RBA: Bank offshore borrowings won’t increase

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By Leith van Onselen

The Q&A session of Tuesday’s speech by RBA Assistant Governor, Guy Debelle, contained an interesting tid-bit on bank offshore borrowings, which Debelle believes will not grow from their current level, and might even fall slightly, over the foreseeable future:

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Certainly, Debelle’s comments that bank offshore borrowings have peaked are backed-up by ABS data, which shows almost zero growth since the onset of the GFC, with the size of offshore borrowings relative to both total liabilities and loans falling over this period (see next chart).

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The composition of the banks offshore borrowings have also changed recently, with some bond issuance replaced by foreign deposits (see next chart).

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Were Debelle’s predictions of no growth in bank offshore borrowings prove correct, it has implications for the banks’ ability to fund increased mortgage lending and house prices. As shown by Houses & Holes recently, bank deposit growth is falling, meaning that the banks might soon be unable to expand their mortgage book without seeking additional funding from offshore.

Perhaps this is why Debelle last month threw caution to the wind and suggested the banks should look to ramp-up their offshore wholesale borrowings, as without this source of funding, the current housing recovery could be stifled, laying to waste the RBA’s plan for housing to fill the void left as the mining boom unwinds.

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Unconventional Economist

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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Comments

  1. Debelle is right. The Banks should be getting what they can, whilst they can – like everyone else.

    • Debelle’s graph No. 4 in his speech is probably incorrect as its not consistent with Leith’s graph above and Debelle’s own comments.

      So long as the government continues to run deficits and issue bonds offshore, this new money will find its way into deposits which are able to be turned into lending.

      The question is whether this is enough to sustain the required mortgage growth? I’d say no!

      • In fact the foreign capital inflow is matched by recurrent outflows, to cover interest owed on past loans and our net import bills.

        The funds come in as capital and leave as expenditure. They do not stay in the domestic economy.

  2. The banks respond to demand for credit from the household sector, which is restrained by capacity to service. As well, since most household demand for credit relates to housing, and house rices are at all-time highs in relation to income, underlying demand for housing is also curbed.

    So while deposit growth has slowed, banks would probably think that’s no bad thing. Why would they want to increase expensive deposits (liabilities) when their assets are not growing quickly?

    As for public sector debt, this is twinned with the net income deficit in the external accounts. Unless the external deficit is eliminated, and as long as households do not increase their foreign borrowings (why would they?), the public sector will remain in deficit, and axiomatically, it will be funded from abroad. This is necessarily the case since the recurrent income deficit in the external account has its obverse – a capital account surplus.

    The resource boom will lead to expanded export volumes and notional export receipts. But this will not be much help to the export income deficit, because most of the increased export income flows do not accrue in the domestic economy. They accrue in the accounts of the foreign equity holders of the resource projects. So exports will improve, but the current account, by itself, will not because of the financial structure of income flows.

    As a result, despite the boom, the Australian economy has the same imbalances that it has always had: we consume more in the domestic economy than we produce and the gap is filled by imports. While we are large exporters, we export less than we import (especially in a financial sense) and therefore depend on foreign capital inflows to balance the accounts.

    The liabilities associated with these inflows are accumulating in the public sector. This has always been the case in Australia, other than in the the few years of the financial bubble, when liabilities were built up in the household sector.

    As the “shocks” of the inflation/deflation of the financial bubble recede, we can see we are back exactly where we started in the 1980’s.

    We have an over-valued exchange rate, a permanent current account deficit/capital account surplus, a public sector deficit that is growing faster than the economy, (unsupportable) high real wages and an investment framework that perpetuates this dysfunction.

    We are entitled to ask what the managers of this economy, including the RBA, have been doing for the last 30 years.

    • Good summary Briefly!

      I’ve remarked on this often before but I’ll do so again as i really hate euphemisms that are really untruths.

      I believe it was during Malcom Fraser’s time as PM that “Foreign Borrowings” and ‘Foreign Investment’ became ‘Capital Inflows’.

      Similarly the term “Capital Account Surplus” seems to be a term specifically designed to hide the term “Current Account Deficit”

      Old sayings something to do with wool and eyes again comes to mind.

