Chapter 3 - Australia's
current account – key issues
At some point, net
external liabilities to GDP have to stop rising. They cannot go on going up
forever, but it is far from obvious how much further net external liabilities
to GDP could rise.[18]
Background
3.1
This section of the report explores a number of key
issues relating to Australia's
current account which were raised in submissions to the Inquiry, and discussed
during the Round Table held in Canberra
on 15 August 2005.
3.2
The economists who participated in the Round Table
were:
-
Professor Ross Garnaut, Professor of Economics,
Division of Economics, Research School of Pacific and Asian Studies, Australian
National University;
-
Dr David Gruen, Chief Adviser (Domestic),
Macroeconomic Group, Department of the Treasury;
-
Mr John Hawkins, Manager, Domestic Economy
Division, Department of the Treasury;
-
Mr Anthony Pearson, Head of Australian
Economics, ANZ Banking Group;
-
Mr Michael Potter, Director of Economics and
Taxation, Australian Chamber of Commerce and Industry; and
-
Dr Richard Simes, Vice President, CRA
International (appearing in a private capacity).
3.3
Evidence presented by Mr
Pat Conroy,
National Projects Officer of the Australian Manufacturing Workers Union (AMWU)
at the public hearing in Sydney
on 16 May 2005 was also
considered in the context of this chapter.
3.4
At the conclusion of the Round Table, the Chair invited
each participant to make concluding remarks.
The concluding remarks are set out in full in Appendix 4 to this report,
as they are a good summation of the views expressed.
3.5
The key issues which were considered during the Inquiry
are expressed as a series of questions in this chapter.
What has been driving the Current Account Deficit?
3.6
There was general agreement in the evidence received by
the Committee that the household sector has been the main driver behind the
Current Account Deficit (CAD) in recent years.[19]
3.7
Professor Garnaut
expressed it this way:
The biggest single cause of a large current account deficit is
the decline in household savings, which I think most economists ... would
attribute above all else, directly and indirectly, to the extraordinary wealth
effects of our housing boom, which is
large by our historical standards and large by world standards. It led
Australian households ... to think that they were very wealthy and very
comfortable, and that they could comfortably go through a period of higher
consumption expenditure and low, zero or negative savings ...[20]
3.8
Dr Gruen
also believes that the present CAD is attributable to the household sector. He
said:
In the last 25 years it is only in the last couple of years that
the household sector has run a savings-investment imbalance of the order of the
size of the current account. I think it is reasonable from that perspective to
say that it is the household sector where, if you like, you can explain why the
current account has been as large as it has recently. I think it is reasonable
to say that that is largely a consequence of savings-investments decisions by
the household sector.[21]
3.9
Likewise, Mr Conroy
identified households as the driver of economic growth in recent years:
The growth in household
debt has been the driver of Australia’s economic growth over the last eight years
and in particular the last two years.[22]
3.10
But Mr Pearson
said that he preferred to look at the CAD from a trade perspective. He attributes the present high CAD to an
'acceleration of import growth since 2001, particularly in volume terms, but in
particular there has been flatness in the volume of exports'. That meant a
widening trade deficit which fed into a high CAD. However, he considered that the breaking of
the drought would lift agricultural exports and higher prices for minerals and
energy can also be expected to lift exports.[23]
What is the outlook for Australia's
current account?
3.11
At the
Round Table discussion Dr Simes expressed the view that the average of the CAD is moving up to a new
and higher level. He said:
My assessment of the numbers is that, after some of the things
in the system work their way through, we are probably looking at the average of
the current account deficit to GDP increasing from around 4½ per cent to maybe
between five and six per cent.[24]
3.12
Figure 3.1 shows the wide fluctuations over the last 45
years in the balance of the current account when expressed as a percentage of
GDP. As discussed in Chapter 2, the
current account has been in continuous deficit since 1973 and the deficits
appear to be increasing in size, both in dollar terms and as a percentage of GDP.[25]
Figure 3.1: Balance on current account as a percentage of GDP
![Figure 3.1: Balance on current account as a percentage of GDP](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_01_jpg.ashx)
Sources: ABS, Balance of Payments and International
Investment Position (Cat. No. 5302.0) and National Income Expenditure and Product (Cat. No. 5206.0)
3.13
A way of looking for trends is to identify if there
have been periods which have involved a quantum shift. Figure 3.2 suggests that
since 1960 the CAD has experienced two periods involving quantum shifts, with a
possible third period starting in 2003.
Figure 3.2: Balance on current account as a
percentage of GDP, showing period averages
![Figure 3.2: Balance on current account as a percentage of GDP, showing period averages](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_02_jpg.ashx)
Source: ABS, Balance of
Payments and International Investment Position (Cat. No. 5302.0) and ABS, National
Income Expenditure and Product (Cat. No. 5206.0). Bars show quarterly results based on original
figures.
3.14
Figure 3.2 shows that in the period 1960 - 1980 the CAD
averaged 2.4 per cent of GDP. There was a quantum shift to a new level for the
period 1981 - 2002, during which the CAD averaged 4.4 per cent of GDP. Figure 3.2 speculates that in 2003 Australia
may have taken another quantum step up, to a period when the CAD could average
around 6 per cent of GDP per annum.
3.15
During the second 'step' period shown in Figure 3.2
(1981 - 2002) the quarterly CAD was less than the average of the previous
period in only two quarters - in the June 2001 quarter (2.0 per cent), and in
the September 2001 quarter (1.8 per cent).
All the other quarters in the second period recorded current account
deficits which were above the 2.4 per cent average for the 1960 - 1980 period.
3.16
There have been several periods since 1960 during which
the CAD has exceeded 5 per cent for more than three consecutive quarters. These periods were:
Table 3.1: Periods of consecutive quarters
when the CAD exceeded 5% of GDP.
Period |
Number
of consecutive quarters the CAD exceeded 5% of GDP |
June 1960 – March 1961 |
4 |
December 1981 – June 1982 |
3 |
June 1985 - September 1986 |
6 |
December 1988 - March 1990 |
6 |
September 1994 – June 1995 |
4 |
September 1998 - March 2000 |
7 |
December 2002 – present (June 2005) |
11 |
Source: ABS, Balance
of Payments and International Investment Position (Cat. No. 5302.0)
3.17
These periods of high CAD appear to be occurring more
frequently and for longer.
3.18
The CAD of 5.7 per cent in the June 2005 quarter means
that the CAD has now been over 5 per cent of GDP for eleven consecutive
quarters (including the new record of 7.2 per cent set in the December 2004
quarter). The average of the CAD for the last 11 quarters was about 6 per cent.[26]
3.19
Mr Conroy
opined that the recent current account deficits would have been higher except for
the record terms of trade. He said:
The only reason that the 2004 and 2005 current account deficits
have not attracted as much concern as the ones in the mid-80s is due to the
record high terms of trade. Had the terms of trade stayed at their 1990s average,
the external deficit would now be 10 per cent, not 6.75 per cent, of GDP ... These historic
terms of trade cannot last and serve to conceal the true nature of Australia’s external imbalance.[27]
3.20
Professor Garnaut
made a similar point when he said that the recent high levels of CAD would have
been even higher except for a fortuitous combination of events - Australia's
very high terms of trade and very low international interest rates. He said:
There are a couple of features of that big number [CAD of 7.2%]
... it has occurred at a time of historically extremely high terms of trade ... a
time of unusually low global interest rates so that the financing demands of
the large external liabilities are less severe than they would be in normal
times for international interest rates. If international interest rates were
near the average of the last 20 years, rather than historically extremely low,
then that would add possibly a couple of per cent to the current account
deficit.[28]
3.21
Dr Gruen
disagreed as to the level of risk posed by future increases in international
interest rates:
In terms of servicing the foreign debt, I do not think that
global interest rates are all that relevant. The ABS did a survey in 2001 of
the hedging practices of Australian companies. They have just redone this
survey and the results will be published later in the year. When the first
survey was done, the ABS was given the answer that 77 per cent of the value of
foreign currency denominated debt was hedged back to Australian dollars. That
is more than three-quarters. If you hedge foreign currency debt back to
Australian dollars, you effectively pay Australian interest rates. I do not
know the results of the more recent survey, but, if that is a reasonable
reflection of the situation as it is now, the servicing of Australia’s
foreign debt is largely in Australian interest rates, and a change in global
interest rates has a relatively small effect on that.[29]
3.22
Mr Hawkins
supported that assessment by Dr Gruen:
... while we have large net external liabilities to GDP, as had
some of the East Asian countries, we are much less vulnerable to a large
movement in the exchange rate, because, as David [Gruen] commented earlier, we
are not in a position where all our debt is in foreign currency and unhedged. A
significant amount of our debt is in Australian dollars and a significant
amount of the debt that is not is either hedged in financial markets or
naturally hedged through the export flows that companies which have borrowed
have.[30]
3.23
But Professor Garnaut
cautioned that currency hedging is not risk-free:
... I think we should not become too complacent about a high
proportion of our foreign debt being hedged against currency risk, because
there are specific terms to those hedging contracts and when they come to an
end they have to be recontracted. And if there is any deterioration in our
circumstances—in interest rates, perceptions of capacity to repay the debt of
Australian entities or currency risk—then that will affect the terms on which
the hedges are rolled over. So that can mean that a problem is phased in, if
things turn against us, but it does not mean to say that you avoid the problem
altogether.[31]
Is there a link between offshore borrowing and the current account?
