HSC Topic Two – AUS’s Place in the Global Economy

AUS’s trade and financial flows

Value, composition and direction of Australia’s trade and financial flows
 trends in Australia’s trade pattern
 trends in financial flows – debt and equity
Australia’s Balance of Payments
 structure
- Current Account, debits and credits
- Capital and Financial Account
 links between key Balance of Payments categories
 trends in the size and composition of Australia’s Balance of
Payments
- international competitiveness, terms of trade, international
borrowing, foreign investment
- effects of these trends on Australia’s Balance of Payments

Exchange rates
 measurement of relative exchange rates
- to other individual currencies
- Trade Weighted Index
 factors affecting the demand for and supply of Australian dollars
 changes in exchange rates – appreciation/depreciation
 determination of exchange rates including fixed, flexible and
managed rates
 the influence of the Reserve Bank of Australia on exchange rates
 the effects of fluctuations in exchange rates on the Australian
economy

Free trade and protection

 Australia’s policies regarding free trade and protection
 Australia’s multilateral and bilateral free trade agreements –
(overview of two
examples of each type of agreement)
 the implications of Australia’s policies for individuals, firms and
governments
 implications for Australia of protectionist policies of other countries
and trading blocs.

Chapter 4: Australia’s Trade and Financial Flow

Value, composition and direction of Australia’s trade and

financial flows
 trends in Australia’s trade pattern

Understanding AUS’s place in the global economy:

- AUS’s place in the global economy focuses on trade and financial
links with the rest of the world.
 - AUSian economy ranks 13th in the world – placing it in the middle
rank of advanced economies, between Mexico and South Korea
- AUS was ranked 10th in the world in terms of quality of life,
according to the U’ 2023–24 HDI.
Trade in AUS’s trade patterns:
- AUS’s economic activity is represented in a high proportion because
of overseas markets for AUS’s primary commodities, such as
minerals and agricultural products.
- AUS’s level of development has made it an exporter of services such
as tourism and education.
- AUS is sometimes referred to as a small, open economy.
The changing direction of trade:
- China has become AUS’s dominant trading partner, while India and
ASRAN countries have also become more important
- in previous decades – Japan and the UK and Europe – have declined
in importance.
- There was a historic shift in the direction of AUSian trade after the
UK joined the EU in 1973.
- UK has been AUS’s major trading partner prior to this period. UK
imposes the same barriers to trade with AUS as with other
countries, in effect giving a preference to trade from European
countries.
- Though, since 2023, AUS and the UK have had tariff-free trade
(following the signing of a trade agreement after the UK’s departure
from the EU).
- When AUSian exporters found it more difficult to gain access to
European markets, their focus shifted to other areas, particularly the
North-East Asian and ASEAN countries,

- In the 1960s, AUS capitalized on Japan's rapid economic growth and

rising demand for minerals and energy, making Japan its largest
export market for several decades.
- In the early 2000s, exports (X) to China began a sustained period of
rapid growth which, since 2007, has made China AUS’s largest
trading partner (calculated by adding Imports (M) and X together).
- China is AUS’s dominant export market with more than twice as
many X as the next largest export market, Japan.
- China accounted for 33 per cent of AUS’s export earnings and
annual X to China exceeding $200 billion in 2023.
- In the 2020s, AUSian trade is shifting towards rapidly growing
economies like South Korea, India and Indonesia with X to these
countries growing over 10 per cent annually.
- Though AUS does not sell a high proportion of its output to other
advanced economies, it still buys a substantial amount from these
economies, in particular EU and the US.
- This reflects the importance of M and X from these countries, for
capital equipment and for many customer items.
 - China and ASEAN economise are also large sources of M, reflecting
AUS’s demand for manufacturing M that these economies specialise
in producing.
- China has been our largest source of M.

The changing composition of AUS’s trade:

- Primary industries main focus of AUSian X, as of a comparative
advantage in commodities due to its vast natural resources.
- Agricultural and mineral X account for more than two-thirds of AUS’s
export earnings.
- AUS has been less competitive in manufacturing, but continued to
rely on its primary X, while importing large quantities of capital
goods and manufactured consumer goods.
- In 2023-24, AUS’s total X were worth $657 billion, down from $686
billion in 2022-23, reflecting a decrease in commodities X, following
a worldwide decline in export prices for commodities and weaker
global demand.
- Several factors have contributed to the decline of agriculture X
- Large fluctuations in world prices as well as the trade protection
policies of other countries have influenced the export revenue from
agricultural commodities.
- Agricultural trade involves commodity items to which little extra
value is added in processing.
- Natural disasters such as floods and bushfires, reduced the output
and productivity of the agriculture sector.
- Niche-market-manufactured goods picked up in the 1990s.
- The mining boom increased the value of the AUSian dollar in the
mid-2000s, AUSian manufacturing exporters have encountered
more difficult conditions, alongside increased competition from
goods manufactured in China and other low-cost economies in Asia.
- Some economists argue that the prospects for high commodity
prices are positive in the medium to longer term because of the
rapid growth of China, India and other developing economies.
- Others risks of AUS being too reliant on commodity Xand one major
export market (China), especially given China’s recent history of
imposing trade barriers against AUSian X
- AUSian exporters have experienced volatility in the past two
decades, although commodity prices have since the early 2000s
remained well above historic average.
- Specific risks in AUS’s reliance on global demand for coal and gas X
- Strong demand for these X, following Russia’s invasion of Ukraine,
demand is expected to fall as economic transition to energy sources
with lower carbon emissions.
- AUS is harder hit if carbon tariffs are adopted around the world as
part of the global response to climate change.
 - One long term alternative is to diversify X towards new mineral and
energy X
- Future Made is AUS package:
 Emerging critical minerals needed for renewable energy
technologies, such as lithium for battery production.
 Included a $22.7 billion I in new export industries such as
renewable hydrogen, green metals and critical minerals
processing.
 Service industries and a highly skilled workforce, nearly three-
quarters of which is employed in service industries.
 Export markets for education services, financial services,
insurance and tourism has grown, as well as smaller markets
for transport, health and communications services.
- Trends in the composition of AUS’s M as a percentage of total
import expenditure.
- AUS’s M has changed moderately.
- Consumer goods as a proportion of M have increased.
- Shift away from large-scale manufacturing in AUS, especially with
the gradual reduction of tariffs and local content rules. In 2023–24,
AUS’s total M were valued at $526 billion.

