our current account dilemma

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    Today, the Current Account Deficit (CAD) figures for the December Quarter were published by the ABS. Officially, the figures demonstrated that our external imbalance has now hit 7.1% of GDP.

    The likely March Quarter figure could top out at 7.5% (for the reasons explained, below).

    This is significant as it comes on top of yesterday's 2nd worst trade deficit result (ie: the $2.7B January trade deficit).

    Chiefly, our CAD is made up of 2 primary components:
    the trade balance (or deficit); and
    the net income balance.

    Traditionally, the net income balance has been a negative figure whereas our trade balance has, at times, traded in surplus (as well as deficit).

    The trend revealed by the December Quarter CAD was, however, somewhat worse than expected.

    In the main, this was due to the rapid and accelerating deterioration in our net income balance.

    12 months ago (ie: 4q03), this stood at 3% of GDP, whilst our trade deficit stood at 2.8%. At the time, our CAD was 5.9% of GDP.

    Today, our income balance (deficit) stands at 3.8% of GDP, whilst our trade deficit is 3.2% of GDP. Our CAD is 7.1% of GDP.

    Throughout 2004, our income balance averaged 3.3% of GDP, vs our trade deficit average of 3.0%. During the same period, our CAD averaged 6.4% of GDP.

    What, however, is quite disconcerting is the rapid deterioration in the net income balance, measured as a proportion of GDP, as the following demonstrates:

    % OF GDP
    2Q03 2.8% Stable
    3Q03 2.7% Stable
    4Q03 3.0% Deteriorating
    1Q04 2.7% (3.3%) Improving (one-off)
    2Q04 3.0% (2.9%) Deteriorating
    3Q04 3.5% (3.1%) Deteriorating
    4Q04 3.8% (3.3%) Deteriorating

    In the same time period, our trade deficit has been relatively stable, as the following demonstrates:

    % OF GDP
    2Q03 3.4% High
    3Q03 3.3% Improving (gradual)
    4Q03 2.8% Improving (strong)
    1Q04 3.2% (3.2%) Deteriorating (one-off)
    2Q04 2.5% (3.0%) Improving (one-off)
    3Q04 3.2% (2.9%) Deteriorating
    4Q04 3.2% (3.0%) Stable

    Given yesterday's January trade deficit, it now seems quite likely that the March Quarter trade deficit will grow to ~$7.5B.

    It is likely that the net income balance will further deteriorate to ~$8.6B.

    Overall, the March Quarter CAD will likely deteriorate to $16.3B (including miscellaneous adjustments).

    As a proportion of GDP, this suggests that the March Quarter CAD could well top 7.5%, of which:
    net income balance = 4% of GDP; and
    the trade deficit = 3.5%.

    The future direction of our CAD, therefore, seems to be reflected in a net income balance (or deficit) of >4% of GDP, and an oscillating trade deficit averaging well above 3% of GDP.

    Once all this becomes apparent to the markets, it is quite likely that a sharp and sustained $ adjustment will be required and that the RBA and the Federal Government together will need to carefully address the situation.

    So-called higher export prices for our extracted commodities from April onwards, however, is simply not going to do the trick.

    Australia's external imbalance is much worse than that of the USA, and our capacity to redress it is that much more constrained.

    Our imbalance is now heavily structural (ie: income balanced) in nature and nothing short of running sizeable trade surpluses in the future will re-dress that problem. Canberra indeed has a problem brewing up.
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