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Australia's Balance of Payments, Trade, and Exchange Rates (Vocabulary Flashcards)

Page 1

  • Australia’s Place in the Global Economy
    • Importance of trade to Australia
    • Trade = exports + imports
    • International trade = exchange of goods and services between nations
    • Australia relies on imports for certain products and technologies not produced domestically to assist its own industries
    • Direction of trade
    • Exports: destination of goods/services (where exports are going)
    • Imports: sources of goods/services (where imports come from)
    • Composition Of Trade
    • Definition: pattern of goods and services traded; types of products exported and imported
    • Value of Trade
    • Value = volume traded × price
    • Prices for each volume depend on import price and export price
    • Terms of Trade (TOT)
    • Definition: the prices received for exports versus prices paid for imports
    • TOT is the ratio of export price to import price, often expressed as a price index
    • Formula: ext{TOT}= rac{ ext{Export price index}}{ ext{Import price index}} imes 100
    • If TOT index increases, Australia earns relatively more for exports; if it decreases, Australia earns relatively less
    • TOT: Examples
    • Improvement in TOT: export prices rise faster than import prices
      • Example: export price index = 120, import price index = 105
      • Calculation: ext{TOT}= rac{120}{105} imes 100 \approx 114.29
      • Interpretation: a country can finance a greater volume of imports with existing exports
    • Deterioration in TOT: export prices rise less quickly or fall faster than import prices
      • Example: export price index = 110, import price index = 115
      • Calculation: ext{TOT}= rac{110}{115} imes 100 \approx 95.65
      • Interpretation: a country can finance a lower volume of imports with existing exports
  • Page 2
  • Financial Flows
    • International financial flows: movement of capital, money and currencies between countries for investment or business activity
    • Key types of flows
    • Foreign Direct Investment (FDI): money invested in overseas country with controlling interest (usually ≥ 10% of asset value)
    • Development Aid: grants (no repayment) or loans with low interest
    • Debt Repayment: repayment of borrowed money with interest
    • Portfolio Investment: investment in overseas stocks/bonds/assets without controlling interest (< 10% of asset value)
    • Loans: borrowed money expected to be repaid with interest
    • Remittances: money international migrants send home
    • Financial Derivatives: contracts whose value is based on an underlying asset (e.g., swaps, futures, options)
    • Foreign Debt: borrowing from overseas with obligation to pay interest and repay principal
    • Debt metrics
    • Gross foreign debt: total amount Australians borrow from non-residents
    • Net foreign debt: gross foreign debt − total lending by Australians to non-residents
    • Example: if government, businesses, and individuals borrow 2 ext{ trillion} from overseas, gross foreign debt = 2 ext{ trillion}
      • If Australians have lent 0.5 ext{ trillion} to foreigners, net foreign debt = 2 - 0.5 = 1.5 ext{ trillion}
  • Page 3
  • Types of Foreign Debt and Equity
    • Foreign Debt by sector
    • Public sector debt (external sovereign debt): money owed by government to overseas parties; ~40% of net foreign debt
    • Private sector debt: money owed by financial institutions and other businesses to overseas parties; ~60% of net foreign debt
    • Foreign Equity concepts
    • Total Foreign Equity: total value of Australia’s domestic assets owned by foreigners
    • Net Foreign Equity: value of foreign-owned domestic assets minus value of Australian assets owned overseas
    • Foreign Equity types
    • Foreign direct investment (FDI) in equity: complete takeover or substantial share purchase with management control (≥ 10% of asset)
    • Portfolio Investment: investment in stocks/bonds/assets without control (< 10% of asset)
  • Page 4
  • Foreign Liabilities and Assets; Savings-Investment Gap
    • Foreign Liabilities: Australia’s total financial obligations to foreigners (foreign debt + foreign equity)
    • Decomposition reminders
    • Foreign debt split: amount borrowed from foreigners vs. amount Australians lend to foreigners
    • Foreign equity split: value of domestic assets owned by foreigners vs. overseas assets owned by Australians
    • Total Foreign Liabilities vs Total Foreign Assets
    • Total Foreign Liabilities = amount borrowed from foreigners + value of domestic assets owned by foreigners (capital inflow)
    • Total Foreign Assets = amount Australians lend to foreigners + value of overseas assets owned by Australians (capital outflow)