 trends in financial flows – debt and equity

Trends in AUS’s financial flows (FF):

- FFs has been much greater, as international businesses have in
AUSian businesses, and as AUSian companies have increased their
overseas investments.
- Exchange rates around the world were floated and restrictions on
the movement of capital across national borders were removed.
- FFs grew rapidly as international capital markets opened up,
exchange rates were floated, and technological changes were
made.
- I overseas by AUS has grown rapidly during the era of globalisation.
- Direct I include the establishment of a new company, or the
purchase of a substantial proportion of shares in an existing
company (10 per cent or more).
- Portfolio I includes loans, other forms of securities and smaller
shareholdings in companies.
- The rate of growth of portfolio I into AUS – the shorter-term and
more speculative inflow – has been significantly faster than the
growth in longer-term FDI.
- Value of our I into major Asian economies also doubled in the
previous decade.
- Imbalance between I in AUS and AUSian I overseas.
- AUS is a net capital importer; this reflects the historically low level
of domestic savings within AUS.
- AUS has relied on FFs from overseas to make up for the shortfall
between savings and I in AUS.
 - AUS’s large superannuation funds have increasingly pursued I
opportunities overseas.

Australia’s Balance of Payments

 structure

The (BoPs):
Structure of the BoPs:
- Definition: the BoPs is a monetary record of transaction into and
out of AUS.
- Single most important economic indicator of the relationship
between AUS and the global economy.
- Shows the trade and FFs in and out of the AUSian economy.
- Money that flows into AUS is referred to as a credit, e.g. an
American company buying AUSian wheat.
- All money that flows out of AUS is referred to as a debit, e.g. an
AUSian business that has a loan from a Japan bank paying interest
on that loan.
- The BoPs figures are presented in two accounts – the current
account (CA) and the capital and financial account (KAFA).
- Compiled according to a set of international accounting standards,
easier to compare AUS’s BoPs with other countries

- Current Account, debits and credits

The CA
CA:
- CA is the part of the BoPs that shows the receipts and payments for
trade in GS, transfer payments and Y (Y) flows between AUS and the
rest of the world in a given time period. These are non- reversible
transactions.
- It’s a bit like a bank transaction recorded, for the whole country (and
we don’t all share the same bank account). So, it’s more record than
an account
Net goods:
- Difference between what AUS receives for its X and what it pays out
for its M of goods.
- Three possible outcomes:
 AUS could be in balance (where export receipts equal import
payments).
 AUS could have a surplus (S) (where receipts exceed
payments).
 AUS could have a deficit (D) (where payments exceed
receipts).
Net services:
- Services that are bought and sold without people receiving a
“good”.
- Services that AUS sells are an inflow of money and are shown as
credits.
 - Services that AUS buys are an outflow of money and are shown as
debits.
Balances on goods and services (BOGS):
- BOGS is the amount that is derived by adding net goods and net
services together.
Net primary income (NPY):
- Earnings on investments, that is, Y that is earned as a return from a
factor of production.
- It covers interest payments on borrowings and returns on other FI.
- Foreigners invest in AUS, Y in the form of rent, profits, interest and
dividends flows overseas
- AUSians invest overseas, there is a flow of Y back to AUS.
Net Secondary Income (NSY):
- Non-market transfers, that is, Y that is not earned through a factor
of production.
- Occur when products or financial resources are provided without a
specific good or service being provided in return, a small and
relatively technical account,
- NSY include:
 Payouts on insurance claims, workers’ remittance.
 Funds taken out of AUS in the form of ‘unconditional’ aid to
developing nation (such as funds given as a gift to a F
government without a specific purpose).
 Pensions received by residents from F government
Balance on CA:
- This refers to the addition of the BOGS, net primary Y and net
secondary Y.
- To work out the balance of the CA, you must add the balance of
each account together
- If money inflows (credits) are greater than the outflows (debits), the
CA will be S (CAS).
- If money out flows (debits) are greater than the inflows (credits), the
CA will be in D(CAD).