3.24
Offshore borrowing by banks and other financial institutions
has increased in recent years.[32] The RBA estimates that the major Australian
banks now consistently source around 25 per cent of their liabilities offshore.[33] This suggests that approximately $50
billion per year of funding is sourced from overseas.[34]
3.25
Although
offshore borrowing as a transaction is recorded on the capital account
(the counterpoint to the current account), is there a link between offshore borrowing and the
current account? For example, could a large inflow of funds exert upward
pressure on the value of a currency?
3.26
The Committee did not receive any direct evidence of a
possible relationship between large inflows of offshore funds and the current
account, but it would like to see Treasury undertake further research in this
area.
Committee views
3.27
The Committee agrees that the driver of the CAD in
recent years has been the household sector which has gone on a spending spree.
3.28
There is evidence that the household sector is now more
cautious than a couple of years ago.
Household consumption increased by 3 per cent in 2004-05, well below its
long-term average. In contrast, business
investment increased about 12 per cent and appears to be replacing
households as the main driver of economic growth.[35]
3.29
The Committee does not agree with Treasury's view that
there has been no obvious trend in the balance on current account. The evidence clearly suggests a long-term
trend towards larger deficits.
3.30
Could we be in the beginning of a new and higher
'step' level for a CAD averaging around 6 per cent of GDP, as implied in Figure
3.2?
3.31
The long-term trend in the CAD warrants close
monitoring by the Government. What would
it mean for Australia
if the CAD averages around 6% of GDP over an extended period? At what level does the CAD become
unsustainable? The Committee believes that such questions need to be asked,
researched and debated so that appropriate policy responses can be identified
and adopted as required.
3.32
An intriguing issue is that of a possible relationship
between the inflow of offshore borrowing and the current account. Can capital
inflow of such dimensions exert upward pressure on a currency, with all the
consequences of a higher-than-normal currency? Does it matter that much
of the overseas borrowings by the financial sector have been for unproductive
purposes, unlike corporate borrowings that would increase productivity and
exports? Are these borrowings keeping the currency at levels that make it
difficult for the export sector to compete in overseas markets? The Committee
would like to see more research to clarify whether such linkages exist and
their significance.
Recommendation 1
The Committee
recommends that Treasury undertakes more analysis related to the longer-term
outlook for the current account, and publishes its findings to enhance public
understanding and discussion.
Is the present level of Australia's
net foreign liabilities a problem?
3.33
Australia's
foreign liabilities have been increasing for many years, both in value and as a
proportion of GDP, but do they pose a major risk to the economy at this stage?
Table 3.2 shows details of Australia's
net foreign debt and net foreign equity positions since 1980.
Table 3.2: Australia's net foreign liabilities[36]
|
Net foreign debt |
Net foreign equity |
Total net foreign
liabilities |
As at 30 June |
Net foreign debt $b |
% of total net foreign
investment % |
% of GDP % |
Net foreign equity $b |
% of total net foreign
investment % |
% of GDP % |
$billion |
1980 |
-7.9 |
29.0 |
6.1 |
-19.4 |
71.0 |
15.1 |
-27.4 |
1985 |
-53.1 |
67.2 |
23.5 |
-25.9 |
32.8 |
11.5 |
-78.9 |
1990 |
-130.8 |
75.7 |
34.0 |
-42.0 |
24.3 |
10.9 |
-172.8 |
1995 |
-190.8 |
74.7 |
40.6 |
-64.7 |
25.3 |
13.8 |
-255.5 |
2000 |
-272.6 |
82.9 |
43.7 |
-56.1 |
17.1 |
9.0 |
-328.8 |
2005 |
-430.0 |
83.2 |
49.8 |
-86.9 |
16.8 |
10.1 |
-516.8 |
Sources: ABS, Balance of Payments and International
Investment Position (Cat. No. 5302.0);
ABS, National Income, Expenditure
and Product (Cat. No. 5206.0)
3.34
Most of the foreign investment coming into Australia
now is in the form of debt (borrowings) rather than equity investment, as shown
in Table 3.2 and graphically in Figure 3.3. As at June 1980, 29.0 per cent of
foreign investment came into Australia
in the form of borrowings and 71.0 per cent was in the form of equity
investment in Australian companies. By June 2005 the proportions had reversed
with 83.2 per cent coming in as borrowings and 16.8 per cent coming in as
equity investment.
Figure 3.3:
Australia's
net international investment, by debt and equity.
![Figure 3.3: Australia's net international investment, by debt and equity.](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_03_jpg.ashx)
Source: ABS, Balance of
Payments and International Investment Position (Cat. No. 5302.0).
3.35
Table 3.3 shows the major sources of foreign debt
(borrowings) in the last four calendar years.
Note that this is total or gross foreign debt, whereas the
amounts in Table 3.2 are for net foreign debt.
Table 3.3: Major sources of foreign debt (borrowing) in Australia, calendar years
Country |
2001 |
2002 |
2003 |
2004 |
2001 |
2002 |
2003 |
2004 |
|
As at 30 December,
$ billion |
% of total |
UK |
123.8 |
150.8 |
155.3 |
179.1 |
24.3 |
26.2 |
25.4 |
25.6 |
USA |
114.4 |
136.7 |
159.0 |
165.1 |
22.5 |
23.7 |
26.0 |
23.6 |
International Capital Markets |
90.0 |
94.7 |
98.4 |
137.9 |
17.7 |
16.5 |
16.1 |
19.7 |
Unallocated |
25.6 |
26.9 |
33.1 |
50.3 |
5.0 |
4.7 |
5.4 |
7.2 |
Japan |
33.6 |
32.3 |
27.2 |
25.7 |
6.6 |
5.6 |
4.5 |
3.7 |
Belgium
/ Luxembourg |
9.0 |
7.3 |
10.9 |
17.7 |
1.8 |
1.3 |
1.8 |
2.5 |
Hong Kong |
26.1 |
29.6 |
21.0 |
16.8 |
5.1 |
5.1 |
3.4 |
2.4 |
Singapore |
22.8 |
20.8 |
17.6 |
15.0 |
4.5 |
3.6 |
2.9 |
2.1 |
Total all countries |
508.6 |
575.5 |
611.4 |
699.2 |
100 |
100 |
100 |
100 |
Source:
ABS, International Investment Position, Australia: Supplementary Country Statistics 2004 (Cat No. 5352.0)
3.36
These figures raise the question whether lenders in Japan,
Hong Kong and Singapore
could be losing confidence in Australia
(perhaps because of the consistently high current account deficits we have
recorded in recent years?). Fortunately
the biggest lenders to Australia,
the UK and USA,
do not appear to share these concerns.
3.37
As at 30 June
2005, official (i.e. government) gross foreign debt liabilities
(borrowings) totalled $32.4 billion while official foreign debt assets and
reserve assets totalled $64.1 billion.
