Essay Wow!

Introduction

The balance of payments current account is one of popular indicators of a country’s economic health. “Current account deficit means an excess of imports over exports of goods, services, investment income, and unilateral transfer (Carbaugh, 2002, p.350).”Although Australia’s current account deficit has exceeded about 3 percent of GDP for about 20 consecutive years (Sighvatsson, 2001), there has not been that a big current account deficit problem. Mexico had a current account deficit which became a big problem to the country because there was a large debts service payment relative to GDP. This problem led Mexico to the economy collapsed at the end of 1994. As a result, about 20000 small and medium-sized enterprises declared bankruptcy, two million people lost their jobs, the real wage declined (The Development Gap, 1998). Running current account deficit was also a big problem in Thailand. This is because there was a huge capital inflow at that time while Thai used the fixed exchange rate and tried to defend the currency. Moreover, some of foreign funds did not use in the investment sector but they were spent in the consumption instead. However, Thai decided to give up defending the currency and used the floating rate instead. As a result, there was devaluation in Baht so the foreign loans increased. This is because Thai used the fixed exchange rate and tried to defend the currency. Consequently, Thai government had to turn to IMF for help because Thai could not return all foreign liabilities at that time (Kokko, 1999).

The purpose of this essay is to demonstrate whether the Australia has a current account deficit problem. First of all, the meaning of current account deficit and the problem is being explained. Then the current account deficits in Australia from 1998 to 2003 are being discussed. After that the solutions, recommendations, and conclusion are being described.

Current Account Deficit

“Current account deficit means an excess of imports over exports of goods, services, investment income, and unilateral transfer (Carbaugh, 2002, p.350).” It is also stated that when a nation experiences a current account deficit, its expenditures for foreign goods and services are larger than its incomes received from the national sales of its own goods and services (Carbaugh, 2002, p.352). Due to its expenditure is bigger than income so the nation has to find some source of fund to finance its current account deficits. To do this, the nation may either sell its assets or borrow from foreign capital market, or both. According to Pitchford (1989, p.26), “a current account deficit means an increase in the net level of foreign indebtedness by the private or public sector.” After the net capital inflow, there is a surplus in capital account which is correct as the Balance of Payments system, which stated that when there is a deficit in current account, the capital account must be in surplus.

However, the excess of expenditures for foreign goods and services over the incomes is not the only factor bringing the nation current account deficit. There are two more factors, which are the excess of investment over the national saving and the fiscal deficit. The fiscal deficit occurs when the government spends its expenditures over its revenues deriving from taxation. It is mentioned that the investment must be actually financed by the national saving and if a national saving is not sufficiently, the country has to rely on foreign saving to finance the difference (Carbaugh, 2002, p.352).

Is it a problem?

One aspect deciding whether it is good or bad that the nation runs the current account deficit is the source in which the nation spends the money (Carbaugh, 2002, p.351). If the money is used to finance an increase in domestic investment, this could be a slight burden. This is because when the money spent to the investment sector, there is an increase in the nation’s stock of capital and it also expands the economy’s capacity to produce goods and services. In contrast, if the money is used to finance domestic consumption in private or public sector, there is no boost given to future productive capacity. Moreover, it was demonstrated by Carbaugh (2002, p.351) that the rapid growth of production and employment is usually related to the large or growing trade and current account deficit. It is also stated that if the current account deficits are caused by the investment in the strong profitable programs, the rate of output and employment growth will raise (Carbaugh, 2002, p.353).

