AOS 3: Eco - KK 2-3

The balance of payments and its components

The Balance of Payments (BOP)

provides an annual statistical record of all the financial transactions between Australians and residents of the rest of the world

Credit

A credit item on the balance of payments is any financial flow that leads to money entering the country.

Debit:

A debit item on the balance of payments is any financial flow that leads to money leaving the country.

Balance on current account (also called the capital and financial account balance)

is equal to the total value of all credits minus the value of all debits for goods, services, primary incomes and secondary incomes, measured over a period of time.

The balance can be a CAD or a CAS.

• CAD = Current Account Deficit

• CAS = Current Account Surplus

The Balance of Payments ‘Current Account’

1. Net goods

2. Net services

3. Net primary incomes

4. Net secondary incomes

Net goods

This is the difference in total value between export credits for goods or merchandise sold overseas (e.g. wool, minerals and manufactured items) minus import debits for goods purchased from abroad (e.g. oil, electronic equipment and machinery).

Net services

This is the difference between the value of service credits received by Australia (e.g. from tourism, education, transportation, construction, financial, royalties and licence fees) minus service debits paid abroad (e.g. for transportation, tourism, education, royalties and licence fees, and insurance).

Net primary incomes.

This is the difference in value between income credits received from overseas (e.g. wages, salaries, interest, dividends and profits) minus income debits paid out abroad (e.g. for wages, salaries, interest, rent, dividends and profit remittances).

Net secondary incomes.

This is the difference between the value of secondary income credits received by our residents (e.g. non-life insurance transfers such as pensions) minus the value of secondary income debits paid abroad (such as gifts, taxes and some foreign food aid donated by our residents).

Secondary incomes are different from other transactions in that they are a one-way transaction with nothing exchanged in return.

differnece between net primary income and net secondary income

The main difference is that net primary income is payment for economic services (working, lending, or renting), while net secondary income is money transferred for free (gifts, aid, or taxes) without any goods or services given in return

To calculate the overall balance on capital and financial account

Overall balance on capital account = Net capital + Net Financial

The balance of payments on capital and financial account

1. Balance on capital account.

   • Capital transfers

   • The net acquisition/disposal of non-produced

2. Balance on financial account.

   • direct investment

   • portfolio investment

   • Net financial derivatives and other investments

   • Net reserve assets

   • Net errors and omissions

Balance on capital account (also called the capital account balance)

is a subsection in the BOP capital and financial accounts. It records the total value of credits minus the total value of debits for capital transfers and other intangible assets.

Capital Transfers

Transactions where one party has transferred ownership of something to another party without receiving anything specific in return. 

For example:

• forgiveness of debt (so that the borrower no longer has to pay back what they borrowed) 

• conditional grants for capital projects (e.g. foreign aid to build roads, dams and schools) 

• transfer of assets between residents and non-residents.

The net acquisition of non-produced, non-financial assets:

covers the excess of transactions of credits over debits that involve intangible assets (e.g. patents, brand names, copyrights, overseas franchises and trademarks) and rights to use land or water

(e.g. for mining or fishing)

Debit: MasterChef has sold its license to Australia to play on TV

Credit: Vance Joy playing his music on Spotify in America. 

Balance on financial account

a subsection in the BOP capital and financial accounts. It mainly records international transactions involving the movement of money capital or investment, as well as the dealings of the Reserve Bank of Australia (RBA).

Direct investment

Direct investment involves capital movements into and out of Australia that involve the establishment, purchase or expansion of companies and other assets.

Financial transactions related to long-term capital investment in a business (e.g. purchase of machinery, buildings and factories), where the investor has significant voting power in the business (10 per cent or above ownership of shares).

Credit: purchase of toll group by a Japanese company and Uniqlo opening a store in Chadstone. 

Debit: oil field being opened up in Papa New Guinea by an Australian company 

Portfolio investment

Portfolio investment involves money transactions into and out of Australia involving shares, debt and securities.

The purchase of equity or debt (shares or bonds) in a business. Transactions involving less than 10% of shares

Credits: Sale of Qantas shares to foreign buyer. 

Debits: Purchase of Apple shares by an Australian Superannuation Company

Financial Derivative 

Net financial derivatives and other investments are the difference in the value of credits (the inflow of funds or assets) minus debits (the outflow of funds or liabilities) for financial contracts between two parties where the value is derived from another financial instrument, such as a bond or share.

The purchase of financial derivatives (i.e. financial contracts between two parties where the value is derived from another financial instrument, such as a bond or share, or a market index). These transactions involve the exchange of risk between parties, rather than funds.