- Capital and Financial Account

The KAFA:
KAFA:
- Other side of the BOPs.
- KAFA records the money flow that result from borrowing, lending,
sales and purchases of assets between AUS and the rest of the
world.
- Major feature is it is that these transactions are reversible, in the
sense that after the transactions occur, they can be undone in the
future.
- KAFA is the measure, in dollar terms, of money flows coming into
and out of the AUS over a period of time.
Capital account:
 - Capital account is mainly in the form of “conditional” Faid grants
(which are linked to specific capital project)
- Two main components – capital transfers and entries for the
purchase and sale of non-produced, non-financial assets.
- First item is capital transfers, form of assistance to other countries
to build up their infrastructure of capital stock.
- Second item is entries for the purchase and sale of non-produced,
non-financial assets - mainly intellectual property rights such as
patents, copyrights, trademarks and franchise.
Financial account:
- Shows AUS’s transactions in F financial assets and liabilities (L),
categorised by the type of investment.
- Size can change substantially from one time period to the next,
result of the large money flows that underlie the balance on the
financial account.
- Credit entries represent net inflows, because of either an increase in
F I in AUS or a reduction in AUSian I overseas.
- Debit entries represent net outflows.
- AUS has consistently recorded a positive FA balance, showing that
the rise in AUS’s L to the rest of the world is higher than the
increase in the L of the rest of the world to AUS.
- AUS has effectively drawn on the savings of the rest of the world to
finance a D on its CA.
- Five main financial account components:
 Direct Investment:
- F financial transactions to fund new I in AUS or overseas
or to buy more than 10 per cent of shares in an existing
company.
 Portfolio Investments:
- Buying of land, shares and other marketable securities
in existing companies, also where most F debt is
recorded.
- Involves the largest volume of transactions on the
capital and financial account.
- Value of AUSian PI overseas exceeds the value of
overseas PI in AUS.
 Financial Derivatives:
- Complex financial assets that have become increasingly
significant in recent years.
- Value of these investments is normally derived from the
performance of specific assets, interest rates, exchange
rates or indices.
- Important part of global financial markets.
 Reserve assets:
- F financial assets that are available to and controlled by
the central authorities for financing or regulating
payment imbalances.
 - Include monetary gold (gold held by the RBA, Special
Drawing Rights, reserve positions in the International
Monetary Fund and F exchange held by RBA.
 Other Investments:
- A residual category that captures transactions not
classified as the four other components.
- Covers trade credits, loans including financial leases,
ccy and deposits, and other accounts payable and
receivable that do not meet the classification
requirements of the other components.
Balance on KAFA:
- Determined by adding the categories together.
- Outcome should be approximately equal to the D on the CA.
- AUS’s BoPs are derived in the following way:
CA:
net goods + net services (BOGS) + NPY + NSY
KAFA:
KA + 5 FA components
BoPs:
CA + KAFA + N/E = 0
- This represents the equilibrium between the supply and demand for
AUSian dollars created by the floating exchange rates.
- Final part, BoPs is the category of net errors and omissions.
- This refers to statistical discrepancies, included because under a
floating exchange rate system, the BoPs would always balance to
zero.
- Easier understanding, balancing item is often added on to the KAFA
figure to ensure the balance of payments sums to zero.
- Therefore, reported with capital and financial account.

 links between key Balance of Payments categories

Links between key BoPs categories:

- Important relationship between CA and KAFA on the BoPs.
- The two accounts need to add up to zero = BoPs
- The D on the CA is equal to the S on the KAFA (allowing for the
small category of N/E and omissions).
- An increase in CAS will result in a rise in the KAFAD.
- The floating AUS dollar plays the key role of ensuring that there is a
balance in the BoPs.
- Supply of A$
 Payments for M on GS(M)
 Primary and secondary Y/transfers overseas (Y debits)
 KAF outflow (K outflow)
=
- Demand for A$
 Receipts for X of GS (X)
 Primary and secondary Y/transfers from overseas (Y credits)
 KAF inflows (K inflows)
- Therefore, for equilibrium in the F exchange market:
Supply of A$ = Demand for A$
- Which in turn implies:
M + Y debits + K outflows = X + Y credits + K inflows
- Rearranging the equation:
M – X + Y debits – Y credits = K inflows – K outflows
Or
D (or S) on the CA = S (or D) on the KAFA
- Strongest link between CA and KAFA can be seen on the NPY of CA
to the KAFA investments.
- In long term, a KAFA S will result in a large D on the NPY account.
- Because any FFF that comes to AUS must earn some kind of return
for its owner (debits or outflow) recorded in the PY account,
- Financial inflows can create debits on the PY category of the CA in
two ways:
 International borrowing (F debt):
- Require regular interest repayments.
- These interest payments, or servicing costs, are
recorded as debits on the NPY part of the CA.
- Repayment of the principal (the original amount
borrowed) is recorded on the FA.
- AUS’s high level of borrowing from overseas has
contributed significantly to the NPYD due to the
servicing costs of Fdebt.
- Loan  initial amount  credit inflows on FA
- Repayment on loan  interest = debit outflow on NPY
 F I (F equity (E)):
- Require returns on the E investment.
- E financial inflows are related to the F purchase of
AUSian assets such as land, shares or companies.
- F owners of AUSian land will receive rent, owners of
shares will receive dividends, and owners of companies
will receive profits.
- These returns on I are also recorded as debits on the
NPY part of the CA.
- E  initial amount = credit inflows on direct I
- Repayment on shares  dividends  debit outflows on
NPY
- High level of KAFA S es will result in a widening CAD because of the
servicing costs associated with increased FL.
- In extreme cases this leads to a ‘debt trap’ scenario in which an
economy borrows from overseas merely to pay the interest-
servicing costs on its existing F debt.
- Another perspective on the link between CA and KAFA can be seen
by examining savings and investment.
- AUS’s low savings relative to I demand necessitates financial
inflows, contributing to CAD beyond trade imbalances.
- Economists from the mid-1980s to mid-1990s attributed these Ds to
weak international competitiveness in BOGS.
 - Low savings result in a need for FC inflow to fund I within AUS (that
is, making the CAD a KAFA problem).
- NFL: net foreign liability, NFD: net foreign debt, NFE: net foreign
equity.
NFL = NFD + NFE
- Even if its debt or E, they are a L.
- NFE: share dividends, NFD (F  international loans).

 trends in the size and composition of Australia’s Balance of

Payments

Trends in AUS’s Balance of Payments:

