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- Global Research
- General Research Insights
Australia: Embracing the global opportunities … part 3, capital flows
Cross-border financial connections are the grease which keeps the Australia’s growth engine lubricated, allowing the country to take best advantage of its global economic opportunities. An open capital account, and deep, liquid and sophisticated financial markets support these connections. For most of Australia’s history the country has been a net importer of capital, with local investment exceeding local saving. In recent times, the country has more regularly been a net exporter of capital, as more local superannuation saving – a rapidly growing, large pool of funds – is invested globally. Policymakers ought to remain focused on reform to make the economy as competitive as possible to continue to attract much needed foreign investment to facilitate and underpin growth.
As we wrote about in part 1 and part 2 of this three-part series, trade and migration flows are critical growth engines for Australia. Global financial connections are a third key element.
Australian policymakers have long recognised the importance of strong global financial connections. Opening Australia's capital account and the floating of the Australian dollar over forty years ago were critical reforms that have supported growth and improved the stability of the economy.
Deep, liquid and sophisticated financial markets formed as the market and policymakers adapted.
As is well understood, being a large commodity exporter subjects the economy to the high volatility of commodity price movements, but institutions and markets have developed to stabilise the local economy in the face of this. A critical feature has been the floating currency and independent central bank, but a well-regulated and managed financial system are also key.
Much of Australia's daily cross-border financial transactions are portfolio movements, in equities, debt and derivatives. So large are Australia's financial connections to the world that the AUD-USD exchange is the sixth most traded currency pair in the world (BIS, 2022), despite Australia being only the 13th largest economy (World Bank, 2023).
Australia’s strongest financial connections are with Western countries. Around 61% of Australia’s foreign liabilities – the accumulated stock of capital inflows – are with the US and Europe. Likewise, around 62% of Australia’s foreign assets are with the West.
Capital account connections to Asia are smaller than those to the West. The strongest connections are to Japan, which accounts for less than 6% of Australia’s foreign liabilities. Foreign investment from Mainland China and Hong Kong together account for 5% of foreign liabilities. Asia as a whole is around 16%.
In short, the country-composition of Australia’s cross-border financial linkages is quite different to its trade and people connections, with the latter dominated by Asia and the former mostly with the West.
In some ways, given the strong trade connections to Asia, Australia is a platform for Western investors to get high exposure to the Asia growth story. This is particularly clear through the resources sector, which dominates Australia’s exports and which is predominantly foreign owned.
Broken up by type, the stock of financial connections – for assets and liabilities – is a mix of foreign direct investment, portfolio holdings, of equities and debt as well as cross-border bank funding connections. Over 50% is portfolio, reflecting historical demand for Australian government bonds and the growth in Australia’s equity market. FDI accounts for 26%.
Naturally, as Australia's growth story has shifted, so too have the cross-border capital connections.
In the earlier part of the century, Australia's enormous mining investment boom played a large role, as did the housing price boom at the time. The mining sector attracted a surge in FDI into Australia, though a high share of foreign ownership in the mining sector also saw income flow offshore. Banks also avidly increased their wholesale funding in global markets, underpinning a local lending boom in the early 2000s.
When the mining boom ended, property still played a key role, and more recently a large local pipeline of infrastructure investment has been partly supported by foreign capital. After the Global Financial Crisis, banks shifted to more local deposit funding.
Local savings has also accumulated in Australia's superannuation system, which is now worth $A3.9 trillion (180% of GDP) and the third largest in the world. This has been funded by a policy mandate that employers contribute what is now 11.5% of workers' pay to a separate individually held pension fund, a programme which started in 1989.
In addition to the inflow of funds, the large pool of superannuation saving also reflects the stock value mining companies, banks and other listed firms, which have of course benefited from strong resource exports.
In recent years, lower mining investment and a boosted local pile of superannuation saving have shifted Australia's current account from persistent deficits, to more regular surpluses over the past few years. That is, Australia has become a net capital exporter, rather than an importer.
In tandem, Australia's net foreign liabilities – which tracked broadly sideways at around 50-60% of GDP from 1990 to 2020 – have fallen sharply, to 27% of GDP. Net foreign equity has shifted from a large liability position to a net asset position as Australia's superannuation holdings of foreign equities have risen rapidly.
An open capital account, which is market-driven on the back of a well-regulated and stable local financial system have collectively played a critical role in allowing the Australian economy to embrace the global opportunities.
Maintaining this is critical. In addition, policymakers need to navigate the shifting geopolitical environment, while still taking best advantage of the opportunities that come from large-scale foreign investment. This is tricky, but the key to be as consistent and transparent as possible on foreign investment rules and decisions.
Like trade and migration, Australia's global financial connections are key engines that support the economy's growth prospects. All three linkages – trade, migration and capital flows – are fundamental drivers of Australia’s economic success and managing all three well should continue to support Australia’s global growth opportunities.
