Wednesday, March 9th, 2016
A few months ago, following the release of the September Quarter national accounts, we opined that Australian’s would be shocked to learn when Australia’s net foreign debt breached $1 trillion in the December Quarter.
We were wrong on two accounts.
First, the net foreign debt had actually breached $1 trillion in the September Quarter. The ABS had actually underestimated the September Current Account deficit by $2 billion in its September quarter release; and
Second, last week the media and the Government jumped on the surprising GDP growth in the December Quarter and totally glossed over the National Foreign Debt – again!
The following table presents the latest estimates of external debt and deficits by the ABS for the last two quarters.
The ABS explained the Current Account machinations as follows:
“Latest Australian Bureau of Statistics (ABS) figures show that in seasonally adjusted, current price terms, the current account deficit increased $2,258m (12 per cent) to $21,106m in the December quarter 2015. Exports of goods and services fell $2,550m (three per cent) and imports of goods and services rose $43m. … Australia’s net International Investment Position was a liability of $943.6b at 31 December 2015, an increase of $19.2b (two per cent) on the 30 September 2015 position of $924.5b. Australia’s net foreign debt liabilities increased $2.8b to a net liability position of $1,005.6b. Australia’s net foreign equity assets decreased $16.4b (21 per cent) to a net asset position of $61.9b at 31 December 2015.”
Unfortunately it appears that no one in the media, or in politics or indeed the plethora of economists that work for our financial institutions, felt that a burgeoning current account deficit (running at an annualised $80 billion) and the 30% increase in net foreign debt (some $250 billion) in just 3 years is worthy of comment.
Today, the mainstream analysis of Australia’s net foreign debt is truly embarrassing. It reflects our view that no one in this country has a solution and there seems to be too many major institutions whose profitability is intrinsically linked to higher debt.
What investors need to know about the Foreign Debt
The above table indicates two poor trends. The trade deficit is annualising at about $40 billion per annum. Concurrently the Current Account (that includes the trade deficit) is lurching towards $80 billion per annum.
The substantial and continuing rise in foreign debt is due to a number of major reasons. These include:
- Australian banks continue to access wholesale funding from offshore markets. Collectively their borrowings account for about 40% of our foreign debt. Cheap (relative) offshore funding then allows Australian mortgage borrowers to access historically low interest rates – and a lot of debt;
- The Australian Government is seeing a significant portion of its issued bonds being snapped up by foreign investors who are accessing relatively higher yields than they can achieve in their own jurisdictions (for example Japan). Australia could soon forecast a $40 billion fiscal deficit for 2015/16 and this will require more bond issuance; and
- The foreign debt will continue to balloon until commodity and energy prices rise, our LNG plants become operational and interest rates lift in offshore markets.
The recent rise in the $A defies the trends in our Current Account and is arguably a short term bounce that is based on speculation rather than logic. Countries like us whom access high levels of foreign capital and debt (over 50% of GDP) are susceptible to significant currency shocks. In contrast countries with higher debt levels, funded internally, are less susceptible. For instance, Japan has recently seen its currency revalue despite negative interest rate settings because foreigners simply do not own Japanese Government debt.
In time what could confront Australia would be a collective decision by foreign investors or debt holders to withdraw funds from the Australian economy. This occurred in 2014/15 and it drove the currency lower. A view (even if wrong) that Australia has no potential to pay back its foreign debt could cause a currency crisis.
What could cause that type of view?
One possibility is an external shock caused by say a substantial slowdown in China, a lift in interest rates in our creditor countries or the realisation that our trade deficit is intransigent.
Australia will benefit from the emergence of LNG exports from 2017 and the burgeoning inbound travel from China. However, we need profitable trade and we need to maximise the tourism potential. A weaker $A is absolutely essential to ensure that Australia does not have a confronting period with our foreign creditors. We remain of the view that if the $A does not stabilise at lower levels than today then it will correct more harshly in the future.
Therefore our view remains that it is essential for Australian investors to retain USD exposures. It will be a rocky road, full of currency manipulation, but the foreign debt of Australia cannot be ignored – even if it is a secret.