Tuesday, 4 February 2014

Current Account Surpluses: The Norm for Australia?

Michael Blythe the Chief Economist at CBA Economic research has  this hypothesis for the future for Australia.

Current account surplus – or banana republic no more?
Australia may be at the start of an era of current account surpluses.
Funding flows, trade flows and income flows are evolving in a way favouring a shift to surplus.
Countries that run current account surpluses typically have strong currencies – the AUD could trade well above parity with the USD again.

Current account deficits are the norm in Australia.  Deficits have been recorded in 128 of the past 150 or so years.  The relatively rare surplus is typically associated with extreme economic events.  Wars and recessions seem quite effective in producing surpluses!  The historical experience has conditioned expectations and large current account deficits are expected to persist.  But we see a significant probability that surpluses emerge over the medium term. 
Current account deficits, like budget deficits, are widely seen as a problem.  They need to be funded and they lead to an accumulation of debt over time.  We need to tap into the savings of the rest of the world, leaving us exposed to the whims of global financial markets.  From this financing perspective, the current account deficit reflects a shortfall of domestic savings relative to domestic investment.  The gap reflects high investment rather than low savings.  By running current account deficits we have been able to sustain a higher investment rate than otherwise.  Economic growth rates and living standards are higher than otherwise as a result. 
Looking ahead, the flow‑of‑funds will evolve in a way that could produce a current account surplus (or net lending to the rest of the world).  Households will remain significant net lenders.  The change in household behaviour was underway before the financial crisis hit.  The pickup in household savings and reduction in borrowing appetite looks permanent.  Business net borrowing is set to decline.  The mining construction boom that drove business funding requirements to exceptionally high levels is ending.  Government net borrowing should decline.  The recent mid‑year review shows the Commonwealth budget deficit slowly declining.  We suspect, however, that the government will proceed further and faster than the baseline projections suggest. 
These shifts will narrow the gap between domestic savings and investment and reduce net borrowing from the rest of the world.  We may be generating small current account surpluses within five years. 
From a real world perspective, the move to current account surplus requires a shift to trade surpluses and a narrowing in the net income deficit.  A sharp rise in resource export volumes and a marked reduction in resource‑related capital goods imports as the mining construction boom winds down will drive the move into trade surplus.  The expanding middle income population in Asia should lift demand for Australian services exports as well.  On the income side, the broad macro backdrop suggests foreign liabilities should grow reasonably slowly.  But the expansion of Australian superannuation funds will boost foreign assets by more.  The net income deficit should narrow as a result.
Countries that run current account surpluses typically have strong currencies.  Examples include Switzerland, Japan and Singapore.  The argument is reinforced from the deficit perspective.  The fears about global capital flows generated by the Fed tapering debate in 2013 had a bigger negative impact on those emerging economy currencies with large current account deficits.  As a result, we would expect the AUD to strengthen should a persistent current account surplus emerge.  Abstracting from USD‑specific influences, the combination of a AAA rating and a current account surplus would likely see the AUD again trade well above parity to the USD.
Another feature of current‑account‑surplus countries is that average interest rates are lower than otherwise.  There are two reasons.  By definition, surplus economies have national savings running ahead of national investment.  They do not need higher interest rates to attract capital.  And the lack of reliance on global funding sources means surplus economies are often seen as safe havens and have lower risk premiums.'

 very very interesting.