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Chapter 13
The balance of payments
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Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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Australia’s Current Account Balance
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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Comparative Current Account Balance,
2003, US$ billion and % of GDP
US$ Billion
% of GDP
–530.7
–4.8
136.2
3.2
17
2.0
UK
–33.4
–1.9
Australia
–30.2
–5.9
China
45.9
3.2
Hong Kong
16.7
10.7
Singapore
28.2
30.9
Korea Rep.
12.3
2.0
United States
Japan
Canada
Source: adapted from IMF, Economic Outlook, September 2004.
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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, nonfinancial assets (e.g. sales of embassy land or
copyrights)
(cont.)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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?
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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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$357.7 billion (48.8% of GDP)
Over 96% of NFD is private and < 4% is government
(In 1991, 45 % of NFD was owed by the government)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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Two Kinds of Foreign Debt
• Foreign debt: comprises of funds borrowed by
Australian businesses from overseas financial
securities and the purchase of government and
semi-government securities by overseas residents
• Foreign equity debt: the amount invested in base
capital on which dividends are usually paid
• Thus, Australia gains overseas funds through the
overseas purchases of Australian shares and
through direct foreign investment in businesses in
Australia
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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Australia’s Foreign Investment and Foreign Debt,
A$ Billion and %, 2001, 2002
Indicator
2001
2002
Foreign liabilities A$ billion
858.1
903.6
Foreign assets A$ billion
488.1
486.9
47.8
59.0
322.2
357.7
46.7 %
48.8%
Net foreign equity A$ billion
Net foreign debt A$ billion
– NFB as a % of GDP
Source: Adapted from Australian Economic Indicators (ABS 1350.0, June 2003).
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
13-13
% of exports of goods and services
Net Foreign Debt Ratio (Net Interest as a
% of Exports of Goods and Services)
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
1995
1996
1997
1998
1999
2000
2001
2002
Source: Adapted from Australian Economic Indicators (ABS 1350.0, June 2003).
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
13-14
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
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser
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