Outline the trends in Australia's current account since 2000 and analyse the main causes of the trend.

There have been various trends associated with Australias current account in the last 12 years. Historically, Australia has had a current account deficit (CAD) and this is fundamentally due to multiple structural factors in the Australian economy. However, the extent of this deficit has varied over time due to cyclical factors in the domestic and global economy which influence the individual components of the current account; that is the balance on goods and services (BOGS), the net primary income account, and the net secondary income account. Overall, there have been various trends since 2000 in the current account balance and these trends have been caused by a combination of cyclical and structural factors in the domestic and global economy. Traditionally, the Australian current account has been in deficit and this has held true for the period since 2000. Commonly expressed as a percentage of GDP, the CAD has averaged at 4.4 precent of GDP in the 2000s, peaking at just above the 6% of GDP. The CAD deteriorated dramatically from the early 2000s, increasing from 2.4% in 2001 to 6.3 % of GDP in 2008 before slightly improving in the following years. The BOGS component of the CAD has fluctuated dramatically over the last 10 years, recoding a surplus in 2008-09 and again in 201011 of $20.8 billion. The net primary income component on the other hand has remained relatively consistent; usually recording a deficit between 3 and 4 precent of GDP, reaching its maximum level in the mid 2000s of just over 4 precent. The current account has had a persistent deficit since 2000, however to varying extents. A major cause of variations in Australias CAD is cyclical factors in the global economy, one of which is the exchange rate. Australias exchange rate with it trading partners has a major impact on the size of the current account deficit. An appreciation in value of the Australian dollar (AUD) will cause exports to become more expensive and imports to become cheaper, decreasing international competitiveness and encouraging import spending. This in turn will lead to deterioration in the CAD. Conversely, a depreciation in the value of the AUD will cause exports to become cheaper, increasing international competitiveness and improving the CAD. Furthermore imports will become more expensive leading to decreased import spending. This effect was evident in 2000-02, where the Australian dollar depreciated to less than $US 0.50, leading to a diminished CAD of only 2.5 % of GDP. The exchange rate has a significant impact on the CAD, and has been a major cause of variations in the CAD since the year 2000. Another cyclical factor that has had a significant impact on trends in the CAD over the last 20 years has been the Terms of Trade. The terms of trade shows the relationship between the prices Australia receives for its exports and the prices its pays for its imports. If export prices increase relative to import prices, Australias Terms of Trade will improve and vice versa. The Terms of Trade mainly impacts the BOGS and its importance has grown over the 2000s. The boom in global commodity prices saw a significant improvement in Australias terms of trade and hence a significant impact on the BOGS. Between 2000 and 2010 Australias terms of trade almost doubled in value, reaching their highest in 140 years in 2010-11. This in turn saw a remarkable improvement in the BOGS, moving away forma historic deficit to post two surpluses, one in 2008 -09 and one in 2010-11.

Domestic economic growth and the international business cycle are also both cyclical factors behind the trends in the CAD. Domestic economic growth primarily influences the BOGS by affecting demand for imports. An upturn in the domestic business cycle results in higher levels of disposable income which leads to higher consumption, some of which will inevitably spill over to imports. This in turn will lead to a worsening of the BOGS and hence a deterioration in the CAD. This effect was evident in the mid to late 2000s with high growth in household disposable income resulting in increased import spending, and a poor BOGS performance. In contrast, the slowdown in growth during the GFC led to decreased spending on imports helping the BOGS move into a surplus of 5.9 billion in 2008-09. Similar to domestic economic growth, the international business cycle also impacts the BOGS and therefore Australias CAD. It does this by influencing global demand for Australias exports. Strong global economic growth increases demand for Australias exports, improving the BOGS. This is evident over the 2000s as Australia major trading partners, such as China, experienced rapid rates of economic growth dramatically increasing demand for exports and hence export revenue. Hence, it is clear that both domestic economic growth and the international business cycle have an influence on the CAD and have contributed to the trends since 2000. Though cyclical factors are behind the variations in the level of Australias CAD, the deficit itself is caused by underlying structural factors in the Australian economy. One such factor is Australias narrow export base. The Australian economy has a narrow export base, in the sense that Australia's exports are heavily weighted towards primary commodities. This means that the products exported are low value added products such as minerals and resources. In contrast, Australia lacks international competitiveness in manufacturing and tends to import high value added products such as consumer goods and capital goods. As a result the long run BOGS trends to be in deficit rather than surplus because import payments outstrip export revenue. This in turn contributes to the overall current account deficit. Another structural factor behind Australias persistent CAD that has particularly emerged over the last decade is capacity restraints on Australias exports. These capacity restrains are primarily due to poor transport infrastructure. Over the mid 2000s, Australia was unable to take full advantage of booming global demand for commodities due to poor transport infrastructure, such as low capacity at the nations ports and inefficient road and rail networks. Similarly, shortages of skilled labour also act as capacity restraints by pushing up wages, adding to business costs and hence, restricting growth in exports. Capacity restraints are another underlying structural factor behind Australias persistent current account deficit. However, the single largest structural factor contributing to Australias consistent current account deficit is the savings and investment gap. The Australian economy functions on high levels of investment however have low levels of domestic savings due to a relatively low household savings ratio, which declined for the majority of the 2000s, remaining consistently below 12%, with household debt equivalent to 150 percent of household income in 2011. Australias major industries naturally require enormous amounts of capital investment to function, for example mining needs a large amount of capital goods for exploration and excavation before any extraction can begin. To finance these high levels of investment, firms look to foreign sources, meaning that Australia tends to fund a large part of investment through international borrowing ( debt financing) or selling ownership of its assets (equity financing). This is evident with 40 percent of Australian shares being foreign owned, and 83 percent of mining shares being foreign owned. This increases Australias liabilities and creates future

servicing obligations in the form of interest repayments and dividends, recorded as an out flow on the primary account. These liabilities are the main contributor to the deficit on the net primary income component of the current account, which is in turn the main contributor to the current account deficit. The savings and investment gap within the Australian economy is a fundamental structural feature behind Australias persistent current account deficit.

In conclusion, there have been various trends in Australias current account balance and these trends have been caused by a combination of structural and cyclical factors. Structural factors such as capacity restraints, a narrow export base and the savings investment gap are fundamentally responsible for the deficit on the current account. However cyclical factors such as the international business cycle and exchange rates are responsible for variations in the level of this deficit by influencing the individual component of the current account. Ultimately, the trends in the current account result form the interaction of a multitude of both structural and cyclical factors.