Current Account Deficit in Australia and Relevant Economy Policy free essay sample

The overall economy condition of Australia Australia’s economy has experienced positive reforms over the last two decades. These reforms have boosted the country’s economy and raised the country’s standard of living. In 2009, Australia was the 13th largest economy by nominal GDP of US$930. 8 billion (Wikipedia). Positively engaged in world trade, Australia is ranked the 21st largest importer and 23rd largest exporter in the world (Economy Watch 2009). Export commodities are: coal, iron ore, gold, meat, wool, alumina, wheat, machinery and transport equipment. The top5 export destinations are China, Japan, North Korea, India and United States. Import commodities are: machinery and transport equipment, computers and office machines, telecommunication equipment and parts; crude oil and petroleum products. The top5 import sources are China, United States, Japan, Thailand and Singapore (Australia fact sheet 2009). Balance of payments in Australia Although Australia has achieved significant economy growth, it still has many problems in developing its economy. To be specific, Australias large current account deficit is currently the greatest concern to some economists. For the past three decades, Australia has had a BOP deficit with its CAD having grown from $195 million in December, 1979 to $18483 million in December, 2009 (ABSxls). With the enormous BOP deficit, Australia has to take measures to control the sources of BOP deficit, so that it will not fall into a debt crisis like Greece’s. The latest BOP statistics are listed below: Table1 Current account ;-18483 Goods and Services ;-7467 Goods and Services credits ;60234 Goods and Services debits ;-67701 Goods ;-6898 Goods credits ;46638 Goods debits ;53536 Services ;-569 Services credits ;13596 Services debits ;-14165 Primary income ;-10897 Primary income credits ;9672 Primary income debits ;-20570 Secondary income ;-119 Secondary income credits ;1608 Secondary income debits ;-1727 (Sources: ABS 2009) Table2 Capital and financial account ;17943 Capital account ;-35 Acquisitions/disposals of non-produced non-financial assets ;0 Acquisitions/disposals of non-produced non-financial assets credits ;0 Acquisitions/disposals of non-produced non-financial assets debits ;0 Capital transfers ;-35 Capital transfers credits ;0 Capital transfers debits ;-35 Financial account ;17978 Direct investment ;7731 Direct investment, Assets ;-6087 Direct investment, Liabilities ;13817 Portfolio investment ;-298 Portfolio investment, Assets ;-34144 Portfolio investment, Liabilities ;33846 Financial derivatives ;-2165 Financial derivatives, Assets ;12133 Financial derivatives, Liabilities ;-14297 Other investment ;11529 Other investment, Assets ;-4008 Other investment, Liabilities ;15536 Reserve assets ;1181 Net errors and omissions ;541 (Sources: ABS 2009) From the first chart, we can see that the major components of current account deficit were primary income deficit and goods deficit. At the end of 2009, Australia had a current account deficit of $18483 million in current price terms. Specifically, primary income had a total negative amount of $10897 million, which forms the largest part of current account deficit. Goods had a negative amount of $6848 million, so Australia’s net import was $6848 million. Besides, services account had a negative amount of $569 million, which illustrates that services import exceeded the services export by $569 million. There were large amount of transactions in goods and services, with a total debit of $67701 million and a total credit of $60234 million. From the second chart, we can see that little capital transactions happened during 2009. The total amount of capital account was -$35 million, which belonged to capital transfer. Financial account had a surplus of $17978 million, with the imbalance in other investment account contributing $11529 million to the surplus. Although there were large amount of transactions in portfolio investment account (assets had an amount of -$34144 million and liabilities had an amount of $33846 million), its net amount was only -$298 million. According to analysis above, the major contribution to current account deficit is the imbalance in primary income. As the debits amount exceeds the credits amount by over $10000 million, which tells us that income outflow—that is the income paid to foreigners by Australians is the major cause of current account deficit, government should