Examine the structure of Australia's balance of payments including the current account and the capital and financial accounts, and analyse the links between them

What this dot point is asking

NESA wants you to explain the structure of the balance of payments (BoP), identify the components of the current and capital accounts, and analyse the link between them through the accounting identity. Expect a 4 to 6 mark short answer or a stimulus-based Section III question using ABS BoP data.

The answer

The balance of payments defined

The balance of payments is the statistical record of all economic transactions between Australian residents and the rest of the world over a given period, prepared by the Australian Bureau of Statistics (cat. no. 5302.0, quarterly). It has two main accounts:

1. Current account (CA): flows of goods, services, primary income and secondary income.
2. Capital and financial account (KAFA): changes in ownership of foreign assets and liabilities.

The two accounts must sum to zero (plus a statistical discrepancy item).

The current account

The current account has four sub-components:

1. Balance on goods and services (BOGS)

Exports minus imports of goods (merchandise) and services. Australia's BOGS is heavily influenced by iron ore, coal and LNG prices.

2. Net primary income

Income payments to and from non-residents: interest, dividends, profits and compensation of employees. Australia runs a persistent net primary income deficit (around 4 percent of GDP) because of its large stock of net foreign liabilities.

3. Net secondary income

Transfers without a corresponding good or service: foreign aid, workers' remittances, pension transfers.

4. Capital account

A small balancing item covering capital transfers and acquisition of non-produced, non-financial assets (patents, copyrights). Often included with the financial account.

The recent picture (ABS 2024 annual data, indicative figures):

The capital and financial account

The capital and financial account records changes in ownership of assets and liabilities between Australian residents and non-residents.

Major components:

• Direct investment. Foreign investors taking stakes of 10 percent or more in Australian companies, and Australian firms doing the same overseas (BHP investments in Chile, Macquarie infrastructure investments in Europe).
• Portfolio investment. Foreign purchases of Australian shares and bonds, and vice versa. Australian government bonds are popular with foreign investors.
• Other investment. Bank loans, deposits and trade credit.
• Reserve assets. Foreign exchange and gold reserves held by the RBA.

A net capital inflow (KAFA surplus) finances a current account deficit. A net capital outflow (KAFA deficit) results from a current account surplus.

The accounting identity and economic interpretation

The balance of payments must balance:

This identity can be rewritten in terms of national accounts:

where S is national savings (household, business and government combined) and I is national investment. A current account deficit (CA < 0) means investment exceeds national savings; foreign capital makes up the difference.

Two equivalent interpretations:

1. Expenditure interpretation. A CA deficit means the economy is spending more on goods and services (consumption + investment + government) than it is producing.
2. Savings interpretation. A CA deficit means national savings are insufficient to fund national investment; the shortfall comes from abroad.

Australia's experience

For most of the post-1980 period, Australia ran current account deficits of 3 to 6 percent of GDP, financed by net capital inflow. The deficits reflected:

• High investment, particularly mining capex during the 2003 to 2014 boom.
• Relatively low household savings during the 1990s and 2000s.
• A persistent net primary income deficit on a growing stock of net foreign liabilities.

Since 2019, Australia has run small current account surpluses for the first time in over four decades. Drivers:

• Record terms of trade. Iron ore, coal and LNG prices spiked in 2021-22.
• Higher household savings. COVID-19 lockdown savings, then continued caution.
• Lower mining capex. Investment phase of the resources boom has ended; production exports dominate.

The current account surplus may not persist if commodity prices fall.

Causes of current account deficits

Long-run drivers of Australia's CA deficit:

1. Savings-investment gap. Australia has historically invested more than it saved, especially during the mining boom.
2. Demographics. A growing population requires growing capital stock (housing, infrastructure, business capital).
3. Stock-flow dynamics. Net foreign liabilities generate ongoing servicing costs (interest, dividends), which feed back into the net primary income deficit.
4. Terms of trade volatility. When commodity prices fall, BOGS deteriorates rapidly.

Causes of current account surpluses (recent)

1. Commodity price boom. Iron ore averaged USD 115/tonne in 2021-22, more than double the long-run average.
2. Mining investment phase complete. Less import-heavy capex needed; mature export production.
3. Strong household savings. Household savings ratio jumped from 5 percent pre-COVID to over 20 percent in 2020-21.

Common HSC traps

Confusing the current account and the financial account

The CA records goods, services and income flows. The financial account records ownership changes of assets.

Forgetting the savings-investment identity

Markers reward responses that link the CA to the S-I gap.

Treating the CA surplus as permanent

Make clear it depends on continued high commodity prices and household savings.