Brief history of Australian Economy
Australia has experienced two previous credit bubbles in 1880–1892 and 1925–1932. From 1880–1892, the debt to GDP ratio rose from 40% to 110% while from 1925–1932 the debt to GDP ratio rose from 40% to 80%. Debt crises correct excesses in the system and force society to adopt more conservative and prudent attitudes towards debt accumulation. Past two credit bubbles were shorter in duration, but the current credit bubble is building from 1950, which is a 65 year build up. The current credit bubble started at much lower level of debt to GDP ratio of 20% but it has been higher than what we saw in previous bubbles. This is mainly on the back of Central Bank’s actions of actively reducing interest rates to increase capacity within the system to support higher level of debt. Experts believe that currently we are seeing initial signs of a great credit contraction.
GDP growth and terms of trade performance across the years (Source: ABS; RBA)
The trends in Australian Trade and RBI index of commodity prices clearly indicate that Australian resource boom has peaked out and has been on the downturn from last year. Fall in trade index would impact export, national income and unemployment ratios. Over the past three months, the trade deficit came in at around $10.6 billion. Accordingly, Standard & Poor’s cautioned investors that they might reduce major bank credit ratings if the federal government shows signals of less willingness to offer financial support to banks in a crisis. Moreover, lower bank credit ratings might pose upward pressure on bank funding costs and interest rates paid by borrowers.
Public Debt Interest Costs (Source: Mid-Year Economic and Fiscal Outlook, The Commonwealth of Australia)
In 2008, Australia’s performance was not affected due to natural resources and growing Chinese economy. On the other hand, the scenario has reversed recently while commodity prices have been facing pressure on the back of softening economic conditions in China. The decrease in demand for resources has hurt the Australian economy which is dependent on resource exports.
Australian cash rate (Source: ABS, RBA)
Inflation at record low level
Australian interest rates are expected to continue to be low for long term as there are no signs of inflation in near future. Accordingly, based on an Economist report, the rate hike might not happen till 2018. Moreover, given the challenging housing conditions in Sydney, investors are expecting that Reserve Bank would make cautious steps towards interest rate rises. Accordingly, cash rate might remain near historically low level of 2 % even for 2017.
Government backing for Australian banks
Australia’s credit rating which typically is used by investors, sovereign wealth funds and pension funds to evaluate the credit worthiness of Australia, correlates to the country’s borrowing costs. Australian banks operate based on the implicit backing of the government’s AAA credit rating. As a result, foreign creditors who are aware of this fact are showing interest to buy Australian bank debt during the current times. On the other hand, any unfavorable situations could change the investors’ view towards Australia’s credit rating. For a highly leveraged economy like Australia, a fall in the credit rating might have a more than expected impact. Recently, the sustainability of the AAA rating raised lot of concerns at the back of a risk of a fall without any efforts taken to enhance the revenue in the next budget.
The recent news about central bank cutting interest rates to an all-time low of 1.75% on May 03, 2016 and with Standard and Poor’s and Moody’s maintaining their earlier stance with no ratings actions following the release of the federal budget, Australia’s AAA sovereign credit rating does not seem to be at risk as of now. Both intend to review the budget details in order to offset any possibility of shifts in the market sentiments. The outlook has also been considered as stable though downside risks have still not been completely excluded. Fitch also reiterated Australia at AAA.
Impact on stock market
The Dow Jones Index was hurt during December 2015 to February 2016 on the back of interest rate hike by Fed. Accordingly, the S&P 500 (INDEXSP: .INX) also corrected over 7.12% for the same period. However, global leaders are making every effort to revive the current slowdown in the economy onto the growth track. Accordingly, Fed is signaling that there might not be further interest rate hike till the slowdown subdues. China recently reported favorable measures to boost its economy as well as delivered a positive housing data indicating the country’s efforts to economic recovery. These positive measures drove the S&P 500 by 9.37% in the last three months (as of May 02, 2016). Accordingly, S&P/ASX 200 (INDEXASX: XJO) surged over 9.6% in the last three months (as of May 03, 2016) and 2.18% on May 03, 2016 alone.
Consolidated Cash Balance by Sector (Source: Budget 2016-2017, Federal Financial Relations)
With the budget release and record low interest rates, it has been thus pointed-out that government’s fiscal strength is supported by high debt affordability, as per Moody’s. Nonetheless, public finances have been said to be susceptible to a slump in the housing sector and a reversal in currently favorable external financing conditions. What is being also projected is that slower the path of fiscal consolidation, less resilient would be the Australian economy with regard to various headwinds including the aforementioned.
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