Trade war a significant risk to Australia: RBA

The RBA steps up warnings over the trade war, saying Australia has been a major beneficiary of a system now under threat.

Reserve Bank Deputy Governor Guy Debelle says Australia has been a major beneficiary of the trading system. Picture: John Feder

The Reserve Bank has warned the current threats to the global trading system are “a significant risk to both Australia and the world” and that the nation’s reliance on foreign capital would be significantly reduced if it were not for the heavy foreign ownership of the country’s biggest resources companies.

In an escalation of the RBA’s rhetoric over the growing trade war between China and the US, RBA deputy governor Guy Debelle told a conference in Canberra that the dangers are not just to Australia, but extend globally.

“Australia has clearly been a major beneficiary of that (trading) system. The current threats to the system are a significant risk to both Australia and the world,” he added.

The comments come after RBA Governor Philip Lowe told the world’s central bankers at a meeting in Jackson Hole, Wyoming, over the weekend that political shocks are now becoming shocks to the global economy.

With US President Donald Trump last week targeting both US Federal Reserve Chairman Jerome Powell and China’s leadership in his bid to win ground in the trade dispute, the atmosphere at the Jackson Hole conference was one of deepening concern that the global trading system was under attack.

The RBA cut interest rates in June and July, its first policy easing since 2016, citing the deteriorating global outlook for the move.

The irony for Australia amid the global trade dispute is that it is expected to post its first current account surplus in close to half a century in the second quarter, supported by strong Chinese demand for iron ore and a weaker Australian dollar.

Dr Debelle said in his speech that the improvement in Australia’s balance of payments has taken place under the rules-based global trading system that has been in place for a number of decades.

Speaking to The Economic Society of Australia, Dr Debelle said the current account deficit – a measurement of the country’s reliance on foreign capital – would likely be slimmer, or the potential surplus would be larger, if it were not for Australia’s largest mining companies being 75 per cent owned by foreigners.

The current account deficit is currently at its smallest point compared to the size of the economy since the 1970s.

The last time Australia recorded a current account surplus was in 1975. However, Australia this year has posted a record high trade surplus of almost $20 billion, thanks to soaring iron ore prices and LNG exports, along with the winding down of foreign investment in LNG projects, and analysts believe the current account may now be in surplus. This would mean Australia is investing more outside its borders than it is reliant on foreign sources of funding.

“For pretty much all of its modern history, Australia has been a net importer of capital,” Dr Debelle said. “In the 80s, foreign liabilities were often regarded as a significant vulnerability for the Australian economy. I think this risk was overstated,” he said.

Australian public debt held by the government has risen from about 10 per cent before the global financial crisis to about 20 per cent currently. At the same time, foreigner ownership of government bonds has risen from 40 per cent to about 80 per cent.

During financial crises in Latin America and Asia, high levels of foreign debt denominated in foreign currency caused large capital outflows when it was believed nations were unable to repay the debt.

However, Dr Debelle said the vast bulk of foreign debt held by Australia is denominated in Australian dollars. “To put some numbers on this, 68 per cent of foreign liabilities are denominated in Australian dollars. This increases to 85 per cent after hedging,” he said.

Because Australian debt is denominated in Australian dollars, a falling exchange rate acts as a “shock absorber” to global financial crises, Dr Debelle said. The local dollar has fallen close to its weakest point in a decade amid the trade war between the US and China.

Dr Debelle said the country is also less reliant on foreign capital now because education is a large export, and tourism is also a big contributor to the economy.

Meanwhile, Australia’s previous position as being much more favoured by foreign investors in the sharemarket has flipped because of the massive growth of the country’s $2.8 trillion superannuation sector, which has meant that since 2013, Australians now own more foreign equity than foreigners own local equity.

While the country has reduced its reliance on foreign funding, Dr Debelle said the amount of income flowing into Australia through its offshore equity holdings is tempered by foreign ownership of the country’s large resources exporters.

This “net income deficit” is due to “significantly higher payments recently to foreign owners of direct equity in Australia’s mining sector because of the increased profitability of the mining sector. The foreign ownership of the large mining companies is around three-quarters,” Dr Debelle said.

“The trade surplus had risen to historically high levels because of higher resource exports.

“These higher payments to the foreign shareholders limit the narrowing of the current account that occurs from the boost to the trade surplus from this source,” Dr Debelle said.

Rio Tinto this month announced $US3.5 billion worth of dividends following its $6 billion annual profit. BHP Billiton said this month it would pay $2.5 billion in dividends on top of $5.2 billion worth of share buybacks over the last six months.

However, Dr Debelle said the country’s reliance on foreign capital has come a long way from the “banana republic” days Paul Keating warned of in 1986.

“The structure of Australia’s external accounts now resembles that of the United States. While Australia doesn’t have the exorbitant privilege of the US, the external accounts do not constitute a source of vulnerability and have become increasingly resilient over the past 30 years,” Dr Debelle said.

“All of these developments have taken place under the rules-based global trading system that has been in place for a number of decades now. Despite some flaws, that system has delivered sizeable benefits for global growth and welfare.

“Australia has clearly been a major beneficiary of that system. The current threats to the system are a significant risk to both Australia and the world,” he said.
With Dow Jones