Australias Trade and Financial Flows

*On size, the Australian economy ranks 14th in the world, but
is relatively small compared to the global giants such as USA, China,
Japan etc.
* In 2009, Australia ranked 2nd in the world according to the
human development index
Trends in Australias Trade Patterns
Australias resources are in demand across the world, and since
Australia has a small population, it has needed to trade these
resources in order to obtain the money to develop. Australia only
produces 2% of global economic output. Exports are around of
production, and imports are around of consumption.
Changing direction of trade:
In recent decades, Japan and China have become Australias major
export buyers. This is because growth rates of Asian economies
have increased considerably, and geographically their markets are
easier for Australia to access than European or American markets,
especially since the advent of trading blocs such as the European
Union (EU) and North American Free Trade Agreement (NAFTA). The
Asia Pacific region is now by far the most important destination for
Australian exports.
In 2007 China became Australias largest trading partner with
exports 17% and imports 14.8% in 2008.
Changing composition of trade:
Primary industries have always been the main focus of Australias
exports since Australia has the greatest comparative advantage in
commodity goods. Australia has exported high volumes of
agricultural products such as beef, wheat and wool and also
minerals such as coal, iron ore, gold and bauxite. Australia is
generally less competitive in manufacturing. Australia imports a
large amount of capital goods, transport equipment; industrial
supples and manufactured consumer goods.

Imports- Capital goods unchanged at around 18% of imports,

intermediate goods and services imports have declined, due to the
reduction and phasing out of protection in Australia. Consumer
goods as a proportion of imports have steadily increased, at around
23% in 2008 from 15% in 1980.
Exports Since the resources boom in 2003-04, Australia has
experienced major changes in the composition of its exports. Rural
exports have declined significantly over the years, from 32% in
1980 to 13% in 2008. Agricultural sector has declined but the
mining and resources sector has boomed. However, mineral exports
fluctuate in demand according to trends of the international
business cycle, e.g. the Global Financial Crisis in 2008 dimmed
demand for resources worldwide, but Chinas strong growth and
demand for resources ensured that Australia did not lose out on a
major export buyer. Australia has experienced a decline in its
agricultural exports due to fluctuations in world prices and also
protectionist policies of other economies. Mining and Resources are
50% of Australias exports in 2008 from 35% in 1980. Australia does
not have the labour force or efficiency to compete on an
international scale for manufacturing or services, however there has
been a slight growth in the relative importance of these industries.
Trends in Australias Financial Flows
Financial flow growth has been greater than trade flow growth. The
floating of exchange rates and removal of restrictions on capital
movement encouraged greater growth in financial flows.
International capital markets opened up, and improvements in
technology enabled movements in financial flows globally to
become a lot more feasible.
Foreign Investment in Australia $47 billion in 1980
Foreign Investment in Australia $1.7 trillion in 2008
Australian Investment abroad $13 billion in 1980
Australian Investment abroad $978 billion in 2008

There has been a change in the composition of financial flows from

direct to portfolio investment.
Direct investment includes the purchase of companies, firms and
the purchase of a substantial proportion of shares in a company
(>10%). When a business undertakes direct investment it is
generally considered to be a longer term investment and the
investor normally intends to play a role in the management of the
business. This is different from portfolio investment which includes
loans, other forms of securities and smaller shareholding in
companies. Businesses and individuals undertaking portfolio
investment generally do not intend to play a role in the
management of the business. Portfolio investment has largely
increased after financial deregulation, consistent to the stats above.
Governments preferred direct investment, because it brought the
benefits of job creation and technological transfer. Unfortunately the
increase in portfolio investment has pushed up share prices and
increased speculation.
Australias investment overseas is more than 50 times what it was
in the 1980s. Australia has always been a net capital importer with
the level of foreign investment in Australia consistently remaining
close to twice the level of Australian investment abroad. In part, this
reflects the lack of domestic savings within Australia. For many
years, Australia has relied on financial flows from overseas to make
up for the shortfall between savings and investment in Australia,
and this remains a feature of financial flows between Australia and
the global economy today.
The Balance of Payments
The Balance of Payments is the record of the transactions between
Australia and the rest of the world during a given time period,
consisting of the current account and the capital and financial
account. It shows the trade and financial flows in (credits) and out
(debits) of the country.

