Impact of the Current Account Deficit on Australia's External Stability

Introduction

• Current Account Deficit (CAD) poses challenges to Australia's external stability.
• External stability: ability to meet foreign obligations and maintain currency/financial system confidence.
• Assessment involves examining:
  • Causes of CAD
  • Consequences of financing through foreign liabilities
  • Roles of exchange rate and Terms of Trade (ToT)

Causes of Australia's CAD

• Savings-Investment Imbalance:
  • National investment exceeds national savings.
  • Creates savings-investment gap financed from overseas.
  • Results in Capital and Financial Account surplus (Balance of Payments - BoP).
  • Surplus matched by Current Account deficit.
• Net Foreign Liabilities (NFL):
  • Servicing NFL leads to income outflows in net primary income component.
  • Major contributor to CAD.
• International Competitiveness:
  • Weak outside primary sectors (mining, agriculture).
  • Contributes to Balance of Goods and Services (BOGS) deficit.

Pitchford Thesis

• Suggests CAD from robust private investment is not inherently destabilising.
• Sustainable if investments generate future income to service liabilities.

Consequences of Persistent CAD

• Accumulation of Net Foreign Liabilities (NFL):
  • Threatens external stability.
  • Increases financial obligations and vulnerability to external shocks.
• Servicing Costs:
  • High NFL leads to ongoing servicing costs (interest, dividends).
  • Creates burden, affects financial stability during global financial tightening.

Role of Exchange Rate and Terms of Trade

• Exchange Rate:
  • Acts as a shock absorber.
  • CAD can pressure AUD downward, making exports cheaper, imports expensive.
  • Helps narrow BOGS deficit, reducing foreign financing need.
  • Sharp depreciation can erode investor confidence, complicating CAD financing.
• Terms of Trade (ToT):
  • Significant for commodity-dependent Australia.
  • Improved ToT reduces CAD, supports external stability.
  • Sharp decline worsens CAD, increases foreign capital reliance.

Conclusion

• CAD's impact on external stability involves structural factors, foreign liabilities, exchange rate, and ToT dynamics.
• Strategic Management involves:
  • Monitoring interconnected factors.
  • Promoting national saving and competitiveness.
  • Maintaining investor confidence through policies.