Trends in AUS’s BoPs:
- Structural changes in AUS’s economy those of our trading partners
have resulted in significant changes in the pattern of X, M and flows
of Y.
- I needs of different sectors of the AUSian economy have driven
changes in the flow of capital.
- In mid 2019, the CA went into S for the first time since 1975.
- A very large trades S, meaning that the value of GS exported by
AUS to the rest of the world exceeded the value of GS imported.
- Outcome was driven by the high prices for resource commodities,
especially iron ore, liquified natural gas (LNG) and coal, as well as a
large increase in the production of those commodities.
- Net Y D has been volatile in recent years.
Trends in AUS’s CA balance:
- CA balance reflects the difference between national savings and
investments.
- The CA balance can be in S (have a positive value), be equal to zero,
or be in D (have a negative value)
- AUS has generally had a CAD reflecting attractive I opportunities in
the economy that exceed our capacity to fund via domestic savings.
- Trends in AUS’s trade balance:
 Changes in AUS’s trade types of GS that AUS X well as the
price that are received or paid for the comparative advantage
in export of resource and agricultural commodities.
- X:
 Since the mining boom in the 2000s, AUS’s X of iron ore, LNG
and coal have become increasingly important, particularly
after the mining I boom in 2000s, which substantially
increased AUS’s capacity extract these resources.
- Major export trading partners:
 Ongoing industrialisation and urbanisation of these economies
increased the demand for AUS’s natural resources, such as
coal and iron ore, which are used in construction,
manufacturing and power generation.
- M:
 They are not available domestically or because they are
cheaper to purchase than equivalent domestic GS.
 - The composition of AUS’s M:
 Services have consistently been one of the largest
components of AUS’s M, accounting for around one quarter of
total M value.
 AUSian residents while they are overseas for holiday,
education and business-related reasons, as well as their
transport costs (e.g. plane tickets).
Trends in AUS’s Y balance:
- Combined P and S Y balance – or NY balance – has been in a D for
manty decades, which means that AUSian residents have paid more
Y to non-residents that they have received form non-residents.
- This has reflected AUS’s NFL position – which so where the stock of
AUSian L held by F investors exceeds the stock of F assets held by
AUSian residents.
- AUSians pay more interest to the rest of the world on the L than
they receive on their assets from abroad.
- Y earned by these companies in AUS being paid to F owners in the
form of dividends.
Foreign Currency Composition:
- AUS's L with the rest of the world are denominated in AUSian
dollars, rather than F cyes, including FI in the E of AUSian
companies.
- AUSian firms that borrow funds in international markets convert
their F ccy borrowings into AUSian dollars using financial
instruments known as derivatives.
- This practise is known as ‘hedging’ - ensures that a depreciation in
the AUS dollar does not make it more expensive for firms to repay
their debts.
- In contrast, over half of AUS's F assets are denominated in F cyes.
- This results in AUS having a net F ccy asset position: AUS residents
own more assets denominated in F cyes than we owe L
denominated in F cyes to non-residents.
- AUS's F assets and L determines how the external position is
affected by movements in the exchange rate.
- Because AUS has a NF ccy asset position, when the AUSian dollar
depreciates, the value of F ccy-denominated assets increases in
AUSian dollar terms, and so our gross F assets increase relative to
our gross FL.
- Y received on our F assets increases relative to the Y paid on our FL,
meaning an overall, a depreciation of the ccy would tend to
strengthen AUSs external position and result in a narrowing of the
NYD.
Trends in AUS’s K Flow:
- To the 1980s, FI in AUS generally took forms of FDI.
- In 1983, AUS’s financial sector underwent a period of deregulation,
which included the removal of K controls and floating of the AUsian
dollar.
- As a result of these reforms, AUSian residents could use their
savings to invest overseas more freely than before and overseas
 investors were able to invest in broader range of AUSian assets
reflecting capital flows to and from AUS increased substantially and
become more varied in their type.
Trends in AUS’s External Position:
- NK inflows from abroad, AUS has accumulated a NL (borrowing)
position with the rest of the world.
- AUS’s NFEL have also declined markedly in recent years. Since
2013, AUS has had a NFE asset position – AUS residents own more E
In F companies than non-residents own in AUSian companies.

- international competitiveness, terms of trade, international

borrowing, foreign investment

The balance of goods and services:

- The BOGS S has been 3.2% of GDP since 2016
Cyclical factors:
- The exchange rate, the terms of trade, and the rate of economic
growth in the AUSian economy.
- Exchange rate (ER):
 Movements in ER, affect the international competitiveness of
AUSian X and the relative price of goods and services that AUS
M.
 A deprecation decreases the F ccy price of AUSian X,
increasing the international competitiveness of AUSian X on
world markets.
 A depreciation increases in AUSian dollar price of M and
discourages consumers from purchasing M, also improving the
BOGS account.
- Terms of trade:
TOT = X price index/M price index x 100
 AUS’s BoPs has been changing in AUS’s TOT.
 TOT measures the relationship between the prices AUS
receives for X and the prices it pays for M.
 Increase in TOT (X prices are rising relative to M prices) leads
to a BOGS S (more money from X than spending on M).
 An improvement in the TOT means that the same volume of X
can buy more M.
- Economic Growth Rates:
 Level of domestic EG influences the BOGS balance by
affecting demand for M.
 Higher disposable Y leads to higher consumption.
 Higher levels of business I and household consumption spill
over into higher M, worsening the BOGS.
 EG is driven by I in productive capacity that will expand X,
worsening of the BOGS will be reserved in the medium term
and X grows.
 Onset of the mining boom in 2003, the BOGs worsened for
several years before its turnaround in 2010s.
  Higher Y and consumption lead to more M, worsening the
BOGS, while I in productive capacity initially increases M but
later boosts X, improving the BOGS over time.
 A slowdown in global EG and weaker growth in AUS,
worsening the BOGS.
 AUS’s economic successes in recent decades is that our
economy has been more closely integrated with faster-
growing economies.
Structural Factors:
- Over the long term, AUS’s BOGS has usually stayed in D. This is
mainly due to two structural factors: AUS’s narrow X base and lack
of international competitiveness.
- Narrow X base:
 Heavily weighted towards a small number of commodities.
 AUS is highly exposed to movements in price and demand in
these marks, this volatility contributing to fluctuations in the
BOGS form year to year.
- Lack of International Competitiveness:
 Lack in manufacturing, so relies heavily of M of value-added
products.
 As a result, BOGS has historically tended to be in D rather
than S because M payments vry outstrip X revenues.
 AUS must diversify its X towards high-growth, high value-
added sectors.
 Elaborately Transformed Manufacture (ETM) – that is,
technologically advanced GS, as opposed to simply
transformed manufactured goods or commodity X.
 Future Made in AUS policy announced by the Albanese
Government in 2024.