    • In many ways, the RBA has been just as lazy and complacent as the political class and the economy in general. They haven’t really need to be anything more than that. Now we’re in a position where the RBA and the political class needs to earn it’s keep, so we’ll see how they go. It’ll make for interesting viewing.

      • I’m concerned that they’re not up to it Ralph. Unfortunately the viewing will affect us all in real life & not in a nice way.

    • “We are entitled to ask what the managers of this economy, including the RBA, have been doing for the last 30 years”.

      Since floating the currency the managers of the economy have not only ignored the CAD problem, they have actually used the CAD to keep inflation close to target. Battelino sort of admitted this before leaving the RBA.

      The net income deficit is a real problem. If markets came to a view that we had reached the external solvency limit, we would then need to generate trade surpluses large enough to offset the net income deficit (to keep the external debt/GDP ratio stable). This would be a tall order. As you say it would be especially hard, because large foreign ownership of our greatest export industries would mean that increases in exports would also increase the net income deficit. Which suggests that a large drop in imports may be required to fill the gap (but how do you do that without inflicting a recession?).

      And if you inflict a recession to fix the CAD, you run into another problem. The nominal GDP growth rate will then be lower than the interest rate, which will mean an even greater trade (primary) surplus will be required to keep the external debt/GDP ratio stable. This is the problem Spain etc. are having now.

      There aren’t really any easy answers to this.

      • 🙂 The answers lie back in time.

        “Since floating the currency the managers of the economy have not only ignored the CAD problem, they have actually used the CAD to keep inflation close to target. Battelino sort of admitted this before leaving the RBA.”

        Exactly!
        The reaosn increased money supply over the decades has not resulted in inflation is because it ended up in the CAD. Virtually the moe you printed the more cheaper goods got imported leading to low inflation numbers.

        I was about to remark on Ralph’s comment ” It’ll make for interesting viewing” in regard to this problem when I noted your post Sweeper. It’s sure going to make for interesting viewing as the old model of cheap goods from Asia, lasting over five decades, is now rapidly drawing to a close.

        It’s more than interesting. To me its bloody scary but everyone else, other than a few here, seems to be heading off into the future with cheery optimism!

  3. I symphasize with the sentiments, but at what stage do all the commentators on this site give the Pitchford thesis some validity. We are now up to over 30 years of CAD’s with no discernible effect on risk premiums, growth, or anything else that indicates that the outside world thinks the money is being p*ssed against the world. Maybe, just maybe, the bulk of capital account inflows have been appropriately invested. Do all the sceptics have to see another 1,5,10,30 years of experiences similar to the past 30 years to change their minds

    • I believe in the pitchford thesis , that CAD’s dont matter until they do matter.

      i suspect Iceland and Argentina and probably Malaysia in 1997 were not specifically worried about the CAD until it became an issue.

      The problem with the rest of the world is that there are very little options and Australia is still reasonably attractive, which I suppose Iceland was prior to the GFC.

      The only country that I believe had an interesting solution was Russia, just default on the foreign denominated debt and then become a CAS country exporting energy and arms

      • Well we were running similar CADs in the 90s when Malaysia went down and its now been a decade and a half since that event. When does your view become untenable? What will it take to convince you that the CAD is not the appalling problem that you currently think it is
        Iceland was a fraud and Argentina is an excellent example that Pitchford does work. People stopped funding it years ago because the inflow was badly invested.

    • I never really got the Pitchford Thesis. Does it claim that there is no external solvency limit? If so, how can that be correct? Can a country amass external debt all the way to infinity?

      Isn’t that just as absurd as claiming there is no long-run budget constraint?

      • Sweeper…you probably know more than I do but fwiw the theory is that external debt doesn’t matter as long as it is PRIVATE debt. If a privatge company arrangement goes haywire well what the hell? Who cars except the various shareholders? It’s wrong on a couple of grounds including the fact that the sovereign eventually has to guarantee the private Banks or everything goes to hell in a wooden hand-cart!
        I doubt it needs the Sovereign to cover the banks for it all to go askew.

