Measurement and Performance

The balance of payments is the name given to the record that we keep which shows where our foreign currency comes from, and how we use it. Every day, billions of dollars flow in and out of Australia; this money is tracked, and the net impact is reflected in changes to the value of our dollar.

This record is made up of three accounts:

The diagram above reflects the fact that we would expect the current account to “balance” the capital and financial accounts. For example, if we find that the current account has recorded a deficit of $20 billion, then we would expect to see a surplus result in the capital and financial accounts. This surplus, nor surprisingly, would be $20 billion.

It is important that you know where various international transactions might be recorded in the balance of payments. First, you should know that any money coming into Australia is recorded as a credit, while any money leaving Australia is referred to as a debit. Traditionally, Australia has recorded more debits than credits in the current account. As a result, we run a current account deficit. This is often abbreviated to CAD. There are four sub-accounts in the CAD:

Net Services – Here we record the import and export of services.

Net Income – In this account we record any income (rent, interest, wages and so on) coming into Australia, and any income paid from Australia to overseas.

Net Transfers – A transfer payment is made when the money has not been earned. For example, the transfer of pension income between countries is recorded here.

Australia maintains a deficit in the current account. This is largely because we pay a lot of interest to other countries to service our large net foreign debt. These payments are recorded as debits in the net income account; while the other accounts might fluctuate, this account is always in deficit.

As we are running a deficit in this account, we need to gain access to foreign funds in some way. It is very important that you note this key fact: the current account deficit is NOT a debt. It is simply a record of transactions which have already occurred. The phrase “fund the deficit” does not mean that we are trying to repay a debt; it means that the foreign currency we used to create these debit entries had to come from somewhere. The source of that currency is recorded in the capital and financial accounts.

Of these, the most significant is the financial account. The capital account records permanent migration, and the transfer of intangible assets. On the other hand, the financial account records investment in the Australian economy. There are a number of different types of investment that could occur:

1. Direct Investment – any purchase of 10% (or more) of a business between countries. That is, if foreign interests buy more than 10% of a business that was previously 100% Australian owned, it will be recorded here. Similarly, Australians can make direct investment decisions about companies overseas.
2. Portfolio Investment – another form of investment between countries. In this case, it is usually in the form of share purchases, and it is recorded here when the total purchase is less than 10% of the business.
3. Other investment – here we record any investment that does not fit into the other categories. For example, trade credits are recorded here. (The reality is that this is not a large section.)
4. Reserve Assets – Sometimes governments and central banks will trade, and this trade is recorded here. Statisticians will record dealings in gold, foreign currencies and other international financial transactions.

After all of this, you might wonder how the two sides actually end up balancing. The answer lies in the fact that Australia has a floating exchange rate. Imagine for a moment that Australia chose to import more than we exported, and we were not able to find the foreign currency that we needed through the capital and financial accounts. What would happen? The answer is that we would end up increasing the supply of Australian dollars on to the foreign exchange market, and the dollar would depreciate. This would make exports more attractive, and the return on Australian investments would be higher. As a result, we would gain access to the foreign funds that we need.

Few economists worry about the balance on current account today. The only time during which this would become a problem is if we were unable to finance the deficit. Although the current account deficit expanded during 2006, it is also true that the dollar appreciated. This suggests that Australia was very successful at finding the foreign investment needed, and so we would argue that external stability was achieved during this period.

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