The Primary Income Account:

- Payments of interests and dividends on AUS’s NFD and E.
- NPYA D of 2023-24 was 3.6 per cent of GDP.
Cyclical Factors:
- Domestic EG:
 Experiences strong growth, company profits rise, and these
profits are redistributed to shareholders ads dividends,
 40 per cent of the AUSian public share market is F owned
 Payments to overseas shareholders – increase servicing cost
 increase the NPYD.
- ER:
 Movements in the ER alter the AUD value of debt
denominated in F cyes– ‘Valuation Effect’
 An appreciation decreases the AUD value of debt
denominated in F cyes, decreasing AUS’s debt servicing cost.
 Reducing the value of NPY outflows and reducing NPYD.
 Depreciation of the AUS results in the opposite impact.
 However, the valuation effect is limited.
  A large amount of AUS’s F debt is ‘hedged’ =, the lender and
borrower will agree to fix this exchange rate over.
 A significant part of the AUS’s F debt is denominated in AUD,
which means it is not affected by ER movements.
- Changes in Interest Rate:
 AUS’s overseas loans can be taken out with overseas interest
rates.
 When interest rates change, the cost of servicing F debt also
changes.
 To 2023-24 to $38 billion in net terms, an interest rate on debt
in both AUD and F ccy rose sharply.
 If the o/s int rate increases – NPY outflows increase, vice
versa.
Structural Factors:
- Savings Investment Gap
 A gap between savings and I because of a historically low
level of national savings, the AUS economy requires high
levels of K I.
 Main structural factor for NPY.
 As AUS is an open economy, firms are able to look to F
sources of finance to fund their I.
 This increases AUS’s F L and creates future servicing
obligations in the form of interest repayments (on debt) and
dividends (on E).
 Servicing costs are outflows on the NPYA even as AUS
sustained trade S.
 AUS relies heavily on F borrowing (increasing F debt) so this
rises FL, leading to future interest and dividend payments, this
is recorded as an outflow in the NPYA, being a D in the CA.
 AUS companies and superannuation funds are being invested
overseas which is a debit outflow on the FA, which means in
the future, returns on the NPY would be higher, being a credit
inflow in the CA.

- effects of these trends on Australia’s Balance of Payments

The consequences of a high CAD:

- The IMF considers a CAD to be too high if its average over -4 per
cent in the medium to long run or if it is above 6 per cent in the
short term.
Risks associated with a sustained high CAD:
- Growth of FL:
 Over a period of time, a high CAD will contribute to an
increased level of F L.
 This will mean lenders may become more reluctant to lend to
AUS or to I in AUS.
- Increased Servicing Costs:
 This would worsen the CAD, a higher CAD would increase
servicing costs
  Higher levels of F debt can result in F lenders demanding a
‘risk-premium’ on loans, forcing up interest rates.
- Increased volatility for ER:
 By reducing demand for AUS’s ccy, may result in a
deprecation of AUD.
- Constraint on future EG:
 a high CAD may become a speed limit on EG. Higher levels of
EG generally involve an increase in M and a deterioration in
the CAD.
 To limit G to the level at which the CAD is sustained. This is
known as the BoPs constraint.
- More contractionary economic policy:
 Uses tighter macroeconomic policies
 Tighter fiscal and monetary policies will reduce economic
growth and contribute to a lower CAD.
- Loss of int. investor confidence:
 A sudden shift in the attitude of global markets towards a
country whose external imbalance appears unstable,
- Although AUS sustained a high CAD, concerns external balance have
decreased in recent years.
- Confident that AUS ‘s natural resource wealth will underpin
continued strong X growth in the future, allowing AUS to service its
FL + consenting adults theory.
- Some economies warn that a long-term risk for AUS is, a loss of
China X markets or a rise in global interest rates, could return a high
CAD.

Chapter 5: Exchange Rates

Exchange rates
 measurement of relative exchange rates

Exchange Rate:
- The exchange rate is the price of one ccy in term of another
country’s ccy.
- Ccy conversion occurs in the F exchange market (also referred to as
the forex market)
- The forces of supply and demand interact to determine the
exchange rate and that happen in the forex market.
- 92 per cent off all AUD sold in the AUS F exchange market are used
to buy USD.
AUS’s Floating Exchange Rate System:
- In Dec 1983, AUS moved to a floating ER system, which opened the
economy to global financial flows and the ER is determined by free
market forces.
- Floating ER is when the value of an economy’s ccy is determined by
the forces of demand and supply in F exchange markets (easier for
investment to flow into and out of AUS).
 - to other individual currencies

AUD trends:
AUD: Recent Movements and Outlook:
- The AUD experienced a sustained appreciation during the 2000s.
- 2021 to almost USD 80 cents, before depreciating again to around
US65 cents in mid-2024.
- During the resources boom, commodity prices soared to over three
times their pre-2003 value, fuelling demand from trade as well as
speculative I in the AUD.
- 7.5 per cent appreciation of the AUD from January to March 2022.
However, AUD depreciated from August to December 2023.
- US Federal Reserve pushed out cash rate cut expectations to the
end of 2024, investors moved their savings to higher returns in the
United States, causing the AUD to fall.

