8 February 2023
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Ian Zhou
Economic Policy
Executive summary
Australia recorded a current account deficit of
$2.3 billion in the September quarter of 2022, the first such deficit in
more than 3 years. A nation’s current account imbalance can be
indicative of structural economic problems, therefore
it is important to understand its causes. Put simply, a nation’s current
account deficit is like a person’s credit card spending: it can be good or bad
depending on what it is used for.
This Quick Guide sets out the international and domestic factors
that caused the September quarter deficit. It updates an earlier
FlagPost published in May 2022, which asked if Australia was set to return
to a current account deficit in 2022–23.
Furthermore, this Quick Guide argues that the recent deficit
is likely to be temporary. Australia’s current account balance could still
return to a surplus for the remainder of 2022–23 because weak global demand for
Australian iron ore is offset by soaring demand for Australian energy
commodities and agricultural exports.
What happened to Australia’s
current account position in the September quarter 2022?
The latest
data from the Australian Bureau of Statistics (ABS) shows Australia’s
current account balance decreased by $17.0 billion, from a surplus of
$14.7 billion in the June quarter of 2022 to a deficit of $2.3 billion
(seasonally adjusted, current prices) in the September quarter.
The Australian
Financial Review reported that the deficit news disappointed market
expectations, as the $2.3 billion deficit was well below an expected
surplus of $6.0 billion.
What caused the September current
account deficit?
In balance of payments statistics, the current account
balance is made up of 3 components: the trade balance, primary income balance,
and secondary income balance (see Figure 1).
Figure 1: the 3 components of the current account balance
Source: Reserve Bank of
Australia, ‘The Balance of Payments Explainer’.
Grace Kim, acting manager of the International Statistics branch
at the ABS, said in a media
release that ‘the current account deficit reflected a narrowing but robust
trade surplus, which was offset by a record high income deficit in the
September quarter.’
ABS
data shows that although Australia’s trade balance remained in a
surplus of $31.2 billion, that surplus had declined by $11.1 billion
from the June to September quarters of 2022. Over the same period, Australia’s primary
income balance declined by $6.4 billion, and this widened an
already-high net primary income deficit from $26.8 billion to a record $33.2 billion.
We unpack the real-world causes later.
These declines in Australia’s trade balance and primary
income balance made up the bulk of the quarterly $17.0 billion decrease in
the current account balance (see Figure 2). Changes in Australia’s secondary
income balance were insignificant.
Figure 2: the current account deficit was caused by a decline in trade balance
(top blue line) and a decline in primary income balance (bottom blue line) in
September 2022
Source: Ronald Mizen, ‘$31b trade surplus swamped by offshore dividend flows’, Australian Financial Review, 6
December 2022.
What caused the trade balance
decline?
A surplus trade balance means Australia exports more goods
and services than it imports from abroad.
The decline in the trade surplus in the September quarter
was driven by several factors. Notably, extreme
weather conditions disrupted Australia’s commodity exports. For example,
exports of coal, coke and briquettes dropped by 11.4% or $4.7 billion, and
exports of metal ores and minerals (largely iron ores) dropped by 3.8% or
$1.6 billion.
These declines were somewhat offset by the unusually strong
global demand for Australian grain exports and favourable weather conditions in
some areas, which led to a bumper
winter crop.
On the other side of the ledger, a surge in Australians
travelling overseas led to a 19.7% ($4.5 billion) increase in the value of
services imports – because Australians’ spending while overseas is recorded as
an import of services. The declines in Australia’s commodity exports and the
surge in the value of services imports made up the bulk of the $11.1 billion
decline in the trade surplus.
What caused the primary income balance decline?
The primary income balance captures wages and profits Australians earn from abroad, minus what is paid in wages and profits to the rest of the world.
Australia has had a net primary income deficit for several decades, as profits from foreign-owned investments in Australia have persistently exceeded returns from Australian-owned investments abroad. As a lucky country endowed with plentiful natural resources, Australia has abundant investment opportunities – but insufficient domestic savings to finance them. Consequently, Australia has consistently attracted foreign investment, in particular to the mining sector.
