Explain the structure of the balance of payments, the current and capital and financial accounts, and the causes and consequences of current account deficits and surpluses

What this dot point is asking

SCSA wants you to explain the structure of the balance of payments, define each component, show why the accounts net to zero, and analyse the causes and consequences of a current account deficit (CAD). Expect a balance of payments table as stimulus plus a short or extended response.

The two accounts

The current account

The current account records non-capital flows. It has three parts:

• Balance on goods and services (BOGS): exports minus imports of goods and services. A surplus means Australia exports more than it imports.
• Primary income: income flows on investments and labour, mainly interest and dividends paid to and received from abroad. Australia runs a large primary income deficit because it has historically been a net borrower, so it pays more interest and dividends out than it receives.
• Secondary income: transfers with no good or service in return (foreign aid, gifts, some pensions). Usually small.

The capital and financial account

This account records transactions in assets and liabilities:

• Capital account: small; conditional transfers of capital and non-produced, non-financial assets.
• Financial account: the large component, recording flows of direct investment, portfolio investment (shares and bonds), and other investment. A net inflow means foreigners are buying more Australian assets than Australians are buying abroad.

Why the accounts balance

The logic: if Australia spends more on imports, income and transfers than it earns (a CAD), it must fund the gap by either borrowing from abroad or selling assets to foreigners, which is recorded as a net inflow on the financial account.

Causes of a current account deficit

• Strong domestic spending on imports relative to export earnings.
• A high level of foreign liabilities generating large net primary income outflows (interest and dividends).
• Commodity price movements: falling export prices worsen the BOGS; rising prices improve it.
• Exchange rate movements: a higher AUD makes exports dearer and imports cheaper, worsening BOGS, though the J-curve means timing matters.
• The savings-investment gap: if national investment exceeds national saving, the shortfall is funded from abroad, producing a CAD.

Consequences of a persistent CAD

• Rising net foreign liabilities (the cumulative stock of foreign debt plus foreign equity), which must be serviced through future income outflows.
• The debt-servicing burden: larger primary income deficits can entrench the CAD.
• Sustainability question: a CAD driven by productive investment that lifts future export capacity is more sustainable than one funding consumption.
• Exchange rate and confidence risk: very large deficits can pressure the dollar and raise the risk premium on Australian borrowing, though a floating dollar acts as a shock absorber.

The Pitchford thesis argues that a CAD arising from private sector borrowing and lending decisions is not a policy problem, because private agents bear their own risks. This view underpinned the relaxed official attitude to Australia's CAD from the 1990s.