take measures to minimize income outflow in order to control the deficit of current account. Since the current account balance is synonymous with net foreign investment in national income accounting (Carbaugh 2002), we can also analyse foreign investment to get an understanding of current account deficit. Table3 Sep Qtr 2009 Dec Qtr 2009 Sep Qtr 2009 to Dec Qtr 2009 $m $m % change _______________________________________ BALANCE ON CURRENT ACCOUNT Trend estimates -14 587 -17 509 -20 Seasonally adjusted -14 731 -17 459 -19 BALANCE ON GOODS AND SERVICES Trend estimates -3 345 -6 349 . . Seasonally adjusted -4 224 -6 062 . . NET PRIMARY INCOME Trend estimates -11 027 -10 973 Seasonally adjusted -10 270 -11 234 -9 LEVELS AT END OF PERIOD International Investme nt Position 756 233 768 628 2 Net foreign equity 122 511 120 733 -1 Net foreign debt 633 722 647 895 2 ________________________________________ . . not applicable nil or rounded to zero (including null cells) Sources: ABS 2009) Table4 Australias investment links, as at 31 Dec 2009: Level of Australian investment abroad (A$m): 1,159,088 Level of foreign investment in Australia (A$m): 1,927,716 (Sources: Australia fact sheet 2009) From table4, we can calculate the net foreign investment is $768628 million at the end of 2009, which is consistent with the figure in table3. From September to December, international investment position increased by $ 12035 million while the current account deficit increased by $2922 million, which indicates that the change directions of IIP and CAD are the same. With net foreign debt account for the major part of IIP, we can come to the conclusion that foreign investment contributes to the CAD in Australia, especially the foreign debt. Table5 International Investment (Sources: ABS 2009) According to figures in table5, Net IIP increased steadily from June, 2008 to December, 2009, which indicates a possibility of continuous growth of Net IIP. From analysis results above, change directions of IIP and CAD are the same, thus we can make a prediction of increase in CAD for the year 2010. The importance of BOP to Australia’s economy Table6 SELECTED INTERNATIONAL ACCOUNTS RATIOS(a)(b) 6-07 07-08 08-09 Sep Qtr Dec Qtr Mar Qtr Jun Qtr Sep Qtr Dec Qtr 2008 2008 2009 2009 2009 2009 GDP ($MILLION) 1 091 328 1 181 751 1 256 458 317 319 329 497 301 194 308 448 312 031 nya Current account –5. 4 –6. 2 –3. 0 –5. 5 –4. 4 –3. 2 –3. 0 –3. 4 –4. Goods and Services –1. 2 –2. 1 0. 5 –1. 6 –0. 7 0. 3 0. 5 0. 1 –0. 6 Credits 19. 7 19. 8 22. 7 20. 8 22. 4 23. 2 22. 7 21. 6 20. 0 Debits –21. 0 –21. 8 –22. 2 –22. 4 –23. 1 –22. 9 –22. 2 –21. 4 –20. 6 Primary income –4. 2 –4. –3. 4 –3. 9 –3. 7 –3. 5 –3. 4 –3. 4 –3. 5 Net International Investment Position 56. 1 56. 0 57. 1 57. 2 57. 7 58. 1 57. 1 60. 4 61. 4 Net foreign equity 6. 7 4. 8 6. 4 3. 0 1. 4 4. 3 6. 4 9. 8 9. 6 Net foreign deb t 49. 4 51. 2 50. 6 54. 2 56. 3 53. 8 50. 6 50. 7 51. 8 ya not yet available (a) Derived from current price original data. The net international investment position ratios are derived from the net foreign liabilities at the end of the period and GDP for the year ended with that period. Other ratios use only data for the year ended with the period shown. (b) For the latest reference period, GDP for the year ended with the previous quarter is used. (Source: ABS 2009 ) From table6, we can see that the ratio of current account to GDP increased from an absolute value of 5. 4% (06-07) to 6. 2% (07-08), which shows the growing importance of current account in Australia’s economy growth. The ratio fell to 3. 0% (08-09) as a result of world economic recession. However, after June of 2009, it started to increase again. Net IIP has an increased ratio of 56. 1% (06-07) to 57. 1% (08-09) and at the end of 2009, the ratio boosted to 61. 4%. The steadily increased ratio demonstrates IIP has a close connection with Australia’s economy growth. Therefore, we can safely make the conclusion that current account balance plays an increasingly important role in Australia’s economy and change of Net IIP have direct connection with Australia’s GDP. Imbalance of primary income account accounts for the main part of CAD while Net Foreign debt accounts for the main part of Net IIP. Here comes the question that is the continuous CAD a problem to Australia’s economy? For Australia, the answer is â€Å"no†. As a net borrower, if Australia borrows money to invest in capital equipment which generates a high enough return instead of borrowing money to consume , then the CAD is beneficial for the economy growth since the investment reaps benefit from borrowing (McTaggart, FindlayParkin 2003). Table7 LEVELS OF FOREIGN DEBT AT END OF PERIOD AND SELECTED RATIOS ________________________________________ Period Debt liabilities(a) $m Reserve assets $m Other debt assets $m Net foreign debt(a)(b) $m Ratio of net foreign debt to GDP(c) % Ratio of net interest to goods and services credits(d) % ________________________________________ANNUAL ________________________________________ 1996–1997 302,846 -22,791 -71,427 208,628 39. 