So the government sector is in surplus.[37]
3.38
As at 30 June
2005, of Australia's
total gross foreign liabilities $275.8 billion was repayable in Australian
dollars (38.9%) and $433.4 billion was repayable in foreign currencies (60.1%).[38]
Borrowings in US dollars represented 56 per cent of total foreign
currency borrowings as at 30 June 2005.[39]
3.39
The Round Table considered various aspects of Australia's
foreign liabilities. Mr Hawkins
pointed out that on several counts Australia's
foreign debt did not pose major problems:
There are three aspects that people consider in looking at
whether or not a debt is a problem. One aspect is the public-private ratio, and
the fact that ours is predominantly private is better than it being
predominantly public. The second aspect is the currency in which the debt is
denominated. In the classic cases of countries having debt crises, all of the
debts have been in foreign currencies. In Australia’s
case, quite a lot of our debt is in Australian dollars or is hedged one way or
another. The third aspect is the maturity structure of the debt. Ours is around
the OECD average. It is certainly not all short-term debt, as has been the case
in some countries that have had a crisis.[40]
3.40
However, Professor
Garnaut pointed out that having
predominantly private sector debt is not risk-free:
I am not seeking to draw a parallel between Australia and any of
the East Asian countries that went into crisis, but until right on the point of
the crisis, in the main, those economies had consenting-adult deficits, mainly
driven by debt-funded assets booms in the private sector. We are taking comfort
from the consenting-adults view of debt and the fact that it is in the private
sector. There have been lots of circumstances in other countries where that has
looked like a comfort for a while and then quite quickly has ceased to be a
comfort. Even in our own history, the most severe depression we ever had, in
the 1890s, followed the deflation of a private sector asset boom: the great
housing boom of the late eighties, which extended into 1890 and then collapsed,
which was greatest in Melbourne
but had Australia-wide ramifications in the early 1890s. It was not principally
a problem of government debt, and yet the consequences were severe.[41]
3.41
On the question whether equity is better than borrowings
Mr Pearson
commented:
There is no ‘right’ form of foreign capital inflow. Debt is not
‘bad’ and equity is not ‘good’. Remember, if you go back in the political
debate in Australia there was a time when people did not want to have equity,
because they thought that was ‘selling off the farm’, and the alternative was
to have debt. Neither is better or worse. They have different servicing
obligation characteristics and different ownership characteristics, which are
neither good nor bad. They are just different.[42]
3.42
Professor Garnaut
observed:
On the question of debt versus equity, if the concern that we
have about an unusually large current account deficit is that, in certain
circumstances, it would make us vulnerable to the need for painful adjustment,
selling off a lot of equity leaves us less vulnerable than selling off a lot of
debt, because if our economy comes upon harder times then the equity that
foreigners hold loses value; foreigners share in that adjustment.[43]
3.43
Mr Hawkins
indicated that the maturity structure of the debt is about average for the OECD
economies,[44] and Mr
Pearson provided the following detail:
On the question of foreign debt, the latest figures up to the
March [2005] quarter were that there is about $370 billion of gross foreign
debt in risk liabilities of more than one year’s maturity. The total
outstanding is about $690 billion. That is, more than half have more than one
year’s maturity.[45]
Servicing Australia's
foreign liabilities
3.44
The financing of a deficit on the current account
produces an increase in foreign liabilities.[46] Dr Gruen
commented that, while net foreign liabilities as a proportion of GDP cannot
increase indefinitely, he did not see the present circumstances as posing a
particular threat to Australia. He said:
As a consequence of that [current account deficits], net
external liabilities as a proportion of the size of the economy have been
gradually rising. But, again, that has been true for 20 years, and I do not
think there are any magic numbers here. At some point, net external liabilities
to GDP have to stop rising. They cannot go on going up forever, but it is far
from obvious how much further net external liabilities to GDP could rise. I do
not think it indicates emerging structural problems in the economy. In the broad,
I think it is a continuation of something that we have seen for an extended
period.[47]
3.45
Debt service ratios provide an indication of the
ability of a country to service its foreign liabilities. Table 3.4 shows how Australia's
debt service ratios have changed since 1990.
Table 3.4: Debt service ratios, 1990 - 2005
June
quarter |
Net
interest payments to exports, % |
Net
income[48] payments to exports, % |
Net
interest payments to GDP, % |
Net
income payments to GDP, % |
1990 |
19.6 |
25.0 |
3.1 |
4.0 |
1993 |
12.2 |
16.5 |
2.2 |
3.0 |
1996 |
11.5 |
19.7 |
2.3 |
3.9 |
1999 |
9.4 |
16.5 |
1.8 |
3.1 |
2002 |
8.9 |
12.8 |
1.9 |
2.8 |
2005 |
9.5 |
19.2 |
1.8 |
3.6 |
Source: RBA Bulletin, Australia's service
payments on net foreign liabilities,
Table H7.
3.46
The figures in Table 3.4 show that net interest
payments as a percentage of export earnings almost halved between 1990 and
2002, but that ratio is now edging up.
The early 1990s was a period of very high interest rates, and Australia
obviously benefited from the significant fall in interest rates in subsequent
years (see Figure 3.4 below).
3.47
However, the ratio of net income payments as a
percentage of exports is again getting uncomfortably close to 20%. This ratio reflects both interest payments
and dividend payments and reinvested earnings. Foreign shareholders appear to
be reaping the benefits of their equity investments in Australian companies.
3.48
The high ratings given to Australia
by the international rating agencies suggest that they continue to regard Australia's
debt service ratios as manageable, despite the sharp increase in the net income
payments ratio in the last 3 years. On this point Professor Garnaut commented:
We have been able to finance the large current account deficit
because the international financial markets, the various sources of capital -
equity and debt—and other instruments of capital transfer have not formed a
view that the Australian deficit is unsustainable.[49]
3.49
Later in the discussion Dr
Gruen made a similar point:
The reason we were re-rated back up to AAA by the rating
agencies, even though the current account deficit remained large, was precisely
because their view about the rest of the economy was that it was more resilient
and that it was performing well based on a wide range of other factors.[50]
3.50
Mr Potter
made the observation that the international rating agencies are experienced
judges of risk:
What else, other than the international ratings agencies, can we
use to indicate independently that it [a high CAD] is a problem? Saying it is
at historical highs does not really indicate anything much.[51]
3.51
Mr Conroy
commented:
The AMWU believe that
foreign debt is not a problem as long as foreigners are happy to hold
Australian debt - which they have been in recent years because of Australia’s AAA credit rating and high interest rates
relative to the rest of the world[52].
3.52
But Mr Conroy went on to caution that the differential
between Australian and US interest rates would decrease as US rates go up. That will put pressure on the Reserve Bank to
lift Australian interest rates with potentially dire results for the local
economy.
3.53
As we have seen with movement of the net income
payments ratio, debt service ratios can change quickly if economic
circumstances change. Figure 3.4 shows
that international interest rates have been at historical lows, but some rates
are now showing signs of moving up. That trend is already starting to be
reflected in the higher interest payments ratios shown in Table 3.4. There is little to suggest the net interest
payments ratio will not worsen in the foreseeable future.
Figure 3.4: Short term interest rates, Australia, USA and Japan, 1964 –
2004
![Figure 3.4: Short term interest rates, Australia, USA and Japan, 1964 – 2004](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_04_jpg.ashx)
Source: RBA Bulletin datastream
3.54
The recent upturn in US and UK interest rates is
evident in Table 3.5, which shows the movement in interest rates in seven
countries since 2000.
Table 3.5: Short term interest rates, selected countries, 2000 - 2005
Country |
Calendar year annual
average % |
Month of June 2005, % |
|
2000 |
2001 |
2002 |
2003 |
2004 |
USA |
6.5 |
3.7 |
1.8 |
1.2 |
1.6 |
3.2 |
UK |
6.1 |
5.0 |
4.0 |
3.7 |
4.6 |
4.8 |
Japan |
0.2 |
0.1 |
0.1 |
0.0 |
0.0 |
0.0 |
Germany |
4.4 |
4.3 |
3.3 |
2.3 |
2.1 |
2.0 |
EU av. |
4.8 |
4.4 |
3.5 |
2.6 |
2.6 |
2.6 |
Canada |
5.7 |
4.0 |
2.6 |
3.0 |
2.3 |
2.6 |
Australia |
6.2 |
4.9 |
4.8 |
4.9 |
5.5 |
5.7 |
Source: RBA Bulletin datastream
3.55
Low international interest rates have benefited
Australia. For example, while Australia's net foreign debt increased by $257
billion between June 2000 and June 2005, net interest payments to service the
debt only went from $14.6 billion in 2000-01 to $15.4 billion in 2000-05, as
shown in Table 3.6 below.
Committee views
3.56
The May 2001 edition of Treasury's Economic Roundup
bulletin contained an article titled 'The
net income deficit over the past two decades'. The article found that the net income deficit
had shown steady improvement (i.e. decrease) since the mid-1990s, which augured
well for Australia's future ability to finance its foreign liabilities. However, that trend of steady improvement in
the net income deficit between 1996 and 2002 has not continued, with the trend
reversing and the net income deficit sharply worsening in the last year as
shown in Figure 3.5.
Figure 3.5: Net income deficit as a percentage of exports and of GDP
![Figure 3.5: Net income deficit as a percentage of exports and of GDP](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_05_jpg.ashx)
Sources: ABS, International Trade in Goods and Services (Cat.
No. 5368.0) - for export data; ABS, National Income, Expenditure and Product
(Cat. No. 5206.0) - for GDP data; Reserve Bank of Australia Bulletin,
Table H7 - for net income payments
3.57
Table 3.6 shows Australia's net foreign liabilities
(debt and equity) and the amounts used to service those liabilities over the
last six years. The Committee notes with concern that the net income balance
has deteriorated sharply, from -$18.2 billion in 2000-01 to -$31.2 billion in
2004-05.
Table 3.6: Net foreign liabilities and their annual servicing amounts,
$billion
|
Net foreign debt, as
at 30 June |
Net interest payments
over 12 months |
Net foreign equity, as
at 30 June |
Other net income
payments over 12 months |
Total net income
balance over 12 months |
1999-2000 |
-272.6 |
-13.4 |
-56.1 |
-4.8 |
-18.2 |
2000-01 |
-302.5 |
-14.6 |
-63.1 |
-4.1 |
-18.7 |
2001-02 |
-324.2 |
-13.6 |
-41.0 |
-5.7 |
-19.3 |
2002-03 |
-357.9 |
-11.6 |
-70.3 |
-9.9 |
-21.5 |
2003-04 |
-394.7 |
-12.5 |
-75.8 |
-11.2 |
-23.7 |
2004-05 |
-430.0 |
-15.4 |
-86.9 |
-15.8 |
-31.2 |
Source: Derived from RBA monthly bulletin, Tables H5 and H7.