In recent times, Australia’s net primary income deficit has reached record levels because ever more investment income and dividends are being paid to foreign investors. In an interview with the Australian Financial Review, Thomas Kennedy (chief investment strategist at JPMorgan) confirmed that the widening of Australia’s net primary income deficit in the September quarter 2022 was ‘mostly a function of foreign-owned corporates repatriating profits to offshore parent entities, and increased dividend payments from portfolio investments to non-resident holders’.
Looking ahead to the remainder of
2022–23
Lacklustre iron ore prices
Although the September quarter deficit disappointed market
expectations, it should come as no surprise because the Treasury
forecasted in March 2022 (p. 37) that Australia’s current account balance
would shift into a deficit in 2022–23 due to faltering iron ore prices and weak
overseas demand for Australian iron ore.
In the October 2022 Budget, the Treasury changed its
forecast to a 0.5% of GDP current account surplus in 2022–23. In both Budgets,
the Treasury expected deficits in 2023–24 (see Table 1).
Table 1: projected
current account balance, percentage of GDP
| Budget |
Outcomes |
Forecasts |
| 2020–21 |
2021–22 |
2022–23 |
2023–24 |
| March 2022 |
3.3 |
3.75 |
–3.25 |
–6 |
| October 2022 |
n/a |
2.2 |
0.5 |
–3.75 |
Note: for the
current account balance a positive number indicates surplus and a negative
number indicates deficit.
Source: Budget Strategy and Outlook: Budget Paper No. 1: March 2022–23, p. 37 and Budget Strategy and Outlook: Budget Paper
No. 1: October 2022–23,
p. 47.
As noted in the Reserve
Bank’s explainer ‘Trends in Australia’s Balance of Payments’, Australia’s
current account surplus over the past 3 years was mostly due to a very large
trade surplus, driven by record-high commodity (especially iron ore) prices (p.
1).
The Treasury’s March forecast assumed that record-high iron
ore and coal prices would fall to levels consistent with ‘long-term economic
fundamentals’, which would narrow the trade surplus.
While coal prices have instead soared due to the
Russia–Ukraine war, the iron ore price has tumbled from its peak of US$229 per
tonne in May 2021 to around US$100 per tonne in September 2022. The fall in
iron ore prices is largely due to weaker Chinese demand as a result of the country’s
COVID-19 restrictions and deleveraging
policy for its property sector.
Figure 3 below is taken from the Resources
and energy quarterly: December 2022 report, and it forecasts that iron
ore prices will average US$85 a tonne in 2023.
Figure 3 Iron ore price outlook in 2023
Source: Office of the Chief
Economist, Resources and energy quarterly: December 2022, p. 41.
Some commentators believe iron
ore prices will rally again in 2023 because the Chinese Government has
recently abandoned its zero COVID policy. However, even with an easing of
COVID-19 restrictions in China, it is doubtful that the country will
immediately revive its historical demand for Australian iron ore, damping hopes
for a return to a large trade surplus in Australia’s current account balance.
Chinese policymakers have repeatedly stated that ‘houses
are built for people to live in, not for [financial] speculation’. Such
muted state support for Chinese property development implies a weak outlook for
this sector, which historically accounted for almost 40% of China’s steel
consumption. Furthermore, Chinese
investment in Africa’s emerging iron ore facilities and the creation
of the state-backed China Mineral Resources Group are designed to reduce
the strong bargaining position of Australian iron ore producers, which could depress
iron ore prices over the longer term.
Strong global demand for Australian
energy commodities and agricultural exports
Although iron ore prices are unlikely to rally in 2023,
Australia’s current account position could still return to a surplus for the
remainder of 2022–23. At a minimum, it is doubtful that the scale of annual
current account deficit will reach the Treasury’s initial forecast of 3.25% of
Australia’s GDP (approximately an annual current account deficit of
$75 billion for 2022–23) due to the following countervailing factors.
