1980s, at around 10 per cent. one could argue that housing assets should be excluded from this latter measure, since foreigners ’ participation in the housing market is relatively limited. on that basis, the ratio rose somewhat in the early 1990s, but has been relatively steady since. in short, these measures do not suggest the build - up of any significant disequilibrium in the economy resulting from foreign liabilities. for developed economies with a floating exchange rate and the capacity to borrow offshore in their own currency, the risk from rising foreign liabilities is not that they will cause a traditional balance of payments crisis, but that they will undermine financial stability. the process by which this can happen typically starts with a country, for one or more reasons, becoming attractive to foreign investors. capital floods in, overwhelming the capacity of the economy to use it productively. credit is misallocated and eventually there is some form of a domestic financial crisis. this type of crisis can occur even in highly sophisticated economies, as illustrated by the recent sub - prime crisis in the united states. the policy challenge for countries in this situation is to ensure that the ready availability of offshore funds does not end up distorting or weakening the financial side of the economy. as the recipient of large amounts of offshore funds for much of the post - float period, australia has had to remain alert to these challenges. by and large, it has been able to successfully absorb significant amounts of offshore capital over many years. there are several factors that have contributed to this : first, the country ’ s foreign liabilities are virtually all either in australian dollars or hedged back to australian dollars. 2 australia is able to do this because foreign investors are happy to hold a certain proportion of their assets denominated in australian dollars. this means that australian borrowers do not face foreign exchange risk on the capital sourced from overseas. therefore, if sentiment turns and the exchange rate falls, domestic borrowers are largely unaffected. the large swings in the exchange rate of the australian dollar that have occurred over the past couple of decades in no way threatened the corporate and financial sectors. second, the offshore capital that has flowed into australia has been used essentially to fund high levels of investment. australia uses foreign capital not because its national saving ratio is low, but because its investment ratio is high by the standards of developed economies ( table 2 ). in the past decade, for example, the national savings rate in australia has averaged 22 per cent, much the same

as in europe and well above the figure of 15 per cent in the us and uk. over the same period, the investment ratio in australia averaged 27 per cent, whereas in most developed economies it has averaged around 20 per cent. this high ratio of investment to gdp d ’ arcy p, m shah idil and t davis ( 2009 ), “ foreign currency exposure and hedging in australia ”, rba bulletin, december, pp 1 – 10. is, i believe, an indication that australia is using foreign capital productively, and sustaining the capacity of the country to service that capital. third, credit standards, by and large, have remained robust and the amount of capital wasted through bad loans has remained limited. foreign borrowing by banks within australia ’ s total foreign liabilities, the proportion accounted for by the foreign borrowing of australian banks has increased. virtually all this rise took place through the decade of the 1990s. banks accounted for a little over 20 per cent of australia ’ s foreign liabilities in 1990 but, by 2001, this had risen to around 40 per cent. it has not changed much in the past decade ( graph 9 ). part of this trend was the result of banks adjusting their balance sheets following financial deregulation and the growth of financial markets. these developments gave banks the opportunity to move from deposit funding to various forms of funding through markets, as a way of diversifying funding sources or reducing funding costs ( graph 10 ). the growth of the superannuation industry, following government decisions to promote compulsory superannuation, probably contributed to this trend. firstly, it meant households became less inclined to hold their savings as bank deposits, and second, the pool of funds created by superannuation increased demand for securities such as bank securities. within this trend away from deposits to funding through securities markets, there were also forces that resulted in banks increasing their use of offshore funding. as an example, a substantial proportion – about 20 per cent – of superannuation savings flow offshore, mainly into foreign equities. this reduces the pool of savings available domestically to banks and, other things equal, increases the amount of offshore funding banks need to undertake. it is also an inescapable fact that, with australia running a current account deficit, some funding for the economy needs to come from offshore. households, by and large, cannot borrow offshore and the government sector has not had much need for offshore funding. that leaves the corporate and the financial sectors. of these