3.58
This deterioration is also reflected in the debt
service ratios shown in Table 3.4 and shown graphically in Figure 3.5, above.
After several years of improving ratios, net income payments as a percentage of
exports jumped from 12.8 per cent to 19.2 per cent in three years. Over the same period net income payments as a
percentage of GDP rose from 2.8 per cent to 3.6 per cent
3.59
While these figures are still below the highs reached
in the December 1990 quarter (26.5 per cent and 4.3 per cent respectively), the
Committee considers that recent trends are worrisome.
3.60
The Committee is puzzled by the sharp increase in the
category 'other net income payments' (basically, dividends and reinvested
earnings paid to foreign equity holders). Most commentators suggest that this
is a result of the very high corporate profits earned in Australia in the last
couple of years, but can that be the whole story behind a four-fold increase in
just five years (from $4.1 b in 2000-01 to $15.8 b in 2004-05)? Such a dramatic change begs for a clearer
explanation by Treasury.
3.61
The Committee received conflicting evidence in relation
to the likely impact of movements in international interest rates on the income
balance. Professor Garnaut believes that if international interest rates go
back to historical average levels, that would have a significant impact on
Australia's income balance and possibly add a couple of points to the CAD.
However, the Treasury representatives (Dr Gruen and Mr Hawkins) argue that
hedging of foreign borrowings by Australian banks has greatly reduced the risks
posed by higher international interest rates.[53]
3.62
The Committee considers that it would be useful for
Treasury to undertake some modelling of various scenarios (such as a rise in
international interest rates, and a fall in the terms of trade), to ascertain
what impact such changes would have on the current account. The results of that research should be
published to facilitate understanding and debate on this important issue. The
Committee is concerned at recent trends, and believes that it would be useful
for Treasury to regularly publish detailed analyses of developments in the
trade balance and income balance.
Why are exports important?
3.63
Exports are important because, together with imports,
they make up the trade balance. If
exports grow faster than imports, the trade balance improves and there is a
likelihood that the current account deficit may decrease. However, if export growth is slower than
import growth, then the deficit in the trade balance widens which puts pressure
on the current account.
3.64
So, two key issues to consider are the prospects for a
better performance by exports in the future, and whether it is realistic to
hope for regular trade surpluses.
3.65
After matching import growth for most of the 1990s,
export growth slowed in 1997. It then
grew rapidly, to such an extent that in 2000-01 exports actually exceeded
imports. But since that time export
growth has again fallen behind import growth.[54]
3.66
Figure 3.6 shows how exports have performed. After solid growth through the 1990s they
grew very quickly during 1999-2001.
However, they declined in 2002 and 2003 and are only now picking up
again due to higher prices of mineral and energy exports.
Figure 3.6: Exports of Goods and Services
![Figure 3.6: Exports of Goods and Services](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_06_jpg.ashx)
Sources: Department of
Foreign Affairs and Trade (DFAT), Exports
of Major Commodities Time Series; DFAT, Exports
of Primary and Manufactured Products Australia; ABS, Balance of Payments and International Investment Position (Cat. No.
5302.0)
3.67
The commodity boom has pushed up the price of exports
relative to imports with the result that Australia's terms of trade are at 30
year highs as shown in Figure 3.7. The
terms of trade are expected to settle back to more normal levels in the next
few years.
Figure 3.7: Terms of trade, quarterly
![Figure 3.7: Terms of trade, quarterly](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_07_jpg.ashx)
Source: Australian Bureau of Statistics cat. no.
5206.0.
3.68
A rise in the terms of trade adds to real national
income. According to Treasury's
submission: 'While real GDP expanded by 1½ per cent through 2004, the rise in
the terms of trade meant that real national income grew by almost 3 per cent'.[55]
3.69
If export
prices are so high, why have export revenues not accelerated? The
Treasury submission provides one explanation:
There is currently very strong demand for our resource exports.
This is reflected in high prices for these exports, but so far there has been
little rise in export volumes. This is partly due to firms underestimating the
strength of global demand and the lags associated with expanding capacity.
Furthermore, the diversity of ownership of the various linkages between mines
and ships has made coordination of improvements to transport and port
facilities difficult. Nevertheless, there is a substantial amount of investment
currently under way, which should allow significant expansion in these exports
in coming years.[56]
3.70
While Treasury is confident that export volumes for
resource exports will pick up shortly, it is less sanguine in relation to
exports of manufactures for the following reasons:
The volume of manufactures exports has been weak for some time.
This reflects maturing of the sector, the appreciation of the Australian
dollar, growing sophistication of Asian competitors and perhaps some diversion
of production as a result of high domestic demand.[57]
3.71
The export of Elaborately Transformed Manufactures
(ETMs) and Services both grew strongly from the mid-1980s to late 1990s,
increasing their share of total exports and increasing their contribution to
GDP. However, both have slowed
significantly in recent years, as shown in Figures 3.8 and 3.9.
Figure 3.8: Exports of Elaborately
Transformed Manufactures and Services
![Figure 3.8: Exports of Elaborately Transformed Manufactures and Services](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_08_jpg.ashx)
Sources: Department of
Foreign Affairs and Trade (DFAT), Exports
of Major Commodities Time Series; DFAT, Exports
of Primary and Manufactured Products Australia; ABS, Balance of Payments and International Investment Position (Cat. No.
5302.0)
3.72
The declining contribution to the economy made by
exports of ETMs and services since about 1997 is apparent when they are shown
as a percentage of GDP, as in Figure 3.9.
Figure 3.9: Exports of ETMs and Services as a percentage of GDP
![Figure 3.9: Exports of ETMs and Services as a percentage of GDP](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_09_jpg.ashx)
Sources: Department of
Foreign Affairs and Trade (DFAT), Exports
of Major Commodities Time Series; DFAT, Exports
of Primary and Manufactured Products Australia; ABS, Balance of Payments and International Investment Position (Cat. No.
5302.0)
3.73
In Australia high terms of trade normally reflect high
commodity prices, and the exchange rate usually moves in sympathy with the
terms of trade. That means exports
become relatively more expensive and over time tend to fall, while imports
become relatively cheaper and tend to rise.
Receipts for exports of commodities reflect the higher export prices,
but manufactured products and services feel the impact of the higher exchange
rate and tend to fall.
3.74
Professor Garnaut pointed out that a number of periods
of economic prosperity ended when there was a sharp fall in the terms of trade
- as a result of which the exchange rate falls, inflationary pressures
increase, interest rates rise, investment falls, and government revenue (and
expenditure) falls. He said:
I am not predicting a
large and sudden retreat of the terms of trade, but one has to recognise that
it is historically normal to get these corrections, so it is one of things that
we should turn our minds to. If that were accompanied by a lift in global
interest rates, increasing the cost of servicing our external debt, it would
put an additional burden on our external accounts.[58]
3.75
Dr Simes noted that exports of ETMs and services grew
quickly from the mid 1980s to the late 1990s, due to a combination of factors
such as the low exchange rate; the removal of tariffs which made local firms
more internationally competitive; and the intensified engagement with
Asia. But the situation has changed:
If you look at the situation today, we have got a much more open
economy - that is, the imports to GDP is much higher than it was then [in the
1980s] ... it is hard to conceive of a scenario where we are going to get a lot
of mileage from the rural sector ... it is hard to see a situation where we get a
long-term big boost from the mining sector also. A lot of the big boost we have
at the moment is coming off the terms of trade ... the focus needs to come back
to ... do something a bit more proactive on manufacturing and services.[59]
3.76
Mr Hawkins pointed out that the greater diversity of
Australia's exports makes us less vulnerable.
While Professor Garnaut agreed with that assessment, he called for a
careful analysis of the reasons for the recent slowdown in exports of ETMs and
services. He said:
It is very important to the diminution of vulnerability in
future that we understand that slowdown [in exports]. My thoughts would go not
to new interventions by government to artificially increase incentives to those
sectors but to understanding the barriers of various kinds that have emerged to
continued rapid growth in services and manufacturing exports.[60]
3.77
Mr Potter agreed with Professor Garnaut – 'I understand
what you are saying: we should not be looking at industry specific measures to
artificially promote a sector, but we might want to look at industry-specific
barriers to those particular industries. I think that is absolutely correct [61]
3.78
Mr Conroy saw innovation as the key to increasing
exports of ETMs:
We believe that if we
increase innovation in the industry, and in manufacturing in particular, it
will increase our long-term competitiveness and our exports because we could
then compete with Asian countries not on the price of labour - which we can
never win - but on the price of our innovation and keeping ahead of the curve.[62]
Committee views
3.79
It seems to the Committee that there is little prospect
that Australia's net income balance will improve over the short-to-medium
term. If anything, the deficit on the
income balance is likely to worsen given the combination of rising net foreign
liabilities and rising US and UK interest rates. So if there is to be a significant
improvement in the CAD it will most likely have to come from the trade
balance. But how realistic is such an
expectation?
