Chapter 3 Balance of Payments

Question 1

Balance of Payments Definition

Answer 1

The Balance of Payments (BOP) is an accounting record of all economic transactions between residents of Australia and residents of the rest of the world.

Residents of a country = individuals, businesses, and the government.

Question 2

What are on Credit entries (increasing balance)

Answer 2

Export of Goods and services
Income receivable
Increase in foreign liabilities
Export of Currency

Question 2

What are characteristics or credentials of BOP

Answer 2

every transaction has an inflow and outflow element.

The balance of payments uses a double entry accounting system.

This means that every inflow and outflow element has two equal and opposite entries.

One debit and one credit entry.

Question 3

What are on debit entries (decreasing balance)

Answer 3

Import of goods and services
Income payable
Increase in foreign assets

Import of Currency

Question 4

Current Account strcuture diagram

Answer 4

good exports- good imports = net goods
services exports- services imports = net services
net services plus net goods = balance on goods and services, trade balance, net exports
primary income plus secondary income = net income
balance on goods and services + net income = balance on current accunt

Question 4

Income Account what is it divided into

Answer 4

Divided into primary and secondary incomes.
Primary income is the largest component of the current account

Question 5

Capital and financial account structure

Question 5

3 main accounts of BOP

Answer 5

Current Account
Capital Account
Financial Account
current acount=financial and capital account

Question 6

What transactions are included in current account

Answer 6

Involves transactions to do with goods, services and income flows.

Question 7

What is recorded in service accounts

Answer 7

This account records all transactions involving services rendered, such as tourism, education, transport, banking and legal consultation.

Question 7

What are recorded on current account in good accounts

Answer 7

Goods Account
This account records all transactions involving physical goods, e.g. televisions, cars and food

The (net merchandise trade) balance on goods is the total value of all goods exported minus the total value of all goods imported into a country.

Question 8

what is trade balance

Answer 8

trade balance = total values of goods and services exported minus total value of goods and services imported

Question 9

What is included in primary income

Answer 9

compensation for employees (for the use of labour) which is the payment of wages and salaries of workers
investment income for the use of financial capital or foreign investment. Examples are dividends or interest paid or received on investments

Question 9

What is secondary income and some examples

Answer 9

Transactions where real or financial resources are provided, but nothing of economic value is received in return.

“One sided” transactions.

Examples – Foreign Aid, Gifts, Donations, Pensions.
Foreign Aid given by Australia to Indonesia (debit).
Gifts received by Australian residents from a resident of Indonesia (credit)

Question 10

4 main categories of financial account

Answer 10

Direct investment
portfolio investment
reserve assets
other (currency is recorded here)

Question 11

What is Net error and ommisions

Answer 11

In reality, there will always be net errors and omissions in the Balance of Payments.

This is due to measurement errors, timing differences, or unrecorded transactions

This is a balancing entry to make sure that the Current Account + Capital & Financial Account = Zero

Question 11

Direct investment account characteristics

Answer 11

Is longer term investment
Less prone to fluctuations over time.
Occurs when an investor obtains 10% or more of a foreign firm.
Gives the investor the ability to exercise a significant degree of influence on the firm and its management

Question 11

Capital Account characteristics

Answer 11

Comprises of non produced, non financial assets such as intangible assets such as patents, copyrights and trademarks.

Also comprises of capital transfers – these include the transfer of migrant funds (permanent) to/from Australia.

The balance on this account is usually less than $1 billion in Australia.
very small account

Question 12

Example of direct investment

Answer 12

An Australian resident/company buys 11% of Subway shares in the USA.

An Australian resident buys a KFC franchise in the USA.

Question 13

Portfolio investment characteristics

Answer 13

Shorter term in nature.
More prone to fluctuations over time.
Occurs when an investor obtains less than 10% of a foreign firm
Does not give the investor a significant degree of influence on the firm and its management.
The purchase of debt or loans is also included here.

Question 14

Other investment characteristics

Answer 14

Comprises transactions that do not fit in the other categories. The import and export of currency is recorded here.

Question 15

What is important to rember about current account trends

Answer 15

that the trends in the current account are the same (but opposite) to the trends in the capital and financial account.

Question 15

Reserve investment chatacterestics

Answer 15

The purchases or sale of reserve assets held by the Reserve Bank of Australia. Examples of reserve assets are gold.

Question 16

Trend of current account in last 10 yrears

Answer 16

The current account balance has fluctuated from a deficit of $78 billion in 2016 to a surplus of $63 billion in 2021, and then back to a deficit of $19 billion in 2024.

Question 17

What does ervice account normall record

Answer 17

normally a defecit

Question 17

What about net income trends

Answer 17

The net income balance is always in deficit. This is due to the high amount of historic net foreign investment into Australia.

