Reserve Bank of Australia Annual Report – 1977 The World Economy and the Australian Balance of Payments
Economic conditions in major industrial nations improved modestly in 1976/77; with a renewal of growth in world trade, there was stronger demand for Australia's main exports.
Economic and Financial Conditions Overseas
Over the eighteen months to June 1977, the world economy made progress in emerging from the most severe recession since World War II. Real output in the major industrial economies grew by about 6 per cent in calendar 1976, after falling by 1 per cent in calendar 1975. Recovery from the deep trough was not smooth and even; a surge in the growth of real output in the first half of 1976 was followed by a pause during the second half of the year. Inflation, unemployment and unused capacity remained high. As Chart 3 shows, the pick-up in business fixed investment in the major industrial countries was subdued.
The United States, Japan and West Germany experienced more favourable growth and price performance in 1976 than most other developed economies, and, in particular the United States, emerged more quickly from the pause in late 1976. At the Economic Summit talks in London in May 1977, the governments of these three countries agreed to follow policies which would help create an environment conducive to expansion in other countries, but without adding to inflation. Forecasts for the other four Summit countries pointed to less rapid growth, and their governments indicated that their demand management policies would need to be more restrained in order to effect a further reduction in inflation.
Unemployment continued high in industrial countries in 1976/77. There were some short-lived reductions in unemployment in the early part of 1976 as growth in output picked up, but, by the end of that year, the average unemployment rate in OECD countries had risen again and was 5.2 per cent, about the same level as at end 1975. Unemployment has since fallen in the United States; elsewhere, unemployment rates have either shown little change or risen further and, with modest growth and continued inflation forecast over the rest of 1977, the prospect is not good for early reductions in unemployment.
Although there was concern that, with the pick-up in demand and activity in the first half of 1976, there would be renewed inflation, wage and price increases slowed in that year. In the OECD countries, consumer prices rose by about 9 per cent in 1976 compared with a little over 11 per cent in 1975 and about 14 per cent in 1974. The progress in reducing inflation was uneven; in major industrial countries, consumer price increases in 1976 ranged from a low of 4.5 per cent for West Germany to a high of about 17 per cent for Italy. The OECD average increase in hourly earnings was about 11 per cent in 1976 – down from around 14 per cent in 1975. Much more marked was the slowing of the increase in unit labour costs in the major industrial countries, from over 16 per cent in 1975 to around 1.5 per cent in 1976.
Indications are that inflation may have quickened in the first half of 1977 as increases in commodity prices, which were incorporated into wholesale prices early in 1977, began to reflect at the retail level. Also, the results of wage bargaining rounds in several countries point to increases in nominal wages about the same as, or a little higher than, in 1976. With that year's above-average productivity increases less likely to be repeated in the second year of recovery, increases in labour costs may be reflected more directly in prices. As well, businesses in some countries will seek further restoration of profit margins. Such factors underlie continuing concern about the persistence of inflation.
In a number of international forums, there seemed to be general acceptance that the pace of the restoration of growth in economic activity towards which policies are directed should be gradual, so as not to rekindle inflation. To that end, budgetary policy was tightened in a number of countries over 1976; several countries gave attention to reducing their public sectors' borrowing requirement and took measures to reduce public outlays or increase taxes. In the early part of 1977, governments continued to be cautious in using public expenditure to stimulate growth. The incoming Administration's proposals for fiscal stimulus in the United States were, in April, much reduced; West German and Japanese measures of stimulus were expected to provide no more than a mild boost to activity.
Monetary policies were also tightened in a number of countries during 1976. However, for the most part, a combination of subdued business loan demand and, in some cases, lower financing requirements of governments reduced the demand for funds so that the broad stance of monetary policy was not unduly restrictive. Growth in monetary aggregates in 1976 was generally about the same as, or lower than, in 1975 and in most major countries presented no great cause for concern. Those countries using guidelines (or target ranges) for the growth of monetary aggregates mostly appear to have been reasonably close to their announced goals. The setting of target ranges/guidelines for growth in monetary aggregates was a growing practice in 1975 and continued during 1976, with central banks in the United Kingdom and France joining other countries using such a framework. The adoption of such targets seems to imply a desire to avoid the disturbances which stem from excessive instability in the growth of monetary aggregates and a view that public commitment to moderate monetary growth can restrain inflationary expectations and underpin business confidence.