- Trade Weighted Index

Trade Weighted Index:

- TWI is a measure of the value of the AUSian dollar against a basket
of foreign cyes of major trading partners. These cyes are weighted
according to their significance to AUS’s trade flows.
- Trade Weighted Index gives an indication how the value of the A$ is
moving against all cyes in general.
- An importance limitation of the TWI ER measurements in that the
weighted us only based on volume of trade regardless of the ccy in
which X and M are involved.
- AUS sells it commodities in USD
- The A$/U$ ER is far more important than the weight it receives n
TWI calculation.

 factors affecting the demand for and supply of Australian

dollars

- Increase in supply, leads to deprecation of ER, while an increase in

demand leads to appreciation of ER.
Factors influencing the Demand for AUD:
- Size of financial flows:
 Who wish to invest in AUS need to convert their ccy into A$
 The level of AUSian int rates relative to o/s int rates. Relatively
higher AUSian int rates  increase the demand for A$.
 AUS has more availability of I opportunities.
- Expectations of future movements:
 Expectations of a future appreciation of the A$ will increase
current demand for A$ by speculators.
- AUSian X:
 AUS X need to convert their ccy into A$ to pay AUSian X.
  A rise in commodity prices and an improvement in the term of
trade are generally associated with an increase in the value of
AUSian X.
 Increasing the value of the dollar with an expectation that the
value of X will increase.
 Int. competitiveness of domestic X and AUS’s inflation rate
relative to o/s countries.
 AUS’s X will generally be relatively cheaper and more
attractive to F buyers, therefore causing increased demand for
A$.
 Global economic conditions influence the overseas demand for
X.
 When the world economy is in a boom, demand and prices for
AUS’s X rise.
Factors affecting the Supply of AUD:
- When you sell the ccy.
- Level of financial flows:
 AUS investors who wish to invest o/s and sell A$ and purchase
F ccy.
 Level of AUSian interest rates relative to o/s interest rates
influences financial flows out of AUS and the supply of A$.
 Relatively lower AUSian interest rates will make investing
savings more attractive hence increase the supply of A$.
 More I opportunities o/s leads to higher financial flows out of
AUS as AUSian start businesses or purchase shares o/s,
increasing the supply of A$.
- Speculations:
 Value of the A$ to go down will sell.
- Domestic Demand for M:
 Important is domestic Y.
 Strong EG and rising Y will result in the demand for M also
rising, increasing the supply of A$.
 Domestic inflation rate is higher, and its M-competing firms
are relatively uncompetitive, M will be relatively cheaper than
domestic products and demand for M will be higher.

 changes in exchange rates – appreciation/depreciation

Appreciation of the AUD:

- The left side is an increase in the
demand for A$, increasing the price
of A$.
- The right side is a decrease in the
supply of A$, will also increase the
price of A$.
Depreciation of the AUD:
- The left side is a decrease in
demand for A$, decreasing the price
of A$.
 - The right side is an increase of supply of A$, decreases the price of
A$.

- A floating ER is not only about supply and demand, but it also acts
as an “automatic stabiliser”.
- During the mining boom, mid 2000s to the early 2010, increase in
demand for AUSian resources pushed commodity prices up, which
lead to the appreciation of the A$.
- However, industries that did not directly benefit from the mining
boom saw their costs increase and demand for output fell.
- The appreciation of the A$ helped the economy to re-allocate labour
and K to the booming mining sector, reducing inflationary pressures
and maintaining a stable employment level within the economy.

 determination of exchange rates including fixed, flexible and

managed rates

Fixed Exchange Rate Systems:

- in previous decades, however, it operated on a range of fixed ER
systems.
- Prior to Nov 1976, AUS had a fixed ER system – A$ was pegged.
- Nov 1976 to Dec 1983 managed a flexible system
- And from 1983, it is a floating ER.
- Fixed ER:
 Under the fixed Er system, The RBA sets the ER, for example,
a$ = 0.80$ used.
 By either buying or selling F in exchange for A$. Buying the
excess supply of A$ (that is Q1Q2) at ap rice of US80 cents, but
the Government would need F reserves.
The manged fixed peg:
- A variation of the fixed ER is the managed flexible peg.
- The RBA would ‘peg’ the value of the A$ and each day and that
price would operate throughout the day.
- This was an overvalued ER.

 the influence of the Reserve Bank of Australia on exchange

rates

RBA intervention in the FER:

- RBA sometimes plays a role in influencing the value of the ccy.
- To smooth out swings in the dollar by dirtying the float and through
the monetary policy.
- Dirtying the float:
 The RBA steps into the FE market, either as a buyer or a
seller, in order to stabilise the A$.
 In order to curb a rapid deprecation, the RBA will buy A$,
putting upwards pressure on the ER by increasing demand.
 On the other hand, selling A$ the RBA may prevent a rapid
appreciation by increasing supply.
  The RBA’s ability to intervene through buying A$ is limited by
the size of its F ccy holding.
- Monetary Policy decisions:

 Indirect way of the RBA wants to curb a rapid depreciation, it

may increase the demand for A$ by raising interest rates.
 O/s countries will increase the demand for A$ and put upward
pressure on the ER only be effective for a limited time.
 It’s unusual for the RBA to do it and usually focus on domestic.

 the effects of fluctuations in exchange rates on the

Australian economy

Exchange rates in the Australian economy:

- ER matter to AUS’s economy because of their influence on trade and
FF between AUS and the rest of the world.
- Direct effect on the prices of goods and services in AUS.
- Indirect effect on economic activity and inflation as change in the
relative prices of goods and services produced domestically and o/s
influence decision about production.
- Together these effects also have implications for the BoPs.
Direct effects:
- AUD depreciates, value, less F ccy is required to purchase a given
amount of AUD, making AUSian produced goods and services
cheaper.
Indirect effects:
- Because changes in the relative prices of AUSian and o/s goods and
services affect economic activity and inflation in AUS, example of a
depreciation of the AUSian dollar
- Economic activity and the labour market:
 Increase in int. competitiveness of AUSian Xers.
 F consumers and firms will demand more AUSian goods and
services, leading to an increase in the volume (that is,
quantity) of AUS X.
 The ER depreciation affects the M goods and services become
more relatively more expensive.
 AUS consumption to demand more M competing god and
services produced in AUS, leading to a decrease in the volume
of M.
 The resulting increase in X volume and decrease in M volumes
will increase national Y in AUS, this will increase demand for
non-trade good and service produced in AUS.
 AUS firms will have to hire more workers, which will increase
employment and lower the unemployment rate in AUS.
- Inflation and interest rates:
 Deprecation of the ER will increase inflation into two ways.
 First, prices of M goods and services will increase, contributing
to inflation.
  Second, expansion of aggregate demand and increase in
employment will cause an increase in wages and other costs.
 RBA may need to tighten the MP in order to achieve its
inflation target.

