The annual budget deficit that results from next month’s budget is probably going to come in around 5% of GDP, which is not bad compared to 12.3% in the U.S. or 12.5% in the U.K. But it’s going to be around $50 billion. And remember, just over a year ago, you were looking at a surplus of $22 billion. A $72 billion one-year swing in Australia’s public sector finances is an impressive accomplishment by the Rudd government, but probably not one it will be campaigning on next time around.
In February the government raised its borrowing ceiling from $75 billion to $200 billion. Last week, Finance Minister Lindsay Tanner said the bleak IMF report highlighted the big revenue gap in Australia’s budget. He said Australia might have to raise its debt ceiling to $300 billion.
This is the nice thing about being a sovereign government. A household cannot arbitrarily vote itself the power to go deeper into debt. Households are at the mercy of their creditors. This either forces households to live within their means, or forces lenders to be more discrete with their loans.
A sovereign government generally doesn’t face the same kind of restrictions on its ability to borrow. The only real restriction is that it doesn’t much up its public finances so badly that creditors begin to demand higher interest rates. Or even worse, turn their back altogether.
Granted, Australia’s funding needs look pretty modest in the global scheme of things. But the question we ponder to start the week off is whether the Rudd government can trash the country’s credit rating even more quickly than anyone expected.
Australia’s triple A credit rating could indeed be at risk, according to an article in the Sunday Age. S&P sovereign risk analyst Kyran Curry says his agency is watching Australia’s current account deficit to determine if the government is borrowing more than it should. He says the current account deficit shows both Australia’s need to import capital and the effects of declining export revenues (an even larger deficit).
He wasn’t ringing any alarm bells just yet. But it was pretty clear what he meant. “We believe this Government will develop a credit exit strategy to stabilise its fiscal (budget) position in the medium term…But if the balance sheet weakened (the current account deficit), combined with a further weakening in the fiscal position (the budget deficit), that could bring some pressure on the rating.”
“Pressure on the rating,” means higher borrowing costs for the government in the future. That makes all sorts of financing more expensive, and exposes Australia’s big vulnerability, its reliance on foreign capital to grow the domestic economy.
So how big would an annual deficit have to get before the ratings agencies downgraded sovereign Aussie debt? “It is believed a deficit of $60 billion or more could prove a trigger point for ratings agencies to re-think the outlook, which would lead to higher interest rates and a bigger taxpayer-funded public interest bill,” the Age concludes.
David Uren in the Australian writes that it could come sooner than you think. “The crunch point for government borrowings will be reached in 2010-11, when government bond issues totaling $17 billion fall due, compared with just $6billion in 2009-10. This would potentially lift the financing requirement in that year to well above $70 billion, requiring the Treasury to issue bonds at a rate of more than $1.3billion a week.”
The job of borrowing $1.3 billion a week from the rest of the world falls on the shoulders of Andrew Johnson, the Chief Executive Officer of the Australian Office of Financial Management (AOFM). Good luck to him on that.
Mr. Johnson gave a speech in Sydney last week called, “Australian Government Debt in a Changed Financial World.” In that speech he said, “If we were to continue our current pattern of bond issuance at the rate of $1 – 1.4 billion per week, this would provide $48 -$ 67 billion over the course of 2009.” He then showed a chart to prove it.
Let’s be clear, we’re not saying the AOFM is going to have trouble selling this much Aussie debt. Some of it will be bought domestically by super funds. Some will be bought by European and North American financial institutions. And some will be bought by the Chinese we reckon. One clear result is that non-residents will end owning a larger piece of Australian government bonds than ever before.
Maybe it’s good that foreigners want a piece of Aussie debt. Maybe that means the place remains attractive to foreign capital. And maybe it means the government can run even larger deficits in the coming years without paying substantially higher interest rates. But maybe it also means the Aussie dollar is headed down soon.
Over to Alan Kohler at Business Spectator who writes that, “International investors will not buy Australian government debt at a yield of 4.7 per cent and an exchange rate of 70c/70¥, when debt levels are at the point where a negative rating watch is likely, if not an actual downgrading.” Alan predicts/suggest that the Reserve Bank ease the government’s borrowing pain by lowering the cash-rate to two percent by June 30th.
It’s just over two weeks until Wayne Swan has to present his budget. But we’d expect currency and share markets to start putting the pieces together before then. The weaker Aussie dollar ought to be a bonus for the Aussie gold price (and investors in gold shares). Meanwhile, another big question is whether the share market can keep up its recent run.
You know our take on it by now. Deleveraging and liquidation have a long way to go. There are many more housing-related losses to take for U.S. and European banks (not to mention emerging market debt). Governments are trying to spend their way out of it, and in the process they’re jacking up tax rates to soak the rich.
Bottom line? The plan to borrow and spend our way out of the recession isn’t going to work. The results of the stress tests for U.S. banks are due the first week in May. But the bigger stress test is going on in the bond markets right now. It’s a stress test for sovereign governments in the U.S., the U.K. and here in Australia. Who’s going to pass and who’s going to fail? More on that tomorrow.
for Markets and Money