TOPIC 4: MACROECONOMIC OBJECTIVES 2012

SOUTH AUSTRALIAN MATRICULATION

ECONOMICS

TOPIC 4:
MACROECONOMIC
OBJECTIVES
Macroeconomics

Chapter 4.4 : External Balance

(Foreign Debt)

1
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

TOPIC 4: MACROECONOMIC OBJECTIVES

AREAS OF LEARNING

 Full employment of labour;

Concept of full employment; causes of unemployment, changing employment trends,
effects of unemployment

 Price Stability;
Concept of price stability, CPI as indicator, inflation and its effects

 Economic Growth;
Concept of economic growth, GDP as indicator, methods of calculating GDP, effects of
economic growth

 External Balance;
Concept of external balance, structure of current account, impact of capital flows,
indicators of external balance, causes and effects of external balance

Chapter 4.1 Full employment of Labour

Chapter 4.2 Price Stability (Inflation)

Chapter 4.3 Economic Growth

Chapter 4.4 External Balance

2
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

:
Materials have been extracted from
various sources for classroom teaching
purposes only.

Due credit is being given to relevant

authors.

3
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Foreign Investment
Refers to the stock of financial assets in Australia owned by foreign residents.

Difference Foreign investment and investment:

 Investment is the creation of productive capital (capital goods)

 Foreign investment refers to the flow of funds, some of which may go to the creation of capital
goods

Foreign equity: represents the extent to which foreign residents own Australian assets

Foreign Liabilities: include both FOREIGN DEBT and foreign equity

 Every time Australia records a CAD, total foreign liabilities increase, but this may be
either foreign debt and/or foreign equity

Forms of Foreign Investment

Borrowing/debt: in the form of * debenture or interest earnings

* Debentures have no collateral. Bond buyers generally purchase debentures based on the
belief that the bond issuer is unlikely to default on the repayment. An example of a
government debenture would be any government-issued Treasury bond (T-bond) or Treasury
bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at
worst, can print off more money or raise taxes to pay these types of debts.

Equity : the selling of assets to overseas such as shares which earn dividends or profits

 Foreign Investment can be undertaken by the private sector, the government (public sector)
and the RBA
 Official : Foreign investment undertaken by the government and the RBA
 Non-Official: foreign investment undertaken by the private sector; firms, financial institutions
and individuals.
 Reinvestment of earnings

4
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Portfolio Investment: Includes all foreign investment in Australian enterprises other than
direct investment and generally involves less than 10% ownership:

 Represents equity investment; investment for income or speculative gains rather than control
or ownership
 Represents institutional loans – loans raised from financial institutions and other companies

Direct Investment: is investment in Australia branches of foreign enterprise and investment

by foreigners in Australian enterprise where there is significant influence on the business in
terms of control and the organization:

 More than 10% ownership

 Equity – gives investor some degree of control therefore a continuing claim on profits
 Some directed investment can be classed as debt investment; e.g. when an Australian
subsidiary borrows from its parent company overseas (Shell Woodside petroleum)

Recipients of foreign Investment in Australia:

 Mining (highest foreign ownership)

 Manufacturing
 Finance, property, business services and insurance (by far the biggest recipient)
 Retail trade
 Motor vehicles and parts
 Petroleum refining

5
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Stock of total foreign investment: source countries

In 2009 the US regained the position as the top source of the stock of total foreign investment
in Australia, overtaking the United Kingdom which topped the list briefly in 2008. In 2009,
the top sources of the stock of total foreign investment in Australia were:
 USA with 27 per cent of total foreign investment (A$514 billion, up by 16 per cent)
 UK with 26 per cent (A$499 billion, up by 26 per cent)
 Japan with 5.4 per cent (A$102 billion, up by 14 per cent)
 Netherlands with 2.3 per cent (A$43.4 billion, up by 44 per cent)
 Hong Kong with 3.3 per cent (A$43 billion, down by 22 per cent)
 Singapore with 2.1 per cent (A$40 billion, down by 7 per cent), and
 Germany with 2.0 per cent (A$31 billion, up by two per cent).

Since 2003, the USA has dominated Australia’s inward stock of total investment with a share
of more than 25 per cent until 2007.

