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Australia's Current Account Deficit Explained

May 6, 2025

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.