Selected Issues

Abstract

Selected Issues

Prospects for Australia’s Current Account Deficit: Lower for Longer?1

A. Current Account Balance Developments Over the Past Decade

1. Australia’s current account has been in deficit for most of its history. In the 1960s and 1970s, the current account deficit fluctuated around 1-2 percent of GDP (Edey and Gower, 2000). The deficit widened from the early 1980s and averaged around 4 percent of GDP for around 3 decades after that (Kearns and Lowe, 2011). The current account deficit sharply decreased immediately after the Global Financial Crisis (GFC) and again in 2016-17, fluctuating at a lower level (Figure 1). This paper examines the narrowing of current account deficit since the GFC and seeks to draw the implications for the current account going forward, using primarily a sectoral saving and investment balance approach. It focuses on developments in Australia, taking developments elsewhere as given.

Figure 1.
Figure 1.

Current Account Balance

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.

2. The narrowing of the current account deficit over the past decade can be broadly divided into two phases.2 During the first phase, which can be defined between the GFC and the end of commodity price boom at roughly the end of 2011, most of the adjustment occurred, from an initial position of a large deficit. The substantial narrowing to a deficit smaller than average in that phase was driven primarily by favorable terms of trade, leading to higher savings in non-financial corporates. In the second phase, the current account deficit narrowed further, but by a smaller amount, with the largest positive contribution coming from the real trade balance, driven by the end of mining investment boom and weaker consumption. In both phases, improvements in primary income balance also contributed.

Figure 2.
Figure 2.

Current Account Balance

(Contributions to annual change, % GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.
Figure 3.
Figure 3.

Terms of Trade

(2015Q3-2016Q2=100, seasonally adjusted)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Source: Haver Analytics.

B. Dissecting the Narrowing of the Current Account Deficit

3. The narrowing of underlying current account deficit started with the GFC and has been maintained since, with offsetting dynamics across sectors. The adjustment has been most notable in the household and non-financial corporate sectors (Figure 4). The overall patterns in the narrowing are broadly consistent with sharper slowdowns in Australian domestic demand relative to its trading partners (see Blanchard and Milesi-Ferretti, 2009 and Garton and others, 2010). The changes in the global financial conditions because of the GFC were also reflected in lower gross capital inflows (Figure 5). More broadly, the following five developments are key to understanding the narrowing of the current account deficit and its prospective development going forward.

Figure 4.
Figure 4.

Current Account Balance by Sectors

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.
Figure 5.
Figure 5.

Gross Capital Flows

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.

4. First, Australia experienced larger slowdown s in domestic demand growth relative to its major trading partners. In the GFC, from 2007-09 with annual data, growth in Australia’s domestic demand dropped by around 7 percentage points, while the weighted average of the growth rate in its major trading partners’ domestic demand declined by 4 percentage points, with developments in the latter strongly influenced by China’s continued relative strength. The domestic demand gap relative to trading partners widened again in the beginning of the second phase as Australia was hit by the decline in global commodity prices leading to a persistent (and perhaps permanent) decline in mining investment (Figure 6).

Figure 6.
Figure 6.

Domestic Demand

(Y/Y percent change)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Source: IMF staff calculations.

5. Second, household saving ratios sharply increased around the GFC (see Finlay and Price, 2014). The increase in the household saving ratio since the GFC mirrors that observed in other advanced countries, although the extent of the increase in Australia is relatively large (Figure 7). The increase in Australia’s ratio partly reflects the transfers to households during the fiscal stimulus of 2008-09. But it is also consistent with two developments after the GFC: households’ more cautious attitude, which is also reflected in a notable increase in share of cash and deposits in total financial assets (Figure 8); and the presence of tighter lending standards by banks, including higher collateral requirements for households. While households’ savings-investment balance has remained elevated compared to its pre-GFC level, it has narrowed in recent years, with a decrease in saving to GDP ratio and some increase in the dwelling investment to GDP ratio because of the housing market boom (Figure 9).

Figure 7.
Figure 7.

Household Saving Ratio

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Source: IMF, World Economic Outlook.
Figure 8.
Figure 8.

Share of Total Households Financial Assets

(Percent)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Figure 9.
Figure 9.

Household’s Saving and Investment

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF calculations.

6. Third, non-financial corporates (NFCs) reduced net borrowing. In the first phase, firms increased their saving with the support from the favorable terms of trade while reducing investment in the wake of the GFC. This was reflected in the sharp decline in balance sheet leverage. In terms of the debt-to-equity ratio adjusted for price changes3, non-financial corporates reduced their leverage ratio by almost half (Figure 10). This decline was mirrored in a decline in the ratio of business credit to GDP, the extent of which is broadly comparable to the decline associated with the 1991 recession. During the second phase, the negative savings and investment gap initially widened as the economy went through the commodity price bust, exerting downward pressure on saving. However, mining investment remained high, as it lagged the decline in commodity prices. In the most recent period, the gap has largely stabilized as the decline in mining investment is almost complete, the terms of trade has improved and there has been deleveraging by NFCs in particular among resources companies. (Figures 11, 12).

Figure 10.
Figure 10.

Non-Financial Corporates’ Debt to Equity Ratio

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: ABS
Figure 11.
Figure 11.

Investment

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.
Figure 12.
Figure 12.

