If world growth, exceeds domestic growth, then this will increase the level of Australia's exports. This will decrease the CAD and thus decrease the level of foreign debt in the Capital and Financial account and thus its servicing cost. This is an advantage as it reduces Australia's foreign liabilities and debits in the future. However it can also be seen as a disadvantage as foreign debt is used to fund projects such as infrastructure.
An example of this is the strong world growth that occurred in 1992-94 which led to higher export demand, reducing the goods deficit, lowering/stabilizing the CAD.
Conversely if world growth decreases, then this will decrease the level of exports. Increasing the CAD. An example of this was in 2002-03 the CAD increased by 91% on the 2001-02 figure. This was caused by the major internal shock of drought in 2002 and poor global growth, reducing farm exports by 25%. Contributing external shocks was the weak US and global recoveries reducing demand, with 0 growth in export volumes in 2002-03. Yet imports increased by 13% due to strong domestic growth.The drought and lack of global demand decreased the level of exports, reducing the balance of goods and services credits in Australia, and thus increasing the CAD relative the money flowing in.This can be a disadvantage as it too reflects an increase in foreign liabilities. However an advantage of this is that it increases the amount of investment within the domestic economy (as the Capital and Financial Account must fund the CAD) allowing greater access to foreign savings, and funding for infrastructure, company expansion and new enterprises.
Reasons for such trends however also include structural factors. In structural terms the problem of the CAD is the size of the net income deficit and the associated cost of servicing both debt and equity borrowings (external liabilities) in the Australian economy. In every year excluding 1994-95 and 2002-03 the net income deficit was more than 80% of the deficit. This means that the payment of interest, profits, dividends and royalties to the forign lenders and investors exceeded the receipt of income from Australian investment and lending overseas.
One disadvantage of increased payments of interest, profits, dividends and royalties to foreign lenders and investors, (an increase to the CAD in terms of an income deficit, relative to GDP) is that it represents an increase in Australia's foreign liabilities, in order to fund the deficit. Not only does this add to the existing net external debt and equity but it also increases the servicing cost in terms of interest repayments on debt, and the remittance of profits and dividends to service the equity borrowings respectively.
A disadvantage of this structural factor is that it involves a large amount of capital in order to repay the foreign liabilities, in order to reduce the servicing cost of the foreign debt.
Australia's Balance of Payments (BOP) consists of both the Current Account and the Capital and Financial Account. The balance in the Current Account directly determines the balance in the Capital and Financial Account. This is because the Capital and Financial Account must fund the Current Account (if in deficit). Since Australia generally has an ongoing Current Account Deficit (CAD), The Capital and Financial account is usually in surplus. When added together both accounts must equal zero, when errors and omissions are also added towards the total. The Balance in the Current Account, is influenced through structural and cyclical factors, which in turn influence the level of foreign debt and liabilities in the Capital and Financial Account. A disadvantage of having cyclical factors effect the CAD, is that it represents Australia's lack of independence. In the case of global downturns, it can mean decreased sales of exports and income, and if the level of imports demanded stays the same, could result in a CAD.
This could have negative effects to the Australian economy, if trade dependency is too great as it may result in unemployment in Australia's export industries. However an upside is that it will increase investment within Australia, via the Capital or financial account, in order to fund the deficit, increasing greenfield investment to build new capacity including new factories and infrastructure, thus resulting in increased employment. A disadvantage of Australia's structural factors influencing the CAD, is that it involves a large amount of capital in order to repay the foreign liabilities, which can be a disadvantage if considered unsustainable. Thus the reasons, cyclical and structural, have their disadvantages and advantages, leading to trends that often hold many implications for the domestic economy.
