A Short Summary Of Australia: A Comforting Position In A Turbulent World

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Includes: FXA
by: Navid Ghanooni

Every country is currently facing its own unique problems but some problems are far worse than others. The debt debacle in the euro zone and the ever-expanding debt of the U.S. is definitely a concern to the global community so let us cast some attention to another area of the world. Although it is facing some problems at the moment, Australia's strength and resilience has gained the attention of a growing number of foreign investors keen on extracting yield.

The strong points of Australia can be very succinctly summarised by the following points.

  • Small open market economy
  • Democratically elected government
  • Independent Central Bank - the Reserve Bank of Australia (RBA)
  • Open capital account
  • Freely floating exchange rate
  • AAA-rated sovereign debt with a stable outlook (a rarity nowadays)

A point that was neglected is Australia's reliance on the resources industry. This is chiefly fueled by the aggressive demand for resources from developing countries. Although this has established unprecedented growth in the resources sector, many other sectors have suffered from the rising Australian dollar. The strength of the AUD has heavily disadvantaged manufacturing and consumer discretionary companies with many of them currently undergoing major restructures. However, the AUD has also shown peculiar behaviour recently, since it has remained high even though the terms of trade has dropped. This shows that there are additional sources of demand for the AUD (outside of commodities) and this is probably caused by the reallocation of foreign central bank reserves as the AUD receives more attention.

The resources industry may seem small in Australia but it has a significant role in its export industry. Mining only accounts for 7% of GDP however iron ore, coal and other minerals account for 65% of the value of exports. Australia's largest export markets include China, Japan, Korea and India so it is obvious that the export market is highly leveraged to the developing economies. It is this reliance on a single industry that casts a shadow on the boom that has been provided by mining. This was highlighted recently by the two consecutive months of trade deficits caused by bad weather that hit coal shipments. Coal and iron ore are the two biggest export earners in Australia and a 16% fall in coal exports was too much for the export industry to handle. The deficit in February of AUD480 million was particularly surprising considering analysts expected a surplus of AUD1.0 billion. However, it should be noted that Australia was able to pass the GFC relatively unscathed due to its exposure to developing countries.

The Australian Treasury expects growth to average 3.25% both this financial year and the next and this will be achieved by the strength of the fast growing resources sector; namely from robust capex growth. Investment in resources is expected to reach AUD120 billion by 2012-13 resulting in a dramatic increase in export volumes for iron ore, coal and liquefied natural gas (LNG). In relation to LNG, output is expected to triple as AUD180 billion of projects come on stream making Australia the world's largest LNG exporter by 2017.

The current cash rate set by the RBA is 4.25% resulting in the high government bond yields that many foreign investors have been busying gathering. However, an important factor about the RBA is its balance sheet which is in a much healthier state than that which belongs to the Federal Reserve. The RBA has a AUD80 billion balance sheet and holds gold and foreign exchange reserves amounting to AUD45 billion. The remainder of the assets are in the form of liquid AUD denominated assets. This can be compared to the Federal Reserve's balance sheet which no longer contains as many highly liquid US Treasuries as it did before the GFC.

For the US readers who appreciate any form of fiscal responsibility, Australia has a debt ceiling of AUD250 billion and there has never been an issue to raise the ceiling in order to increase borrowing capacity. However, government debt has risen rapidly since the GFC as can be seen below both in terms of net debt and debt-to-GDP.

The figures above show that the Australian government had a period of negative net debt during what is known as the 'boom years'. Also, debt-to-GDP was only 14.7% in 2008 and skyrocketed to 30.3% in 2011.

In 2009, the Federal Budget moved into a deficit and the return to a surplus has recently ignited debate in the country. At the moment, the Australian government is committed to turning around an expected deficit of at least AUD40 billion into a AUD1.5 billion surplus in 2012-13. If achieved, this would be one of the largest budget turnovers in Australian history. The possibility of this occurring has become more and more uncertain since the forecast deficit for this year was AUD13 billion in May 2010 and it has been increasing ever since.

The issue of the budget deficit has raised a large amount of concern on Australia's spending and revenue generation. Government revenue has dropped since the GFC from decreased company tax receipts, lower income tax revenue and lower economic growth. Before the GFC, high household income, aided by a low AUD, increased company tax revenue. The change in the structure of the economy is quite dramatic since during the mid-2000s, household savings was effectively zero whereas in the last December quarter, it was recorded at 9% (last achieved in the 1980s).

The reduced tax receipts is considered to be one of the lingering effects of the GFC that still plagues the domestic economy. Over the 5 years to 2012-13, tax revenue has fallen by AUD140 billion. Another factor that played its role in reduced tax receipts is the loss of significant capital gains taxes from the booming housing and share markets prior to the GFC. This is no longer achievable as the asset price rises of that period will not be repeated for a long time.

However, like most other economies, Australia has also been hit hard with large fiscal programs that have riddled the economy with debt. Some of these programs include overspending of a stimulus package introduced in 2009 and a AUD36 billion National Broadband Network that has tested the patience of the Australian people.

Australia is a country that has exhibited impressive growth and resilience in such a turbulent and worrisome global economy. The country is facing its share of problems but compared to the rest of the developed world, it is certainly in a comforting position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.