Foreign Investment

Australia’s Net international Investment Position (NIIP) records the stock or level of foreign investment into Australia (FOA) and the level of Australian investment abroad (AIA).

The net? International investment position (NIIP) of a country is a financial statement of the value and composition of its external financial assets and liabilities.

• A positive IIP value indicates that it is a creditor nation, while a negative value indicates that it is a debtor nation.

The stock of foreign investment into Australia is referred to as foreign liabilities

• A LIABILITY is something you OWE

The stock of Australian investment abroad is known as foreign assets

• An ASSET is something you OWN

Examples of Foreign Assets and Liabilities:

• If a firm in the United states invests in the Australian share market or invests money into the Australian financial market, this represents an increase in Australia‘s foreign liabilities - an increase in net capital inflow or inbound foreign investment.
• If, on the other hand, an Australian firm buys shares in an overseas company or lends money to a foreign bank then this would represent an increase in Australia foreign assets – an outflow of capital or foreign investment abroad

Foreign investment – an inflow of money from overseas & an outflow of money outward overseas (refers to the flows of money between countries both in and out)

• Foreign liabilities – created when Australian residents borrow from overseas or sell assets such as shares to foreign residents
• Foreign assets - created when Australian residents lend money to foreign residents or purchase foreign assets - It is called Australian investment abroad and is an outflow of money

Foreign Liabilities > Foreign Assets = A negative IIP value (!!!does not mean its bad)

It is interesting to know that the rate at which foreign assets (97% of GDP -> 155% of GDP) increased is higher than foreign liabilities (155% of GDP -> 193% of GDP).

Net foreign liabilities have been increasing over 2010 to 2022 by 10%.

• BUT measured as a percentage of GDP, net foreign liabilities have actually decreased significantly – from 58 per cent of GDP in 2010 to 37 percent in 2022.

Debt and Equity (ignore for now):

• Debt - Borrowing (inflow cash) or lending (outflow cash)
• Equity - purchases (outflow cash) and sales (inflow cash) - these are same as buying and selling
• If Australian residents (households, firms or government) borrow form overseas, then this increases Australian foreign debt liability
• If Australian residents sell assets to overseas residents, then this increases Australia’s foreign equity liability.
  • Sell assets -> Outflow of money -> Liability
• Australia’s net foreign debt in 2022 was 1,158 billion dollars, while net foreign equity was -$324 billion – Why is the equity figure negative?
  • This means that Australia now owns more foreign equity than it owes, so in fact net foreign equity is no longer a liability – it is now an asset.
• Borrowing funds is seen as being a more prudent and flexible approach compared with selling assets.
• Foreign debt (borrowing) needs to be serviced with interest payments, while foreign equity (sales) involves the remittance of profits and dividends.

Foreign Investment and Current Account

Income payments are recorded in the current account in the balance of payments

• Remember that foreign investment flows are recorded in the financial account
• Normally Australia will record a financial account surplus and hence a current account deficit

Australia’s foreign liabilities are greater than its foreign assets which means that more foreign investments flows into Australia than flows out and most of this capital inflow is in the form of borrowing (debt rather than equity).

Servicing costs associated with foreign liabilities result in a current account deficit due to dividends and profits.

It is important to remember that the current account balance reflects the gap between national saving and national investment (S-I gap), so a higher level of investment will increase the nation’s capital stock

• This will expand the economy’s productive capacity (potential growth) and provide for future income growth

Expressing foreign liabilities as a proportion of an economy’s GDP is also not the most relevant measure and in fact can be quite misleading

• Foreign liabilities are a stock variable (accumulated over time) while GDP is a flow variable

A savings gap that is filled by foreign liabilities, because of our high investment to savings ratio.

Foreign Investment

Every year there is a flow of foreign investment into Australia which adds to this stock.

If this inflow of foreign investment exceeds the outflow, then there is a financial account surplus. - this is the majority of Australia’s BoP status

• If Australian investment abroad exceeds the inflow, then there is a financial account deficit – this happened in 2020 to 2022

Foreign investment may take the form of borrowing or it may be in the form of equity – the selling of assets (shares of companies, resources) to overseas residents.

• Australia has, for most of its history been a financial capital importer.

Most important categories of foreign investment is the portfolio and direct investment.

• Portfolio investment is the dominant type of foreign investment in Australia - Accounting for around one half while direct investment makes up one quarter of the total.

Direct Investment

Foreign direct investment occurs when a foreign investor establishes a new business or acquires 10 percent or more of an Australian enterprise.

• The 10 percent measure provides the foreign investor with ‘significant influence’ over that enterprise.

Examples of foreign direct investment include the establishment of Australian branches of multinational companies or joint ventures between Australian and foreign companies.

• Joint Ventures are partnership more or less split 50-50

Direct investment is associated with a degree of ownership and/or influence of Australian enterprises and resources.

