AUSTRALIA faces a flood of foreign capital as the mining boom boosts export receipts and makes the country a more attractive place to invest in, according to Reserve Bank research.
Mining iron ore in the Pardoo, Western Australia.
Inflows could increase by as much as 10 per cent of GDP, or about $120 billion a year, as global investors decide to invest in Australian resource projects and companies.
The inflow would put further upward pressure on the Australian dollar, says the June 2010 paper, "The effects of large increases in capital inflow for Australia", by RBA economist Kristina Clifton.
Strong corporate demand over the weekend pushed the Australian dollar to a post-float high of $US1.0296.
The research paper, which was included in advice to the RBA board and obtained by The Australian under the Freedom of Information law, presents a new twist on the resources boom.
Not only is the economy being inundated with direct foreign investment in resource projects, but the boom could create a virtuous cycle in which portfolio investors also choose to sink their funds in the Australian dollar.
The paper says a key policy response for Australia to offset this upward pressure would be to invest offshore through a new future fund, such as a stabilisation fund or a sovereign wealth fund.
"Offshore investment has the advantage that it will reduce the upward pressure on the real exchange rate and resulting negative effects on the tradable and import-competing sectors," it says.
Reserve Bank governor Glenn Stevens has called on the government to consider setting up such a fund to ensure that Australia does not waste the proceeds of the resources boom, and that the economy is less adversely affected by sharp swings in national income. Several leading business figures have also supported his call.
The Greens have publicly support the policy, but not Labor or the Coalition.
The paper says Australia will be more attractive to investors now that interest in the US currency is waning. The prospect of inflows to Australia increasing is in step with the declining share of the US economy in global GDP, says the paper.
Ms Clifton says some emerging countries are now raising the possibility "that the US dollar will not be the sole reserve currency in the longer term".
Private investors are likely to increase their portfolio investment in Australia "in anticipation of the resource boom", she says.
The potential size of the inflow is based on the assumption that foreign investors might increase their holdings of Australian assets by about 10 per cent over a two-year period.
Foreign investment in Australian as a share of global investment is 1.8 per cent. The paper looked at what would happen if that rose to 2 per cent for a period of two years. The result is an increase of investment inflows of about $120bn a year.
The RBA paper says one solution to smooth this impact is to create a "stabilisation fund", which could evolve into a sovereign wealth fund for long-term accumulation that would transfer assets to future generations.
The paper explains the danger of allowing increased tax revenue from resources to flow through to the economy, as happened with the Howard government's spending of a $300bn windfall in its last three years of office.
It explains the difference between the two types of funds, and how one could morph into the other, depending on the length of the boom.
The increasing popularity of the dollar has been noted by some analysts, who say that in response to the decline of the US currency it has become a new hard currency.
Commodity analyst Peter Strachan said wealthy Asian investors who had traditionally put their savings into US dollars were now switching to the Australian currency.
"In Hong Kong, people say you buy gold or you buy Australian dollars," Mr Strachan said.
MARKETS BUOYANT P22
©theaustralian.com.au
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