Australia's External Debt - Assignment Example

AUSTRALIAS EXTERNAL DEBT Introduction The issue of high foreign debt has been traditionally focused on the less developed countries which have been suffering from chronic fiscal and current account deficits. Typically imports in these countries exceeded exports as savings rates fell far short of the requirements to finance public and private investments. When these countries failed to pay their debts, such as those that happened during the 1997 Asian financial crisis, they were declared in default, it would necessitate drastic policy measures to be carried out to restore external equilibrium such as a currency devaluation. When these countries seek the help of the International Monetary Fund and other international funding agencies, as South Korea, Thailand and Indonesia did in the aftermath of that crisis, they often had to follow harsh prescriptions or conditionalities that were to cause immense difficulties for their citizens and businesses, sometimes with serious political consequences. It is in this context that most debates about external debt are conducted. Hardly is the topic a hot issue in advanced countries. The United States, the worlds most heavily indebted country, hardly ever takes it up as a serious issue of high public concern. The purpose of this paper is to examine whether the high – in absolute terms -- external debt level of Australia is a cause for concern on the part of its policy makers and its citizens. External Debt: Concept and Definition External debt is defined by the Banking Dictionary as the total amount of bank debt owed by debtor nations to foreign lenders and creditor banks. Foreign lenders and creditor banks (collectively the creditors) can be other governments, commercial banks, international financial institutions such as the IMF and the World Bank, corporations, or households. The International Monetary Fund (IMF) defines gross external debt as the outstanding amount, at any given time, of current, not contingent, liabilities that require payments of principal and/or interest on the debt at some point(s) in the future and that are owed to nonresidents by the residents of an economy. (citation.. . .) The elements of the definition are clear enough, but some remark about contingent liability might enlighen. Contingent liabilities are those under which one or more conditions have to be fulfilled before the obligation takes effect, and therefore may entail some risk. External debt can be classified into 1) public or publicly guaranteed debt, 2) private non-guaranteed credits, 3) central bank deposits, 4) and loans due to the IMF. The Reserve Bank of Australia (RBA) provides its own definition of gross and net external debt. To the RBA gross external debt includes borrowings by both the private and government sectors, and net external debt represents the gross external debt less lending by Australian residents to non residents. A qualification is added: Debt is not the only form of external liability: Foreigners can also hold equity claims on residents in the form of share portfolios and ownership of subsidiaries or branches or real estate, and conversely, Australians can have equity and property investments abroad. . The Australian central bank applies the term "net international investment position, (IIP)," the overall net claims against residents, to refer to the sum of external debt and net equity liabilities in its accounts. It indicates whether Australia is a net supplier of funds to the rest of the world or a net user of funds from abroad. A common comparative measure relates the IIP to the GDP.A Because debt and equity claims are consolidated in the IIP, a distinction has to be made. Debt is a contractual obligation to pay both principal and interest, whilst an equity liability entails no such obligation as holders only share in the profits of the business through dividends. It is noted that using the methodology of splitting the IIP into foreign equity and debt, Australia showed a net IIP of $312 billion consisting of net foreign equity of $98 billion and net foreign debt of $213 billion. (http://www.abs.gov.au/AUSSTATS/abs@.nsf). More recently, as of June 2008, the IIP of Australia showed an international investment position of $692 billion, split into net foreign equity of $92 billion (up from $687 a quarter earlier) and net foreign debt of $600 (a slight drop from the previous quarters $604 billion. This indicates that close to $10 billion of new investments entered Australia, while repayments exceeded new debt by about $4.5 billion. (Source: http://www.abs.gov.au/ausstats) Australia and the External Debt Issue With a per-capita GDP (ppp basis) of $36,300, Australia is one of the most advanced countries in the world. It has enjoyed an uninterrupted economic growth in the last 16 years, mainly