1. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-1 Chapter 13 The balance of payments A$ ¥ US$ €

2. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-2 Lecture Plan Definition of the balance of payments Current account structure Current account balance Composition of the capital and financial account Foreign debt composition Solutions to the foreign debt problem

3. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-3 The Balance of Payments (BOP) Record of the value of all the economic transactions between residents of one country (e.g. individuals, firms, governments) and residents of all other countries during a given time period Double-entry bookkeeping system For nations with floating currencies, the entire balance of payments must by definition numerically balance, while individual accounts or sub-accounts may not balance Structure – Current account – Capital and financial account

4. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-4 The Current Account International transactions involving goods and/or services, income and current transfers. Main items: Goods (credits, debits) Services (credits, debits) Income (credits, debits) – Investment income and compensation of employees Current transfers (credits, debits)

5. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-5 The Balance on the Current Account The difference between the sum of credits and the sum of debits for the four categories of transactions Indicator of a nation’s performance in the world economy The crux of the problem of Australia’s current account deficit is the net income deficit

6. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-6 Australia’s Current Account Balance

7. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-7 Comparative Current Account Balance, 2003, US$ billion and % of GDP US$ Billion% of GDP United States–530.7–4.8 Japan136.23.2 Canada172.0 UK–33.4–1.9 Australia–30.2–5.9 China45.93.2 Hong Kong16.710.7 Singapore28.230.9 Korea Rep.12.32.0 Source: adapted from IMF, Economic Outlook, September 2004.

8. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-8 Capital and Financial Account Shows transactions in foreign financial assets and liabilities 1. Capital account, e.g. (a) Capital transfers – General government (e.g. debt forgiveness) – Other (e.g. migrants’ transfers) (b) Acquisition/disposal of non-produced, non- financial assets (e.g. sales of embassy land or copyrights) (cont.)

9. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-9 Capital and Financial Account (cont.) 2. Financial account (a) Direct investment (abroad or in Australia) (b) Portfolio investment (transactions in equity and debt securities) (c) Other investment (e.g. trade credits, loans, currency and deposits, other) (d) Reserve assets (e.g. monetary gold, foreign exchange, reserve position in the IMF) 3. Net errors and omissions

10. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-10 Current Account = Capital and Financial Account Impact of the current account – Effects on exchange rates (growing current account deficit, $) – Effects on macroeconomic policies (e.g. monetary) Capital and financial account is a mirror of the current account – If current account is (–), capital and financial account is (+). – A current account deficit requires inflows of foreign direct investment (equity or debt) Current account = capital and financial account (including ‘balancing item’) Is current account deficit a big worry?

11. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-11 The Foreign Debt (Gross and Net) Gross foreign debt = the total amount which, at any given time, Australian residents (government, firms and individuals) owe to overseas countries – June 2002: A$523.6 billion (about ¾ of GDP) Net foreign debt (NFD) = gross debt – foreign assets (e.g. Australian holdings of foreign currency and Australian lending overseas) – 2002: A$357.7 billion (48.8% of GDP) – Over 96% of NFD is private and < 4% is government (In 1991, 45 % of NFD was owed by the government)

12. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-12 Two Kinds of Foreign Debt Foreign debt: comprises of funds borrowed by Australian businesses from overseas financial securities and the purchase of government and semi-government securities by overseas residents Foreign equity debt: the amount invested in base capital on which dividends are usually paid Thus, Australia gains overseas funds through the overseas purchases of Australian shares and through direct foreign investment in businesses in Australia

13. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-13 Australia’s Foreign Investment and Foreign Debt, A$ Billion and %, 2001, 2002 Indicator20012002 Foreign liabilities A$ billion858.1903.6 Foreign assets A$ billion488.1486.9 Net foreign equity A$ billion47.859.0 Net foreign debt A$ billion322.2357.7 – NFB as a % of GDP46.7 %48.8% Source: Adapted from Australian Economic Indicators (ABS 1350.0, June 2003).

14. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-14 Net Foreign Debt Ratio (Net Interest as a % of Exports of Goods and Services) Source: Adapted from Australian Economic Indicators (ABS 1350.0, June 2003).

15. Copyright  2005 McGraw-Hill Australia Pty Ltd PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser 13-15 Solutions to the foreign debt problem Improve economic fundamentals – Inflation – Interest rates – Wage increases More investment in export-expanding and import- replacing industries Encourage domestic saving Further improve productivity, transport and shipping facilities and management