3.80
For the trade balance to have a significant impact on
the CAD, exports must consistently grow faster than imports. The ideal
situation would be for Australia to run a trade balance surplus on a regular
basis.
3.81
The Round Table noted that the short term prospects are
for strong growth exports, driven by high export prices for minerals and energy
and increased export volumes as infrastructure capabilities are expanded. But
if China's extraordinary growth falters, that scenario could quickly change.
3.82
Most of the discussion focused on the need to improve
the export performance of ETMs and services, which had stalled in recent years.
3.83
The Committee agrees that exports of ETMs and services
must perform well if there is to be a medium-to-long term improvement in the
trade balance. Unfortunately the Round
Table did not have sufficient time to consider possible strategies to achieve
that goal but in any case that is the role of the Australian Trade Commission
(Austrade).[63]
3.84
Austrade is the Government's export promotion agency.
Its focus is on the export of ETMs and services, as commodities are
internationally traded goods and exports of commodities basically look after
themselves.
3.85
Austrade's priority for the last 5 years has been to
double the number of exporters. To
achieve that goal Austrade has concentrated its efforts on small-to-medium
sized companies. Realistically, such
companies will make very little difference to Australia's overall exports for
many years to come. Large companies,
with the necessary financial and management resources, are the only ones which
can make a significant impact. Australia needs to nurture manufacturers and
service companies which export $10 million per annum, not $10 000.
3.86
The recent falling off of export growth suggests that
Austrade should urgently re-assess its priorities.
3.87
The Committee urges Austrade to develop strategies
which will increase the export of ETMs and services on a sustainable
basis. Exports as a whole, and in
particular ETMs and services, need to grow at a faster rate than imports for
the next few years if there is to be any chance for the CAD to achieve a
significantly lower average level.
Recommendation 2
The Committee
recommends the Government develop new strategies to promote the export of
Elaborately Transformed Manufactures and services to underpin a long term
improvement in the balance of trade.
What are the links between household debt, imports and the CAD?
3.88
The overall aim of this Inquiry was to explore possible
links between household debt, demand for imported goods and the current account
deficit (CAD). One of the specific terms of reference was to look at 'the
extent to which demand for imported goods by Australian households contributes
to the current account deficit'.
3.89
Mr Conroy saw a direct link between household
consumption and imports and the CAD. He
said:
The explosion in the
current account deficit in the last five years has been driven by an increase
in imports. It is not about borrowing more to fund capital expansion here; it
is about borrowing more and buying more consumer goods. If you look at the
growth rates in the last eight years, consumer goods have risen by about 140
per cent and capital good imports only by 70 per cent, so what is happening is
that Australians are buying more and more consumer goods from overseas. This is
part of an underlying structural problem here in that we are not funding
productive investment; we are borrowing now to purchase goods and we will pay
for it later ...[64]
Households and the CAD
3.90
There is a direct link between household debt and the
current account deficit. As discussed in
Chapter 2, from a savings/investment perspective, household debt has been the
principal contributor to the CAD in recent years.[65]
3.91
The official or government sector is now a net lender
(that is, the government sector is in overall budget surplus). The private
sector is made up of corporations and households. Corporations have
traditionally been heavy borrowers but in the last couple of years they have
become net lenders as high profits have exceeded investment. In contrast, households have traditionally
been net lenders but in recent years they have become net borrowers. Since
about 2000-01 household spending/debt has been the main driver of the current
account deficit.
Imports and the CAD
3.92
There is also a direct link between imports and the CAD
in the sense that imports are part of the trade balance which, in turn, is a
major component of the current account - see discussion on the trade balance in
paragraphs 2.10 to 2.20 in Chapter 2.
Households and imports
3.93
One could reasonably expect a link between households
and imports, particularly imports of consumption goods. Households consume both domestically produced
goods and services, and imported goods and services. These might be direct purchases of imported
televisions or cars or indirect purchases of, for example, kitchen appliances
if a house they buy is fitted with imported kitchen appliances.
3.94
Figure 3.10 shows the result of plotting the movement
of household liabilities against imports of consumption goods in the period
1987-88 to 2003-04, both measured at constant prices. Superficially, the graph suggests a strong
linear relationship between these two variables (reflected in the high
regression coefficient of 0.9711). However, it would be premature to read too
much into this graph without further research to more definitely establish the
causal links.
Figure 3.10: Statistical correlation between household liabilities and
imports of consumption goods
![Figure 3.10: Statistical correlation between household liabilities and imports of consumption goods](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_10_jpg.ashx)
Sources: ABS, Financial
Accounts (Cat. No. 5232.0) - for total household liabilities; ABS, National Income Expenditure and Product
(Cat No. 5206.0) - for the implicit price deflator for non-farm GDP; ABS, International
Trade in Goods and Services (Cat. No. 5368.0) - for imports of consumption
goods.
3.95
Imports of consumption goods have grown strongly in recent
years, driven by strong consumer demand.
Strong Asian competition and an appreciating Australian dollar have
helped to keep prices of imported manufactured goods relatively low.
3.96
Figure 3.11 shows how imports of goods and
services have increased since 1981-82, and Figure 3.12 is a representation of
how the major components of total imports have changed. This shows that imports of consumption goods
have increased at a faster rate than the other components, thus increasing
their share of total imports of goods and services.
Figure 3.11: Imports of goods
and services, by major components
![Figure 3.11: Imports of goods and services, by major components](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_11_jpg.ashx)
Source: ABS, International Trade in Goods and Services
(Cat. No. 5368.0)
3.97
Figure 3.12 shows the percentage of total
imports represented by its four components: consumption goods; capital goods;
intermediate goods; and services.
Consumption goods have increased their share of the value of total
imports of goods and services from 16 per cent in 1981-82 to 25 per cent in
2004-05, largely at the expense of intermediate goods and services.
Figure 3.12: Composition of
imports of goods and services, percentage of total
![Figure 3.12: Composition of imports of goods and services, percentage of total](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_12_jpg.ashx)
Source: ABS, International
Trade in Goods and Services (Cat. No. 5368.0)
3.98
A recent Treasury study examined the question: 'Why
have Australia's imports of goods increased so much?'[66]
The study noted that imported goods increased their share of nominal
domestic demand from about 11 per cent in the 1960s to about 17 per cent in
2004, as shown in Figure 3.13, below.
Figure 3.13:
Import penetration ratio (imports of goods as a % of GNE.
Chart 1: Import penetration ratio
(imports of goods as percentage of gross national expenditure)
![Figure 3.13: Import penetration ratio (imports of goods as a % of GNE.](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_13_jpg.ashx)
Sources: Australian Bureau of
Statistics, Balance of Payments and
International Investment Position, cat.
5302.0 and National Income
Expenditure and Product, cat. 5206.0.
3.99
Treasury identified rising incomes and falling relative
prices for imports as the key factors behind increased imports. In the last 10 years growth in household
spending exceeded growth in income, with the short-fall made up from a
combination of decreasing savings and increasing debt.
3.100
The study concluded:
Over the past decade the volume of imported goods grew by an
average rate of 9 per cent a year, while real Gross National Expenditure grew
by 4½ per cent. While a large part of the fast growth in imports can be
explained by rising incomes and falling relative prices, other factors such as
changes in tastes and specialisation have also played an important role.[67]
Committee views
3.101
The Committee concludes that there are a number of
linkages between households and imports and the CAD, some more direct than
others.
3.102
The import penetration ratio (Figure 3.11) suggests
that imports represent a growing share of consumption. At least some of that would be at the expense
of local manufacturing. That is an
unfortunate fact of life in an increasingly globalised world. Communication and access are much easier
today. Australian consumers demand access to an ever-wider range of products in
quality and price, and that expectation can not be denied. The growth of
imports would be of less concern if exports as a percentage of GDP were also
growing, which is not the case, as shown in Figure 3.9.
What are the risks of a persistently high CAD?
3.103
In the December 2004 quarter the CAD set a new record
of 7.2% of GDP. A number of economists
pointed out that this record was reached during a period when Australia's terms
of trade were the highest in 30 years (which should have improved the trade
balance), and when international interest rates have been low (which should
have improved the income balance). One could reasonably have expected this to
be a period of relatively low current account deficits, instead of a period
when new records were being set.
3.104
The Treasury submission points out that the CAD has
fluctuated between 3 and 6 per cent over the last 20 years, commenting:
Fluctuations in the CAD are not a bad thing. They are a means by
which Australia smoothes consumption in the face of income shocks, such as the
Asian crisis. That is, the CAD, like the exchange rate, acts as a buffer or
shock absorber between domestic demand and global developments.[68]
3.105
The Round Table discussed the question of whether a
high level of CAD is necessarily bad, and the risks involved.