It is believed that the benefit of a current account deficit is the ability to push current spending beyond current production. Cashin and McDermott (1998, p.346) referred to Pitchford in order to demonstrate the Australia’s current account position in 1998. It was stated that Pitchford used the intertemporal approach to argue that the situation in that year should be little concern. Intertemporal model is used by the nations by undertake external borrowing through running a current account deficit in order to smooth the aggregate consumption when they face the temporary adverse shocks, which could be productivity shocks, changes in government consumption spending or fluctuations in investment. Moreover, if the nations face the permanent adverse shocks, they may permanently lower aggregate consumption by leaving the current accounts unchanged (Cashin and McDermott, 1998, p.347). However, according to Pitchford (1989, p.30), it is more acceptable if the nations run current account deficit to increase the import of investment goods rather than consumer goods. It was also stated that given the Australia has a large investment opportunities relative to its level of national savings, the intertemporal model suggests that it is clearly optimal for Australia to run the current account deficits. This is because when an increment of net foreign liabilities is added into the investment part, then future net exports must be generated. If the increment is not spent in the investment, the external debt will grow faster than debt service capacity (Cashin and McDermott, 1998, p.348). Moreover, it was also suggested by Cashin and McDermott (1998, p.348) that the real interest paid on additional debt must grow at a rate less than or equal to the rate of growth of exports. Thus, if the foreign debts are invested wisely and the nation can return at least their servicing costs, this is not a major concern. According to Fraser (1993), the servicing of foreign debts has not been an unmanageable problem for Australia, while the net foreign debt has been raised to almost 4.3 percent of GDP in June 1993.

However, the countries which run the current account deficit have to concern about how to handle the foreign liabilities as well. It is stated that if the nation has a high level of an external debt, it has to pay a high cost of borrowing for an additional loans. This is because lenders feel the risk of default increases with the overall size of debt (Pitchford, 1989, p.30). Moreover, if the current account deficits and external debts are built up by unsound private borrowing, the public must spend more concern about it. In addition, if public and private borrowers create externalities for one country risk, it should be concerned because this additional risk is not wholly internalised by individual borrowers (Cashin and McDermott, 2002). It was demonstrated by Fraser (1993), that the terms that the nations have to concern when paying the cost of investment are the interest rates and exchange rates.

Australia Current Account Deficit

The major cause of the raise in the current account deficit in the late 1980s and mid-1990s is the strong growth in import volumes, which was push by strong domestic demand growth (Commonwealth Budget, 1999). The strong growth in domestic demand spilled over into imports and led to domestic inflationary pressures. According to Cashin and McDermott (1998, p.352), it was argued that an important factor in the deterioration of the current account was a 15 percent worsening of the terms of trade which occurred in 1985 and 1986. In the late 1980s, these inflationary pressures brought high rates of asset price inflation to Australia. It was shown that the total asset prices rose by about 55 percent between quarter 1987 and September quarter 1989 (Commonwealth Budget, 1999). As the indicators shown that Australia had a relatively high level of net foreign liabilities, Australia had a high service requirement which was higher than Mexico’s in 1994. In this year, it was also found that Australia current account deficit, which was about 5 percent of GDP, was higher than most industrial countries (Cashin and McDermott, 1998, p.352). However, it was smaller than Mexico’s current account deficit which was nearly 8 percent (Cashin and McDermott, 1998, p.352).

However, the worsening terms of trade did not play a direct part in the period of large current account deficits in some years. For example, the large current account deficit from 1989 to 1990, which was about 5 percent of GDP, was not caused by the worsening term of trade directly. A sharp appreciation of the currency pushed the imports up by 22 percent in 1989 (Sighvatsson, 2001). As stated above that the fiscal deficit is another factor leading the current account deficit. According to Sighvatsson (2001), the fiscal deficit was another consequence of the contraction in GDP which results in the current account deficit. Moreover, because of loose fiscal policy, the current account deficit was slower to return to nominal than it would have been.

Current Account Deficit from 1998 to 2003

1998-99

The current account deficit between 1998 and 1999 was about 5.3 percent of GDP, while there was a deficit in goods and services record about AUD$ 14.5 billion (Australian Bureau of Statistics, 2001). It was demonstrated that the main reason of the current account deficit was the weakness in Australia’s trade performance (Treasurer of the Commonwealth of Australia, 1999). This is because of the slower in world economic growth, particularly in South East Asian region after the economic crisis. It has resulted in Australia’s exports and lower world commodity prices. Moreover, the strong in domestic demand drive the growth volume of imports.

However, there was an improvement in public saving which has resulted from the Government’s fiscal consolidation program (Treasurer of the Commonwealth of Australia, 1999). The net saving in 1998-99 rose by about AUD$ 3 billion form 1997-98 to AUD$10 billion (Australian Bureau of Statistics, 2003). The increase in the current account deficit also reflected private investment decisions rather than an increase in government borrowing (Treasurer of the Commonwealth of Australia, 1999).

