Trends in Australia’s Balance of Payments | Explainer | Education (2024)

Australia's trading patterns have evolved considerablyover the past century. Structural changes in Australia'seconomy and those of our trading partners haveresulted in significant changes in the pattern ofexports, imports and flows of income. At the sametime, developments in financial markets and theinvestment needs of different sectors of the Australianeconomy have driven changes in the flow of capital.

This Explainer summarises the longer-term trendswithin the two sides of Australia's balance ofpayments: the current account and the combinedcapital and financial account. (For a discussionabout the economic concepts and frameworkof the balance of payments, see Explainer:The Balance of Payments.)

Trends in Australia's Current Account Balance

The current account balance reflects the differencebetween national savings and investment, and ismeasured as the sum of the ‘trade balance’, ‘primaryincome balance’ and ‘secondary income balance’.For simplicity, the primary income balance andsecondary income balance are often combinedand referred to as the ‘net income balance’. The currentaccount balance can be in surplus (have a positivevalue), be equal to zero, or be in deficit (have anegative value).

Australia has generally had a current account deficit,reflecting attractive investment opportunities inthe economy that exceed our capacity to fundvia domestic saving. Changes in the size of thecurrent account deficit have been largely driven bydevelopments in the trade balance, which tends tobe volatile from quarter to quarter, while the net incomebalance has been more stable over time.

In mid-2019, the current account went into surplus for the first time since 1975. This wasmainly due to a very large trade surplus, meaning that the value of goods and servicesexported by Australia to the rest of the world exceeded the value of goods and servicesimported. This outcome was driven by high prices for resource commodities, especially ironore. The net income deficit – which captures Australian residents' income from overseas lessany payments made by Australian residents to the rest of the world – had also narrowed overa number of years (see below), further contributing to the current account surplus.

Trends in Australia's Trade Balance

Changes in Australia's trade balance have been influenced by the types of the goods andservices Australia exports and imports, as well as the prices that are received or paidfor these goods and services. Australia has a comparative advantage in the export ofresource and agricultural commodities. Together these commodities account for arelatively large share of our exports and have more volatile prices than those of thegoods and services Australia imports. As a result, the nation's trade balance tends tofluctuate alongside changes in these commodity prices. (For a discussion of commodityprices, see Explainer:Australiaand the Global Economy – The Terms of Trade Boom.)

This section explores in more detail how changesin the structure of the Australian and globaleconomies have influenced what Australia tradesin and with which economies Australia trades.

Exports

An open economy like Australia can choose to export goods and services to the rest ofthe world for a range of reasons. One possibility is that domestic production is higherthan domestic consumption, creating an excess of supply. Another is that an overseasbuyer may be willing to pay a higher price for the goods or services than a domesticconsumer; for instance, because the goods or services are not available in their homeeconomy.

The composition of Australia's exports

Over the past century, Australia's exports to therest of the world have been dominated by eitheragricultural or resource commodities, reflectingAustralia's natural advantage in producing thesegoods. Up until the mid-1960s, wool was Australia'slargest export, accounting for around 40 per centof Australia's total export values. As the agriculturalsector gradually became a smaller part of theAustralian economy, its share of exports alsodeclined, accounting for around 10 per cent oftotal export values in recent years. Meat and wheatexports are currently Australia's predominantagricultural exports, while wool accounts for amuch smaller share than it has historically.

Australia has also had a long history of exporting many different natural resources tothe rest of the world, consistent with Australia's large natural resource endowment andrelatively low domestic usage of these goods. In the early 1900s, gold was Australia'stop resource export, accounting for around 10 per cent of total export values. However,exports of iron ore, coal and liquefied natural gas (LNG) have become increasinglyimportant, particularly after the mining investment boom in the 2000s, whichsubstantially increased Australia's capacity to extract these resources. Together, ironore, coal and LNG now account for around three-quarters of the value of Australia'sresource exports. The COVID-19 recession and associated international border closuresresulted in a sharp decline in education and tourism service exports.

Australia's major export trading partners

From the early 1900s through to the 1950s,Australia mainly exported agricultural products(wool, wheat and dairy) and gold to the UnitedKingdom and other European economies,reflecting Australia's close political ties with theseeconomies. After the Second World War, exportsof resources, manufactured goods and servicesstarted to grow in importance but the directionof Australia's trade started to change.

In the late 1960s, Australia's export trade becameincreasingly oriented towards those Asianeconomies experiencing rapid growth (includingJapan, South Korea and later Mainland China).

