Ratings agencies want foreign debt back on the policy agenda
The Australian May 12, 2016 12:00am
David Uren
Australia’s foreign debt, which tops $1 trillion, has not figured in the policy debate since the early 1990s, but it is the biggest concern of the credit ratings agencies. They worry that if global markets lost confidence in Australia, it would be hard to roll over debts as they fell due, raising a risk of default.
With government deficits the biggest factor driving growth in the foreign debt, the agencies believe stronger action is needed to repair the budget. Economic growth will not be enough. Governmen¬t debt accounts for about a quarter of Australia’s foreign¬ borrowing¬, while the privat¬e sector dominated by the banks holds the rest.
Each agency has its own measures¬, but Standard & Poor’s compares a country’s foreign debt with its international income from its exports, royalties, dividends and interest. In the advanced world, Greece tops this ranking, with debts that are 3½ times its incom¬e. The US, which doesn’t have to worry about its foreign debt because¬ the US dollar is the global currency, comes next. Australi¬a is third, with debts more than twice the size of its income.
S&P’s sovereign risk indicators also show Australia is spending more of its international income on foreign debt interest payments than any other advanced country except Spain, while its current accoun¬t deficit is the third largest after Turkey and New Zealand.
As one of only 10 AAA-rated economies, Australia enjoys a high level of confidence from financi¬al markets. The Australian dollar has become the fifth most widely traded currency and global investors are impressed¬ with the strong performan¬ce of the economy since the global financial crisis and since export prices¬ and resource investment have been tumbling in the past four years. Australia’s performance has far outshone other resource¬ nations, including Canad¬a, Brazil and South Africa. There is eager competition among global investors to get a share of the $2 billion in commonwealth government bonds that Treasury puts up for auction every week.
But global markets are fickle and suddenly can turn tempestuous. During the GFC, the International Monetary Fund expressed alarm that Australia’s banks had borrowed¬ more than $200bn on global short-term money markets that had to be renewed every 90 days. It was only the government guaranteeing bank debts that staved off disaster. The IMF has always¬ worried about Australia’s global deficits, noting in its latest review that its external position is weaker than it should be.
China is the obvious risk to market confidence in Australia. An S&P review published last week looked at what would happen to the world economy if China’s growth rate halved in the next three years because of a fall in investment. Australia would be one of the hardest hit nations, with an almost 4 per cent hit to its gross domestic product and would suffer a credit rating¬ downgrade. Last week’s budget papers and the Reserv¬e Bank’s economic review both cited the Chinese economy as a source of uncertainty about Australia’s economic outlook.
The vulnerability generated by Australia’s persistent international deficits was a constant concern through the 80s and early 90s.
Paul Keating’s famous outburst that Australia risked becoming a banana republic was prompted by a particularly bad balance of payments report. The nation was spending more than it was saving and government deficits were contributing to this. It could not count indefinitely on the largesse of globa¬l investors to support its profligacy. Keating embarked on a campaign to slash government spending, which came down from 27.4 per cent of GDP in 1985-86 to 22.9 per cent by 1989-90. It was a performance Scott Morrison could only marvel at.
After Keating became prime minister in 1991, his treasurer John Dawkins commissioned a review of Australia’s savings performance from economist Vince FitzGerald. The Treasury officer leading the team that brought the report togethe¬r was John Fraser, now the department’s secretary. It argued that Australia’s growth would be stunted unless it was able to lift its savings rate, as foreign funding would not support our investment needs in the face of a gaping current¬ account deficit. The federa¬l government should seek to return its budget from an overall deficit to a persistent surplus.
However, through the 90s Australia’s economic debate was transformed by the arguments of the Australian National University’s John Pitchford. He said when companies or banks borrowed from overseas, borrowers and lenders were making a commercial decision that should be of no concern to government. The current account deficit, which resulted from Australians spending more on housing, business investment and government outlays than they saved, was a matter of “consenting adults”, he argued. With the eventual endorsement of Treasury and the Reserve Bank, this view resulted¬ in Australia’s foreign debt slipping off the policy agenda.
The current account deficit got no discussion in last week’s budget and was not mentioned in the Reserve Bank’s quarterly economic statement released on Friday. The foreign debt was not referred to in either document. However, it would not be surprising if Treas¬ury’s independent review of the budget, which must be published within 10 days of the election being called, draws the link between the persistent budget deficits and the risks from Australia’s dependence on international capital markets.
Treasury’s pre-election econo¬mic and fiscal outlook cannot be expected to contain criticism of the budget forecasts, which Fraser told the Senate economics committee last week he had signed off on before they were shown to Morrison. However, Fraser can be expected to use PEFO to show that we still have a budget problem, despite the projections of a return to surplus in the early 2020s. There are risks to the forecasts and our international exposure means we cannot build up public sector debts as do countries that run inter¬national surpluses.
Fraser, who is likely to step down after the election, spent 20 years in international banking and knows full well the harsh judgments global capital markets can reach. A wake-up call about the danger of assuming economic growth will be the answer to Australia’s budget hole would be timely for all contestants in the forthcoming election.