    • Net Foreign Liabilities: Total Foreign Liabilities − Total Foreign Assets
    • Net Foreign Liabilities = Net Foreign Debt + Net Foreign Equity
    • Foreign Investment and the savings-investment gap
    • The Australian Government has encouraged foreign investment to supplement the domestic savings pool
    • Australia’s low domestic savings partly due to small population
  • Page 5
  • Trade and Financial Flows; Balance of Payments (BOP)
    • Goods balance: goods credits − goods debits
    • Service balance: service credits − service debits
    • Balance of Payments (BOP): records all transactions between residents and the rest of the world over a period; shows money inflows and outflows
    • Credits vs Debits
    • Credits = inflows (payments received)
    • Debits = outflows (payments made)
    • BOP accounts structure
    • Current account (CA)
    • Capital and Financial Account (KAFA)
    • Note: BOP is a recording of transactions; requires accuracy and consistency
  • Page 6
  • Current Account Components: NPI, NSI
    • Net Primary Income (NPI)
    • Records income flows from factors of production (land, labour, capital, entrepreneurship)
    • Related to earned income and investment returns
    • Credits: income from lending to overseas (interest received); income from Australian-owned assets overseas (rent, profits, dividends)
    • Debits: borrowing from overseas (interest payments); income from foreign-owned assets in Australia (rent, profits, dividends paid to foreigners)
    • Net Primary Income: Credits − Debits (usually a deficit, i.e., outflows exceed inflows)
    • Net Secondary Income (NSI)
    • Records one-sided, unearned transfers with no corresponding goods/services provided
    • Examples: government grants, worker remittances, insurance claims, foreign aid for non-capital items
  • Page 7
  • Capital and Financial Account (KAFA)
    • KAFA records reversible transactions between Australia and the rest of the world; typically in surplus
    • KAFA categories
    • Capital account: transfers of non-produced, non-financial assets (intellectual property rights like patents, copyrights, trademarks, royalties, franchises)
      • Example: Australian company purchasing rights to operate a US Subway outlet in Australia is a debit on the capital account (outflow)
      • Foreign aid can be recorded here as foreign infrastructure/capital aid (specific aid)
    • Financial account: financial transactions (borrowing/lending, asset purchases) that are reversible
  • Page 8
  • Balancing the Balance of Payments
    • The total balance of payments should sum to zero in the long run
    • In practice, measurement errors and omissions can cause discrepancies
    • Errors and Omissions: a CAFA subcomponent used to balance the accounts
    • Why BOP sums to zero
    • CAD increases require higher KAFA surplus and vice versa (inverse relationship)
    • Floating exchange rate context
    • Floating dollar helps restore BOP balance by adjusting demand/supply for AUD
  • Page 9
  • Market for the Australian Dollar (AUD)
    • Supply and demand in forex market are derived from cross-border trade and investment
    • Demand for AUD is derived from foreigners needing AUD to buy Australian goods/services/assets; and from returns like rents/dividends/interest paid to Australians
    • For supply of AUD, Australians supply AUD to buy foreign currency when purchasing imports or investing overseas
    • Notation: x-axis = quantity of AUD; y-axis = price (exchange rate in terms of another currency, e.g., USD)
  • Page 10
  • Floating Exchange Rate and CAKAFA Relationship
    • When Australians borrow from overseas (outside money), KAFA records inflows (credit) and primary income records interest payments as debits
    • Principal repayments appear as KAFA debits; this interacts with CA via net primary income movements
    • Foreign investment in Australia (FDI/portfolio) is KAFA credit; returns (rent/dividends/profits) are debited in the current account as part of NPI
    • Consequences
    • Increases in foreign inflows raise KAFA surplus but can widen the current account deficit (CAD) due to greater returns (NPI) payable
    • CAD growth necessitates more KAFA inflows, potentially creating a debt-trap cycle
  • Page 11
  • Debt Trap Cycle and Competitiveness
    • Debt trap cycle concept
    • Australia’s low savings rates lead to reliance on overseas investment to fund investment and growth
    • Inflows boost KAFA surplus but increase interest costs on foreign liabilities, worsening CAD
    • Higher CAD requires more foreign borrowing to service debt, raising foreign debt further
    • Impact of international competitiveness on the Balance of Trade (BOGS)
