by Michael Collins, Investment Commentator at Fidelity - March
2014
Australia’s economy has grown for more than 22 years without
interruption. The country can
boast years of close to full employment and tame inflation. Government debt is
low by international standards. As a result, Australia is one of the few
countries that can boast the highest-possible ratings from all the major global
credit-rating agencies. Foreign confidence in the country has helped drive the
dollar to record post-float highs.
Such are the well-documented achievements of the Australian
economy in recent years. Yet over that time our economy has contained a time
bomb that belies the complacency that has set in among the population and
investors. This is the rarely-spoken-about pile of foreign debt that is the
result of 40 years of uninterrupted deficits on the current account, which
records a country’s trade in goods and services and its income flows with the
rest of the world.
A current-account deficit can be viewed as a country’s savings
shortfall that is funded by foreigners through the capital account, the other
side of the balance of payments. (The current and capital accounts must add up
to zero.) Current-account deficits are not bad per se if they are bankroll
investment opportunities that will earn the foreign exchange that helps repay
foreign capital. Until these borrowed foreign savings are paid back, they sit
among a country’s liabilities as foreign debt.
There is a risk that, at some point, global investors would
baulk at adding to Australia’s foreign debt, which stood at $852.8 billion on a
net basis (after allowing for foreign loans owed to Australians) on 31 December
2013. This is equal to a record 55.5% of GDP, a high ratio by international
standards. Net foreign debt exceeded Australia’s so-called net international
investment liability position of $829.8 billion on that day. Our net foreign
equity assets of $23.1 billion on that day explain the difference. (The
December quarter marked the first time that an asset position was recorded on
net foreign equity.)
These debt numbers show that at any time, Australia could face
an economic crisis if foreigners became less willing to sending their
savings. This is especially so as about 81% of our gross foreign debt of $1.63
trillion is held by private investors, while about 21% of this gross debt has a
maturity of less than 90 days. That almost means about $340 billion of our
gross debt needs to be renegotiated at acceptable rates every three months for
Australia’s economy to run smoothly. What is happening to the most tormented of
emerging countries and their currencies could easily be Australia’s fate. Many
of these nations have lower foreign-debt ratios than Australia and a falling currency only adds to a
country’s foreign debt in local-currency terms.
Happily, the chances of a crisis erupting in Australia centred
on its foreign-debt burden are now fading. Six liquefied-natural-gas projects
(built at a cost of about $200 billion) are set to earn enough export income
over the coming two decades to soon tip Australia’s current account into
surplus, according to some forecasters. The optimistic predictions, if correct,
herald profound benefits for Australia.
Australian indifference to its foreign debt (as distinct from
the angst over small levels of government debt) is justified to some extent.
There have been no signs that a crisis in investor confidence is brewing over
the issue. Our stable and largely corruption-free politics, strong civil and
legal institutions, relatively high interest rates and many investment
opportunities seem to soothe any concerns foreign investors might have about
Australia’s creditworthiness. But there was no forewarning of the
current-account and foreign-debt crises of the mid-1980s that sent the
Australian dollar below 50 US cents for the first time and prompted rating
agencies to cut our credit rating. Net foreign debt was only about 30% of GDP
when then-Treasurer Paul Keating in May 1986 warned that Australia was becoming
a “third-rate economy, a banana republic”, though admittedly inflation at 9%
and a federal deficit at close to 7% of GDP were higher then. No one can rule
out a replay of the crisis of the 1980s, for net foreign debt above 30% of GDP
is regarded as worrying. Foreign investors are fickle and no country can borrow
endlessly.
Weekly
Indices:
The
Australian All Ordinaries Index has moved up increasing by +0.3%
since closing last Friday to 12:10 pm today.
The
rest of the world as measured by the MSCI index decreased -8.1%
in A$ from closing last Friday to end of trade Thursday.
Have a good weekend,
The team at IPS
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