The ongoing industrialisation and urbanisationof these economies increased their demandfor Australia's natural resources, such as coaland iron ore, which are used in construction,manufacturing and power generation. Duringthe 1980s, as average household incomesin neighbouring economies rose, demandfor Australian services also started to rise inimportance, particularly for education and travelservices. More recently, Mainland China has overtaken Japanto become Australia's largest trading partner,owing to its strong demand for natural resources.Resource exports currently account for morethan half of Australia's total export values.

Although the relative importance of non-Asianeconomies as direct export trading partners hasdeclined over time, they remain an importantindirect source of demand for Australia's exports.This is because many of the goods that Australiadirectly exports to Asian economies are partof global supply chains, where products areassembled in Asia and the finished productsare then sold to buyers, many of whom arein advanced economies.

For example, consider an Australian miningcompany that exports $100 million of iron ore toa steelmaker in Mainland China who produces steel for arange of manufactured products. A manufacturerin Mainland China uses this steel to produce ‘white goods’like washing machines and refrigerators that arepurchased by consumers in the United States for$120 million. Although Australia did not directlyexport these products to the United States,demand for Australia's resources was indirectlyboosted by American consumers through theirtrading relationship with Mainland China.

Imports

Goods and services can be imported into anopen economy like Australia because they arenot available domestically (for example, a highlyspecialised piece of mining equipment or a familyholiday to see the Eiffel tower in Paris), or becausethey are cheaper to purchase than equivalentdomestic goods and services.

The composition of Australia's imports

Australia imports a wide variety of goods and services from the rest of the world. Incontrast to the composition of Australia's exports, Australia's imports are not clearlydominated by one or two categories. In addition, the composition of imports has beenmore stable over time. Nevertheless, there have still been some changes in thecomposition of imports that have occurred alongside longer-run changes in the types ofgoods and services that are produced within the Australian economy.

For instance, the share of imports accounted forby industrial supplies – such as specialised partsfor machinery & equipment, chemicals and plastics– has declined as manufacturing has becomea smaller share of the Australian economy. Thedecline in Australian manufacturing has meantthat fewer goods are assembled in Australia and,as a result, demand for inputs from overseas hasdeclined. A related consequence has been thatimports of fully assembled goods, which are readyto be used, have increased; these types of finishedgoods are commonly referred to as ‘final’ goods.These have included consumer goods – suchas clothing and footwear, toys and householdelectrical items (like televisions and radios) – aswell as capital goods. Capital goods are typicallyused for investment purposes and include itemslike specialised machinery, telecommunicationsequipment and computer hardware.

Services have consistently been one of the largest components of Australia's imports,accounting for around one-quarter of total import values, on average, over the past fewdecades. Service imports mostly reflect the expenditure of Australian residents whilethey are overseas for holiday, education and business-related reasons, as well as theirtransport costs (e.g. plane tickets). As with service exports, service imports also fellsharply during the COVID 19 pandemic due to restrictions on international travel.

Australia's major import trading partners

In the early 1900s, Australia mostly imported goodsfrom the United Kingdom and other Europeaneconomies. However, the United States was also animportant source of imports, especially around thetime of the Second World War. Australian importsfrom the Asian region started to increase duringthe 1970s and the share from many advancedeconomies declined. Since the 1990s, at least halfof Australia's imports have been sourced fromeconomies in Asia.

Trends in Australia's Income Balance

Australia's combined primary and secondary income balance – or net income balance – hasbeen in deficit for many decades, which means that Australian residents have paid moreincome to non-residents than they have received from non-residents.

The ‘financial investments' component of the primary income balance has historicallydriven the majority of the net income deficit. This has reflected Australia's netforeign liability position – which is where the stock of Australian liabilities held byforeign investors exceeds the stock of foreign assets held by Australian residents. As aresult, Australians pay more interest to the rest of world on these liabilities thanthey receive on their assets from abroad. In recent years, Australia's mining sector hasbeen a large component of Australia's net income outflows, as this sector has a highdegree of foreign ownership. This results in part of the income earned by thesecompanies in Australia being paid to foreign owners in the form of dividends.

Trends in Australia's Capital and Financial Account

The combined capital and financial account recordsthe capital and financial transactions betweenAustralia and the rest of the world. Historically,the Australian economy has generally been a netrecipient of capital inflows from the rest of theworld. In other words, the savings of the domesticeconomy have been supplemented with inflows ofcapital from abroad in order to fund the relativelyhigh level of investment in the Australian economy.This has been reflected in a capital and financialaccount surplus – the counterpart to Australia'scurrent account deficits.