Non-financial Sector’s Saving and Investment

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.

7. Fourth, less benign global financial conditions and tightening regulatory requirements have led the financial corporations to increase their saving (Figure 13). Banks lowered the share of dividend payments out of gross operating surplus by one third, from 60 percent to 40 percent. Consequently, retained earnings and saving have increased, contributing to higher capital adequacy ratios (Figure 14).

Figure 13.
Figure 13.

Financial Sector’s Saving and Investment

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.
Figure 14.
Figure 14.

Share of Dividends to Gross Operating Surplus

(Percent)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.

8. Fifth, interest payments to non-residents declined, reducing the primary income deficit (Figure 15). Interest payments to non-residents as a percent of GDP decreased by one half, from about 3 percent before the GFC to 1.5 percent. Two factors are at work. First, the composition of external debt shifted toward government bonds away from bank liabilities. The share of general government external debt almost quadrupled while that of banks dropped by 20 percentage points (Figure 16). The increase in the government external debt to GDP ratio is mostly due to fiscal policy producing a larger government deficit in response to a weaker economy after the GFC. Banks reduced reliance on external funding while increasing their share of domestic deposits mainly due to tighter external funding condition and liquidity requirement. Second, risk-free government bond yields and risk premia on Australian bonds decreased, largely because of a relatively more accommodative monetary policy stance in Australia since the GFC. The lower interest burden, other factors being are equal, has likely resulted in higher saving by governments and banks.

Figure 15.
Figure 15.

Interest Payment to Non-Residents

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.
Figure 16.
Figure 16.

Share of Gross External Debt

(Percent)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.

C. Prospects for the Current Account Balance

9. Australia’s underlying current account deficit is likely to remain lower than pre-GFC period. The improvement in the terms of trade in 2017 relative to the previous year should result in a current account deficit of around 2 percent of GDP, given developments to 2017Q3. While the current account deficit is expected to widen as the output gap closes with strengthening domestic demand, the widening of current account deficit will be small, given the size of the gap (Figure 17).

Figure 17.
Figure 17.

Projected Output Gap

(Percent)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Source: IMF staff calculations.

10. Other considerations support this expectation. First, mining investment is expected to remain lower, as the industry will focus more on maintaining its capital stock after a substantial expansion during the recent commodity price boom. Staff forecast non-mining business investment to strengthen, but a substantial pick-up relative to GDP is less likely with capacity utilization rates of mining capital not far away from their long-term averages and trend declines in the prices of many investment goods. Second, household saving is expected to remain at around current levels, with continued higher precautionary saving and some deleveraging (Figure 18). Dwelling investment is likely to moderate toward longer-term averages, given the expected cooling in the housing market. Third, government saving is expected to improve on the back of the overall economic recovery and the government’s commitment to return its budget to balance. Fourth, interest spreads in Australia relative to other major advanced economies are expected to remain low, contributing to a continued lower primary income deficit, also supported by a narrower inflation differential (Figure 19).

Figure 18.
Figure 18.

Wisest Place for Savings

(Percent of respondents)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculations.
Figure 19.
Figure 19.

Australia Sovereign Spreads

(Australia Commonwealth bond spread over U.S. Treasury bond yields)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Figure 20.
Figure 20.

Australia: Sectoral Savings and Investments Balance

(% GDP)

Citation: IMF Staff Country Reports 2018, 045; 10.5089/9781484341872.002.A004

Sources: Haver Analytics and IMF staff calculationsNote: Statistical discrepancy between current account balance and savings and investments balance of national account is allocated to each sector in calculating sectoral savings and investment balance.

References

  • Belkar, R., L. Cockerell, and C. Kent, 2007, “Current Account Deficits: The Australian Debate”, Research Discussion Paper 2007-02 (Reserve Bank of Australia).

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  • Bishop, J. and N. Cassidy, 2012, “Trends in National Saving and Investment,” Bulletin, March, 918 (Reserve Bank of Australia).

  • Blanchard, O., and G-M. Milesi-Ferretti, 2009, “Global Imbalances: In Midstream?” IMF Staff Position Note SPN/09/29 (International Monetary Fund).

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  • Edey, M. and L. Gower, 2000, “National Saving: Trends and Policy” in Reserve Bank of Australia (ed.), The Australian Economy in the 1990s, (Reserve Bank of Australia).

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  • Finlay, R., and F. Price, 2014, “Household Saving in Australia”, Research Discussion Paper 2014-03 (Reserve Bank of Australia).

  • Garton, P., M. Sedgwick, and S. Shirodkar, 2010, “Australia’s Current Account Deficit in a Global Imbalances Context,” Economic Roundup, Issue 1-2010 (1). Australia: The Treasury.

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  • Kearns, J. and P. Lowe, 2011, “Australia’s Prosperous 2000s: Housing and the Mining Boom” in Reserve Bank of Australia (ed.), The Australian Economy in the 2000s, (Reserve Bank of Australia).

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1

Prepared by Kyungsuk Lee (APD).

3

According to the ABS (Australian Bureau of Statistics), the adjusted ratio reflects the removal of price change from the original series and therefore provides an indicator of leverage without the market price changes.

Australia: Selected Issues
Author: International Monetary Fund. Asia and Pacific Dept