Stock of FDI: source countries

In 2009, the stock of FDI in Australia was $436 billion. The top sources were:
 USA with 23 per cent (A$99 billion, down by 0.6 per cent)
 UK with 15 per cent (A$63billion, up by three per cent)
 Japan with 10 per cent (A$45 billion, up by 23 per cent)
 Netherlands with eight per cent (A$34 billion, up by 63 per cent), and
 Switzerland with four per cent (A$18 billion, down by 20 per cent).

The overall trend of FDI from the European and North American markets appears to be
gradually softening, yielding to other emerging markets.

6
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Foreign Investment in Australia 2009 & 2010 ($ million):

2009 2010 % change in total % change in

Level of Direct Level of Total Level of Direct Level of Total
Country Investment FDI
Investment Investment Investment Investment
UK 63,633 498,991 52,525 472,649 -5 -17
USA 99,760 541,919 120,289 549,881 1 21
Japan 44,962 102,539 49,417 117,633 15 10
Hong Kong 5,464 43,201 6,694 40,774 -6 23
Singapore 16,512 41,088 20,240 43,771 7 23
Switzerland 17,636 32,226 20,735 40,731 26 18
Germany 16,514 38,232 16,224 40,756 7 -2
Netherlands 33,713 43,436 31,128 42,425 -2 -8
France 12,608 22,976 12,563 23,861 4 0
New Zealand 6,141 31,682 6,460 33,773 7 5

APEC 181,828 796,024 241,863 858,798 8 33

ASEAN 21,819 52,688 27,477 61,332 16 26
EU27 147,262 659,820 131,562 647,400 -2 -11
OECD 330,832 1,365,297 347,888 1,414,184 4 5
Source: ABS catalogue 5352.0 (Table 2)
http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/5352.0Calendar%20year%202010?OpenDocument

NOTE: visit the following website for more statistics

 http://www.ausstats.abs.gov.au/ausstats/meisubs.nsf/0/1B2DEB3C2687F0DFCA25795D002112
57/$File/53020_sep%202011.pdf

7
TOPIC 4: MACROECONOMIC OBJECTIVES 2012

8
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Trends in Australia’s Foreign Investment

Australia’s foreign liabilities increased from around 47% of GDP in 1991 to 61% of GDP by
2009 and then dropped to around 57% by 2011. Remember that this is because each year
Australia records a current account deficit so foreign liabilities must increase each year by the
size of CAD. Figure above shows accumulation of external liabilities over time. Notice that
most of Australia’s foreign liabilities are mainly foreign debt. Borrowing (debt) provides a far
more flexible and prudent approach than selling ownership of one’s assets.

Foreign debt has increased from around 35% of GDP in 1991 to 53% of GDP in 2009 and
dropped to around 47% in 2011. Foreign equity on the other hand has fallen from 12% of
GDP in 1991 to around 8% of GDP in 2009. Both types of liability involve an income
payment to foreign interests. Foreign debt needs to be serviced with interest payments, while
foreign equity involves remittance of profit and dividends.

Between 1984 and September 2011, total foreign investment in Australia rose from
$82billion to $ 848.3 billion. Remember the change in foreign liabilities each year is recorded
in the financial account of the balance of payments. The income flows associated with
foreign liabilities are recorded in the current account. The servicing costs associated with
foreign liabilities (interest & dividends) result in a large net income deficit in Australia’s
current account. Whether the current account deficit is financed by either equity or debt will
results in outflow of income to overseas residents in the form of dividends, profits or interest
payments.

Business and firm borrow with the intention of making more money; hence borrowing should
not be seen as harm to a nation. Because the CAD reflects the gap between national
investment and nationals’ savings, the higher level of investment will increase the nation’s
capital stock. This will expand the economy’s productive capacity and provide for future
income growth that will help service the CAD. Running a CAD can actually lead to a country
increasing its national wealth and standard of living over time.

9
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Arguments for foreign investment in Australia

 Foreign investment is a source of finance for industry:
 This allows Australia to access new capital which would otherwise not have been available,
Australia is a resource of rich country with low savings
 Foreign investment has allowed Australia to supplement its domestic savings and this has
allowed higher levels of investment

 Foreign Investment that is directed towards productive investment has a multiplier effect on
national income, and output (employment) and therefore economic growth.

 Foreign investment can be used to develop import competition industries or to increase

production of output and therefore exports.

 The inflow of foreign investment provides foreign exchange to help finance the purchase of
imports (finance CAD)

 New investment from overseas brings with it new ideas in management practise or introduces
new technologies and knowledge that leads to increased productivity in the workforce.

