rates, tax holidays, and other financial benefits. Such

incentives make it more attractive for foreign companies to invest in the host country,

which can lead to increased economic activity and job creation.

Outline the negative effects of FI

May lead to larger CAD requiring financing (both FDI and FPI), loss of owenership (affects only FDI), Higher prices for Australians due to reduced competition (affects only FDI), can be short term and speculative (affects only FPI) and AUD depreciates (affects only FPI).

Explain the effect of FI on the CAD

Foreign investment, both equity and debt, creates debit items in Australia’s primary

income section of the current account (ie dividend and interest payments to foreign

investors). This diverts income from domestic spending and may lead to a larger CAD that will

require further financing.

Explain the effect of FI on the loss of australian ownership

Some of Australia’s capital inflow comes after they have sold some Australian assets

(direct investment). This means that Australians do not have control over their own

their own assets. When foreigners control Australian assets, profits made by them

will be taken back to their countries.

Explain the effect of FI on higher prices for Australians due to reduced competition

Foreign direct investment involving takeovers of Australian firms may reduce

competition. This could eventually lead to higher prices that would be

disadvantageous to consumers. However, foreign firms are subject to the same regulations as domestic firms and the same scrutiny by the ACCC. However, if an investment was considered to be against the national interest, then the Foreign Investment Review Board (FIRB) and/or the Treasurer would not allow

the foreign investment to occur.

Explain the effect of FI on FPI

Portfolio investment (debt) can be short term and speculative which may be destabilising for the economy. If Australia’s level of foreign debt was to be considered a ‘risk’ then it could lead to a possible credit rating downgrade, that results in future higher interest rates for borrowing on international markets. This could then impact on domestic interest rates. However, this has not occurred in the last decade, despite global uncertainty and Australia’s high CAD and debt.

Explain the effect on FI on depreciation

If the AUD depreciates, then the level of foreign debt and interest payments will increase making debt servicing more difficult

Describe the composition of Australia’s foreign debt in terms of the public sector component and private sector component.

Public debt: Borrowing by the government. One consequence of this development is that future generations will need to share the burden of repaying this debt. This comprises of 26% of GDP. Private debt: The main private sector borrowers are the large companies who need to raise money capital for financing business expansion and takeovers. High local interest rates, and a lack of national savings, have contributed to foreign debt. This debt is considered superior to public debt. Private debt is likely to increase investment and will lead to increased future income to service the debt. Australia tends to pay their debt in a short period of time. This comprises of 74% of GDP.

Explain reasons for foreign debt

Insufficient domestic savings → Australia cannot fund large levels of investment internally. Large mining investment (driven by industrialisation and urbanisation of China and India) → Requires funding beyond domestic savings → Borrowing from overseas. Strong economic growth (pre‑2020) → Higher incomes and spending → Increased imports of capital and consumer goods → Net goods deficit and CAD. Current account deficit → Financed by overseas borrowing → Higher foreign debt. Higher foreign debt → More interest payments overseas → Larger income deficit → Further borrowing required. Government budget deficits → Partially financed by borrowing from overseas → Increase in foreign debt

Explain the benefit of foreign debt when it is owned by the private sector

If the debt is owned by the private sector. The private sector is profit driven who forego current consumption for infrastructure. They are more profit driven to pay overseas back with interest repayments.

Explain the benefit of foreign debt on the expansion of Australia’s industry

If the debt is used to expand Australia’s industry. As the private sector borrows money from overseas, it is used to buy imported machinery. This increases income, economic growth, expenditure and output in the economy.

Explain the benefit of foreign debt on the appreciation of the Australian dollar (AUD).

If there is an appreciation of the AUD. Due to high economic growth, there is an increase in demand for goods and services. This causes an appreciation of the AUD and this decreases the cost of servicing the debt and Australia is able to pay off their loans quicker.

Explain the cost of foreign debt on Australia’s credit rating.

Downgrading of credit rating. When Australia defaults on a payment, their credit rating would decrease. Less investors will be willing to lend money to Australia due to unreliability of paying back.

Explain the cost of foreign debt on debt servicing costs.

Increased Foreign Debt servicing costs. To attract foreign investment into Australia, higher interest rates are encouraged but this affects all parts of the community and even borrowers. Borrowers look at overseas banks to borrow and this further increases Australia’s foreign debt to the world. This also means that Australia has to make more interest repaymentsto the rest of the world.

Explain the cost of foreign debt in making Australia vulnerable to external shocks.

Vulnerable to external shocks. If one of Australia’s major trading partners had an economic crisis, the demand for Australian goods will decline causing a depreciation of the AUD. This means that more AUD is required to service the debt.

Explain the cost of foreign debt on international confidence.

Decreased international Confidence. Debt levels only become a problem when the level of debt servicing becomes excessive, or where high levels of debt unnerve foreign investors. High debt countries are vulnerable to changes in foreign investor sentiment, resulting in volatility of capital inflows (investments).

Explain the cost of foreign debt when Australia’s terms of trade fall.

Terms of Trade Fall. If terms of trade fall (export prices are lower than import prices), this will reduce exporters income and the burden to service the debt increases.

Explain the cost of foreign debt on currency depreciation.

If the Australian currency depreciates, foreign currencies will cost more and more AUD is required to service the debt.