If you’re studying HSC Economics and are trying to get a grasp on current account surplus and its placement within Australia, we’ve got you covered!
Today, we’re looking into why Australia has a current account surplus, what are some of the main implications, what this means for the country in the near future, some of the major trends, and global factors.
So, let’s dive in!
How did Australia gain a current account surplus?
Over the past 50 years, Australia has had a consistent current account deficit as a percentage of GDP (Gross Domestic Product), basically meaning that our imports were overriding our exports.
However, in 2019, we had a surplus of 0.6% of GDP, which grew to 2.5% in 2020. Now considering the impact of COVID on our economy, this is pretty unusual!
Now if we look at this in comparison to Mining Boom Mark II in 2011, our current account was at a deficit of negative 3% of GDP. And note, that this was considered a major peak in volumes, yet Australia’s current account remained a deficit!
So the real question here is, how have we managed to gain a current account surplus amidst the recession brought about by the COVID-19 Pandemic?
Why does Australia have a current account surplus?
The main accounts that we want to look at here, of the three accounts, are the Balance of Goods and Services (BoGS) and the Net Primary Income (NPI).
Essentially, there is only a current account surplus if either the BoGS or the NPI are in a huge surplus, or both of them are. In this instance, it’s pretty clear that the BoGS are in a major surplus due to mining exports, particularly iron ore.
During the Global Financial Crisis in 2007, the net income balance was at negative 3% of GDP, and has been pretty consistent ever since. However, the real shift has been seen with the trade balance.
The trade balance is incredibly cyclical and fluctuates regularly as we saw a change from the average negative 1-2% to a recent positive 3.5% GDP. This is a pretty significant growth, from a deficit into a surplus!
Trends in Australia’s Trade
When thinking about Australia’s trade, we need to consider trade volumes, and naturally, trade prices. Of course, the volume of trade exports and imports are a simple matter. But you also need to remember that the price of these exports can have a substantial impact.
So, what are the prices of Australia’s typical exports, and is there an overall measure that we can use to determine this?
We would use the index of terms of trade. This is calculated by dividing the index of export prices over the index of import prices and multiplying it by 100 to give you a percentage.
What you’ll then have is an understanding of a ratio between the average export prices and average import prices. But remember, that this is an average!
What we’ll find is that an increase in the terms of trade means we are selling more valuable exports at a higher price, relative to our imports.
Right now, we have a huge increase in Australian trade, and therefore, a huge increase in exports. In particular, we have to thank our mining exports for this surplus, despite economic tensions with China and a couple of other countries.
Another interesting point to look at here is the composition. So back in the 1970s, Australian agriculture made up almost 60% of our exportation, however there’s been a major shift in this, especially in Mining Boom I and II. At these stages we saw Australian resources peaking at almost 60% of our exports as agricultural exports decreased.
What are the global factors?
So now, let’s take a look at what’s happening around the globe and how this is impacting the price on resources.
At a base level, the price is determined by supply and demand. So due to COVID restrictions, lockdown, loss of jobs and a lack of spending early last year, we would have expected a decrease in demand.
However, in terms of supply, it was Australia’s luck that there was a lack of supply in Brazil, which allowed us to step in. Let’s backtrack a little.
Brazil has, traditionally, been a particularly large iron ore producer. Though, with major dams collapsing, there’s been a lack of supply of iron ore as they haven’t been able to mine. This has given Australia a window of opportunity to not only help supply this demand with iron ore, but also charge some pretty high prices for it too.
Demand has been particularly high as well, due to China’s Belt and Road Initiative which will require a lot of iron ore. So with demand at a high and supply at a low, Australia has been able to charge a much higher rate for iron ore.
To really see this change, Australia was previously charging $61.57 for one tonne of iron ore, which has been jacked up to $173 per tonne, almost matching the rates during the mining boom!
What has been the impact?
Coming back to the terms of trade and the index of prices, essentially the more we export products, the more these prices will impact the terms of trade. So now that resources make up around 60% of our export base, and the price of these commodities have gone up, our terms of trade increase as well.
In 2016, our terms of trade was sitting at just over 70% as an index, which isn’t very high. But in 2020, this has jumped to over 100% as an index, which again, is similar to the peak of Mining Boom II in 2011. 70% to 100% may not seem like much, however this is a 30% increase, which is a substantial turnaround.