4 -11. 2 1997–1998 346,971 -24,260 -94,929 227,782 40. 6 -9. 7 1998–1999 359,839 -23,954 -105,196 230,689 39. 0 -9. 4 1999–2000 421,771 -27,948 -116,019 277,804 44. 2 -10. 6 2000-2001498,775-37,951-147,352313,47246. 6-9. 6 2001-2002523,654-37,435-156,456329,76347. 0-9. ________________________________________ (a) Levels from December quarter 1991 are not strictly comparable with levels from earlier periods, due to changes in methodology. (b) Equals debt liabilities less reserve assets and other debt assets. (c) Ratio derived by expressing net debt at a particular date as a percentage of current price original GDP for the year preceding th is date. (d) Ratio derived by expressing net interest on debt as a percentage of exports of goods and services for the year preceding this date. (Source: Balance of Payments and International Investment Position 2002). Table7 illustrates that although ratio of net foreign debt to GDP increased from39. 4% to 47. 0% between1996 and 2002, the ratio of net interest to goods and services credits decreased 2 percent for this period. Hence, it can be claimed that Australia has used the borrowed funds wisely during this period and this increased consumption possibilities for all Australians in the future. If Australia continues to use foreign debt wisely, CAD will bring benefit to the country. Analysis of consequences and prospects of BOP The GDP of Australia has grown with Australia’s BOP deficit. In other words, CAD in Australia is good for the nation’s economy development. With a large growing amount of Net IIP, Australia’s economy growth will be greatly influenced by foreign investments. Thus, a continuing deficit in BOP is expected for the following years. Put it into details, large amount of transactions will be entered into goods and services account which belongs to current account and similar transactions will be recorded in portfolio investment account which belongs to capital and financial account. The total amount of BOP deficit will increase steadily with Australia’s GDP growth. Internal balance vs. external balance The basic objective of economic policies is the country’s economic stability with full employment. This is known as internal balance and considered to be of primary importance. What’s more, policy makers are also aware of a nation’s BOP position. A nation’s external balance is said to be achieved when it realizes BOP equilibrium. Nations usually consider internal balance to be the highest priority unless they are confronted with large and persistent external imbalances, when the priority will be switched to external balance (Carbaugh 2002). Major internal variables of Australia According to statistics released by CIA for the year of 2009, at the end of 2009 Australia had a GDP of US$ 824. 3 billion (PPP) and increased by 1% compared with the year before. Its labour force was 11. 44 million, ranked 44 in the world. The unemployment rate was 5. 7% and increased by 1. 5% from the year before, ranked 55 in the world. The inflation rate fell from 4. 4% in 2008 to 1. 9% in 2009, ranked 62 in the world. The average exchange rate per US dollar is 1. 2894, a slight increase from 2008. In summary, Australia enjoyed an economy growth with relatively low inflation rate and unemployment rate. Macroeconomic and microeconomic policy settings The significant economy performance of Australia in 2009 cannot be apart from the nation’s wise implementation of macroeconomic and microeconomic policies. With its wide choice in economy policy, Australia recovered from the world economic recession quickly. Microeconomic policies Product and labour market reforms have been implemented since 1990’s. This has led to the growth in employment and productivity. Owing to a lack of water supply, water management issues have remained one of hot topics for discussions of Australia’s economy policy. In order to reduce the over-exploitation and wastage of water and natural