 Foreign investment has increased the diversity of Australia’s industry by allowing for investment
in industries with high capital establishment costs and which do not show a high rate of return
for some time such as mineral exploration.

10
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Arguments against foreign investment

 Direct investment involves a loss of control and ownership of Australian resources and industry:
- Decision making can occur overseas without consideration of the interests of Australians
can lead to public hostility, e.g. Vegemite going offshore

 Interest, dividend and profit payments flow overseas and out of the domestic economy
creating a net leakage and adding to the net income deficit on the current account.
 The multiplier effect on national income may also serve to weaken the CAD by increasing
spending on imports
 Portfolio investment can be destabilising in that the funds may leave the country as quickly as
they arrived
 Some of the investment funds do not go to wealth creating activity :
- Funds used for speculative property investment do not enhance the productive potential of
the economy.

11
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

NOTES:

WHY DO WE NEED FOREIGN INVESTMENT IN AUSTRALIA?

As a large, resource rich country with relatively high demand for capital, Australia has, for
over two centuries, relied on foreign investment to meet the shortfall of domestic savings
against domestic investment needs. Foreign capital has allowed the Australian people to
enjoy higher rates of economic growth, employment and a higher standard of living than
could have been achieved from domestic savings alone.

Foreign direct investment (FDI) is normally regarded as amongst the most stable forms of
capital inflow because it generally involves a substantial commitment from the investor in
acquiring business facilities and hiring staff, whereas debt finance and portfolio investment
can be recalled relatively quickly. An example of this is the recent Asian financial crisis that
resulted in a deficiency of short-term debt finance, but did not have a significant impact on
the level of foreign direct investment in the Asian region.1 Also the return to direct
investment is dependent on profitability unlike debt finance where the capital and interest
must generally be repaid, regardless of performance.

FDI brings with it increased competitiveness, through exposing local management to

international standards and best practices, and through technological benefits associated
with the establishment of new businesses, or the modernisation of old ones. Accordingly, the
economy emerges better able to provide high-productivity, well-paid jobs into the future.

12
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

FOREIGN DEBT: is defined as the amount of money that Australian residents, both public
and private. It is also called external debt. It is the amount of money that Australian
residents, both public and private, owe to the rest of the world.

Gross Foreign Debt: is the total amount of borrowing from non-residents. It includes
securities issued as bonds as well as loans, advances, deposits, debentures and overdrafts.

Net Foreign Debt: is distinguished from other kinds of foreign investment capital inflow
such as foreign ownership, because it carries with it the obligation to pay interest and repay
the principal.

* It may come as a
Australia’s Net Foreign debt ($ billion) surprise that a large
proportion of Australia’s
Year Public Private Total Ratio of
foreign debt is due within
(June) Net Foreign a very short period of
Debt to GPD time. In 2008 37% of
foreign debt loan were
(%)
due within 90 days and
2005 -28 456 428 46.5 48% were due within a
2006 -38 533 495 49.8 year. This completely
dispels the fear that
2007 -54 593 540 49.9
future generations will be
2008 -7 608 601 51.5 burdened with foreign
2009 -15 640 626 50.0 debt!

2010 42 644 686 53.0

2011 77 609 686 49.0
Source: RBA – Australia’s Net Foreign Liabilities (H5) & ABS- cat.5204.0 Table 1: Key National Accounts
Aggregates

13
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Trends in Australia’s Foreign Debt

Between 1991 and 2010, net foreign debt has increased from around 35% of GDP to 53% of
GDP. This reflects the accumulation of debt over time resulting from continued current
account deficits. If a nation spends more on overseas goods and services than it earns in
income, then it must become indebted to the rest of the world. This indebtedness is measured
by the capital and financial account surplus, and it may be in the form of equity and debt.
Australian firms have over this time preferred to borrow against, rather than sell their assets
and this resulted in the large increase in foreign debt as a proportion of GDP.

Until 2008-09 years federal and state governments had reduced their need to borrow from
overseas. This is due to their programs of fiscal consolidation, whereby budget surplus
(government income (taxation) exceeds government spending) funds were used to repay
foreign debt. With government (official) overall debt levels falling and consequently lower
interest payments, the net incomes balance had a decreased contribution resulting from the
official sectors.