because of its robust agricultural and mining exports. It enjoys a standard of living that is higher than that of any other industrialized country with the probable exception of the United States. But to some, it also has a “high” level of external debt. This has drawn the attention not only of its citizenry but even of those in power, former Prime Minister Keating no less, who declared, at one point during his incumbency, that the high level of external debt was “unsustainable.” Because most literature on external debt focus on developing countries, and therefore normally accessible data are compiled with regard to them, statistics and statistical analysis relative to he external debt of developed countries such as Australia are not easy to come by. However, in a compilation by the World Factbook , the following table shows the foreign debt statistics of countries arranged according to the size of their external debt. The United States leads with $13,773 billion, followed by the United Kingdom and Germany. Australia ranked only 12th with $826 billion, behind Italy and Spain. To make the data meaningful and comparable, the population data were factored in for the purpose of deriving the foreign debt per capita of each country.(Wikipedia, October 2008) Switzerland ranked first with $509,529 per capita, followed by Ireland with $448,032 and the United Kingdom with $189,855. Australia was a distant $22,801, at the bottom quarter among the developed countries, with a derived ratio to GDP of 106.91 per cent, which is again relatively low. The definition of foreign debt in these data excluded foreign equity investments into the country.(https://www.cia.gov/library/publications/the-world-factbook/rankorder/2079rank.html (http://en.wikipedia.org/wiki/List_of_countries_by_external_debt). Fig. 1: External Debt Data, ranked by size, per capita debt, and ratio of debt to GDP An earlier analytical work done by Mark Rider of the Reserve Bank of Australia ) made a cross-country comparison of external debt in 1994. In that study it was shown that Belgium-Luxembourg had the highest ratio of gross external debt to GDP with 267 per cent compared to Australias 53 per cent, which put the country in the lower half of the group and which was lower than that of Germany, France, Canada and New Zealand (but higher than those of the Unite States and Japan of 34 per cent each). Net debt was highest for New Zealand with 62 per cent while Australia had 42 per cent, which can be explained by the fact that Australians did not have much loans outstanding claims against foreigners. . Net liabilities item showed New Zealand again with 70 per cent, whilst that of Australia was 55 percent, ranking third after Finland. Again, this may be explained by the fact that Australia has had larger inflows of equity capital investments from foreigners than most other countries in the group. (cite http://www.rba.gov.au).(1994 Debt is used to finance projects, services and businesses around the world. It is estimated that debt levels are worth 3 times GDP in developed countries or those countries that have an annual per capita above $10,000. On a global basis debt levels can average about 2.5 times GDP (See approximations by Wikipedia) More recent data from the Australian Bureau of Statistics show gross external debt position of Australia during the fiscal period 2008. It shows a gross external debt figure of $979,570 million but total foreign debt liabilities was increased by $92,894 million because of financial derivatives liabilities, bringing the total foreign debt liabilities, as reflected in the IPP, to $1,072,463 million. (http://www.abs.gov.au/websitedbs/d3310114.nsf/0/1cbac1ab0cca2049ca256d8f0080ec28/$FILE/Table%2031%20Gross%20External%20Debt%20Liabilities%20JQ2008_53020%20June%202008.pdf) Revision of Concept by IMF In 2002 the IMF revised the concept of external debt to distinguish it from the definition of foreign debt that Australian Bureau of Statistics had been using for the IIP. The difference is that financial derivatives are excluded from the total external debt. It also includes only debt liabilities, without the netting off of debt assets. The statistical agency will therefore publish both external debt statistics as so defined as well as foreign debt statistics as prescribed by Australian reporting process.http://www.abs.gov.au/ausstats/abs@.nsf/featurearticlesbyCatalogue/3B087E0F1B47BDABCA256DEE00802168?OpenDocument./ The Guide also explains the concept of net external debt—that is, a comparison of the external debt position with holdings of foreign financial assets in the form of debt instrument—and incorporates financial derivative positions into external debt analysis. In an IMF report of September 21, 2006, it was stated Australias external liabilities, which were mediated through the banking