3.106
Dr Gruen saw the record deficit of 7.2% as a natural
part of the wide fluctuations which have characterised the CAD over the last 20
years. He said:
The Australian current account deficit has cycled between about
two and seven per cent of GDP for 20 years now and has averaged just under five
per cent of GDP for 20 years ... in the last several years we have seen both the
highest ratio to GDP and the lowest. My characterisation of the situation would
be that we have seen quite big cycles in the current account but no obvious
trend over that period. As I say, it has been around 5 percent - I think the
average is 4.75 per cent - of GDP for 20 years and there have been quite big
cycles around that.[69]
3.107
On the other hand, both Professor Garnaut and Dr Simes
expressed concern at recent levels of the CAD.
Professor Garnaut commented:
Having a current account deficit of seven per cent of GDP does
not prove that you have a big problem or crisis coming, but it should be a
warning bell that you should look very carefully at what is generating it and
at whether or not the things that are generating it are sustainable. It is an
unusual figure for Australia and very unusual in the world, especially amongst
developed countries ... in earlier periods when it has gone up to that level it
has been followed by quite severe adjustment problems. That does not prove that
it is a problem now but it should get us thinking. [70]
3.108
Dr Simes described his misgivings about a CAD of recent
proportions on several occasions during the Round Table, in the following
terms:
To me, a high current account deficit is a signal of something
not quite right and it is something that ... you should be cautious about.[71]
...
I think the size of the current account deficit is such that it
is symptomatic of an underlying problem and should be a source for doing
something about it. Again, because of the robustness of the financial markets
and the rest of it, I have tried to say that there is no need to do anything
quickly; it is more medium-term structural policies that we should be looking
at.[72]
...
Why is a larger current account deficit a problem? Unless it is
lifting the level of production - unless it is getting into investment and increasing
the base - there is an issue for longer-term economic welfare for the next
generation et cetera. To me it is symptomatic that we are not optimising our
long-term economic welfare.[73]
...
There is no right and
wrong level about the current account deficit in the first place. I am
concerned that we have been at 4½ per cent of GDP for 20 years, and it looks
like it is edging up. I would prefer it to be coming down ... the current account
deficit is too high today and looks like it is going to settle at an average
level which is uncomfortably high over the next, say, five years or whatever,
without policy adjusting it or doing something about it.[74]
3.109
Mr Conroy asserted that the high level of household
debt in Australia posed three specific threats to the economy:
The first is a
recession induced by household demand evaporating to service debts. The second
comes from the large external imbalance caused by the debt-induced current
account deficit and spiralling foreign debt levels. The final risk to the
economy originates from a misallocation of resources caused by the housing
bubble and the consumer debt explosion reducing the long-term competitiveness of
the Australian economy.[75]
3.110
Mr Conroy felt that the Australian economy is
vulnerable not only to recession caused by a collapsing consumer demand but
also to a change in the international sentiment regarding the Australian
economy.[76] Professor Garnaut sounded a similar
cautionary note: 'the views of international markets can change
rather quickly.' [77]
3.111
The Round Table discussed
various risks facing the private sector. Dr Gruen advised that in the
aftermath of the Asian crisis Treasury has kept a close eye on the liabilities
of the private sector. He said:
There has been much more careful analysis by regulatory
authorities of the sorts of liabilities in the private sector that could
ultimately cause systemic problems. The lesson from the Asian crisis is that
those are exactly the sorts of things you have to look at carefully. That is
precisely what we have done ... if one is going to have a consenting-adults view
about the current account it is extremely important to take a view about
possible shocks that could lead to systemic problems. In the Asian crisis case
economists were not very good at predicting it. With the benefit of hindsight,
we are much better at predicting things.[78]
3.112
The Round Table considered whether a sharp fall in
house prices would impact on the ability of households to make their loan
repayments. On this point, Dr Simes
said:
My view is that it is not only the fact that you have a large
proportion of the population who are not in debt and who can support the
others; it is also that the financial sector is attuned to providing credit et
cetera in a fairly smooth way. Given that most of this debt is secured against
a house and is being serviced by regular income, the real problem is only going
to arise if you have a sharp lift in unemployment, not just if house prices
fall.[79]
3.113
Both Dr Gruen and Mr Potter referred to a recent APRA[80] survey which found that the major
banks could comfortably accommodate a 30 per cent slump in housing prices.
3.114
Dr Simes thought there is a low risk that interest
rates would go to levels which would result in severe unemployment and have a
major impact on the ability of households to service their debts. On the other hand, if foreign investment is
withdrawn Dr Simes said that the exchange rate would respond appropriately to
restore balance:
If foreign investment is withdrawn, the adjustment will be
through the exchange rate - that is, foreign money will be available at a price
and it will be the exchange rate that does the buffering, as we saw in the
Asian financial crisis, if you like. That will be manageable unless you have a
system in the price-wage interactions where it is going to get into ongoing
inflation, and that is hard to see in the current structure of the economy or
for the next five years. You could not rule that coming back into play at some
point, but it is a long way off.[81]
3.115
The Round Table discussed the adverse
impact on local manufacturers of large fluctuations in the exchange rate within
relatively short periods, as happened about 5 years ago, when the exchange rate
went down to US$0.49 and then moved up to US$0.80. That kind of wide
fluctuation puts considerable stress on local manufacturers as they endeavour
to adjust to rapidly changing circumstances.
3.116
Dr Gruen agreed that this had put pressure on domestic
manufacturers but said that a floating exchange rate is essential to sound
economic management:
The recent period ... moving from US49c to something close to
US80c, is not very usual. We have been in an extremely unusual circumstance of
going from being viewed as the old economy in 2001 to this huge rise in the
terms of trade, and the currency has gone with it. Given that the terms of
trade are something that we get dealt largely by the rest of the world,
allowing the currency to move with them may have sectoral implications that
some people [manufacturers] would not like but, in terms of the stability of
the overall economy, it is a huge advance on the last time we had a huge
terms-of-trade rise like this, which was in 1973-74. The Australian economy did
not cope well with that. We ended up with a big rise in inflation and a lot of
other things as well. Nothing has only good sides, but my judgement is that
this is a much better way of allowing
the economy to adjust than the alternatives.[82]
3.117
Dr Gruen reinforced the importance of a floating
exchange rate by describing the important but adverse role fixed exchange rates
played in the Asian financial crisis. He
said:
... it came as a rude shock to everyone when the Asian countries
went into severe recessions. We discovered that they were running either fixed
exchange rates against the US or effectively fixed exchange rates against the
US. It was perhaps not realised that the financial health of most of the
economies, not only the financial system but also the non-financial system, was
inextricably tied to this exchange rate policy. In other words, once the
currency depreciated significantly, the unhedged foreign borrowings in the
companies and the financial system bankrupted large parts of the economy.[83]
3.118
Mr Conroy believes that manufacturing sector has
suffered because interest rates have been kept artificially high so as to
attract the funds required to meet excessive household consumption. This has pushed up the exchange rate, which
has made imports relatively cheaper and hurt local manufacturers and
exporters. He said:
The reliance on capital
inflow to fund consumer debt has adversely affected the manufacturing sector ...
it has crowded out direct foreign investment in manufacturing by forcing
interest rates and exchange rates to be higher than would otherwise have been
the case ... it has allowed unsustainable growth in domestic demand resources
which would otherwise have been allocated for manufacturing expansion ... [and] Governments continue to believe that high
and sustained economic growth can be achieved by letting the finance sector
drive the economy ... [they] no longer believe in the importance of
manufacturing.[84]
What could improve the CAD?
3.119
The Round Table discussed various ways in which the CAD
could be brought back to lower levels.
3.120
Professor Garnaut believes the CAD will eventually
self-correct, but questioned the economic and social cost of leaving such
adjustment solely to market forces. He
commented:
There is a sense in which there cannot be a long-term current
account deficit problem because in its nature it is self-correcting. Indonesia
and Thailand had current account deficits in 1996 that some people thought were
worrying. They had large current account surpluses by late 1998 and 1999, so
there is a sense in which there was no current account deficit problem because
it was self-correcting. The problem was the consequences of the adjustment that
the economy had to go through.
So the issue we are talking about is not really a problem of
whether the current account deficit will adjust or whether in the end whatever
deficit is there will be financed - by definition it will be. The question is: what will the process of adjustment be and
what stress will that place on government budgets, on unemployment and on
economic activity - or, to put it another way, will it give us a recession like
similar adjustments have in the past?
So the questions in the end become ones of vulnerability to
circumstances changing and forcing adjustment and of our capacity to handle
without excessive pain the adjustments that will be necessary.[85]
3.121
There was general agreement that the cooling-off of the
housing boom would diminish the 'wealth effect' on households which, coupled
with rising interest rates (and, more recently, rising fuel prices) would in
turn reduce household spending and borrowing.