    • International competitiveness = ability to compete with other countries in exports and imports
    • Factors influencing Australia’s international competitiveness
    • Inflation: high domestic prices raise production costs, reducing competitiveness
    • Wages: higher wages raise prices, reducing competitiveness
    • High labour costs: increase imports and reduce exports
    • Productivity: higher productivity improves competitiveness
    • Exchange rate value: a weaker AUD improves competitiveness; a stronger AUD reduces it
  • Page 12
  • Trends in Net Primary Income (NPI)
    • NPI deficit is typically the largest component of the CA deficit
    • Resource/commodity booms attract foreign investment, increasing repayments overseas
    • Higher TOT due to commodity price booms attracts more foreign investment ( profitable sectors)
    • Lower global interest rates reduce interest payments and improve NPI position
    • Savings–Investment gap necessitates foreign investment; returns on these investments are paid as primary income
    • Note: “Savings-Investment Gap” is a recurrent theme affecting CA dynamics
  • Page 13
  • Impacts of International Borrowing and Foreign Investment
    • International borrowing affects NPI via higher future debt service obligations
    • When Australians borrow, the initial borrowing is a KAFA credit; interest payments are a NPI debit
    • Increase in foreign debt raises foreign liabilities and servicing obligations (interest payments)
    • Foreign investment (FDI/portfolio) improves competitiveness and growth but also generates returns payable in the current account (NPI debited)
  • Page 14
  • Measuring CAD Sustainability and Related Impacts
    • How to measure the sustainability of the CAD
    • Quantitative: CAD as % of GDP; a CAD above 4% of GDP is considered high and potentially unsustainable
    • Qualitative: ability to attract foreign investment; ability to service foreign liabilities; sustained economic growth
    • Effects of a high CAD
    • Growth in foreign liabilities: higher borrowings and foreign equity needs to finance CAD and growth
    • Increased servicing costs: interest on debt and returns on equity (dividends)
    • Constraint on future growth: CAD can constrain growth via the national accounts equation: ext{GDP}=C+I+G+(X-M); higher imports reduce net exports and GDP growth
    • More volatile exchange rates due to investor confidence shifts and risk perceptions
    • Contractionary policies may be used to reduce CAD, potentially lowering growth
    • Loss of investor confidence can hurt credit rating and investment
    • Pitchford Thesis – Consenting Adults
    • CAD is not inherently problematic if driven by private sector savings/investment decisions
    • Private sector borrowing can expand productive capacity, boost growth, create jobs
    • Majority of foreign debt in Australia is private sector borrowing, not government borrowing
  • Page 15
  • Exchange Rates: Basics
    • Exchange rate definition: price of 1 currency in terms of another currency or a basket of currencies
    • Foreign exchange market (forex): market where currencies are bought and sold
    • Bilateral rates: currency value against one other currency (e.g., AUD/USD)
    • Quotations
    • Indirect method (common in media): how much foreign currency 1 AUD can buy (e.g., 1 AUD = 0.68 USD)
    • Direct method: how many AUD per unit of foreign currency (e.g., how many AUD for 1 USD)
    • Converting indirect to direct involves reciprocal relationships
  • Page 16
  • Measuring and Regimes for Exchange Rates
    • Bilateral rates may misrepresent currency performance; compare across multiple currencies or use a Trade-Weighted Index (TWI)
    • Trade Weighted Index (TWI): performance of the AUD against major trading partners’ currencies; better measure of competitiveness
    • Exchange rate regimes
    • Floating/flexible (clean): no government intervention; market forces determine rate
    • Floating/flexible (dirty): occasional short-term central bank intervention to stabilize fluctuations
    • Managed exchange rate: central bank intervenes when currency moves outside a target band
    • Fixed/pegged: currency fixed to another currency or basket; central bank must intervene continuously to maintain the peg
    • AUD supply in forex market
    • AUD is supplied (sold) to buy foreign currency to pay for imports
    • Also supplied when sending income abroad (e.g., returning dividends); investors convert AUD to foreign currency for overseas investments
  • Page 17
  • AUD Demand and Appreciation/Depreciation Dynamics
    • AUD demand in forex market comes from: obtaining Australian goods/services, asset payments (rents, profits, dividends), and foreign investment in Australia