system, had risen steadily in absolute terms and as a share of GDP; however, the composition thereof had shifted towards the private sector as non-resident claims on the public sector had declined. The private sector now accounted for 90 percent of the gross external debt with financial corporations accounting for 4/5 of all private external debt. As a percentage of GDP, gross external debt had risen from 80.6 percent in 2004 to 82.6 per cent in 2005, but net private debt went up from 46.9 per cent to 50.2 per cent whereas net public debt as a ratio to GDP fell from 1.6 per cent to 0.6 per cent. It also noted that that a significant proportion of the borrowings of banks are hedged through the extensive use of derivatives. Nearly 4/5 of these currency exposures are hedged with foreigners, the rest with the Reserve Bank of Australia in the form of swap transactions. As a positive backdrop to this scenario, the foreign currency assets of Australians exceeded foreign currency liabilities by $216 billion, or 26 per cent of GDP. As a result of the hedging strategies, the earnings of the financial sector have varied little in the past several years despite sharp movements worldwide in the exchange rate of the Australian dollar.(p. 14) Historical external debt data up till mid-year of 2007 are shown below: Date - Field Australia - Debt - external 2008 January Debt - external $757.9 billion (30 June 2007) 2007 January Debt - external $585.1 billion (30 June 2006 est.) 2006 January Debt - external $308.7 billion (3rd quarter, 2004 est.) 2005 January Debt - external $308.7 billion (3rd quarter, 2004 est.) 2004 January Debt - external $193 billion (2003 est.) 2003 January Debt - external $176.8 billion (2001 est.) 2002 January Debt - external $168.7 billion (2001 est.) 2001 January Debt - external $220.6 billion (2000) 2000 January Debt - external $222 billion (1999) http://www.exxun.com/afd_hy/Australia/ec_debt_external.html Table 1: Australian external debt data, 1999-2007 Because of the well-developed state of the Australian financial and foreign exchange markets, the IMF argues that the sector enjoys a high AA- credit rating, while Australias sovereign rating is a very high AAA-. If the need to roll over some of these obligations occurs when risks in the world financial markets increase, these high credit ratings may serve to attract investors to Australia rather than elsewhere. As an additional protection, the financial sector is seeking to diversify its international funding sources and the variety of financial instruments. In spite of these positive factors, the IMF has recommended strong financial supervision to control the vulnerabilities associated with high private sector debt. This is so because potential shocks, whether generated from abroad or domestically, can have an impact on the liquidity and solvency of local banks, which could in turn affect the confidence of foreign investors in Australia. Despite the high debt level, the risk of the substantial accumulation of debt would be dampened by the sustained growth in exports, coupled with the sound risk management through hedging.(p.15). Australia has been enjoying a trade boom with its terms of trade rising by 31 per cent compared to the early 1970s. This means that the prices of Australias exports have risen while the prices of its imports have fallen, particularly imports from China. In September 2008, the IM F Executive Board after consultations with Australia, came out with a report praising the countrys sustained economic expansion during the past 16 years aided by sound macroeconomic policies and structural reforms. Because of strong demand, consumer prices rose 4.5 per cent in Australia. A large current account deficit increased net foreign liabilities to 60 per cent of GDP, accumulating as debt of financial institutions. Australian authorities tightened monetary policy by raising interest rates 100 basis points to rein in inflation. Can current account deficit and external debt be optimal? Current account deficit, which leads to an increase in external debt, can be optimal because it reflect unusually good investment opportunities. Some studies initiated in 1992 attempted to quantify such a supposed optimal level, but although it has been applied to other countries, the benchmarks tended to be imprecise and tentative. The current account deficit indicates low saving and high investment or a combination of both. It indicates that there is excessive consumption and more borrowings to finance investment, which may be ideal provided such investments are not inefficient and can grow profitably in the future. It would in this case show that investment opportunities and good and the economic outlook is healthy. Thus a big net external debt is not necessarily bad. An analysis of Australian savings data would show that domestic