Balance of Payments:
ER and BoPs:
- BoPs, however, it is the value – that is the prices as well as the
quantity – of X and M matters.
- The direct effect of an Er depreciation is to increase the price of M
relative to X, which will tend to decrease the value of NX (X less
than M) and widen the CAD.
- However, the indirect effect of an ER depreciation increases the
volume of X and reduce to volume of M. this will tend to increase NX
and diminish the CAD.
- These two effects differ in their timing, direct effect of an ER
deprecation occurs immediately while the indirect effects on X and
M volumes typically occur with a lag.
- In the short run, an ER depreciation is likely to reduce to value of
NX, as X and M volume starts to respond, an ER depreciation is
likely to increase the value of NX. This is referred to as the ‘J-curve’.
- NPY:
 ER movements also affect another major component of CA –
the NYD. ER depreciation will increase the of AUSian residents
of servicing F debt that is dominated in F ccy.
 Amount of AUD required to purchase the F ccy needed to pay
the interest owned on the debt has increased, this Increases
NY outflow and widens the CAD.
 On the other hand, an ER depreciation will increase the Y that
AUS residents receive on their F assets holdings, as the
returns on those assets and now larger in terms of AUD.
 This reduces NY outflow and narrows the CAD.
 However, AUS’s FL exceeds F assets, a large population of the
FL are denominated in AUD so that a depreciation of the AUD
will actually tend to diminish AUS’s NYD. This is because the
interest owned on the FL is not affected by the change in the
ER but the returns on the F assets are.

The effects of change in the ER:

A deprecation of A$:
- Negative Effects:
 AUSian consumers suffer reduced purchasing power – they
can buy fewer o/s produced goods with the same quantity of
A$.
 However, A deprecation increases the interest servicing cost
on AUS’s F debt.
 This increases income outflow on the NY component on the CA
and thus increases AUS’s CAD.
  However, a deprecation will also raise the A$ level of F debt –
known as valuation effect (F current is expressed in AUD)
 A deprecation will raise the price of o/s assets.
 If the AUD depreciates the inflationary pressures will increase
as M would become more expensive, increasing pressures on
the RA to raise interest rates.
- Positive Effects:
 A deprecation causes AUSian X to become cheaper on X are
easier to sell, leading to an increase in X Y and an
improvement in AUS’s CAD.
 M will be more expensive, discouraging M spending, improving
AUS’s CAD. Domestic production of M will increase AUS’s
growth rate.
 A depreciation increases the A$ value of F Y earned on AUS’s I
abroad.
 Will also increase the value of F assets in AUD terms –
valuation effect.
 F investors will find it less expensive to invest in AUS,
generally leading to greater financial inflows. However
financial inflows may dry up if F investors expect ccy to
continue failing (speculation).
An Appreciation of A$:
- Negative Effects:
 An appreciation causes AUSian X to become more expensive
on world markets in term of the ccyes, leading to a decrease
in X Y and a deuteriation in AUS’s CAD
 M will be less expensive. Worsening AUS’s CAD.
 Higher M spending and reduced X revenue will reduce AUS’s
economic growth rate.
 F investors will find it more expensive to invest in AUS,
generally leading to lower financial inflows. However, financial
inflows may continue if F investors expect the ccy to continue
rising.
 An appreciation reduces the A$ value, causing a deuteriation
in the NPY component of the CAD.
 An appreciation will also reduce the value of F assets in AUD
terms - valuation effect.
- Positive Effects:
 An appreciation consumers enjoy increased purchasing power
– they can buy more o/s products goods with the same
quantity of A$.
 An appreciation decreases the interest servicing costs on F
debt because AUSians can buy more F ccy with AUD. Reducing
outflow on the NPY components on the CA – helping reduce
AUS’s CAD.
 An appreciation will also reduce the A$ value of F debt that
has been known borrowed in F ccy – valuation effect.
 AUSian investors looking to purchase o/s assets, an
appreciation will reduce like price of those assets.
  Inflationary pressures in AUS will be reduced as M become
cheaper. This is likely to reduce pressures on the RBA to raise
interest rates to defend its inflation target.

Chapter 6: Protection in Australia

Free trade and protection

 Australia’s policies regarding free trade and protection

AUS’s Policies regarding Free Trade and Protection:

AUS’s policies regarding free trade:
- Free Trade Policy: AUS generally promotes free trade to improve
economic efficiency, increase competitiveness, and provide access
to global markets.
- Trade Liberalisation: Removal of tariffs, quotas, and other trade
barriers to encourage M and X.
- Multilateral Trade Agreements: AUS actively participates in global
trade bodies like the WTO to support free trade.
- Bilateral FTAs: AUS negotiates bilateral trade deals (e.g., with SA,
CH) to open new markets and secure preferential terms.
- X Promotion: Policies such as subsidies, incentives, and grants to
encourage AUSian X, especially in agriculture, mining, and services.
- Protectionist Policies: Although AUS largely supports free trade,
certain sectors (e.g., agriculture) still benefit from some protection
to shield them from global competition.
- Anti-Dumping Measures: Protective tariffs or investigations to
prevent unfair trade practices like dumping (selling goods at a loss
to gain market share).
Objectives of Free Trade and Protection Policies:
- EG: Encourage F I, enhance X, and attract new markets.
- Competitiveness: Improve the efficiency of industries by exposing
them to international competition.
- Consumer Welfare: Lower prices, increased product variety, and
better-quality goods.
- Job Creation: Although some jobs may be lost in the short term, free
trade promotes the creation of jobs in efficient, X-oriented
industries.