Firstly, global
demand for energy commodities (oil, natural gas, and coal) will likely
remain strong for the remainder of 2022–23, and Australia is well-positioned to
benefit from soaring energy prices around the world. Since the onset of the
Russia–Ukraine war, commodity-exporting countries (for example, Saudi Arabia
and Qatar)
have experienced higher export earnings due to price surges. On the other hand,
the current account balances of manufacturing powerhouses (for example, Germany
and South
Korea) have declined due to their dependence on oil and natural gas imports.
Australia is a commodity-exporting country. In particular, Australian
natural gas exports play a crucial role in providing supply to a tight
global market, a trend that will almost certainly continue for the remainder of
2022–23. While Australia’s
coal production and export shipments have been disrupted by extreme weather
conditions in the September quarter, the disruptions are likely temporary.
This means Australian coal exports may resurge in the latter half of the
2022–23.
Secondly, there is an unusually strong overseas demand for
Australian agricultural exports due to fears of a looming global
food crisis. Researchers from the Australian
Bureau of Agricultural and Resource Economics and Sciences forecast that
the value of Australian crop exports will reach a record-high level in 2022–23
as the price outlook remains positive.
Thirdly, Australia’s tourism and international education
sectors may see a surge in Chinese visitors as the Chinese Government opens the
country’s border which will unleash
pent-up demand for international travel. Overseas visitors’ spending in
Australia is recorded as an export of services that contributes to Australia’s
trade balance surplus. The extent of the surge will depend on whether the
Australian Government introduces additional COVID-19
restrictions effecting travellers from China.
Is there a problem?
A popular rule of thumb in economics is
that if a country is running a persistently large current account deficit of over 5% of its GDP, then it could be facing deeper economic problems (p. 1). For
example, in the mid-1990s Thailand was running a current account deficit that was persistently above 7% of its GDP and this exacerbated the
country’s problems in the 1998 Asian Financial Crisis.
This rule of thumb has been contested by some
economists. For example, Professor
John Pitchford of the Australian National University criticised the Hawke
Government’s ‘obsession’ to avoid current account deficits in the 1980s and
argued that government policies to reducing current account deficits tend to be
cost ineffective.
More recent economic consensus appears to be that a current
account deficit in itself is neither good nor bad, whether it indicates deeper
economic problems depends on what the inflow of money is used for and how it is
managed. Economists
at the World Bank summarise:
Although a current account deficit in itself is neither good
nor bad, it is likely to be unsustainable and lead to harmful consequences when
it is persistently large, fuels consumption rather than investment, occurs
alongside excessive domestic credit growth, follows an overvalued exchange
rate, or accompanies unrestrained fiscal deficits …
Sound policies and institutional features can go a long
way to attracting and sustaining a healthy demand for domestic assets.
Australia, for example, has demonstrated considerable resilience, despite
having sizeable current account deficits for much of its history - its vulnerability
is less than what its headline negative NIIP [net international investment
position] might suggest because its foreign liabilities are mostly in
Australian dollars, foreign currency debts are well hedged, macroeconomic
policies are sound, and its economy shows no signs of major economic
distortions. [emphasis added]
Australia’s current account deficit in the September 2022
quarter is relatively small and most likely temporary. Rather than focusing on
the deficit itself, it is arguable that policymakers should pay greater
attention to the international and domestic factors that led to the deficit,
and consider whether these factors will continue to influence the Australian
economy.
Conclusion
A decline in the trade balance surplus and a widening of the
primary income deficit have shifted Australia’s current account position from
surplus to deficit in the September 2022 quarter. While this was foreshadowed
in March 2022, it is doubtful that the deficit will reach the Treasury’s
initial forecast of 3.25% of Australia’s GDP for the remainder of 2022–23
because the decline in the trade balance will be offset by a strong global
demand for Australian energy commodities and agricultural exports.
Economists disagree on whether a
persistently large current account deficit signals deeper economic problems and
whether the deficit should be managed. As with most things in life, the answer
is ‘it depends’.
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