However, this trend has altered significantly since the federal government has run larger
deficits and needs to finance them through increased level of borrowing. The improved
economic outlook as projected in the 2010-11 Budget should see the need for government
borrowing reduced over the next few years as the budget returns to surplus in 2012-13.

The private sector has not followed the government’s lead. It has increased its borrowings to
finance its needs and those of the community. Australia is still heavily reliant on direct and
portfolio investment into the country, with portfolio gaining an increasing share of total
investment.

Despite the fact that official sector debt has fallen significantly over the recent years, the
overall debt figure has continued to rise. This has been partly due to the continued high CAD
and the need to finance them through borrowing. Also exchange rate variations play an
important part in this process. As a large proportion of Australian borrowing is in foreign
currencies, variations in the value of the Australian dollar greatly influence the value of
foreign debt. This trend in rising value of foreign debt is expected to continue.

14
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

How does Australia’s debt position compare with

other industrialised countries?
Australia is one of a number of industrial economies with net Private debt is
foreign debt greater than 50% of GDP. One important considered to be
difference between Australia’s position and that of some other far superior to
economies with large foreign debt has been the comparatively public debt in
small share owned by the government sector. that it is
incurred with
the profit motive
as the guiding
In fact in 2009 95% of Australia’s foreign debt reflects hand
borrowing by private sector and just 5% by public sector. This is
where Australia is quite unique when compared with other
industrial economies. Government debt in UK and US amounts to over 60% of GDP and
Japan exceed 100%. Australia has one of the lowest government sector debts in the
developed world.

Private debt is most likely to result in increased investment and therefore to increased future
income to service debt. Government debt, on the other hand, could result in a burden for
future generations if it was used to fund current consumption rather than public infrastructure.

Factors that leads to Foreign Debt

 Foreign borrowing could be viewed as the difference between domestic investment and
domestic savings. If a country’s savings are not sufficient to finance the country’s investment
requirements, then it must obtain the funds from overseas. Foreign debt in fact refers to the
total stock of debt accumulated over time. The current account deficit adds to this stock of debt
accumulated over time.

 Expansion of Australian investment abroad. This occurred because of the removal of exchange
controls and regulations regarding overseas investment by Australian residents. For example,
since 2001, the Australian investment abroad has increased by over $600 billion. Much of this
outflow of funds was financed by increased borrowing. It is important to remember that
virtually all of Australia’s net foreign debt is owed by the private sector. The government has
repaid all of its past foreign debt.

15
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

 Increase in Australia’s CAD. Spending > Income  CAD , therefore, to fund CAD
 Capital and financial account must be a surplus (either  foreign debt OR  foreign
equity). Australia prefers borrowing, therefore it  foreign debt

 Interest payments on the debt feed into CAD. Even if the balance of goods and
services improves, the interest payments can cause the current account deficit to continue
to rise. The interest payment represents the servicing costs of foreign debt. By 2009,
interest payments had fallen to around 10% of export income, this reduces CAD hence
reducing the need for foreign borrowing.

 Exchange rate fluctuation. $A depreciate  more $A needed to pay for each unit of
overseas currency borrowed from overseas. Therefore,  debt & debt servicing cost

Costs of foreign debt

 Australia’s credit rating being downgraded which means future borrowing will be at
higher interest rates
 Higher interest payments reduce the country’s standard of living as less income is
available for consumption
 Higher debt leaves Australia vulnerable to external shocks such as decline in growth of
trading partner or a fall in TOT (export price falls)
 Depreciation of AUD which will lead to further increase in the AUD value of debt and
to higher AUD debt service payments
 If the growth rate of trading partners falls this will decrease Australia’s export income
and increase the burden of the debt.
 A debt sustainability problem – can the Australian economy afford high debt? Can they
service that debt? It is sustainable? How much is too high?

16
 TOPIC 4: MACROECONOMIC OBJECTIVES 2012

Benefits of Foreign Debt

 Most debt is owed by the private sector, whose motive is profit, rather than public sector
 Debt is being used to expand Australian industry which leads to increased economic
growth
 The debt as a % of GDP has stabilised, meaning that it is easier to sustain in terms of
repayments on that debt
 The debt servicing ratio has fallen, meaning that repayments have fallen.

Is there a cure for Foreign Debt?

 Reduce CAD = decrease in KAS (capital and financial account surplus)

 To reduce CAD we must increase exports or decrease imports, or lower our living
standards to pay debt reduction

17