From Westpac’s Bill Evans:
The Reserve Bank Board meets next week on December 6. The Board is certain to keep rates on hold despite the prospect of a weak print for GDP growth in Australia in the September quarter. Westpac’s current estimate is 0.2% – the lowest since March quarter 2011.
It appears that the new Governor Lowe has decided that any benefits to the economy from a further short term boost to housing and spending from even lower interest rates would not justify the potential risks around household debt that even lower interest rates might bring.
From that perspective it is interesting to consider the debt burdens currently experienced by the world’s major economies.
The Figure uses data from the Bank of International Settlements (BIS) to provide a “like for like” break down between corporate; household; and gross government (including states) debt.
From Australia’s perspective, the key issue is that Australia has “around average” corporate debt but record low government debt (34.5% of GDP) and record high household debt (125% of GDP).
This not a new situation. Australia’s household debt boomed in the ten years leading up to the GFC while Australia’s government debt position deteriorated sharply in its aftermath. That reflected the weight of the short term stimulus packages offered by the Rudd/Gillard governments; the collapse in commodity prices and the embedding of a series of generous social packages during the “plentiful” years when commodity prices were booming.
Australia’s government debt position was so strong during that pre GFC period that it could afford a sharp deterioration post GFC and still have a very strong position relative to other developed economies. The pace of this deterioration has slowed markedly with “calmer” times for commodities; no more poorly targeted short term stimulus packages and some spending restraint from the Coalition Commonwealth government and some state governments.
Household debt ratios have not fallen since the GFC despite a much more cautious household sector. Sharply lower interest rates have sufficiently stimulated new lending that household credit growth continues to exceed growth in incomes.
These issues should be sending a very clear message to the authorities around the optimal policy mix. The policy mix over the last five years has been to slash interest rates thereby putting upward pressure on household debt despite its already excessive starting point. It appears that the Reserve Bank is no longer attracted to that policy mix. On the other hand, the fiscal authorities, with a very strong balance sheet show no inclination to use that balance sheet to provide whatever future boost to demand might be required.
This week both the OECD and the IMF, following intense study tours of Australia, recommended a boost to infrastructure investment, to be funded by borrowings, by the Commonwealth authorities.
Reserve Bank officials have already been on record supporting such an approach. It appears clear that given Australia’s extreme debt mix the Reserve Bank sees fiscal policy as a more appropriate tool to boost demand and raise productivity than further leaning on household balance sheets.
Unfortunately there has been no encouraging response from the government. In response to the IMF/OECD suggestions the Finance Minister indicated that it was not appropriate to borrow for “investment” until the government was not required to borrow more to finance current activities. A likely interpretation of that position is that borrowing for infrastructure cannot be supported until the Budget is in surplus. On current estimates that will not be until 2020/21.
This approach may be a calculated strategy to retain Australia’s current AAA sovereign rating. My view is that the most significant headwind for Australia retaining its AAA rating is its excessive foreign debt (public and private) which runs at around 60% of GDP (compared to the AAA “average” of around 15%). That high foreign debt, in turn, reflects the excessive household debt, as banks funded Australia’s housing booms with offshore funds.
It is certain that Australia will not be able to significantly lower that foreign debt anytime soon.
If the Commonwealth Government is relieved of its battle to retain the AAA it may be more open to adopting a sensible long term infrastructure program. Such a program would boost productivity and while the direct short term impact on demand might be limited, it is likely to boost the confidence and growth expectations of the business community. In turn lifting investment and employment plans.
In the meantime, the government should not look to the RBA for a “short term” fix by further boosting household debt with even lower rates.
Hmm, interesting notion, losing the AAA rating would increase fiscal spending. I think the opposite more likely. More rate cuts are coming.
What you are better off campaigning for, Bill, is much tighter macroprudential policy to accompany the cuts.