Dr Gruen expressed it as follows:
Their [Reserve Bank] latest estimate ... is that in the 18 months
to the December quarter 2003 house prices in Australia went up 29 per cent.
Over the last 18 months they went up by exactly nothing ...the consequences of
that for the savings and investment balance of the household are going to be
very substantial. So I think there are self-correcting forces in play in the
Australian economy which should move us in the direction of smaller current
account deficits.[86]
3.122
Professor Garnaut supported this assessment:
You cannot have your households dis-saving forever, with that
being balanced by ever-increasing asset values - in this case, bubble housing
values. We are going through an adjustment now, as the housing boom has reached
a plateau ... Over time, one would expect that to significantly bring down
consumption and raise saving rates.[87]
3.123
Although Dr Simes considered the high level of the CAD
to be of concern, he does not see a crisis situation yet. He said that there
are several reasons why the level of the CAD may come back to a lower level—for
example, through a slowdown in economic demand and activity induced by a fall
in the terms of trade; or a reduction in house prices; or if foreigners
withdraw capital leading to a fall in the exchange rate. He expressed the belief that the financial
sector is strong enough to absorb such adjustments. He concluded:
The current account is an issue and something we should be
acting to address, but we can do it over the medium term, and we should be
looking at medium-term policy changes either related to savings or to exports.[88]
3.124
An increase in national savings would enable more of
Australia's investment to be financed from domestic savings rather than by
borrowing overseas, thus improving the income balance of the current account.
Additionally, if exports grow faster than imports, the trade balance is
improved. Enhancing domestic savings and
lifting export growth helps the current account.
3.125
Dr Simes suggested looking at 'superannuation and the
like',[89] and recommended raising the superannuation contribution rate from 9 to 15
percent.[90]
3.126
Mr Pearson commented on the impediments that limit the
amount of superannuation people are prepared to take out. He felt that, before
increasing the contribution rate, more should be done to remove the impediments
to superannuation such as the taxes and the residual benefit limits.[91]
3.127
Mr Potter disagreed and argued that targeting
superannuation would not be an appropriate policy response to address the level
of CAD. He said:
We think that super policy should be driven on its own merits,
not because of the effect it has on national savings. I will separate it into
two issues. You can either have the government investing in people’s super -
that is one possibility - or increase people’s compulsory contributions. On the
first one, if the government puts more money into people’s super then that
actually reduces the fiscal balance, so you may end up with no benefit to
national savings. You might have an increase in the amount in people’s super
accounts, but a reduction in the government deficit and you would only be a
little bit better off. On the other hand, you could, for example, increase the
compulsory component of superannuation. We do not think that is such a good
idea because, in a sense, super is like a payroll tax. I think the last thing
that businesses want is to have is an increase in payroll taxes.[92]
Are the self-correcting mechanisms
working?
3.128
A recent article in The
Economist pointed out that a number of self-correcting mechanisms appeared
to have 'jammed' and were no longer working as they were supposed to according
to conventional economic theory. The article gave three examples, based on the
USA whose CAD is forecast to exceed 6 percent of GDP in 2005 (i.e. a deficit of
over US$800 billion).
Firstly, in theory a rapidly rising CAD should cause investors
to demand higher interest rates to compensate them for the increased risk of
currency depreciation. Dearer money then
helps to dampen domestic spending and thus trim the external deficit. This is
what happened when America's CAD exploded in the first half of the 1980s. Real bond yields rose, cooling domestic
demand. Along with the cheaper dollar, this helped to reduce the deficit. This
time, however, the adjustment mechanism has jammed: real American bond yields
have fallen not risen over the past few years, partly because Asian central
banks have been eager to buy US Treasury bonds to prevent their currencies from
rising. So long as low bond yields continue to support America's housing bubble
and hence strong consumer spending, they will block any significant reduction
in the CAD.
Secondly, in the past a rapid rise in consumer borrowing and
spending would cause a central bank to push up interest rates to curb
inflation. Today, however, inflation is held down by cheap goods from China and
other low-wage economies, and inflationary expectations are well anchored
thanks to the credibility of central banks.
As a result, central banks have been able to hold interest rates below
the growth in nominal GDP (the income from which debts must be serviced) for a
prolonged period. This has, in effect,
lifted any constraint on credit growth, allowing a bigger build-up of private
sector debt.
Thirdly, a broken circuit is apparent between interest rates and
growth. Sluggish economies with low
inflation require lower real interest rates than economic sprinters. Yet
despite its faster growth, America's real bond yields are lower than Japan's
and about the same as in the euro area. Yields are arguably too low for America
but too high for Germany and Japan, causing the growth gap to persist. [93]
3.129
The article describes interest rates and bond yields as
the traffic lights of the global economy: they tell economies when to go and
when to stop. The market would punish
economies where governments or households borrow recklessly with higher bond
yields, prompting them to tighten their belts. Prudent economies would be
rewarded with lower real rates. But
today financial markets are doing a poor job as economic watchdogs: in
particular, America's profligacy is being subsidised rather than punished.
3.130
In a closed economy, according to the article, if a
government increases its budget deficit it must pay higher interest rates to
persuade domestic investors to hold more bonds.
But if it can tap global savings, it can borrow more cheaply because a
smaller rise in rates is needed to attract the required funds. Even so, an
efficient international capital market is supposed to ensure that capital is
allocated to the most productive use.
Yet much of the recent inflow of foreign money into America is not
financing productive investment, but a housing bubble and a consumer binge.
3.131
A possible explanation is that, with interest rates low
everywhere, investors are hungry for any sort of yield. This has made them more willing to buy
high-yield bonds, and has pushed down the spread that riskier borrowers must
pay compared with safer borrowers. When
financial conditions tighten, investors are sure to become more discriminating
again.
3.132
The article concludes by warning that when the
inevitable correction comes, it will be all the more painful because of the
large imbalances which have developed.
3.133
The Committee acknowledges that the focus of the
article in The Economist was the USA,
but notes the many apparent similarities with the situation in Australia, with
its big increase in household consumption and debt and the related housing boom
of 2002-04.
3.134
A study by the US Federal Reserve Board in 2000 of a
number of countries found that self-correcting mechanisms should kick in when a
CAD reaches about 5 per cent of GDP:
A typical adjustment occurs after the current account deficit
has grown for about four years and reaches about 5 percent of GDP. The results
from previous episodes suggest that reversals involve a real depreciation of 10
to 20 per cent and slow real income growth for a period of about three years.
Real export growth, declining investment, and an eventual levelling off in the
net international investment position and in the budget deficit-GDP ratio are
also likely to be part of the adjustment.[94]
3.135
A speech in May 2004 by Edward Gramlich, Governor of
the US Federal Reserve Board, focused on the sustainability of rising trade and
budget deficits.[95] These issues are now attracting much more
detailed analysis and debate in the USA, as they should be in Australia.
3.136
Australia has now had a CAD of over 5 per cent of GDP
for 11 consecutive quarters, and the expected correction in the exchange rate
has not taken place. Could this be a practical example of the 'jamming'
referred to by The Economist (above)?
3.137
In another warning that global imbalances need
watching, the International Monetary Fund's World Economic Outlook bulletin
released in September 2005 warns that the USA's growing trade and budget
deficits are unsustainable and will put great stress on global financial
markets unless action is taken to bring them back into line.[96]
3.138
The Governor of the Reserve Bank of Australia, Mr I J
Macfarlane, believes that there are some early signs of a return to normality,
even if they are small and the process likely to be long. He points to the policy of the US Federal
Reserve to gradually move up interest rates and China's abandonment of its
fixed parity to the US dollar as key initiatives to support his thesis.[97]
Is there a need for policy changes?
3.139
The Round Table discussed the need for further reforms
to enable the economy to readily respond to adjustments resulting from the
CAD's fluctuations. They identified two
areas deserving additional attention - reforms to raise productivity and initiatives
to lift exports.