In recent years, however, there has been a netoutflow of capital from Australia – that is, Australianshave invested more overseas than those abroadhave invested in Australia's economy. This has beenreflected in a capital and financial account deficit,and is consistent with the recent shift to a currentaccount surplus.

Trends in Australia's Capital Flows

Prior to the 1980s, foreign investment in Australiagenerally took the form of foreign direct investment.In the early 1980s, Australia's financial sectorunderwent a period of deregulation, which includedthe removal of capital controls and the floating ofthe Australian dollar in 1983 (see Explainer: Exchange Rates and theirMeasurement).As a result of thesereforms, Australian residents could use their savingsto invest overseas more freely than before andoverseas investors were able to invest in a broaderrange of Australian assets. Reflecting this, capitalflows to and from Australia increased substantiallyand became more varied in their type. In particular,investment in portfolio assets (e.g. equities, bondsand cash) increased dramatically. During the2010s, however, foreign direct investment againrepresented a large share of net capital inflows.

Since 2019, Australia has experienced a net outflowof capital. This reflects a reduction in inflows offoreign direct investment and an increase in portfoliooutflows, such as purchases of foreign equities byAustralian investment funds (e.g. superannuationfunds).

Capital flows by sector

Prior to 2007, around two-thirds of foreign capitalflows into Australia was directed to the financialsector. This was because Australian banks fundedmost of their lending by borrowing in overseasmarkets. During the 2010s, net capital flows to theAustralian banking sector declined to around zeroas banks funded more of their operations usingdomestic deposits. Meanwhile, there were largepublic sector capital inflows related to purchases ofAustralian government debt. Foreign investment alsoplayed an important role in expanding the capacityof Australia's resources sector in order to meetgrowing global demand for Australian commodities.These capital inflows to the private sector havebeen partially offset by outflows from Australiansuperannuation funds, which have accumulateda large stock of foreign assets, particularly foreignequities. Since 2020, there have been net capitaloutflows from the financial sector, including banks.This is mainly because banks reduced their stock ofoverseas debt, partly reflecting access to low costdomestic funding, including through the RBA's TermFunding Facility.

Capital inflows by geography

Advanced economies such as the United States, theUnited Kingdom, Europe and Japan have accountedfor the majority of foreign investment in Australiaover the past decade or so. The value of capital flowsfrom Mainland China to Australia in the 2010s increased relativeto these flows in previous decades, though theoverall flows from Mainland China remain small.

Trends in Australia's External Position

As a result of net capital inflows from abroad,Australia has accumulated a net liability(borrowing) position with the rest of the world.However, the composition of these net foreignliabilities can shift over time. In recent years, netlong-term debt liabilities have risen as foreigninvestors have increased their holdings ofAustralian government debt. Meanwhile, netshort-term debt liabilities have fallen. Australia'snet foreign equity liabilities have also declinedmarkedly in recent years. Since 2013, Australia hashad a net foreign equity asset position – Australianresidents own more equity in foreign companiesthan non-residents own in Australian companies.

Foreign currency composition

Most of Australia's liabilities with the restof the world are denominated in Australiandollars, rather than foreign currencies.This includes foreign investment in the equityof Australian companies and in Australiangovernment debt. In addition, many Australianfirms that borrow funds in international marketsconvert their foreign currency borrowingsinto Australian dollars using financialinstruments known as derivatives. This practiceis known as ‘hedging’ and ensures thata depreciation in the Australian dollar doesnot make it more expensive for firmsto repay their foreign debts. In contrast,over half of Australia's foreign assets aredenominated in foreign currencies.

This results in Australia having a net foreigncurrency asset position: Australian residents ownmore assets denominated in foreign currenciesthan we owe liabilities denominated in foreigncurrencies to non-residents. The currencycomposition of Australia's foreign assets andliabilities determines how the external positionis affected by movements in the exchange rate.Because Australia has a net foreign currency assetposition, when the Australiandollar depreciates, the value of foreign currencydenominatedassets increases in Australian dollarterms, and so our gross foreign assets increaserelative to our gross foreign liabilities. In addition, the income receivedon our foreign assets increases relative to theincome paid on our foreign liabilities. This meansthat, overall, a depreciation of the currency wouldtend to strengthen Australia's external positionand result in a narrowing of the net income deficit.These features enable the exchange rate to bea more effective shock absorber for the Australianeconomy (see Explainer: Exchange Rates and theAustralian Economy).