Reserve Assets

Net reserve assets includes the value of foreign currencies, monetary gold, and required contributions to overseas governments and international agencies.

• The purchases or sale of reserve assets held by the Reserve Bank

• are controlled by the Reserve Bank to meet policy objectives such as intervention in the foreign exchange market and to assist the Australian government in meeting its commitments to the IMF.

• Credit: RBA purchases $AUD on forex market to smooth a volatile exchange rate

• Debit: Government transfers money to the UN for research

Other investment 

Transactions that do not fit into one of the other categories.

For example: ‘currency and deposits’, where money is deposited in or withdrawn from banks across borders, or banknotes and coins are transferred between countries.

• Credit: Borrowing by NAB from a Japanese bank

• Debit: Deposit by ANZ into a swiss bank 

Net errors and omissions

Net errors and omissions - reflects the inaccuracies and estimations in the recording of international transactions.

• value can be positive or negative.
  

• While the total balance of payments should be zero, this does not always occur in practice. This can be due to measurement errors, because it is difficult to accurately record every single transaction between Australian residents and the rest of the world. And sometimes transactions are not measured at all – they are ‘omitted’. 

cyclical influences

Are aggregate demand side factors that cause the value of spending to rise or fall (business cycle) thus impacting net exports (X–M) and the balance on current account.

structural influences

The aggregate supply side factors that can affect the current account balance, often by influencing our costs and international competitiveness.

Changing cyclical conditions within Australia affect the current account balance

Stronger cyclical levels economic activity in Australia = tend to weaken the CA balance. 

• For example: high levels of economic activity, can result in a decrease in the unemployment level, higher incomes, increase spending on imports, weakens the current account balance

Weaker cyclical levels of economic activity, end to strengthen the CA balance. 

• For example: Low levels of spending due to consumers and business pessimism, will buy fewer imports, reducing debits relative to credits, strengths the current account. 

Changing cyclical conditions overseas affect the current account balance:

Favourable overseas conditions

• Increase spending from Aus overseas trading partners tends to strengthen the current account balance. 

• Demanding more Aus exports adding to the value of credits relative to debits on the current account. The current account balance strengthens. 

Unfavourable overseas conditions

• Decrease spending from Aus overseas trading partners tends to weaken the current account balance. 

• Depend less exports due to a slowdown in economic activity reducing the value of credits relative to debits on the current account. The current account balance weakens.

Reasons for CAD (current account deficit) 2026

1.Net primary income deficit (largest reason)

Australia has historically relied on foreign investment and overseas borrowing to fund economic growth.

This means:

• Foreign investors own Australian businesses, shares and assets.

• Australia has overseas debt.

As a result, Australia must pay:

• Interest on overseas loans

• Dividends/profits to foreign shareholders

• 
  

2. High demand for imports

Australians buy many imported:

• Consumer goods

• Cars

• Electronics

• Machinery and equipment

3. Strong domestic economic growth

When the Australian economy grows strongly:

• Household incomes rise

• Consumer spending increases

• Businesses invest more

Which cause them to spend more on imports

4. Low national savings compared with investment

Australia traditionally has:

• Relatively low household/government savings

• High levels of investment spending

Because investment exceeds savings, Australia borrows from overseas to finance this gap. This increases foreign liabilities and future interest/dividend payments, contributing to the CAD.

structural(also called aggregate supply-side conditions) influences on Australia's current account balance

• production costs for local firms (e.g. wage costs, labour productivity, the cost of utilities, interest rates on borrowed credit, company tax rates), business profitability

• inflation rate and international competitiveness, relative to overseas. 

less favourable structural or aggregate supply conditions =  CAD

• Caused by less favourable structural influences such as rising production costs and reduced international competitiveness. Slow sales of exports weaken the current account balance. 

• Australia's national saving-investment gap. National savings by households, firms and governments are not sufficient to finance high levels of investment, so the gap is filled by borrowing credit from overseas, structurally weakening the current account balance. (net primary income with higher interest repayments)

more favourable structural or aggregate supply conditions = CAS

• It would be caused by more favourable aggregate supply side conditions (such as reduced cost of production, improve productivity) that in turn, would strengthen the current account balance by boosting the value of credits relative to debits.

Current structural influences on the CAB

Reasons for a CAS

• Slow rises in real unit labour costs, improving international competitiveness.

Reasons we may move towards a CAD

• High levels of overseas debt due to the national savings-investment gap, has weakened the structural component of our current account balance.