• In this way (foreign) direct investment is viewed as more long term and stable

The reinvestment of earnings is specific to direct investment and refers to the income retained from after tax profits that would have other wise left the economy and travelled to the direct investor.

• Many people are under the impression that all profits and income accruing from foreign investment leave the economy - But this is not the case
• A large proportion of this income is retained in the business.

Portfolio Investment

Portfolio investment refers to all other foreign investment that is not direct investment – in other words, when overseas firm purchases less than 10 percent of the shares of an Australian company.

• This means that portfolio investment does not result in foreign control of Australian enterprises.
• Examples of portfolio investment include the purchase of property and/or shares in Australian companies as well as the purchase of government bonds by foreign superannuation or pension funds.
• Portfolio investment is viewed as being more speculative than direct investment

Portfolio investment comprises both equity securities and debt securities (borrowing) such as the issue of bonds and notes (securities such as shares and stocks)

• DEBT (borrowing) securities form the most important sources of portfolio investment accounting for around 63 percent
• This is the opposite case to direct investment where the dominant type is EQUITY (purchases) capital

This means that the portfolio investment is much more volatile than direct investment.

Factors affecting Foreign Investment

Foreign investment is influenced by a number of factors

• Profit expectations, interest rate differentials and political stability have all been important in attracting foreign investment into the Australian economy
• The Australian economy represents a secure and safe haven for financial capital [explain]
• The Australian economy is also well placed in terms of the fastest growing economies of east and south – east Asia (EXPLAIN)
• Over the past decade the Australian economy has been outperforming most of the OECD economies which has contributed to the large inflow of foreign investment (EXPLAIN)
• Australian interest rates are often relatively higher than most other developed economies which also attracts portfolio investment chasing high returns on yields (refers to bonds). (EXPLAIN)
• Australia has a well developed and regulated financial market which offers low risk returns (EXPLAIN) Risk is clearer, decision makers can have a better understanding. Transparent.
• Australia is a resource rich nation which depends on the inflow of financial capital to supplement its own domestic savings to enable it to develop its vast mineral and energy resources (EXPLAIN)

There is a high level of foreign ownership of Australian business firms, but this is incorrect.

• Australian businesses with foreign ownership greater than 10 percent accounts for just 3 percent of all business firms.
• The industry in which the level of foreign ownership is high is the mining industry where 28 percent of mining businesses have foreign ownership greater than 10 percent.

The 3 main sources of foreign direct investment are the United states, Japan and the United Kingdom.

• These three countries account for over 40 percent of all foreign direct investment in Australia.

Costs and Benefits of Foreign Investment

Investment refers to spending on capital goods such as machinery and construction including new housing.

Direct Investment

Foreign Investment also boosts domestic investment.

• Investment expenditure is a component of GDP and plays an important role in the economy.
• It increases the level of economic activity - employment and national income and prices.
• Investment also expands the productive capacity of the economy by increasing the stock of physical capital – in other words it moves the economy’s production possibility frontier outwards.
  • Productive Capacity -> Long Run Aggregate Supply Curve (LRAS)

S-I Gap:

• The amount of investment an economy can undertake is determined by the level of savings.
• If domestic savings are low, then for investment to expand foreign savings must be used.
• Australia normally relies on foreign investment because its investment needs exceeds its level of savings

Foreign investment can help increase the economy’s infrastructure, including transport and communications networks.

• By increasing the capital – labour ratio it can increase labour productivity, leading to higher real incomes.

The most important benefit of foreign investment for Australia has been the development of our industries and resources - Without the large amount of foreign investment that has flowed into Australia, the mining and manufacturing sectors would have been much smaller.

Inflows of foreign investment have also helped to finance the growth of Australia’s stock of housing.

Direct foreign investment has the advantage that it can bring with it new technology and managerial expertise.

Overseas firms establishing new subsidiaries will directly add to employment and contribute to increased taxation revenue for the government

• A large percentage of profits of these firms are also retained and invested back into the enterprise

Portfolio Investment

The general state of the economy, the level of interest rates, government stability and the performance of the share market are all factors affecting short term capital movements.

Portfolio investment is a function of short term profitability and is highly sensitive to relative interest rates.

• The interest rate differential between Australia and the rest of the world plays an important role in the movement of portfolio investment in and out of the Australian economy. (Bonds - Debt)
• When interest rates in Australia rise relative to the rest of the world, then capital inflow in the form of portfolio investment increases.

Costs

The cost of foreign investment are associated with the supposedly twin ‘evils’ of foreign ownership and foreign debt.

• When most capital inflow was in the form of equity, the major concern was the ‘selling’ of Australian assets.
• Foreign equity investment into Australia has declined in recent decades being replaced by borrowing.

It is a fact that interest payments on foreign debt have become the largest debit item in the income category of the current account

• But as long as the foreign investment boosts Australia’s future productive capacity, then the servicing of the debt is not a problem.