Movements in interest rates on national capital markets during 1976 and the first half of 1977 generally reflected weak private demand for funds. In some countries, where the exchange rate was not generally under downward pressure during this period (the United States, Japan and West Germany), short-term interest rates showed little change or, reflecting the weakness of demand for funds, fell a little. In other industrial countries, and particularly where the exchange rate was under pressure, some sizeable upward adjustments in short-term interest rates were made in the last months of 1976; some of these movements have since been largely reversed.
3 Economic Activity in Selected Countries
4 Commodity Prices and World Trade
Commodity Prices, World Trade and Payments
Non-oil commodity prices were higher in 1976/77, reflecting both some strengthening in aggregate demand and factors specific to individual commodities. In terms of aggregate indexes, (shown in Chart 4), prices rose to a new peak in July 1976, then remained steady over the second half of the calendar year. There was a further surge in commodity prices around the turn of the year, but some of these movements were later reversed. By end June 1977, prices were about 18 per cent higher than their level a year earlier. Movements in commodity prices were more muted for Australia's exports, reflecting both the composition of exports and the existence of long-term contracts for some products; such contracts had reduced the effect on certain exporters' returns of the earlier sharp decline in prices for some commodities.
The main impetus to higher overall commodity prices has come from food prices, largely as a result of extraordinary increases in prices for coffee and cocoa and, to a lesser extent, tea. Prices for other food items have generally remained close to their mid-1976 levels. With abundant harvests, wheat prices moved down a little over the year; beef prices increased from low levels. Sugar prices, which had been falling sharply, steadied. Fibre prices showed some strength and, with demand exceeding production and stocks low, prices for wool and cotton held up during 1976/77.
Non-ferrous metal prices rose sharply early in the second half of 1976/77. The price of copper (which was apparently affected by industrial and other disturbances to production) and of lead and tin led the way and rose sharply. Prices of other non-ferrous metals, which had been steady during the first half of the financial year, also recorded sizeable increases in this period. Some of the sharp upward movements were reversed in the last three months of 1976/77. The price of oil rose less rapidly in 1976 than in some earlier periods. Most OPEC countries raised their oil prices by 10 per cent in December 1976; some raised their prices by 5 per cent then but moved up to the 10 per cent level in June 1977.
As well as providing some lift to commodity prices, the general increase in aggregate demand during the first half of 1976 led to a renewed increase in world trade. In volume terms, world trade went up by 11.5 per cent in 1976 after declining by 4.5 per cent in 1975, the first such decline since 1958. With slower growth in domestic economies over the second half of 1976, world trade grew less rapidly in late 1976 and early 1977.
The U.S. trade account shifted sharply from surplus to deficit during 1976 and this deficit widened in the first half of 1977. Exports were sluggish, while imports grew strongly, partly reflecting very heavy payments for oil. The current account balance of the United States declined by around US$12 billion in 1976. This was the main factor in the sharp deterioration of the industrial countries' aggregate current account position with the rest of the world. The other two countries furthest along the track of economic recovery, Japan and West Germany, recorded surpluses on current account in 1976. The experience of most other developed countries was unfavourable; France, the United Kingdom, Italy and the Scandinavian countries again had sizeable deficits. Vis-a-vis the U.S. dollar, the exchange rates of Italy, the United Kingdom and France depreciated during 1976 while the yen and deutschemark both appreciated. In some cases, these exchange rate movements took place despite substantial exchange market intervention by central banks, supported by vigorous use of monetary policies, to oppose the rate shifts.
A continuing feature of world payments in 1976 was the existence of large imbalances on current account. The current account deficits of the developed countries and the non-oil developing countries were large in 1976 while the corresponding aggregate surplus of oil exporters was higher than in 1975 (though not as high as in 1974). The deficits have been financed by continuing very high levels of international lending and borrowing, a high proportion of which has been through major commercial banks. The ready supply of bank finance may have enabled some countries to postpone adopting policies to achieve fundamental adjustments to changed economic circumstances.
