Application Exercise 8f: The causes and implications of NFD and NFE
- Explain why Australia has historically had to ‘import capital’.
We are historically poor savers – and our small population relative to the huge opportunities that exist in Australia (e.g. to farm the country’s abundant land, to mine and other economic development) meant we needed to import capital to fund the economic development of the country. We have either borrowed money from overseas (debt) or allowed foreigners to own Australian-based assets (equity – such as setting up a business in Australia or buying shares in Australian-based companies).
- Describe the benefits for both Australia and foreigners of Australia’s position as a capital importing country. Refer to both debt and equity.
Australia benefits because it can access finance (debt) at a cheaper rate from overseas (compared to relatively high Australian interest rates historically) and our economy grows as foreign firms set up new branches/ companies here (equity) and provide employment, buy supplies from Australian businesses and pay tax on their profits to our government.
- Where has foreign investment in and lending to Australia traditionally come from and how has this changed over time? Based on what you know about the global economy, suggest one reason for this change.
Over time, the source of foreign investment has moved from Great Britain to the USA, to Japan and more recently to China. China (and Asian countries more generally) have risen to be major players in the global economy, including major exporters. This has seen their economy growing very rapidly, with large trade and capital surpluses, which has been used to invest in and lend to other countries.
- Return to the three transactions you considered in Application Exercise 8E above. In question 2 of that exercise, you identified where the ‘future obligation’ created by the transaction would be recorded in the current account.
a. Explain why Australia’s NFE has moved from a value above zero to a negative value since 2013.
Australia has a become a net exporter of capital. NFE is below zero (a negative value) because Australian ownership of foreign assets exceeds foreign ownership of Australian assets. One significant reason for this change has been the growing size of Australia’s superannuation industry – as the more than $3.3 trillion Australians have saved for their retirement needs to be invested, and much of it has been used to purchase overseas-based investment products. There’s also been a decline in foreign direct investment in Australia following the end of the mining boom.
b. Explain what the movement described in part a. above means for the ownership of assets.
It means, in short, that Australians own assets of greater value overseas than foreigners own Australian assets.
c. Explain how the movement of NFE to a negative value would help to increase the value of credits relative to debits on the net primary incomes account of the current account.
The movement of NFE to a negative value would mean that any income earned on the foreign assets (e.g. dividends on shares, rent on foreign property, profits on ownership of overseas businesses) would be recorded as a credit on the net primary incomes account of the current as it is repatriated (comes back to) Australia.
- Some economists argue that we should be more concerned about NFD than NFD. Explain the difference between the two and suggest one reason why debt may be riskier than foreign ownership of Australian assets.
Australia’s owing debt to foreign lenders (NEF which is where Australia’s total borrowing from foreign lenders exceeds Australia’s lending to foreign borrowers) is the largest component of Australia’s net foreign liabilities. It is riskier than foreigners owing equity in Australia because debt must be ‘serviced’. If Australia were to struggle to service its NFD (through regular interest payments, and repayments of the principal borrowed as it becomes due), foreign lenders will continue to demand repayments. On the other hand foreign equity holders (e.g. those who have bought shares in Australian companies) are likely to be more patient because, as owners of those assets, they are likely to lose out if they force the sale of the assets at a very low price (to recoup their investment).
- Based on what you have learned about the relationship between the current account balance and the capital and financial account balance, explain the likely effect of a reduction in the flow of capital and finance from overseas into Australia on the current account balance.
In isolation, as there is a reduction in flow of capital and finance from overseas into Australia, this will reduce the credits on the capital and financial account relative to the debits, leading to a capital and financial account deficit. Because the balance of payments is always equal to zero, the current account balance (CAB) would therefore need to move into a surplus position, to offset the deficit on the CAFA.
- Check your answer to question 6 against the data in Chart 8.5 (Current account balance) earlier in this section. Does it support your conclusion?
Chart 8.5 shows that since mid-2019, Australia CAB has been a surplus. Over the same period, Australia’s NFE has been consistently a negative value, indicating that Australian ownership of overseas assets has exceed foreign ownership of Australian assets. Australia net international investment position (NFL – NFD + NFD) has also fallen in value.