resources, reforms were put into effect. The increase in aging population, shortage of skilled labour and adequate manpower lead to the labour supply problems in Australia. Immigration is a main contributor to the labour supply. Policies related to incentives for work has formulated. Economy policies also include provision of benefits to disabled workers who are over 55 years old. As a result of successful microeconomic reform, private sector savings and investment decisions were used to achieve external balance. Being acknowledged as a capital-importing nation, Australia invites foreign savers to make investments here, causing the current account deficits (Nguyen n. d. ). Other economy policy includes improvement and development of education system, reorganizing industrial relations and putting stress on infrastructure management (Economy Watch c. 2009). Macroeconomic policies Australian government has used macroeconomic policies successfully in the rebound of Australian economy after the global financial crisis. Before, fiscal policy was once used for achieving external balance objectives, and then it was abandoned quietly due to the successful microeconomic reform (Nguyen n. d. ). During the economic recession, a fiscal stimulus package worth over US$50 billion was brought into effect to neutralize the effect of the slowing world economy, while the Reserve Bank of Australia implemented the monetary policy of reducing interest rates to historic low levels. These policies together with aggregated demand for commodities—especially from Chinahelped the Australian economy rebound after just a quarter of negative growth (CIA 2010). Australia was one of the first developed countries to raise interest rates after the economy downturn. Since October, 2009, it has raised interest rates for 3 times. â€Å"As a result of an improved economy, the budget deficit is expected to peak below 4. 2% of GDP and the government could return to budget surpluses as early as 2015† (CIA 2010). Recommendations for future policies Macroeconomic policies should be used in conjunction with microeconomic policies in boosting Australia’s economy. Since the BOP deficit has an increase trend, prudent investigation should be made to analyse the potential threat of CAD to Australian economy. Interest rates can be further increased to attract private investment from foreign savers in exploitation of Australia’s abundant natural resources. Economy policy should also be made in encouraging local residents to make more savings or investments as a source of their superannuation after retirement. As a result, the old will demand less support from the government and the financial burden of Australian government can alleviate to some extent, which leads to a decrease in government deficit and ultimately reduces the CAD. Furthermore, â€Å"reduction in geographical segmentation of markets should be introduced as it slows down greatly efficiency of labour† (Economy Watch c. 2009). Conclusion From contents above, we can come to the conclusion that the main contribution to Australia’s CAD is primary income deficit and that net international investment has a close connection with BOP deficit. Whether CAD is beneficial or harmful to Australia’s economy depends on how the borrowed money is spent. If it is used for investment, then CAD will bring benefits to the country’s economy. Or else, it will be an obstacle to the economy growth. Economy policy is the major determinant of Australia’s economy growth. Macroeconomic policies should be combined with microeconomic policies in promoting the nation’s prosperity. The wide implementation of Macroeconomic policy enabled Australia to recover from the economic downturn quickly. The success of microeconomic reforms promotes the continuous growing of Australian economy. Both macroeconomic and microeconomic policies can be used for adjusting the external balance. Bibliography ABS 2009, Balance of Payments and International Investment Position, ABS 2002, Balance of Payments and International Investment Position , Carbaugh, RJ 2002, International Economics, 8th edn, Thomson-South Western College Publishing, Cincinnati, Ohio CIA 2010 the world fact book Australia, Economy Watch 2009, Australia Economy, Economy Watch 2009, Australia Economic Policy, McTaggart, D. , Findlay, C. Parkin, M. 2003, Economics, 4th edn, Addison Wesley, Sydney, pp. 808-819 Nguyen, D n. d. , Macroeconomic Policy in Australia, Market Information and Research Section 2009, Australia fact sheet,