These issues have been the subject of considerable discussion in international forums during the year. The Interim Committee of the Board of Governors of the International Monetary Fund at its October 1976 meeting expressed the view that the emphasis should be more on the need for structural adjustment than on deficit financing. There has been a growing realization that, especially because of the low absorptive capacity of several major oil surplus countries, the adjustment problem is not a short-term one and that the role of commercial banks in financing deficits has become large in relation to that of official sources. An international consensus has recently developed that, in future, more emphasis should be given to the role of the IMF, possibly with some collaboration with private lenders, in the financing process. The Fund is well placed to play a key role in the financing and adjustment process because, in making finance available, it is the Fund's practice to obtain commitments from national authorities for necessary changes in policy. In view of the magnitude of the overall adjustment and financing problems, the Managing Director of the Fund has been authorised to seek additional resources, both from member countries in a general quota increase, and from a supplementary facility to be financed by OPEC countries and by industrial countries with strong balance of payments positions.
Another aspect of the Fund's operations during the past year or so has been the disposal of part of its gold stock. Since early June 1976, eleven gold auctions have been held and proceeds from sales totalling US$667 million have been transferred to the Trust Fund administered by the IMF for the benefit of developing countries. The first of four annual restitutions of gold to member countries took place in January-February 1977; Australia received 142,349 fine ounces of gold, at the IMF official price of SDR35 an ounce. The Fund has also continued to work towards the implementation of its new Article IV on exchange arrangements; in April 1977, it approved a set of procedures for surveillance of members' exchange rate policies.
5 Australian Exports and Imports
seasonally adjusted–quarterly
The Australian Balance of Payments
There were sharp fluctuations in Australia's external accounts during 1976/77, particularly in private capital flows. The turnaround in this aggregate followed on the devaluation of the Australian dollar in late November. Components of the balance of payments appear in Charts 5 and 6.
The current account deficit widened in 1976/77 to around $1,880 million from $1,100 million in 1975/76. The value of both exports and imports grew strongly, with imports rising a good deal faster; the surplus on visible transactions of about $1,060 million was $430 million less than in the previous year. The deficit on invisible transactions rose by about $350 million.
The value of exports rose by about 21 per cent to $11,400 million for 1976/77. Increases in volume were substantial for both rural and non-rural goods. There were some big rises in average returns; these reflected not only the impact of devaluation, but also higher world prices for a number of export commodities. As indicated earlier, average returns for wool and many metals were higher; on the other hand, prices received for wheat and sugar were lower.
Imports in 1976/77 rose by about 31 per cent to $10,350 million, with prices increasing by 14 per cent and volume increasing by around 16 per cent. Part of the increase in prices arose from the November devaluation. The rise in the quantity of imports was stronger than might have been expected in the light of such price rises, the subdued nature of domestic demand, and the existence of substantial excess capacity in some domestic industries. A strong flow of imports in the first part of the year could have been attributed to exchange rate expectations and a desire to build up depleted stocks; but the flow after devaluation was still quite strong. The outcome has been an increase in the share of imports in total supplies to levels higher than analysis based on past experience would indicate.
During the year, the Reserve Bank's position on forward exchange transactions varied with the balance of forward exchange business written by traders with their banks and with the maturing of previous contracts. The Bank's net over-sold forward position at 30 June was about $450 million; transactions early in 1977/78 reduced this figure.
On invisible account, there were sizeable increases in the deficits for both Australia's trade in services, $150 million and transfers, $200 million. Net payments for freight and transportation rose by almost 31 per cent. With better domestic profitability, property income payable overseas rose by about 9 per cent; returns from Australian investments abroad rose by 6 per cent. The net deficit on invisibles totalled $2,934 million.
There were sizeable fluctuations in capital flows during the year. Total net apparent capital inflow is estimated at $1,390 million. Private capital inflow totalled about $1,160 million and transactions for marketing authorities and official capital amounted to an inflow of about $230 million.
Movements in the capital accounts during the year fell into three phases. In the five months to end November, net inflow from government capital and marketing authorities' transactions amounted to $360 million; the major inflows were from two overseas fund raisings, a Eurobond raising of US$300 million in September and a public bond issue of US$200 million in New York in November. On private account, on the other hand, there was an apparent capital outflow of around $600 million over the same period. In the three months immediately following devaluation, there was some outflow of capital on official account. During this period, however, there was a massive private capital inflow of about $1,230 million. A substantial proportion of the inflow during those months appeared to comprise short-term flows arising from changed patterns of trade financing (the so-called “leads and lags”). In the final four months of the year, the pace of private inflow slowed markedly, largely because of the operation of borrowing controls imposed in January; for those months, net apparent private inflow totalled about $530 million.