1999-00

The current account deficit was about 5.6 percent of GDP, while there was a deficit in goods and services record about AUD$14.4 billion (Australian Bureau of Statistics, 2001). The figures have shown that there was the Government’s budget surplus, whereas the large current account deficit derived from the private sector transactions (Australia Department of Foreign Affairs & Trade, 2001). These include private investment and borrowing.

Australia’s international trade competitiveness is relying increasingly on skills, knowledge, innovation and enterprise, as well as domestic and international information networks. Service industries made up 64 percent of the Australian economy in this year (Australia Department of Foreign Affairs & Trade, 2001). However, it is believed that service exports have becoming an important indicator of progress towards a knowledge-based economy. Moreover, information and communication technologies are currently the Australia’s faster-growing sector and also the key driver of economic growth.

2000-01

Although there was a current account deficit from 2000 to 2001, it was unlike others balance of payments. This is because there was a surplus in goods and services which was about AUD$707 millions between 2000 and 2001. However, the current account deficit caused by the deficit in income. Moreover, there was the inflow of capital to the portfolio investment with the amount of AUD$ 23 billion. The number was higher than the past 2 years by about 3.5 and 1.5 times.

However, the current account deficit was 2.7 percent in 2000-2001. It reduced by 2.4 percent from the year before. Moreover, it is a considerably smaller share of GDP than it was in the mid-1980s. For example, since the beginning of 2000 the current account deficit has averaged around 3.5 percent of GDP compared with around 5 percent of GDP from 1985 to 1989 (Otto, 2003). According to of the Secretary of the Treasury, Ken Henry (2001), it was argued that the size of the current account deficit was essentially of “residential interest”. As a result, it did not cause the problem to Australia.

It is also stated that the decline in current account deficit reflected the impact on net export volumes and the terms of trade of the stronger world economy, along with some moderation in the rate of growth of domestic demand. Moreover, the main boost of exports was form the Olympics (Commonwealth Budget, 2001).

2001-02

According to Australian Bureau of Statistics, the current account deficit from 2001 to 2002 was about 3.1 percent of GDP. It was shown from data of international merchandise trade that the major imports were in the manufacturing industry. For example, the machinery and motor vehicle wholesaling the machinery and equipment; petroleum, coal, chemical, and associated product manufacturing which was about 23.6, 15 and 10.4 percent of the total goods imports respectively. On the other hand, the major imports were in mining industry and basic material wholesaling with the figures of 30.8 and 13.5 percent of the total goods exports respectively. However, the net foreign debt was about 46.1 percent. The household saving was relatively low in this period, which was about 1.3 percent comparing to the average at about 2.95 percent.

As a result of lower exchange rate and the Olympics, the net exports contributed strongly to growth in 2000-2001. This is because the exchange rate has help Australia boosting the competitiveness of many of its export and import competing industries. However, the lower of the current account deficit also reflects a decline in the net income deficit which response to lower world and domestic interest rates and reduced margins between Australia and world investment returns (Commonwealth Budget, 2002).

Due to the products which were imported are in manufacturing sector, it can be implied that they would be used in the investment sector rather than in the consumption sector in the economics. As a result, the current account deficit in this period should be little concern because it would increase the nation’s stock of capital and also expanded the economy’s capacity to produce goods and services.

2002-03

According to Hofmann (2003), the expansion of domestic demand led to the high import intensity of machinery and equipment investment. Moreover, the volume of export fell due to the lost in farm out put which result from the drought. It was also mentioned that the economy would not accelerate significantly in the first half of 2003. This is because the production losses in agriculture are likely to last for at least the long. As a result, whether the current account deficit will improve it depends on the recovery of the exports, which related to the improvement of supply conditions in agriculture.

The higher level of Australian dollar is being shored up by the wide interest rate advantage of the Australian market.

From the statistic, the foreign debt is continually increasing over the time. However, it was shown from the data that most of import goods are related to the investment. As a result, there would be the increase in the future production which may export to elsewhere. Thus, the current account deficit would not be a problem for Australia.

