Funding from overseas
Australia has recorded current account deficits for most of its post–European settlement history. Over the past two decades, Australia’s current account deficit has averaged roughly 4½ per cent of GDP. However, Australia’s gross cross-border financial flows are larger: inflows of foreign funds have averaged around 8½ per cent of GDP over the past two decades, while outflows of Australian investment abroad have been around 4¼ per cent of GDP on average over the same period.
Australia’s open capital account
Ongoing access to foreign funding has enabled Australia to sustain higher growth than otherwise would have been the case. The risks associated with Australia’s use of foreign funding can be mitigated by having a prudent supervisory and regulatory regime and sound public sector finances.
Australia typically has had more abundant domestic investment opportunities than could possibly be funded from historic levels of national saving, and has therefore recorded persistent current account deficits. Compared to other advanced economies, Australia has had a relatively high investment rate and, more recently, a comparatively high saving rate (Chart 3.1). By using foreign funds productively, Australia’s growth potential can be raised to benefit both residents and foreign investors.
Chart 3.1: Gross saving and gross investment for Australia and for advanced economies1
Access to offshore markets (reflected in gross inflows) frees Australian borrowers from domestic financing constraints. Foreign investors may not have the same risk-return preferences as their Australian counterparts, so access to foreign funding markets may enable Australian borrowers to align their funding needs better with investors’ preferences. All else being equal, this would tend to enhance Australian borrowers’ ability to raise funds and lower the cost of those funds. This helps support a higher level of gross fixed capital formation and a higher rate of labour productivity growth.
Investing offshore allows Australians to achieve a more diversified investment portfolio internationally on the basis of expected returns and risks. It also means that Australian entities compete for finance in global funding markets, which has broader productivity benefits.
The continued inflow of foreign funding reflects the confidence foreigners have in both Australia’s growth prospects, and Australia’s capacity and willingness to service and repay its foreign liabilities.
The risks of using foreign funding
The risks to Australia, and to the financial system, from foreign funding relate more to rollover risk on debt than to foreign currency risk.3 Around two-thirds of Australia’s gross foreign liabilities are in the form of debt. Australia is therefore exposed to the risk that foreign debtors may choose to withdraw funding when the debt matures, particularly during periods of financial stress.4 The shorter the term of the debt, the more acute the rollover risk.
Since the global financial crisis (GFC), rollover risk has receded. Although banks still hold the bulk of Australia’s short-term foreign debt liabilities, these now represent a lower share of banks’ foreign debt liabilities than before the crisis.5
If foreigners become reluctant to invest in Australia, the cost of funding (for both debt and equity) for Australian entities would increase significantly. The higher cost of funding would translate into lower growth in gross fixed capital formation and GDP.
As a significant net importer of funds, Australia needs to maintain the confidence of foreign investors to ensure ongoing cheap access to foreign funds. To do this, it should adhere to the following principles:
- Use foreign funds productively.
- Maintain a prudent supervisory and regulatory regime for the broader financial system.
- Run a strong general government balance sheet to ensure governments remain good credit risks. In the event of a significant economic and financial disruption, more sustainable fiscal settings would provide the Government with greater capacity to support the economy and the financial system. Outside periods of stress, the Government’s credit rating is reflected in private sector ratings and therefore affects the cost of and access to foreign funds for the private sector.
1 Gross saving and gross investment reflect total saving and total investment (the aggregate of all sectors).
2 International Monetary Fund (IMF) 2014, World Economic Outlook Database, IMF, Washington DC, United States.
3 As at the end of March 2013, about 70 per cent of Australia’s gross foreign liabilities were denominated in Australian dollars. In addition, about a further 20 per cent of Australia’s gross foreign liabilities were hedged into Australian dollars (this does not account for ‘natural hedges’). Australia as a whole has a net foreign currency asset position — that is, the stock of Australia’s foreign currency assets is larger than the stock of Australia’s foreign currency liabilities (as such, a depreciation of the Australian dollar, all else being equal, would reduce the size of Australia’s net foreign liabilities). Reserve Bank of Australia (RBA) 2013, ‘Foreign Currency Exposure and Hedging in Australia’, RBA Bulletin, December Quarter, RBA, Sydney, page 51.
4 As at the end of March 2014, Australia’s total gross foreign liabilities were $2.5 trillion, $0.9 trillion of which was equity (or 35 per cent). Australian Bureau of Statistics (ABS) 2014, Balance of Payments and International Investment Position, cat. no. 5302.0, ABS, Canberra.
5 For the main categories of foreign debt liabilities (debt securities, currency and deposits, and loans), deposit-taking institutions account for around 90 per cent of foreign debt liabilities that are short term (as at the end of March 2014). For deposit-taking institutions, their short-term foreign debt liabilities (with respect to debt securities, currency and deposits, and loans) have decreased as a share of their foreign debt liabilities (debt securities, currency and deposits, and loans), from 43 per cent in the September quarter 2008 to 28 per cent in the March quarter 2014. Australian Bureau of Statistics (ABS) 2014, Balance of Payments and International Investment Position, cat. no. 5302.0, ABS, Canberra.