6 Australian Balance of Payments
7 Exchange Rates
The overall balance of payments, which was in substantial deficit prior to devaluation, swung into surplus in the months immediately after devaluation then again moved into substantial deficit in three of the last four months of 1976/77; for the year as a whole, there was an overall deficit of $492 million. Excluding valuation effects, official reserve assets declined by $190 million. The difference between the two outcomes relates largely to the drawing of $A309 million (SDR332.5 million) from the International Monetary Fund's Compensatory Financing Facility on 2 July 1976; this drawing added to reserves, but being a transaction between the Reserve Bank and an overseas institution, it had no effect on domestic monetary conditions. At end June 1977, the market value of official reserve assets was $2,638 million, compared with $2,576 million in June 1976; the net devaluation during the year added substantially to the valuation of foreign reserves.
The Exchange Rate and Capital Controls
From around the middle of 1976, the Australian exchange rate came under considerable downward pressure. Following a heavy rundown in reserves, partly of a speculative nature, in December 1975, there had been little movement in reserves in the second half of 1975/76. Early in the new financial year, a downward trend in reserves emerged, and their level fell by about $470 million from the start of the financial year to late November, notwithstanding substantial net official borrowings (including the drawing from the Fund's Compensatory Financing Facility) of about $550 million. The major point of pressure was the private capital account. Compared with that in previous years, private capital inflow over the eighteen months or so to November 1976 had been very slow. In contrast, the current account deficit (a trade surplus being more than offset by a deficit on invisible transactions) was, relative to GDP, not as large as in many previous periods.
The weakness in the capital account partly reflected shifts in the pattern of trade financing transactions and similar precautionary actions by enterprises. Exchange risks also contributed to the reluctance of enterprises to borrow from foreign sources, despite lower interest rates. Potential long-term investors held off bringing funds into Australia, apparently in the thought that assets here might soon be cheaper. The main factors which appeared to enter into the assessments made by businessmen during the early months of 1976/77 included the trend in the overall balance of payments; relative inflation rates; the overall mix and thrust of economic policies; and the fairly easy domestic financial climate (which permitted the financing of “hedging” actions against possible devaluation).
Monetary policy was tightened early in November; but the drain in reserves continued unabated and, from 29 November, the Government devalued the Australian dollar by 17.5 per cent. New arrangements to manage the value of the exchange rate in a more flexible fashion were also announced. (The measures announced with the devaluation are listed on p. 8.) With the aim of minimising the transmission of price rises following the devaluation, monetary and fiscal policies were further firmed; the Government foreshadowed a firmer stance against wage increases before the Arbitration Commission, making the point (which was accepted by the Commission) that identifiable effects on the consumer price index of the devaluation should not flow on into wages.
The large devaluation was clearly decisive in altering short-run exchange rate expectations, and private capital flowed in at a fast pace. Under the new flexible exchange rate regime there was a series of small exchange rate appreciations in December. The trade-weighted value of the $A was raised by about 6 per cent over the month. Notwithstanding the partial reversal of the devaluation, the inflow continued strongly. It appeared to be in part the result of a substantial change in the pattern of leads and lags on trade transactions but, with a marked interest differential favouring foreign borrowings, there was also a flood of proposals for fund raising overseas by Australian entities. In the light of the overly liquid domestic monetary conditions then prevailing, applications to the Reserve Bank for authority to borrow overseas were considered closely; in general, approvals were given only where there was a clear need for early access to overseas funds. By end December, applications to Exchange Control to borrow large amounts ($1 million or more) overseas totalling $1,100 million had been received, of which around $400 million had been approved for drawdown.
To maintain firm domestic monetary conditions while, at the same time, preserving the beneficial effects of devaluation, in mid January the Government introduced a number of additional controls on overseas borrowings. During the months which followed, these borrowing controls were modified to ease their effect in particular circumstances, while for the most part preserving their restraining impact. The original measures and the modifications are detailed earlier in the Report (see pp. 8–9). With the introduction of the overseas borrowing restraints there was a slowing of capital inflows; from 17 January to the end of the financial year, borrowings totalling around $410 million were approved, of which about 12 per cent were subject to the variable deposit requirement.
In early July, the Government decided that the controls had served their purpose in ensuring that domestic monetary expansion was not excessive in the second half of 1976/77. The variable deposit requirement was suspended and the embargo period was shortened to apply, as before, to borrowings for less than six months.