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BOP Topic 2 HSC economics Essay...

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Analyse the implications of the fluctuations in the value of AUD on the Australian BOP Changes in the value of AUD may produce varying results on the Australian BOP with examples in the Australian economy from 2011. The fluctuations in AUD will impact different parts of the Australian AUD however, changes can have the most effects on the BOGS, CA, NPY and KAFA. The BoP refers to the external transactions between the Australian and the global economy over a period of time, normally one year. The BOP consists of the CA(Current account) and the KAFA(Capital and Financial Account). The CA records non-reversible transactions of receipts and payments for trade in goods and services, comprised of the NPY(Net Primary Income), NSY(Net secondary income) and the BOGS(Balance of Goods and Services.) The NPY records the money earnt from factors of production, so land, labour, enterprise and capital. The BOGS represents the net amount of money earnt from exports and imports. The NSY is rather insignificant and represents the ownership of assets making it insignificant. Whereas, the KAFA records reversible transactions such as investment and international ownership of assets. The BOP is largely influenced by the fluctuations in e/r, changes in the e/r can be caused by changes in ToT, interest rates, commodity prices, inflation and speculators. An increase in the supply of AUD will depreciate the AUD likewise, a decrease in demand will depreciate the AUD. These changes in the e/r reflect an economy’s health and trade impacting upon the Australian BOP in various ways. For example between 2009 and 2012, the AUD rose to 1.10 USD in 2012 and this reflected a $13.2 billion surplus in BOGS shown in figure 1.01. This is due to the increased demand for Australian exports from China especially in LNG and during the mining boom. These exports were mainly in industries of mining where commodities were in high demand. These also reflected a slight worsening of the BOP to a $40 billion deficit in 2012 because of the increased dividends after investment.

Figure 1.01 Trends in the AUD

An increase in e/r may decrease the international competitiveness of Australian exports

because it is more expensive to buy domestic exports and likewise, it will lead to more imports. This will theoretically worsen the BOGS because there is less demand for exports and more demand for imports and ultimately, worsen the CA. However, on the other hand, the mining industry which boomed during 2011 and 12 because of the Chinese demand for its industrialisation had inelastic demand, so the appreciation resulted in price spikes, for example, a 300% increase in the price of copper. This ensured the damage to the BOGS and CA wasn’t as bad as theoretically predicted. An increase in e/r may also increase investor sentiment as possible investors may favour an economy with a gradually increase e/r. The gradual increase reflects an increase in trade and greater economic growth and ultimately favourable economic conditions. All these factors culminate to incentivise investors in an economy, the increase in investment can be through FDI(Foreign direct investment) or portfolio investment. This is reflected in the KAFA, as well as an increase in NPY because of the increased dividends and ultimately, worsening the CA. Thus, an increase in e/r can increase opportunities that incentivize investors. An increase in e/r can decrease the NPY deficit, due to the valuation effect which can increase the value of Australia’s net foreign liabilities. Debts can either by unhedged or hedged, an unhedged debt is usually more risky for the lender because the debt is exposed to the risk of currency fluctuations. A rise in the cost of debt will impact unhedged funds, by decreasing the amount of AUD required to pay off the debt. Hence, decreasing the money that leaves the economy and may ultimately increase net foreign liabilities. However, depreciation in AUD will also have a wide range of effects on the BoP. A sharp depreciation in the AUD occurred in October 2008 as the GFC led to increased volatility in financial markets and commodity prices started to fall rapidly. The AUD fell to $0.54 USD with increased volatility in foreign exchange markets in late 2008 and 2009 prompted the RBA to increase its purchases of AUD and prevent further depreciation. However, one benefit that rose from the depreciation was the emergence of the Australian agricultural industry, becoming more competitive and ultimately contributed to a BOGS surplus, loosening the CAD as highlighted in figure 1.02.

Figure 1.02 CA trends

The depreciation of AUD can theoretically improve the BOGS, as M becomes more expensive and discourage M spending and may improve the CAD. The demand for domestically produced goods increases, but the price of production may also increase because they require import inputs. As well as cheaper X, that makes X more competitive and creates an improvement in the CAD. Thus, the decrease in AUD may discourage M spending as well as making X more competitive to improve the CAD. Ultimately, a decrease in e/r means less investment into Australia because it is less attractive to investors when the trade of a country is decreasing. This lowers the total investment into Australia, reducing the interest payments and dividends to ultimately, reducing KAFA and increasing CA. The dollar is decreasing long term, will reduce the incentives for investors because there is less growth and this represents fewer opportunities. Hence, overall changes in the e/r of the AUD will have different impacts on the individual accounts that ultimately change the Aus BOP. The fluctuations in AUD e/r can have a large impact on the BOGS, NPY, CA and KAFA that contribute to the impacts on the Australian BOP....