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Australian Balance of Payments
Per cent of GOP, anal
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11 See Belkar et al (2007).
212
1968
By definition, higher average capital inflows have meant that the current account deficit has
also increased, which begs the question what has been cause and effect.
It is beyond the scope of this paper to give a detailed answer to this question but it would be wrong to conclude that the widening of the current account deficit was due to less disciplined macroeconomic management.
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2023 Australia reserve bank interest rate rise forecast decision news foreign exchange rates
The current account/capital account balances under a floating
exchange rate are determined simultaneously by complex economic and financial interactions, in which foreign investors play a significant role.
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Importantly, if foreign investors decide that they want to invest more in a country, for example because they see it as being well managed and offering good long-run returns, the resulting increase in net capital inflow will through changes in the exchange rate, other financial prices and economic behaviour
more generally-result in the country running a wider current account deficit.
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This, broadly speaking, has been Australia's experience. Some commentators argue that a balance of payments position that involves persistent
current account deficits with matching capital account surpluses is not sustainable.
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But Australia has, excepting brief episodes, consistently run such a position for well over a century, yet it remains a stable, well performing economy." The lesson we would draw from
the Australian experience is that as long as capital inflow is put to good use, and as long as consumers, businesses and financial institutions avoid foreign currency risk on these liabilities, such a balance of payments position is sustainable.
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Measures such as the ratio of net foreign liabilities to GDP are not necessarily good
indicators of the sustainability of the balance of payments. In Australia's case, this ratio has
risen quite noticeably since the floating of the currency, from 27% to over 60% (Figure 7).
Yet, as noted, this has not been accompanied by any decline in economic performance or
increase in financial instability.
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Caphal account
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Source: ABS
2008
Figure 7
Australia's Net Foreign Liabilities
Annual
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Rate to GDP
Ratio to domestic capital stock
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BIS Papers No 61
Another measure is to scale net foreign liabilities relative to the domestic capital stock, so as
to gauge trends in net foreign claims on the domestic capital stock. This measure for
Australia shows that, relative to the domestic capital stock, net foreign liabilities have
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fluctuated around a flat trend, at about 10% (Figure 7).
(d) Financial stability
A striking feature of Australia's experience with a floating exchange rate is that, despite some
very large fluctuations in the exchange rate, the health of the corporate and financial sectors
has been largely unaffected by exchange rate gains and losses. This reflects the fact that,
while Australia has substantial net foreign liabilities, these are mainly denominated in
domestic currency. The debt that is not issued to foreign investors in Australian dollars is
hedged back to Australian dollars.
The country as a whole is able to do this because foreigners are prepared to hold part of their portfolios in Australian dollars. In other words, the currency risk on external liabilities is borne by foreigners, not by Australians.
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It has always been accepted that countries such as the United States, which issue reserve currencies, are able to shed foreign currency risk to foreigners. But other countries can also do this if they are well managed and able to sustain the confidence of foreign investors.
Australians learned early in the post-float period about the dangers of unhedged foreign currency borrowing. In the mid-1980s, some borrowers funded themselves in Swiss francs to avoid paying much higher domestic interest rates. The risks in doing so quickly became clear when the Australian dollar subsequently depreciated sharply against the Swiss franc.
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Many of these borrowers were unprepared for the rise in the Australian dollar payments required to service their foreign debt liabilities. The scale of this borrowing was small enough that it did not have an impact on the economy or the soundness of the banking system, but it received
enough publicity to provide a salutary lesson to Australian banks and borrowers.
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This episode, together with ongoing experience with a floating exchange rate, has encouraged the extensive hedging of foreign currency loans that is present Movements in the exchange rate therefore do not affect the Australian dollar value of these debt liabilities and thereby the ability of the borrower to service (and ultimately repay) those liabilities.
Australia's equity liabilities are all denominated in Australian dollars, so their value is also
unaffected by movements in the exchange rate.
With foreign liabilities largely in domestic currency and foreign assets denominated in foreign
currency, in net terms Australia has a long position in foreign currency (Figure 8). As noted,
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