The main catalyst for this turnaround is different to Mining Boom II, as we were able to increase prices due to China’s demand and the lack of supply coming out of Brazil. Further, if we look at the current account during Mining Boom II, we were sitting at a deficit of 3% GDP, and now, we are at a 2.5% surplus. What’s the differentiating factor this time around?
Back in 2011, the Australian dollar was actually higher than the US dollar, driven by the excessive demand for Australian exports. However, having a higher dollar meant that we became quite expensive to foreigners, and so other industries had a loss in export revenue.
This is commonly referred to as the ‘Dutch disease’ which was coined in the Netherlands in the 1980s. Essentially what happened in 2011, during Mining Boom II, is that the Aussie dollar went up, we were profiting heavily from our resources and consumers were happy.
On the other hand, the services industry took a big hit — education, financial services and tourism were suffering, foreigners no longer saw Australia as a cheap or by any means, an affordable holiday destination.
Services are considered quite elastic, whereas commodities are inelastic, because their prices are a result of economic growth. So even though the industries were booming in 2011, the services industries were taking a toll. Therefore, Australia’s total export revenue could never reach its full potential as the other industries were struggling.
What caused the Australian dollar to depreciate?
The Australian dollar is currently sitting at around 77 cents to one US dollar. Around a year ago, the Australian dollar was on a prolonged depreciation, going from about 80 cents to 57.50 cents when the COVID pandemic started to settle in.
However, recovering around the third and fourth quarter of last year, this post-COVID recovery is largely attributed to Australia handing the pandemic well, periodically with lockdowns and restrictions. So back onto our average 77 cents, Australia is looking a little more attractive from an investment perspective.
It’s pretty hard to pinpoint a singular reason for the depreciation in the Aussie dollar, however it’s worth considering the change in interest rate gains. The interest rate differential is vital when determining the relative demand for Australian currency versus other countries. So, the higher the interest rate or cash rate in a country means a higher value of the country.
Australia’s interest rate has been at 0.1% for the past year, and is expected to remain about the same for the next three or so years. For quite some time, the interest rates were dropping, and in 2019, we saw it reach around 0.75% and now it’s at 0.1%. In 2018, we saw a negative interest rate differential and the US interest rates then peak at 2.5%, to then collapse again.
So we see more demand for the US dollar in comparison to the Australian dollar as a result of their positive differential and our negative differential.
Often, high terms of trade and good international competitiveness doesn’t co-exist, and so the dollar goes up and erases international competitiveness for the service industries. But at the moment, we’ve got great trade and decent international competitiveness, so our exports can do incredibly well.
As export volume has increased and imports have remained stable, the net result is a greater trade balance. In turn, shifting Australia’s current account deficit, into a current account surplus!
What are the implications of an account surplus?
The great thing about a current account surplus is the current income flow into Australia from other countries. Experts have noted that the Australian dollar needs to maintain a position at just under 80 cents to one US dollar, and currently sitting at 77 cents places us in the perfect position, regardless of the pandemic.
However, Australia’s current surplus is covering up the structural issues within the economy, and so maintaining this surplus is a matter of China’s continuing demand and Brazil’s lack of supply. This is also dependent on China’s capacity to source iron ore from Indonesia, which would shift demand away from Australia — impacting our export volume and price.
The recovery of the US economy is another impacting factor, as they are managing the pandemic now, with a much stronger vaccination rollout. So if or when the US economy starts to improve, Australia runs risks around proper inflation and the question of changing interest rates.
As mentioned, this surplus is covering the structural issues in Australia’s economy, particularly the investment gap. In the short-term, the surplus allows Australia to slow down the debt accumulation, but it means that we have a deficit on our capital financial account — where Australia is investing more in other countries than they are in us.
This positively impacts us in the short term for our net foreign liability, which influences our net primary income. This short-term strength provides Australia with the chance to improve the structural problems.
There you have it! Now you will, hopefully, have a better understanding of Australia’s current account surplus, how it’s impacting us positively, but also some of the potentially negative ramifications.
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Nandini Dhir is a Content Writer at Art of Smart and is currently studying a Bachelor of Arts (majoring in Marketing) and a Bachelor of Advanced Studies (Media and Communications), as a Dalyell Scholar, at Sydney University. She enjoys covering local issues in her area and writing about current events in the media. Nandini has had one of her pieces published in an article with the Sydney Morning Herald. In her free time, Nandini loves doing calligraphy, ballet, and sewing, or is otherwise found coddling her cats.