The Current Account: is the part of the balance of payments that

shows the receipts and payments for trade in goods and services,
transfer payments and income flows between Australia and the rest
of the world in a given time period. These are non reversible
transactions. It comprises of Net Goods, Net Services, Net income
and Net Current Transfers.
The Capital and Financial Account: records the borrowing, lending,
sales and purchases of assets between Australia and the rest of the
world. Financial inflow has the immediate effect of increasing the
supply of foreign exchange to Australia while financial outflow
reduces it. These transactions are reversible- borrowings can be
repaid, and assets bought can be sold again. It comprises of the
Capital account and the Financial account (Direct investment,
Portfolio investment, Financial Derivatives, Other investment and
Reserve assets).
The overall balance of the capital and financial account is
determined by adding the categories together. The outcome should
be approximately equal to the deficit on the current account.
Current account + Capital and Financial account + Net errors and
omissions = 0
However, this is true only under a floating exchange rate system.
The supply of $A is represented by:
- Payments for imports of goods and services (M)
- Income/transfers overseas (Y debits)
- Capital and Financial outflow (K outflow)
The demand for $A is represented by:
- Receipts for exports of goods and services (X)
- Income/transfers overseas (Y credits)
- Capital and Financial inflow (K inflow)
Under a freely floating exchange rate, these should be equal.
M + Y debits + K outflow = X + Y credits + K inflow
M X + Y debits Y credits = K inflow K outflow

Deficit on the Current Account = Surplus on the Capital and

Financial Account
Financial inflows can create debits on the income category of the
Current Account in two ways;

Foreign financial inflows: overseas debt requires interest

repayments. These payments/servicing costs are not recorded
on the Capital and Financial Account and are recorded on the
net income part of the Current Account. The most significant
reason for the ongoing CAD is the servicing cost of foreign
debt.

Foreign financial inflows: equity will require returns on the

equity investment. Equity financial inflow can be related to the
foreign purchase of Australian land, shares or companies.
Foreign owners of land receive rent, owners of shares receive
dividends and owners of companies receive profits. This is also
in the net income part of the CAD.

Over time, high KAFAS will result in a widening CAD because of the
servicing cost associated with the increased foreign liabilities. This
can lead to Debt Trap scenario.
Current account deficit $62 billion March 2010
CAD (% of GDP) 4.9% March 2010
It is a danger sign if CAD as % of GDP exceeds 5%. When foreign
debt exceeds 50% of GDP, it is trouble for the economy.
Net foreign debt (% of GDP) 51.6% March 2010
Foreign Liabilities and the Balance of Payments
Net foreign liabilities reflect Australias total financial obligations to
foreigners, minus the total financial obligations of foreigners to
Australia. Two components of foreign liabilities;

Net foreign debt: Total stock of loans owed by Australians to

foreigners minus total stock of loans foreigners owe to
Australia.

Net foreign equity: Total value of assets in Australia such as

land, shares and companies in foreign ownership minus total
value of assets overseas owned by Australians.

Borrowing adds directly to foreign debt, but overseas investment in

Australian equity does not. Servicing of Australian debt constitutes
an outflow of funds on the Current Account, adding to the overall
size of the CAD. The effect of debt servicing on the CAD is very
significant and is the largest single cause of Australias high CAD.
The net income deficit is larger than any other component of the
CAD. Ideally, our exports should be able to comfortably service our
debt. International financial markets generally consider that when a
countrys net foreign debt rises too far, it may pose repayment
problems for the debtor country. This can undermine Australias
credit rating (reflection of confidence in the Australian economy).
Debt servicing ratio is the proportion of export revenue used to
make repayments on foreign debt and is a measure of the
sustainability of Australias foreign debt level. The debt servicing
ratio in Australia peaked at just under 20 per cent in the late 1980s,
but has since fallen back due to lower worldwide interest rates and
Australias continued export growth.

Issues and Trends in the balance of payments

BOP affected by domestic + international factors.
Structure of Australias export base
Australias export base is heavily weighted towards primary industry
commodities. Almost 60% of export earnings come from mineral +
agricultural exports. Australia has an unusually heavy reliance on
exports of primary industries compared to other advanced
economies. In the long term, a narrow export base contributes to
the volatility in the CAD because Australia is exposed to exogenous
fluctuations. Sometimes these moments are favourable, such as

recent times, but in times such as during the Global Financial Crisis,
there is potential for Australias exports to significantly drop. Prices
of some commodity items especially in agriculture have seen a long
term decline as global trade has shifted to sophisticated
manufactured goods and services. Agricultural commodities are also
subject to high levels of protection which can make difficult for
Australia to sell these exports.
Talk about how narrow export base is good when commodity prices
are high and can improve the CAD, but if export base is broadened
to include elaborately transformed manufactures (ETMs) then
Australia is less prone to the fluctuations of the international
business cycle.
Services are the single fastest growing area of global trade and this
is accelerated by new technology such as the internet. Service
industries dominate the Australian economy, employing around of
working Australians, but only a small portion of Australias services
are exported. Expansion of service exports is essential to improving
Australias trade performance. Currently service exports are
narrowly based with half of Australias service exports coming from
tourism. The next largest service export is education, and is about
1/3 of service exports.