How can you Measure External Stability?

External stability is a key economic goal for countries, as it ensures that a nation's transactions with the rest of the world are sustainable over the long term. Measuring external stability involves assessing various economic indicators that reflect the health of an economy's external sector. There are various metrics used to measure external stability, including: Current Account Deficit as a Percentage of Gross Domestic Product (GDP), Net Foreign Debt as a Percentage of GDP, Net Foreign Liabilities as a Percentage of GDP, Terms of Trade, Exchange Rate, and International Competitiveness.

The Current Account Deficit as Percentage of GDP

A persistent CAD can indicate an over-reliance on foreign capital, which may lead to financial vulnerability. However, it can also reflect an economy investing in growth-enhancing projects. For example, Australia's CAD fluctuated around 3-4% of GDP in the early 2000s, reflecting strong domestic investment. In 2023, the CAD was approximately 2.5% of GDP, showing improved trade balances and external economic stability over the last few decades.

Net Foreign Debt as a Percentage of GDP

Net foreign debt represents the total amount owed by a country to foreign lenders minus the amount owed to it by foreign borrowers. As a percentage of GDP, it indicates the country's level of indebtedness relative to its economic output. For example, Australia's net foreign debt as a percentage of GDP was around 55% in 2023, reflecting ongoing borrowing to finance investment, though this has been managed sustainably.

Furthermore, high levels of foreign debt can potentially make a country more vulnerable to external economic shocks. When analysing a country's foreign debt situation, it's not just the overall level that matters; the composition of the debt (whether it's primarily public or private) and its maturity structure are also critical factors to consider. This is because these factors can significantly impact the country's ability to manage and service its debt obligations.

Net Foreign Liabilities as a Percentage of GDP

Net foreign liabilities include both debt and equity liabilities minus foreign assets. This measure provides a broader view of a country's external financial position. A high level of net foreign liabilities indicates significant financial obligations, which can be risky if the country faces economic shocks or if investor confidence decreases. For example, in 2023, Australia's net foreign liabilities stood at around 64% of GDP, showing a significant but manageable level of foreign obligations.

Terms of Trade

A country's Terms of Trade (TOT) measures the ratio of export prices to import prices. An improvement in TOT means a country can buy more imports for a given amount of exports. This indicates stronger economic health. Additionally, improved TOT can lead to higher national income and better standards of living. Conversely, deteriorating TOT can reduce income and economic stability. As of 2023, Australia's TOT remains relatively strong due to increased demand for iron ore by China and increased demand for other commodities across the globe.

Australia's consistent TOT growth, and increase in exporting its commodities and services, is demonstrated by the graph below.

The graph displays a linear trend over the past decade, showing the improvement in Australia's export volumes in the global market.

Exchange Rate

The exchange rate is the value of one currency for the purpose of conversion to another. It affects the competitiveness of a country's goods and services in the global market. A stable and competitive exchange rate supports exports by making them cheaper for foreign buyers. Volatile exchange rates can lead to economic uncertainty and affect trade and investment decisions. For example, the Australian dollar (AUD) has fluctuated between USD 0.70 and USD 0.80 in recent years, reflecting changes in commodity prices and global economic conditions.

Australia's inability to properly stabilise its exchange rate is demonstrated by the graph below:

As seen in the graph, Australia's exchange rate vs the US dollar has experienced moderate amounts of volatility over the last decade.

International Competitiveness

International competitiveness measures a country's ability to sell goods and services in international markets. It is influenced by productivity, costs, and exchange rates. Thus, higher international competitiveness leads to better trade balances, economic growth, and job creation. For example, Australia's competitiveness has been supported by improvements in productivity and favourable exchange rates. However, challenges still remain in maintaining this position amid global competition.