Australia’s external debt crisis is a myth
Australian Financial Review
Monday 4th September
Stop living in the past and start seeing the reality – ‘deficit’ we run on current account is the other sided of a ‘surplus’ on capital account. Des Moore explains.
Writing on this page more than three months ago, I suggested there was no need for concern either about the $A’s depreciation or about a possible rise in official interest rates above the then prevailing 6 per cent (“What crisis? Dollar is fine, so is economy”). However, both US and Australian official rates have since been raised a quarter per cent, and domestic concern has apparently increased about the “low” $A. Some even worry that Australia risks another 1980s type “banana republic” crisis.
Last week’s low increase in wage costs reinforces my May thesis. Indeed, basic
improvements in economic policies and underlying fundamentals not only make absurd any suggestion of another external debt crisis: they also suggest little or no need for pre-emptive monetary tightening while inflation remains within the 2-3 per cent target. Further, the best overall measure of our international competitiveness is not the $US rate but the trade weighted exchange rate index (TWI). As the following chart indicates, that is about the same as in May.
FORGET THE $US, IT’S THE TWI STUPID
Our international competitiveness depends more on the trade weighted exchange rate index than the $US rate
True, the TWI is now around 8 per cent lower than its average during most of the period since the Coalition Government assumed office in March 1996. Nor, contrary to past practice, has it responded to the 8 per cent increase in commodity prices (in SDR terms) over the past year. However, that latter increase has been from a post-Asian “crisis” slump. Such prices may now be seen as more “normal”, although still lower than in 1995 and 1996.
More importantly, perhaps, in an increasingly globalised world where services contribute about 70 per cent of developed country GDPs and final producers are economizing on commodity inputs, it seems to be becoming generally agreed that variations in foreign capital flows are now having a more important influence on exchange rates. Partly associated with the “new economy”, strong growth in private capital expenditures in the US and the UK have been accompanied by increased foreign capital inflows that appear to have contributed to the rising $US and pound sterling (both up over 25 per cent since 1995). By contrast, private capital spending by our businesses has so far fallen since 1997-98 and Australia may have become relatively less attractive to foreign investors in this new environment.
Australia remains nonetheless a major net importer of foreign capital, as we have been for most of our history. Without such capital (including large imports of computers) our economic and employment growth would be lower. Yet few people seem to understand that the “deficit” we run on current account (because we import more goods and services than we export) is the other side of a “surplus” on capital account. Moreover, unlike the large “speculative” borrowings overseas of the 1980s or those induced by Labor’s large budget deficits of the first half of the 1990s, these capital imports are now apparently being used productively. Our current capital surplus of about 5 per cent of GDP can thus be regarded as non-dangerous by comparison with the same surplus in 1984-85.
An important indicator is the (relative) reduction in the cost of servicing foreign capital. Thus, notwithstanding that our net imports of such capital have been increasing faster than the economy, net income payable overseas has dropped from over 4 per cent of GDP and 25 per cent of exports in the early 1990s to only 3 per cent of GDP and 16 per cent of exports today.
Unfortunately, those still living in the past overlook the changed fundamentals. Most importantly, we now have a Reserve Bank committed to maintaining low inflation and substantially independent. This is a radical change compared with the 1980s when the Bank accepted the rate of growth of wages agreed between the Labor Government and the unions. Now, the Bank is largely in control and the Industrial Relations Commission and the unions have to toe the line.
There remains debate as to the detail of keeping inflation to an average of 2 to 3 per cent over the business cycle. But the general situation is dramatically better than in the 1980s.
Equally, the commitment of both major political parties to at least balance the budget over the cycle has removed the 1980s danger of attempts to manipulate domestic demand that way. Micro-reforms such as privatization and competition policies have also lifted efficiency and productivity growth.
In sum, Australia can now live with a “low” exchange rate without fearing a debt crisis. Naturally, we should not readily accept that the price of being a net capital importer is a lower rate. Particularly through reform of workplace relations, much more needs to be done to encourage risk-taking and entrepreneurship so that employment and productivity growth can be lifted further. We may then get a little closer to world leaders such as the US.
Des Moore, a former deputy Treasury secretary, is Director of the Institute for Private Enterprise in Melbourne.