Economics Essay

Analyse the impact of factors affecting the Current Account in Australia’s Balance of
Payments

Changes in the domestic and global economies will affect Australia’s trade, level of income,
capital inflows and outflows. These changes will consequently affect Australia’s current
account, found within the Balance of Payments (BOP). The current account is a record of all
transactions between Australian residents and non-residents. Factors in the global economy
that affect Australia’s current account include the international business cycle and
Australia’s exchange rate, whereas factors in the domestic economy that affect the current
account include the domestic business cycle and Australia’s low national savings rate.

Australia’s current account records all trade and income flows and is comprised of three
components: the Balance on Goods and Services (BOGS), Net Primary Income (NPI) and Net
Secondary Income. Historically, the composition of these components has contributed to a
current account deficit however since 2019, Australia’s current account has been in surplus.
The BOGS component of the current account refers to the total value of Australia’s trade
(imports and exports and net services) and is derived by adding the value of Australia’s net
goods with the value of Australia’s net services. The NPI component of the current account
is made up of earning on investments. It covers interest payments on borrowings and
returns on other foreign investments. Additionally, the NPI is equal to the difference
between interest and dividends earned by Australians and interest and dividends paid to
foreign investors. The net secondary income component of the current account has minimal
impact as it’s flows occur when products of financial resources are transferred without
specific goods/services provided in return.

Cyclical changes in the international business cycle have the ability to affect Australia’s
BOGS, consequently affecting the status of the current account. An upturn in global
economic activity will contribute to an increased global demand for goods and services in
the Australia economy, such as commodities, leading to an increase in export credits in the
Balance on Goods and Services. This increase in export credits will increase the value of
BOGS, hence contributing to a larger current account surplus. Conversely, a downturn in
economic activity will decrease the demand for Australian commodities, worsening the
surplus of the BOGS account and hence deteriorating the condition of the Current Account.
An example of increased demand for Australia’s exports followed the onset of the COVID-19
pandemic and subsequent global recession, with 2021’s value of iron ore exports sitting at
around $147 billion AUD, more than triple the value after the last global recession following
the GFC. This increase in export value can also be observed in the increase of Australia’s
BOGS going from -1% of GDP in 2009-10 to 6% of GDP in 2021-22, contributing to the
current account balance transitioning from a deficit of around -5% to a surplus of around
2%. Hence, upturns and downturns in global economic activity affect the demand for
Australia’s exports, influencing the balance on goods and services and consequently, the
current account surplus.
The value of the Australia dollar (AUD) and it’s exchange rate will affect the Australian
current account by influencing the value of Australia’s balance on goods and services
component. If the Australian dollar was to depreciate, the purchasing power of Australians
in comparison to the rest of the world would decrease, thus decreasing the demand for
Australian dollars as shown in graph one with a shift from D->D1. This decreased purchasing
power would force Australians to pay more imports due to exports in the economy bringing
in less returns. Additionally, a depreciation would cause Australia’s export revenue to
decrease and import costs to increase due to less foreign currency being required to
purchase the economy’s goods. This decreased export revenue would weaken the value of
Australia’s BOGS, hence deteriorating the level of the current account surplus. Thus,
Australia’s exchange rate influences the value of Australian exports and consequently
contributes to the status of the BOGS and current account.

Differing levels of economic activity and growth within Australia’s domestic economy will
affect the level of FDI inflows, consequently affecting the number of outflows from the Net
primary income component of Australia’s current account. If the domestic economy
transitioned into a period of economic downturn, economic activity would decrease, thus
decreasing the level of investor confidence from overseas. This decreased confidence would
decrease the level of Foreign direct investment coming into the Australian economy. As
decreased investment from foreigners would decrease Australia’s level of foreign debt and
equity, as well as the costs associated with debt servicing, the level of NPI outflows would
reduce, weakening the NPI deficit, widening the current account surplus. Evidence of a
domestic economic downturn contributing to a current account surplus can be seen in
Australia’s response to the COVID-19 pandemic. In 2020, Australia’s GDP growth rate was
approximately -0.05%, with this downturn coinciding with the first recorded current account
surplus in 45 years. Thus, Australia’s domestic level of economic activity contributes to
foreign direct investment flows, decreasing the number of outflows on the net primary
income component of the current account, widening the surplus.

Australia’s historical status in the global economy as a “net-capital importer” due to it’s
large savings investment gap has been known to negatively affect the current account
propelling it to a deficit, however recent increase household savings and decreased
investment opportunities has enabled the current account to be in surplus. Following the
GFC, Australia’s level of household savings was approximately 4%, forcing the economy to
look to importing foreign sources of capital, increasing FDI inflows and NPI outflows,
worsening the condition of the current account. Despite this historical record of low
household savings contributing to a current account deficit, the lower consumption levels
brought on by the COVID-19 pandemic saw household savings levels reach a record high of
23% in 2020, almost 19% higher than the value following the GFC. This increase in
household savings has decreased opportunities for foreign direct investment, narrowing the
deficit of the net primary income component of the capital account and hence widening the
current account surplus.

Australia’s current account within the Balance of Payments is heavily influenced by both
domestic and global changes. In the future, a downturn in global economic activity may
cause Australia’s current account to fall back into a deficit due to a weaker BOGS, however a
domestic downturn in economic activity may enable the current surplus in the current
account to widen.