savings have been about 20 per cent of GDP over the past 15 years. More recently the drop in household savings was compensated for by the increase in corporate and public savings. And the national savings rate is close to the average of advanced countries. The strong private investment reflects emphasis on the capital-intensive sectors, particularly mining; and productivity and efficiency have been high as proven by high returns on investment. In conclusion, one may say that high levels of investment in Australia are the main cause of the historically and currently high levels of current account deficits. It would have been a risky proposition if these investments turned out to be inefficient and loss-making enterprises; on the contrary, there is little to fear because they are yielding good returns. Their liquidity and solvency promotes confidence that such a high level of external debt will be sustainable and actually promotes strong development over the long run. Conclusion An analysis will show that Australia has one of the lowest external debt per capita among developed countries with only $22,801. Its ratio of 106.91 per cent is lower than average for the developed countries which approximately is 300 per cent, depending on which countries are included in the calculation. If one compares Australias profile with that of Indonesia, which has a relatively low $140 billion in external debt, some insights can be gained. Owing to its big population, Indonesia has a per capita debt of only $146, and the ratio to GDP is only 16.59. Yet Indonesia has a poor credit rating and suffers in comparison with Australia in most respects. The country risk ratings of done by Coface shows that Australia has an A1 risk rating which denotes that a “steady political and economic environment has positive effects on an already good payment record of companies; a very weak default probability.” In contrast, Indonesia has a B rating: “An unsteady political and economic environment that is likely to affect further an already poor payment record.” In the global competitiveness report of the World Economic Forum, Australia ranked 19th out of 131 countries, on the basis of broad criteria including government organization, infrastructure stability, among others. Indonesia ranked 54th. The conclusion one might derive from these contrasting sets of data the conclusion that one must not confine oneself to absolute figures but should also use :1) comparative statistics and analysis, 2) the economic fundamentals, particularly with regard to production and export sectors; 3) international payment record of companies; and 4) the economic classification – whether the country in question is advanced or emerging country and whether or not it has dynamic economic sectors that have sustained its growth in the past; and 5) the use of sound macroeconomic policies and structural reforms that deal pro-actively with problems that might arise as global shocks. WORKS CITED Krugman, P.Rr. & M. Obstfeld, International economics: Theory and policy. 2nd ed. New York: HarperCollins Publishers, 1991 http://www.imt.hk http://www.globaledge.msu.edu/ http://www.rba.gov.au/PublicationsAndResearch/Bulletin/bu_dec94/bu_1294_3.pdf http://www.abs.gov.au/ausstats/abs@.nsf/7d12b0f6763c78caca257061001cc588/4a1232b66914015cca256dee006f93db!OpenDocument http://www.abs.gov.au/websitedbs/d3310114.nsf/0/1cbac1ab0cca2049ca256d8f0080ec28/$FILE/Table%2031%20Gross%20External%20Debt%20Liabilities%20JQ2008_53020%20June%202008.pdf http://www.abs.gov.au/ausstats/abs@.nsf/featurearticlesbyCatalogue/3B087E0F1B47BDABCA256DEE00802168?OpenDocument http://www.imf.org/external/np/exr/facts/asia.HTM http://www.imf.org/external/np/sta/ed/guide.htm http://www.imf.org/external/np/sta/ed/ed.htm http://www.imf.org/external/np/sec/pn/2008/pn08123.htm http://www.imf.org/external/np/ms/2008/070108.htm http://www.imf.org/external/pubs/ft/scr/2008/cr08312.pdf http://www.imf.org/external/np/tr/2008/tr081106.htm http://www.imf.org/external/np/sta/ir/topic.htm http://www.britannica.com/ has something abourt Australia http://www.exxun.com/e4history.html http://www.exxun.com/afd_hy/Australia/ec_debt_external.html http://en.wikipedia.org/wiki/List_of_countries_by_external_debt http://www.treas.gov/tic/debta308.html https://www.cia.gov/library/publications/the-world-factbook/rankorder/2079rank.html http://www.cia.gov/library/publications/the-world-factbook/index.html http://www.geographyiq.com/ranking/ranking_Population_growth_Rate_dall.htm http://www.treasury.gov.au/home.asp?ContentID=521 http://agencysearch.australia.gov.au/search/search.cgi?collection=agencies&profile=treasury&query=Australian+%22external+debt%22&scope_disable=off http://news.bbc.co.uk/2/hi/asia-pacific/country_profiles/1250188.stm http://www.answers.com/topic/department-of-the-treasury-australia Read More