Domestic and Global Markets (HSC SSCE Economics): Revision Notes

Domestic and Global Markets

Introduction to financial market integration

Australian financial markets have become increasingly integrated with global financial markets over recent decades. This integration is characterised by substantial growth in foreign participation within Australian markets, including increased lending to Australia and greater foreign ownership of Australian companies. At the same time, Australians now have expanded opportunities to lend surplus funds overseas and invest in foreign companies.

Historical vulnerability to global financial events

Although global financial market integration has intensified recently, Australia's exposure to overseas economic events is not new. As a resource-rich economy, Australia has historically depended on foreign capital to finance its economic development. This reliance has always necessitated foreign participation in Australia's financial markets.

Historical examples of global events impacting Australian markets include:

• The global share market crash of 1929
• Rising international interest rates throughout the 1970s
• The share market crash of 1987
• The East Asian financial crisis in the late 1990s
• The global financial crisis (GFC) in the late 2000s

Drivers of increased market integration

Two key factors have accelerated the integration of Australian financial markets with global markets over the past three decades.

Information and communications technology

Advances in information and communications technology have transformed international financial transactions. These developments have:

• Reduced communication costs between market participants across borders
• Increased the reliability of electronic fund transfers
• Enhanced the speed of international transactions
• Enabled real-time monitoring of global market conditions

Financial deregulation

The deregulation of Australia's financial markets beginning in the early 1980s has encouraged greater foreign participation in domestic markets. Key policy changes removed barriers to international capital flows and allowed foreign financial institutions to operate more freely within Australia.

Foreign exchange markets

Foreign exchange markets serve a critical function by enabling the movement of funds around the world. Without the ability to exchange currencies, international investment and lending would be impossible. For example, a Japanese investor must exchange yen for Australian dollars before they can invest in Australian companies or lend to Australian borrowers.

The 1983 float

Australia became more open to foreign exchange markets in 1983 when two major policy changes occurred:

• The exchange rate was floated (allowed to be determined by market forces)
• Most exchange controls were abolished

Scale of Australia's foreign exchange market

By April 2016, the value of daily transactions on Australian foreign exchange markets averaged US$135 billion, representing approximately 2.6 per cent of the global total. The Australian dollar had become the world's fifth-most traded currency worldwide, reflecting Australia's significant role in international financial markets.

Global debt markets

Global debt markets play an important role in Australia's economic development due to the country's ongoing reliance on foreign borrowing.

Australia's international debt position

In 2019, Australia's international debt position showed a significant imbalance:

• Australians had approximately $1.2 trillion in loans to foreign entities
• Australia had outstanding foreign loans of nearly $2.3 trillion (almost twice the amount lent overseas)

This results in a net foreign debt position, meaning Australia owes more to the rest of the world than the rest of the world owes to Australia.

Role of financial institutions

Most international debt transactions are facilitated by Australia's four major banks, which source finance for domestic loans from overseas markets. Foreign banks have also established a stronger direct presence in Australia since they first established Australian operations in 1985, providing additional channels for international debt flows.

Equity markets

Equity markets differ from debt markets in their structure and regulation. They are regulated by national governments and therefore exist primarily within individual countries.

Structure of global equity markets

Major stock exchanges operate in individual countries:

• New York Stock Exchange (United States)
• Tokyo Stock Exchange (Japan)
• Australian Securities Exchange (Australia)

Some regional stock exchanges also exist, such as Euronext in Europe. International movements of funds between equity markets are dominated by large financial institutions including banks and superannuation funds.

Australia's international equity position

By 2019, cross-border equity ownership had reached significant levels:

• Australian ownership of foreign companies exceeded $1.4 trillion
• Foreign ownership of Australian companies reached approximately $1.3 trillion

Regulatory framework

The Australian share market remains primarily a domestic market with foreign participation rather than a fully global market. Key regulatory features include:

• Regulation by the Australian Securities and Investment Commission (ASIC)
• Review of significant foreign purchases of Australian shares by the Foreign Investment Review Board (FIRB)
• National sovereignty over market rules and listing requirements

International regulatory organisations

Global financial markets are not subject to the same level of regulation as domestic markets. However, some international organisations perform important coordinating and oversight functions.

Bank for International Settlements and Basel Committee

The Bank for International Settlements (BIS) is an international organisation that assists central banks (such as the Reserve Bank of Australia) in promoting financial stability through appropriate market regulations.

A related organisation, the Basel Committee, sets standards for banking regulations. Its broad objective is promoting effective and uniform financial regulatory systems around the world. This helps ensure banks in different countries maintain adequate capital reserves and follow sound risk management practices.

International Monetary Fund

The International Monetary Fund (IMF) oversees the general stability of the international financial system. Its key functions include:

• Monitoring economies and financial markets worldwide
• Providing policy advice to member countries
• Assisting countries experiencing difficulty meeting their international financial obligations
• Offering emergency lending during financial crises

Other regulatory coordination bodies

Additional organisations coordinate approaches to financial market regulation in specific sectors:

• International Organisation of Securities Commission (IOSCO): Coordinates regulation of share markets
• International Association of Insurance Supervisors (IAIS): Coordinates regulation of insurance markets

These organisations facilitate cooperation between national regulators and help develop consistent standards across countries.

Benefits and disadvantages of global financial market integration

The integration of Australian financial markets with global markets creates both opportunities and risks for the Australian economy.

Benefits

The primary benefits include:

• Access to foreign capital: Australians can access foreign capital to invest in houses and businesses. Without international finance, Australians would face higher borrowing costs or might not be able to access finance as easily.
• Investment opportunities: International financial markets offer Australians the opportunity to invest in businesses overseas and earn returns from foreign companies.
• Portfolio diversification: Investors can spread risk across different countries and markets.
• Competitive pressure: Foreign participation can increase competition and efficiency in domestic financial markets.

Disadvantages

The main disadvantages include:

• Transmission of overseas disturbances: Regular disruptions in overseas markets are more quickly transmitted to Australia, especially through financial market speculation. Volatility in international markets can rapidly affect Australian asset prices and market confidence.
• Foreign ownership concerns: Periodically, concerns arise about whether high levels of foreign ownership of Australian businesses might negatively affect the Australian economy in the long term. Some question whether Australia should impose greater controls to prevent overseas interests from owning large portions of Australian industries.
• Reduced policy autonomy: Deeper integration may limit the effectiveness of domestic policy measures, as international capital flows can offset or counteract government policies.

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