Okay, in simple terms:
- We know that the NPI deficit is the major contributor to the CAD.
- So how does foreign investment cause the NPI deficit (leading to the CAD)?
- Well, we know that foreign investors will expect returns on the equity investment. So foreign owners of AU assets such as land, shares and companies (these are recorded as credits on the Australian KFA) receive rent + dividents + profits from these things (these are recorded as debits on the NPI).
- Since Australia has more investment inflows than outflows (overseas investing into Australia > Australia investing into overseas), it records more debits (interest/dividend/rent payments to overseas) than credits on the NPI component. Thus, this leads to the NPI deficit and therefore, CAD.
- ToT and CAD.
- The ToT affects the BOGS (a component of the Current Account) which influences the CAD.
- Better ToT (when export prices are increasing relative to import prices) --> better BOGS (smaller deficit or larger surplus) --> decreasing CAD.
- But a better ToT, especially from mining, results in a rising AU dollar (partially offsetting the benefits of rising export prices as our other export industries will lose their international competitiveness). Rising AU dollar --> encourages more import expenditure due to its ability to encourage consumers to purchase imports and when import spending > export receipts, the BOGS worsens.