Question 18

Net good account trends

Answer 18

In 2016 deficit of $27.5 million, whilst in 2023 $151 billion surplus The net goods account in the current account can fluctuate considerably from year to year.

Question 18

when did aus enter saving investment gap

Answer 18

2019 to about 2024 saw Australia enter into a savings-investment gap. This is reflected by the fact that the need for large scale investment into Australia had decreased. Our mining and energy infrastructure was mature and established. Savings in Australia have also increased due to the economic benefits of the previous mining boom, which now exceed the need for investment. The savings-investment gap had allowed Australia to increase its investment abroad

Question 19

How many current account defecits have been recorded in last 10 yrs

Answer 19

6 outta the 10

Question 20

WHat happended in 2020 in regards to BOP AND WHY

Answer 20

2020 was also the first year that Australia recorded a current account surplus in over 40 years!!! Both investment and consumption spending fell – this caused a large decrease in imports. primary reason is Aus investment saving gap Combined with a decrease in the net income deficit, it resulted in a large current account surplus.

Question 21

What is investment savings gap

Answer 21

The investment – savings gap refers to the historical gap between Australia’s savings and its need for investment. Historically, Australia’s need for investment has been very high. Our savings have not been enough to finance these investments for many reasons, including our low population. We therefore have required to get foreign investment from abroad to close this gap.

Question 22

What are all trade balance factors

Answer 22

World business cycle/Commodity Prices domestic business cycle Domestic Economic Growth International Competitiveness Exchange Rates

Question 23

Domestic business cycle affecting trade balance

Answer 23

The trade balance is relatively volatile and is very much influenced by our domestic business cycle, and the world business cycle. Domestic Business cycle – When our economy expands at a rapid rate, the current account balance will decrease due to an increase in spending on imports. An increase in spending on imports will decrease the trade balance (exports minus imports) ceteris paribis. On the other hand a slowing or contracting economy will see the trade balance and therefore the current account increase as spending on imports falls relative to exports.

Question 24

what are all income balance factors

Answer 24

Investment Savings Gap Savings Investment Gap Change in Foreign Liabilities/Assets Interest Rates Company profits

Question 24

World Business Cycle and Commodity prices factor affecting trade balance

Answer 24

World Business Cycle and Commodity prices – The business cycle trends of the world, especially that of our main trading partners (ie China) has a big impact on Australia’s trade and therefore the current account. If a trading partners economy rises (ie China), commodity export quantity and prices rise with the increase in demand. This boosts our export income (both price and quantity), increasing the trade and current account balance.

Question 25

Foreign Liabilities and Foreign Assets affecting income balance

Answer 25

Foreign Liabilities and Foreign Assets FL and FA both are recorded in the Financial Account. The Financial Account balance is reflected by the inflows and outflows of FL and FA. Australia’s savings-investment gap affects the level of inwards and outward foreign investment. In the long term, our net international investment position (NIIP) has an impact to the net dividend and interest payments which are recorded in the current account. More foreign assets relative to foreign liabilities = an increase in net dividends and interest coming into Australia = increase in primary income = increase in income account = increase in current account.

Question 25

Australia’s international competitiveness – affecting trade balance

Answer 25

Australia’s international competitiveness – Our competitiveness on the international stage for our exports also affects the trade balance. Increasing wage levels relative to the rest of the world, as well as increasing relative inflation, decreases our international competitiveness for our exports. This reduces exports and therefore our trade and current account balance.

Question 26

Saving investment gap affecting influence income balance

Answer 26

The Savings – Investment Gap Currently Australia has a mature resources sectors (especially in fields such as iron ore). The need for investment in Australia has lowered, and economic growth previously experienced has increased Australia’s savings. This has turned the Investment – Savings gap into a Savings – Investment gap. This has allowed Australia to increase its foreign investment abroad and therefore its income payments receivable, thus decreasing the income account balance.

Question 26

Exchange Rate factor affecting trade balance

Answer 26

Movements in the exchange rates also affects the demand and supply for our exports as well as the demand for our imports. A fall in the value of the Australian Dollar (a depreciation) will make Australia’s exports “cheaper” in foreign currency and lead to an increase in exports increasing the trade balance. At the same time, it will also increase the price of imports for us, decreasing imports, which also increases the trade balance.

Question 27

Interest Rates and Company Profits factors affecting income balance

Answer 27

Interest Rates It is also important to understand that interest rates connected to foreign debt have an impact on interest payments (both to and from Australia). Higher interest rates means that interest payments receivable or payable will increase. Company Profits Additionally the level of company profits linked to foreign ownership has an impact on dividend payments/received. Australia’s recent increasing net income balance deficit, can be attributed to increased profits of Australian mining companies, which are partially foreign owned, meaning dividends are paid overseas.