    • If demand for AUD increases, AUD appreciates (price rises: e.g., from 0.68 to 0.75 per USD) because more foreigners want AUD
    • Appreciation effects: reduces international competitiveness (exports become more expensive; imports cheaper)
    • If demand for AUD decreases, AUD depreciates (price falls: e.g., from 0.75 to 0.62 per USD) because fewer want AUD
  • Page 18
  • Floating Exchange Rate: Clean vs Dirty; Advantages/Disadvantages
    • Clean float: no government intervention; rate determined purely by market forces
    • Dirty float: occasional short-term central bank intervention to reduce fluctuations
    • Fixed/pegged systems involve continuous government intervention to maintain a target price
    • Consequences of floating rates
    • Reduces need for large foreign exchange reserves
    • Risks include speculative bubbles and volatility in currency values
  • Page 19
  • Direct vs Indirect Intervention by RBA; Revaluation and Devaluation
    • Direct intervention (unsterilized vs sterilized)
    • Unsterilized: direct change in exchange rate by buying/selling foreign exchange; affects money supply and can move short-term rates
    • Sterilized: offset liquidity effects of direct intervention by selling/buying domestic government securities to keep money supply unchanged; preserves the target exchange rate without changing the cash rate
    • Revaluation: central bank increases the value of a fixed currency; may require intervention (buy AUD with foreign currency)
    • Devaluation: central bank lowers the value of a fixed currency; may require intervention (sell AUD for foreign currency)
    • ESAs (Exchange Settlement Accounts): banks hold reserves with the central bank; interventions affect liquidity and thus short-term rates
  • Page 20
  • Managed and Policy Implications of Exchange Rate Management
    • Managing exchange rate fluctuations can reduce volatility and provide stability for businesses and investors
    • Market expectations and speculation can cause overshooting or undershooting; central banks may intervene to keep outcomes within target bands
    • Potential conflicts with other policy objectives (e.g., inflation control) when adjusting currency values
  • Page 21
  • Market for Australian Dollars – Summary of Mechanisms
    • Demand for AUD is derived from: foreigners needing AUD for imports/transactions and for returns on Australian assets
    • Supply of AUD is derived from: Australians needing foreign currencies for imports/investment and for repatriating income
    • Theory summary: intersection of demand and supply determines the equilibrium exchange rate; quotations usually in terms of another currency or a basket (TWI)
    • Indirect method example: 1 AUD buys 0.68 USD; shifts in demand/supply move the rate (appreciation if demand rises; depreciation if supply rises)
  • Page 22
  • Factors Influencing Demand for Australian Dollars (Part 1)
    • Demand for Australian exports increases demand for AUD (foreign buyers convert to AUD)
    • Higher TOT makes exports more expensive for foreigners, potentially influencing demand for AUD accordingly
  • Page 23
  • Continuing Demand Factors for AUD
    • Relative rates of domestic and world economic growth: stronger global growth increases demand for Australian exports, raising demand for AUD
    • Terms of Trade (TOT): higher export prices relative to import prices increase demand for AUD
    • Demand for Australian assets (shares, real estate, government bonds, currency): investors convert to AUD to buy these assets, increasing demand for AUD (appreciation)
    • Australian interest rate differential: higher domestic rates attract foreign capital, causing appreciation; lower rates reduce demand for AUD
  • Page 24
  • Further Demand/Inflation Dynamics; Inflation and Expectations
    • Inflation: higher inflation reduces international competitiveness; exporters pass costs to prices, reducing demand for AUD (depreciation); lower inflation can improve competitiveness and demand for AUD (appreciation)
    • Exchange rate expectations: speculation drives demand; expected appreciation boosts AUD; expected depreciation reduces demand
    • Income repatriation: when Australians receive income from foreign assets, they may demand AUD to repatriate (affecting demand in forex market)
  • Page 25
  • Factors Influencing Supply of the AUD (Part 2)
    • Demand for foreign imports by Australians increases AUD supply (to buy foreign currency)
    • Australian demand for foreign assets (FDI/portfolio) increases AUD supply when converting to foreign currency
    • Shifts in supply depend on relative interest rates and expectations; higher demand for foreign assets increases AUD supply (depreciation), lower demand can cause appreciation