 Australia’s multilateral and bilateral free trade agreements –

(overview of two examples of each type of agreement)

Bilateral FTAs:
Singapore-Australia FTA (SAFTA): - 2003
- The agreement improvers market access for AUSian X of services,
particularly education, environmental, telecommunications, and
professional services.
- Key outcomes and benefits:
 Elimination of all tariffs from entry into force.
  Financial service providers can now provide a range of
financial services on a cross-border basis to Singapore,
including I advise and portfolio management services.
 Removal/easing of residency requirements for AUSian
professionals and short-term entry for AUSian business
extended from one month to two years.
China-Australia FTA: CHAFTA:
- In operation since 2015, was completed to father promote trade
with AUS’s largest trading partner, CH.
- Currently around 93 per cent of AUSian X to CH are tariff-free, rates
will increase to around 95 per cent over the next 10 years, directly
improving the competitiveness of key agricultural industries such as
beef, dairy, wine, fruit and seafood.
- CH has also granted AUS greater market access for certain services
the most other nations with Chinese agreements – particularly for
AUSian financial, professional and education services providers.
- The agreement also includes a number of controversial items.
- Most notably, investor-state dispute settlement (ISDS) provisions
allow F investors to directly bring attribution claims against govt. for
alleged breaches of FTAs, and according to the Productivity
Commission, “potentially undermine the role of domestic courts and
freedom of govt. to regulate in the public interest”.
- The escalation of geopolitical tensions between AUS and CH may
harm bilateral trade over the coming years, despite the FTA.
Comprehensive and Progressive Agreement for Trans- Pacific Partnership
(CPTPP):
- On 1st January 2025, AUS assumed the Chair of the CPTPP.
- AUS is committed to enhancing trade and economic opportunities
for our AUSian stakeholders and all CPTPP members, ensuring the
agreement remains modern, effective, and responsive to global
challenges.
- AUS’s theme for this year is Delivering Sustainable Trade and
Resilient Growth and will focus on three overachieving priorities:
 Increasing trade: leveraging the "gold standard" of the
Agreement to further boost trade between members, bringing
economic gains to our communities.
 Facilitating trade: we aim to make it easier for members to
trade with each other by improving processes.
 Spreading the benefits of trade: AUS is committed to ensuring
thatCPTPP supports inclusive and sustainable trade practices.

 the implications of Australia’s policies for individuals, firms

and governments

Implications of Reduction in protectional levels for the AUSian

economy:
Effect on Firms:
- Short run:
  Firms are forced to innovate, invest and increase
competitiveness to avoid.
 Some inefficient import competing industries may close as
they cannot compete internationally
 Loss of profits in the short-term, while the restructuring
process is necessary.
- Long run:
 Higher overall competition, which contributes to higher
productivity as resources are reallocated to efficient
industries.
 May lower input costs for other firms that use imported goods.
Effect on Individuals:
- Short run:
 Structural and regional unemployment in import-competing
industries may increase
 Less protection means some industries may need to
restructure and cut local production.
- Long run:
 Erosion of skills principle: the long-term unemployed may
experience a decrease in their skills as they are not routinely
practising them.
 Job opportunities increase in more efficient exporting
industries as allocative efficiency of resources improves.
 Wider variety of goods, accessed at lower prices, improving
living standards.
Effect on Government:
- Short run:
 Reduced government revenue due to decreased tariffs and
tax collection from protection
 Government spending may lose votes for reducing protection,
as domestic effects are unfavourable in the short term.
- Long run:
 The restructuring of industries and reallocation of resources
should raise revenue in the future, as the economy can
become more efficient and utilise comparative advantage,
creating sustainable economic growth.

 implications for Australia of protectionist policies of other

countries and trading blocs.

Implications:
Impact of protectionism on AUsian Firms:
- Increased Costs: Protectionist policies in other countries (such as
tariffs, subsidies, and import quotas) raise the cost of AUS goods in
those markets, reducing competitiveness.
- X Barriers: Protectionism creates barriers for AUSian Xer, limiting
market access and potentially leading to a decrease in demand for
AUsian products.
 - Diversification Risks: AUS may need to diversify its X markets to
mitigate the impact of protectionist measures in key markets (e.g.,
China or the EU).
- Competitive Disadvantages: Firms in protected markets (e.g.,
agriculture in some developing countries) may receive govt. support
that allows them to undercut AUsian producers in global markets.
Impact of Protectionism on AUSian Consumers:
- Higher Prices: Protectionist policies lead to higher prices for
imported goods due to tariffs or quotas, making them less
affordable for AUS consumers.
- Limited Choice: Reduced imports may lead to fewer product options,
limiting consumer choice and potentially reducing product quality.
- Reduced Efficiency: If AUSian firms are not exposed to international
competition, they may become less efficient and innovative, which
could harm consumer interests in the long run.
Impact of Protectionism on the AUSian Govt:
- Political Tensions: AUS may face retaliatory tariffs or trade
restrictions from countries that perceive AUS’s trade policies as
unfair or protectionist.
- Loss of Market Access: Countries imposing protectionist measures
may limit AUSian X, affecting economic growth and govt. revenue
from trade.
- Policy Adjustments: The govt may need to negotiate new trade
deals or adjust policies to counteract the effects of global
protectionism.
- Pressure on Domestic Industries: Protectionist measures abroad
may lead to calls for greater protectionism in AUS, which could lead
to internal political debate about the benefits of free trade.
Impact of Protectionism on the AUSian Economy:
- Reduced Economic Efficiency: Protectionism in other countries
reduces the overall efficiency of global markets, which can hurt
AUSian industries that rely on free trade for growth.
- Trade Diversification: Protectionism may push AUS to find new
markets or focus more on niche exports where it has a competitive
advantage.
- Increased Costs of Doing Business: Businesses may face higher
costs when attempting to enter markets that are closed or
protected, thus affecting profitability and economic performance.
- Challenges to Multilateral Agreements: Protectionist policies can
undermine MTA (such as those in the WTO or CPTPP), reducing the
potential benefits from these agreements.