        The corollary is that CAD’s don’t matter. Well I can write a lot of words on that theory! (and have already maybe)

        Cheers

  4. Smokester

    The Pitchford thesis results from a very short term view of economic outcomes. In the long term it is plainly wrong.
    What has kept us afloat has been our huge natural resources per head of population that we have been willing to sell (the assets not the income) in order to maintain our lifestyle.
    Without those sales we’d have drowned in our own muck long ago.

    Seondly note Sweepers comment on inflation and CAD’s. The low inflation as a result of importing deflation to offset RAMPANT domestic inflation is at an end.

    HOWEVER you are right to this extent. This is a Pressure Cooker that has been steadily building up pressure for five decades. As one of my favourite old economists Herb Stein opined “If something cannot go on forever it WILL stop”
    The stopping is unlikely to be pretty.

    • “The Pitchford thesis results from a very short term view of economic outcomes. In the long term it is plainly wrong”.

      Exactly, over the long-run the Pitchford thesis can’t logically be correct, because the interest on the external debt feeds back into the debt etc. etc. etc.

  5. Not necessarily. If the proceeds are invested in activities that exceed the cost of servicing the debt, there is a net positive. Exactly the same way that successful companies can continually expand their stock of debt if they generate higher than debt cost returns.

    • Which is another way of saying that CAD’s are fine as long as they don’t exceed the GDP growth rate over the long run.

      Clearly they have exceeded the growth rate, because the external debt/GDP ratio has got a lot worse over the past 30 years.

      My question is, is there a external debt/GDP limit? And if there is, how can the Pitchford thesis be correct?

      • Once again not necessarily. For example if at onte time there was no external debt and overseas debt was incurred to invest in productive projects, the growth of external debt would exceed the GDP growth rate.
        Once again you get back to the fact that we have been running CADs since the early 1970s. Now I’m sure you are very clever, but the combined market forces are not placing any limits on it yet and you could argue that via interest rate differentials they are placing less of a CAD crisis premium than most times over the past 30 years. They may well in the future but so far you are wrong.
        And the Pitchford theory can be correct . It merely states that the CAD will be funded if the market is happy that the funding will be properly used, or alternatively that the CAD is the obverse of the Capital account and if investors are happy to invest, there will be a CAD

        • But in theory, is there an external debt/ GDP limit?

          Note: I’m not saying that Australia is at the limit (so what it happening now is irrelevant).

      • Thanks Sweeper
        One of the problems is this. The CAD is of itself, short-term, not a calamity. It can be funded by borrowings or asset sales. Indeed as Smokes opines it can be as a result of wise investment. However, just as an aside, those same investments COULD have been and probably should have been funded from our own savings.

        However what a CAD tells you immediately is that POSSIBLY something is out of kilter with your economy. It is likely becoming unbalanced and you should start paying attention. If you don’t pay attention and, instead, cover the CAD through quite massive asset sales and borrowings, then the distortions in your economy become worse and worse.
        So now we have
        1. An impoverished rural sector
        2. Our food manufacturing chain is almost totally foreign owned and is currently being moved offshore at a rapid rate
        3. Our maunfacturing sector is, to all intents and purposes well outlined by ChinaBob, screwed.
        4. Our mining industry is some 80% owned by foreign interests
        5 Our service sector is over-bloated and, generally, overpaid as compared to the rest of the economy.
        6. The education system adapts to providing the education appropriate to the unbalanced economy
        7. We really like living like this…it’s easy!

        By the time your debt and asset sales reach the untenable level you have destroyed the productive capacity of your economy. Itlooks damned difficult, IMO impossible, to get back from here.

        Early attention to CAD’s and adopting appropriate corrective policies is not only about CAD’s. It’s about maintaining a long-term sustainable balanced economy.

  6. It will last for a while – as long as foreigners are willing to hold AUD as reserves. In fact, demand for reserves funds capital inflow, which correspond with recurrent outflows.

    But this economy is just not big enough to provide reserves to others for long. And the faster foreigners add AUD to their reserves, the shorter the span before they will start to lose their value.

    In my opinion, encouraging the AUD to be used as a reserve currency is negative for us. We should discourage it, or at least, every time foreigners buy AUD, we should offset that by buying their currencies in return. That is, we should eschew capital inflow for these purposes. They just disrupt our monetary settings, most notably the exchange rate and they generate persistent current account outflows.