  • Page 26
  • Additional Determinants of AUD Supply and Demand
    • Relative interest rate differential: lower Australian rates encourage capital outflows and increase AUD supply; higher rates attract inflows and reduce supply (or increase demand for AUD)
    • Exchange rate expectations: expected depreciation leads to higher current supply as investors move assets; expected appreciation can reduce supply
    • Relative growth: higher domestic vs. global growth can expand imports, increasing AUD supply; strong growth may also attract foreign investment (unclear net effect)
    • Transfer of income: when foreigners buy Australian assets, remitted income can be repatriated, affecting AUD supply/demand
  • Page 27
  • Link to the Balance of Payments (BOP)
    • How demand/supply of AUD tie to BOP components
    • Demand factors and BOP linkages
    • Demand for Australian exports increases AUD demand, boosting CA/BOGS credits and AUD value (appreciation)
    • Demand for Australian assets by foreigners (e.g., BHP shares) increases AUD demand via KAFA/portfolio investment, causing appreciation
    • Supply factors and BOP linkages
    • Demand for foreign imports reduces AUD demand for AUD (increases supply), causing depreciation
    • Demand for Australian assets by residents abroad increases AUD supply as they convert to foreign currency (debit on KAFA, depreciation)
    • Other transactions on the BOP (e.g., franchise purchases, dividend payments) affect the CA/KAFA balance and AUD exchange rate
  • Page 28
  • Why does the RBA Intervene?
    • The AUD value is not targeted as a specific objective by the RBA, but intervention occurs to manage volatility and align with macro goals
    • RBA interventions historically aimed at smoothing volatility after the 1983 float
    • Objectives include preventing excessive depreciation (which raises import prices and inflation) and excessive appreciation (which raises export prices and may reduce growth)
  • Indirect Intervention (via policy tools)
    • The RBA can influence the currency without changing the cash rate via monetary policy adjustments or macroeconomic policy stances
    • Jawboning: public statements by officials to influence expectations and market behavior
    • Macroeconomic policy adjustments to influence demand for imports and overall growth
  • Unsterilized vs Sterilized Interventions
    • Unsterilized intervention: direct FX market action changes money supply and can move short-term rates
    • Sterilized intervention: FX market action paired with offsetting open-market operations to keep the cash rate unchanged
    • The RBA can use sterilized intervention to influence the exchange rate without altering the monetary policy stance
  • Page 29
  • Mechanisms of FX Market Intervention (Detailed)
    • If the RBA wants a weaker AUD: sell AUD in FX market (buy foreign currency); AUD supply increases; banks’ ESAs rise; cash in money market increases; short-term rates may fall
    • If the RBA wants a stronger AUD: buy AUD in FX market (sell foreign currency); AUD demand rises; ESAs decrease; money market liquidity tightens; short-term rates may rise
    • Direct FX operations and ESAs link to monetary conditions
  • Page 30
  • Sterilized Intervention (Continuing)
    • After FX intervention, the RBA may conduct sterilized operations by selling government securities to shrink the money supply back to its original level, leaving the cash rate unchanged
  • Page 31
  • Practical Outcomes of FX Intervention
    • Increases or decreases in exchange rate can impact inflation, competitiveness, and growth depending on the direction of change
    • FX interventions can be a tool to stabilize macroeconomic outcomes without triggering unwanted monetary tightening or loosening
  • Page 32
  • Changes in Exchange Rates – Appreciation and Depreciation
    • Appreciation: rise in value of a currency; caused by increased demand or reduced supply; example: rate moves from $0.68 to $0.75
    • Depreciation: fall in value of a currency; caused by increased supply or decreased demand; example: rate moves from $0.75 to $0.68
  • Page 33
  • Free Trade and Protection – Policy History
    • Australia’s move from a highly protected economy to a liberal trading regime over decades
    • Tariffs declined gradually since the 1960s; non-tariff barriers (quotas, subsidies) reduced over time
    • Timeline highlights
    • 1901: Protection policies to develop infant manufacturing industries (small population, low production)
    • 1930s: Protection intensified during the Great Depression (British Preferential tariff 35%; General tariff >60% for non-Commonwealth countries)
    • 1967: Joined GATT (precursor to WTO) and began opening up
