External Balance Defining The Problem, Policy Implemented To Deal With The Problem Of External Stability.

1030 words - 4 pages

EXTERNAL STABILITYExternal stability or external balance is a general term which describes a situation where external indicators such as the balance of payment, foreign liabilities and the exchange rate are at a sustainable level, that is, a level where they can remain in the longer term without negative economic consequences. The past two decades saw the sweep in of globalisation, what was also seen as was the significant levels of external imbalance in Australia, which resulted in challenges on all three key indicators of external stability.Balance of payment is influenced by a wide range of domestic as well as international factors. The problem associated with the balance of payments is the growing current account deficit (CAD). Over a period of time a high CAD will contribute to an increased level of foreign liabilities. It is a general rule of thumb that if the CAD is above 6% of GDP there is a problem. It is a problem because any outflow in the current account must be matched by an equivalent inflow in the capital and financial account. Thereby, a deficit in the capital account will result in a surplus on the capital and financial account.There are two components of foreign, net foreign debt and net foreign equity. A current account deficit results in financial inflow, either in form of borrowings from overseas (foreign debt) or through selling equity in items such as property and companies (foreign equity). Therefore CAD, especially high levels of CAD, means that lenders may become more reluctant to lend to Australia or to invest in Australia, and decisions affecting the Australian economy will increasingly be made by international businesses and not by Australians.The money borrowed must be eventually repaid and the debt must be serviced. Increased servicing costs associated with high levels of foreign liabilities impose a substantial servicing cost, reflected by the large net income deficits on the CAD. Foreign debt must be serviced through interest payments that vary according to the level of interest rates in Australia and overseas, and profits must be returned on foreign equity investments. Thus, a high foreign debt can create a vicious cycle, contributing to the problem of a debt trap, where Australia is borrowing money to service its existing foreign liabilities.In the long-term, rising foreign debt in Australia can lead to a debt sustainability problem. This means that over time Australia will find it harder to service its debt. If the size of the debt is rising faster than the increase in GDP, the interest repayments take up a greater proportion of or GDP. As a result, this reduces both Australia's overall living standards and the economic growth potential of the economy.As mentioned, high current account deficits represents a constraint on future economic growth, in the long-term. The current account deficit acts as a speed limit on economic growth. Higher levels of economic growth generally involve an increased imports and...

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