3.140
Professor Garnaut commented:
There is a sense in which this set of circumstances tells us
that we are living beyond our sustainable means. That might not be a terrible
thing if we are given the chance to adjust gradually and pull in our belts a
bit - the household sector spends a bit less, gradually, over a number of years
- so we haul things back into a sustainable shape. But, one way or another, we
have to reduce the rate of growth of expenditure relative to growth in the productive
capacity of the economy. The more we can raise average productivity through
productivity-raising reform and the issues that have been raised about better
utilising underutilised labour in our economy -
and there is a lot of it - and the more we can remove barriers to skills
training and so on, the less we have to reduce our living standards to make the
adjustment.[98]
3.141
He continued:
...a large current account deficit requires, amongst other things,
an adjustment over time. It has to involve some relative shift of resources
from domestic sectors of the economy to international sectors, producing
exports or import-competing products. The more successful we are in raising
productivity, removing barriers to efficient performance of our potential
export industries, the less the external adjustment has to take the form of a
crude reduction in living standards. I think that is the link between
productivity-raising reform in all its forms and the current account deficit.[99]
3.142
Dr Simes agreed with the desirability for
productivity-raising reform, although he cautioned that the impact on the
current account of such reforms is unclear:
This is related to what Ross [Garnaut] is saying. What he is
saying is that, the more the benefits from microeconomic reform or whatever,
the less pain we have with the adjustment. My understanding of the empirical
literature, though, is that we have not seen a direct causation shown between
microeconomic reform as such and the current account. You would hope that,
given some of the points that Ross is raising, that would be there. We want
microeconomic reform, more productivity growth et cetera in any case.[100]
3.143
In response Dr Gruen said that productivity-enhancing
reforms should be undertaken for their own direct benefits (such as enhancing
productivity, raising living standards and increasing the flexibility of the
economy) rather than for any indirect impacts they may have on the current
account. He pointed out that if such reforms make Australia appear an even
better place to invest, they could result in a higher CAD.[101]
3.144
Dr Simes (and Prof Garnaut) believes that fiscal policy
should be such that in periods of high revenue (e.g. due to high terms of
trade) the Government should budget for larger-than-normal surpluses. These surpluses should be saved for use in
years when revenue falls, or used to enhance productivity in areas of national
importance such as education and training.
3.145
Dr Gruen responded that 'the general government sector
in Australia has been in surplus for eight years in a row, with an average
surplus of about one per cent of GDP. That is a significantly tight fiscal
policy...' [102]
3.146
Professor Garnaut agreed that the Government's overall
fiscal policy had been appropriate, but added:
I think we would be less vulnerable to a large deterioration in
the terms of trade if, in the early period after a big improvement in the terms
of trade, we ran a bigger than average surplus and then ran that down in tax
cuts or other productive ways when the terms of trade retreated, or when we had
realised that the China boom is not a short-term boost to minerals and energy
prices but is there forever. In that case, once we know that - and we do not
know it yet - we can absorb it then into our permanently higher expenditure
levels. But the prudent thing is to run larger surpluses when you have boosts
in revenue that are temporary or that may turn out to be temporary.[103]
3.147
Dr Gruen questioned the suggestion that proactive
policy changes are required to address the high CAD. He said:
I think one has to be encouraged by the market’s view of
Australia in a range of circumstances. There was the Asian crisis, when you
might have imagined that a country that was running a large current account
deficit would be treated with suspicion. We experienced precisely the opposite
and were treated as a safe haven. There was the period in 2000 when all things
'new economy' were regarded as the bee’s knees and we were very much out of
favour. The currency fell, but there was no sign of difficulty in funding the
current account. Is it possible at some point in the future that the market
will lose confidence in us? I guess you would have to say it is possible, but
the experience that we have suggests that, in a range of circumstances where
you might have wondered how we would go, we have actually done fine. The
adjustment mechanisms which you would hope would help - namely, the exchange
rate falling and allowing an improving export position - have done what you
would have wanted.[104]
3.148
Mr Conroy proposed seven initiatives to move the
economy from one which is driven by consumer debt to one based on exports of
knowledge-intensive manufactured goods:
... prudent economic
management and solid economic fundamentals; acceleration of the growth of
business investment in R&D; increased greenfield foreign direct investment;
greater import replacement; an increase in exporters and the extension of the
capacity of existing exporters; investment in supporting physical, social,
R&D and environmental expenditure and infrastructure; and increased levels
of private equity investment, especially venture capital.[105]
Committee views
3.149
In theory, when the CAD gets too high self-correcting
market forces are triggered. Interest
rates will tend to rise (slowing economic growth); the exchange rate will tend
to fall (making imports more expensive and exports cheaper); the trade balance
will improve; and as a result the CAD will improve.
3.150
In practice, however, other factors can delay or
inhibit these market forces. The article in The
Economist referred to earlier describes the apparent 'jamming' of
self-correcting mechanisms. That seems
to have been Australia's case recently - despite recording a CAD of over 5
percent of GDP for eleven consecutive quarters the exchange rate continues at a
relatively high level, in response to high terms of trade and a continuing
large inflow of money.
3.151
Figure 3.14 shows how the A$ / US$ exchange rate has
moved relative to the terms of trade.
The two graph lines have tended to be in rough synch, until recent
years. Could this widening gap indicate
the opposing forces of the terms of trade and the CAD at work?
Figure 3.14: Comparison of the
terms of trade and the A$ / US$ exchange rate.
![Figure 3.14: Comparison of the terms of trade and the A$ / US$ exchange rate.](/~/media/wopapub/senate/committee/economics_ctte/completed_inquiries/2004_07/household_debt/report/c03_14_jpg.ashx)
Sources: RBA,
Daily Statistical Release for
exchange rates; ABS, Balance of Payments and International Investment
Position, Cat. 5302.0 for terms of trade.
3.152
The CAD has retreated, at least temporarily, from its
record level of 7.2 per cent in the December 2004 quarter, due mainly to higher
export receipts from high export prices of minerals and energy commodities. Export volumes are also picking up. So the trade balance should show some
improvement in coming quarters. However,
the income balance is expected to deteriorate as net interest payments, and net
dividends and reinvested earnings continue to rise reflecting higher
international interest rates, and high corporate profits in Australia.
3.153
The Round Table discussed, briefly, the need for
greater domestic savings and faster export growth as ways to improve the
current account. Facilitating
superannuation was identified as a means of increasing savings, but there was
no time to consider other possible alternatives.
3.154
The Committee noted recent Government policy
initiatives which will enhance superannuation - specifically, the removal of
the superannuation surcharge and the extension of the co-contribution scheme.
3.155
The Committee believes that these changes represent a
good start, and urges the Government to take further initiatives to increase
the attractiveness of superannuation as a preferred form of savings.
3.156
The Committee received a range of opinions as to the
risk posed by a persistently high level of CAD.
Treasury said that the high level was part of the normal fluctuations in
the CAD and as long as we could readily borrow the required funds, it did not
represent a major problem. On the other
hand, Professor Garnaut and Dr Simes sounded a note of caution and concern.
3.157
After reviewing the evidence presented to this Inquiry,
the Committee has formed the opinion that Australia's large and persistent
current account deficits may be an indicator of underlying imbalances in the
economy. The precise level of risk they pose to Australia's future economic
well-being can be debated, but there seems no doubt that they do present a
risk. This risk needs to be closely monitored,
but more than that the Committee believes that it is time for the Government to
take proactive action.
3.158
The Committee is particularly concerned at the trend
towards a higher average level of CAD, perhaps to around 6 percent of GDP. The Committee accepts that Australia will
continue to run deficits in its current account, but feels that a deficit of
around 2 per cent of GDP would make us much less vulnerable than one of 6 per
cent.
3.159
The Committee would be much more comfortable if the
current trend towards higher average deficits was reversed, and believes that
the Government should introduce policies which will lead to a lowering in the
average CAD over the medium-to-long term.
3.160
The Committee would like to see more debate and
discussion in Australia on this important topic. The Treasury is the obvious government agency
to take the lead in this area.
3.161
While the current account is discussed in Budget
Statements and similar documents, there seems to be infrequent in-depth
analyses produced by Treasury on this important subject. An examination of the publications on the
Treasury website indicated that the last in-depth research on aspects of the
current account was published in the Centenary Edition of Treasury's quarterly
Economic Roundup bulletin, in May 2001.[106]
3.162
Treasury's Economic Roundup bulletin of August 2004
contained an article titled Might the
United States continue to run large current account deficits? That is the type of analysis the
Committee would like to see more of, but focused on Australia's own current
account situation and the risks it might represent to the economy.
3.163
In fact, the Committee suggests that an in-depth
analysis of developments in Australia's current account be an annual feature
article in the Economic Roundup bulletin. Questions which should be analysed on a regular basis include:
-
What would it mean for Australia if the CAD
averages around 6% of GDP for the next few years?
-
Is there a level at which the CAD becomes
unsustainable?
-
What are the options for improving the long-term
average of the CAD?
-
What lessons can we learn from other countries
such as Canada?
-
What would be the effects on the Australian
economy of possible shocks such as a terrorist attack or an energy crisis?
-
What would the implications for the economy be
of large and unexpected falls in business and/or consumer confidence, and what
factors could trigger such falls?
-
What would be the impact of a sharp downturn in
international demand for Australia's exports of minerals and energy?
3.164
The Treasury should also take more opportunities to
publicly discuss issues related to developments in Australia's current account.[107] The Committee recognises that
Treasury's task in managing the economy is not an easy one, but the
precautionary principle demands that it fully considers a wide range of
possible scenarios.
Recommendation 3
The Committee
recommends that the Government introduces policies designed to bring about an
improvement in the medium-to-long term average of the current account deficit,
including improving domestic savings and increasing the diversity and
international competitiveness of the export sector
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