    • 1970–71: Effective protection in manufacturing ~35%; agricultural ~25%
    • 1973: Whitlam government cut across-the-board tariffs by 25% to expose markets to competition
    • 1983: First FTA with New Zealand
    • 1988: Hawke government tariff reductions; manufacturing protection fell from ~15% (1989) to ~10% (1994) with some exemptions (cars, textiles)
    • 1991: Building a Competitive Australia (policy statement)
    • 1995: WTO replaces GATT
    • 2000: Tariffs on passenger motor vehicles gradually reduced
  • Page 34
  • Rationale Behind Policies
    • Benefits of specialization and economies of scale; lower costs, higher productivity
    • Benefits to consumers: lower prices, more choices
    • Supports higher living standards; longer-term employment prospects
    • Encourages competition, innovation, and efficiency (allocative and dynamic)
    • Promotes GDP growth and export expansion; access to new markets
    • Exposes local industries to global competition; aims to improve technical, allocative and dynamic efficiency
    • Process is slow and gradual; structural adjustments managed by government to minimize unemployment costs
  • Page 35
  • Current Policies and Trade Aid
    • Free Trade Agreements (FTAs): pursuing WTO-consistent, high-quality bilateral/multilateral FTAs that offer net benefits; example: Australia–Hong Kong FTA effective 17 January 2020; pursuing EU FTA
    • APEC membership: forum to discuss trade/policy; reduce impediments to business; promote open trade/investment
    • Austrade and export market development grants: provide financial assistance, loans, bonds, guarantees to exporters
    • Budgetary assistance: tax concessions and subsidies across sectors (mining, manufacturing, services, agriculture)
    • Tariff assistance: targeted subsidies for farmers and manufacturing
    • Anti-Dumping Commission: addresses dumping practices
  • Page 36
  • Australia’s FTAs – ASEAN-led and CPTPP Context
    • ASEAN+New Zealand Free Trade Agreement (AANZFTA): multilateral framework with ASEAN bloc; in force since 2010; key members include Australia, New Zealand, Brunei, Burma, Malaysia, Philippines, Singapore, Vietnam; tariff reductions, supply-chain opportunities, investment certainty
    • CPTPP (Comprehensive and Progressive Agreement for Trans-Pacific Partnership): 11 countries; about 495 million people; ~13.5% of global merchandise trade; benefits include reduced tariffs, easier market entry, streamlined customs, growth opportunities
    • Bilateral FTA (CHAFTA) with China: tariff reductions/elimination on agricultural products (dairy, beef, wine) and other goods; expanded access to Chinese market; examples of export growth in beef, wine, dairy; reforms for services and investment, including healthcare and professional services
  • Page 37
  • Australia’s Bilateral FTA with Korea (KAFTA)
    • KAFTA entered into force 12 December 2014
    • Benefits include: 99%+ of Australian goods exports to Korea eligible for duty-free or favorable access; elimination of important tariffs (e.g., 40% tariff on beef in 2028)
    • Reductions in market access barriers for Australian law firms to operate in Korea
  • Negative Impacts of Free Trade on Australians
    • Structural unemployment due to industry restructuring; short-term job losses for low-skilled workers; need for retraining and upskilling
    • Real wages may not rise quickly if demand for labor is weak in affected sectors
  • Page 38
  • Positive Impacts of Free Trade on Australians
    • Workers who adapt quickly gain opportunities in services and high-skilled manufacturing; potential for higher productivity and growth
    • Consumers benefit from lower prices and greater product variety; improved quality from competition; better customer service
    • Businesses can expand to export markets; lower input costs due to tariff reductions; enhanced competitiveness
  • Government Perspectives on Free Trade (Negative)
    • Potential loss of tariff revenue; higher structural adjustment costs (unemployment benefits, retraining)
    • Political costs: policies may be unpopular and contested by voters in the short term
    • Possible negative impacts on the BOGS and CAD if inputs rise and competitiveness worsens
  • Page 39
  • Government Perspectives on Free Trade (Positive)
    • Potential reduction in government spending due to lower tariffs and subsidies
    • Increased efficiency as resources shift to competitive industries; economies benefit from innovation and productivity gains
    • Greater export diversification; buffers against external shocks; potential reduction in imported inflation due to tariff reductions
    • Free trade supports macro policy flexibility by stabilizing inflation and reducing the need for tight monetary policy