By Stephen Koukoulas
10 July 2015
The sharp escalation in the level of Australia’s net foreign debt, the economic problem of years past, has the potential to unleash a wealth-destroying wave that could knock Australia down the list of rich countries.
Yet it’s not getting the same attention as the house price bubble, the fall in the terms of trade, or the failure of the Abbott government to deliver on its promises of budget surpluses and lower government debt.
In fact, it’s not getting much attention at all.
Australia’s net foreign debt is on an unrelenting upward trajectory. What’s more, the recent international trade data points to what could be the start of a significant widening in the current account deficit, which will only add to the pressures that are seeing the level of foreign debt increase.
National debt and deficit worries seem to have taken a back seat to fear and anxiety about government and housing debt in the economic commentary and policy concerns over the past few decades. Yet it remains a potential problem for Australia. This is because it leaves Australia vulnerable to the whims of foreign investors – ie those funding the debt.
If, for whatever reason, they decide to stop lending to Australia – or if the interest rate they demand starts to rise – the Australian economy is in trouble.
As at the end of March 2015, Australia’s net foreign debt stood at $955bn, a record high. As a share of GDP, this was equal to 59.5%, also a record high.
Two decades ago, foreign debt was a centrepiece Coalition criticism of Labor’s economic management. When it was an issue in the 1996 election win by John Howard, net foreign debt was hovering around $190bn – 37% of GDP.
In September 1995, six months before the election which swept Howard into power, he said ‘I can promise you that we will follow policies which will, over a period of time, bring down the foreign debt … our first priority in Government economically will be to tackle the current account deficit.’
It failed to do this. Indeed, since the Coalition returned to power in September 2013, net foreign debt has risen by $142.6bn or a stunning 6.5% of GDP.
In the mid-1980s, Australia’s sovereign credit rating was downgraded, in large part because foreign debt had risen from around 10 to 15% of GDP to above 30% of GDP. With foreign debt set to exceed 60% of GDP, the budget still in deficit and net government flirting with record highs, the ratings agencies might be getting ready to warn Australian policymakers about the imbalances in the economy.
Staggering low global interest rates make the servicing of foreign debt relatively easy, one vital reason the issue hasn’t been in the foreground. In other words, potential cash flow problems and financial pressures from a high and growing level of debt have been masked by the low interest rate environment.
Another reason was the fact that up until a few years ago, all of the net debt was in private hands. It was thus the result of “consenting” private sector transactions. The thinking was that the government had no policy role in controlling the transactions of banks, borrowers and investors.
With the budget in deficit in recent years, this is changing and part of the net foreign debt is now driven by the public sector.
If interest rates were to rise a little, as has already been happening in the market for government bonds, the debt servicing burden becomes more oppressive. Risks to those with debt are magnified. The rise in global interest rates seems certain to get a further boost as the Federal Reserve in the US looks to hike interest rates later this year.
If foreign creditors change their currently favourable attitude towards Australia, the main mechanism through which this will show will be a further depreciation in the Australian dollar exchange rate. Already down a massive 37 cents from the 2011 high, a further Australian dollar fall would see import costs rise and, on balance, living standards fall.
To be sure, a lower level for the Australian dollar would boost export competitiveness and thus help to support exporters and local firms competing with imports. But a permanently lower currency is evidence of economic weakness.
Australia’s foreign debt is high and it is rising. It seems certain that it will rise further in the next couple of years. It could again be an issue for financial markets, ratings agencies and policy makers alike. If so, the consequences could be severe for the economy, with a sharply lower Australian dollar and policies aimed at increasing savings.