Solutions

There are several methods to reduce the current account deficit. For example, decreasing the fiscal deficit and raising the national saving. This is because the nation has to rely heavily on foreign saving when it faces the large current account deficit. Thus, increasing the national savings can reduce the dependence on other sources of fund (Fraser, 1993). Government may decrease the deficit by increasing unpopular tax, belt tightening by cutbacks the government programs (Carbaugh, 2002, p.350). Moreover, it can be done through automatic corrective mechanisms like more dampening demand, more wage restraint, more sharing burden, and more emphasis on allocating resources with respect to national priorities (Pitchford, 1989, p.25).

Beside that, government can also use the monetary or fiscal policy to decrease the current account deficit. The monetary policy can be utilised by curbing the demand and reducing imports and also raising the export, followed by easier monetary conditions to assist the economy out of recession. Australia used the tight monetary policies in 1985 and 1986 to reduce the deficit directly by eliminating the government spending through cutting the government expenditure and increasing the taxation receipts and indirectly through effects on private spending (Pitchford, 1989, pp.26-27). Moreover, the Commonwealth Government run the campaign “buy Australia” in order to reduce the import demand and to increase the supply of import-competing and exportable products (Pitchford, 1989, p.27).

It is also recommended that the tight monetary or fiscal policy is needed to restrain the aggregate demand and rein the current account deficit (Cashin and McDermott, 2002). Moreover, government can decrease the current account deficit by supporting import sector in order to increase the import volumes. Furthermore, boosting public and private savings is another solution that can remove the excess current account deficit. Although increasing the national’s saving is not an easy task, it may help the nation to solve the undersaving problem in the long term (Cashin and McDermott, 2002).

Recommendations

The current account deficit seems to be a problem when it is high. However, it is believed that if it is in the suitable level, it will boost the economic. Moreover, if the funds that country borrows are financed in the investment sector, it will increase the productivity and create the job for people. Then the return on investment will be paid to the foreign lenders. It is like the investor having the opportunity to invest but does not have the sufficient fund. As a result, it has to borrow from the financial companies or banks.

Finding out the cause of the deficit is not an easy task. This is because there are many factors leading the current account deficit and it also depends on the situation or environment in each year. Although there are many kinds of adjustment mechanisms that can reduce the current account deficit, each country may apply the different methods. It depends on the situation they face. For example, if the countries use the flexible exchange rate, the method they exercise may differ from the countries using fixed exchange rate.

As stated above that the current account deficit can boost the investment which is positive to the nations. However, the nation should not neglect about it. The country should control the percent within the suitable level and also keep watching the cause of the current account deficit in each year. If it causes by the growth of domestic demand in consumption products, the government has to utilise the appropriate mechanism to solve it. Moreover, the government has to monitoring the foreign liabilities especially in short well.

Conclusion

Current account deficit occurs when the expenditure for foreign goods and services excess the income receiving from national’s sale, the government expenditure is larger than its revenue, and the investment is over the national’s saving. Deciding whether it is good or bad that the country run the current account deficit depends on the source in which the country spends the money. If it is spent to the investment sector, the economic will be boosted. On the other hand, if it is financed to the national consumption, there is no return in the future so the country may face the problem about returning foreign debts. Whether the current account deficits were the problem to Australia depends on the cause in each year. For example, the current account deficit in 1998-99, was about 5.3 percent of GDP, caused by the weakness of Australian’s trade performance and the slower in economics growth is a problem to Australia which needed a little concern. Whereas, the current account deficit in 2001-02, which was about 3.1 percent of GDP, caused by the excess of exports of goods and products is not a problem. This is because the major imports were in the manufacturing industry, which implied that they would be an increasing in capital stock and national’s product and also a decreasing in unemployment rate. Although Australia has been tackling an extremely persistent current account deficit for a very long time, there is no evidence showing that the current account deficit is a big problem like the economic crisis in Mexico or Thailand.

There are many methods using to adjust the current account deficit, for example, the increasing in the national savings, decreasing the government expenditure, and other mechanisms such as fiscal policy and monetary policy. However, the method using in one country may not suit to others because the situation and environment is different.

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