In February 2014 Stratton Street highlighted a list of countries likely to suffer a ‘dip’ in fortunes, these are countries where weak fundamentals have been ‘brushed’ aside or ignored, but are nonetheless vulnerable. Our view of ongoing deleveraging ‘paints’ a very negative view of countries with large net foreign liabilities, otherwise collectively known as "paintbrush". These “PAINTBRUSH” countries, in no particular order of level of concern, are Poland, Australia, Indonesia, New Zealand, Turkey, Brazil, Romania, Ukraine, South Africa and Hungary. As a guide, since February 2014 none of these countries’ currencies (spot rate) are showing a positive return against the US dollar: not surprisingly the Ukraine is the worst with the hryvnia down ~65% but even Indonesia, the best performer, is down 10%.
Perhaps Australia remains one of the more interesting cases as it still rated AAA by all three major rating agencies. Australia, for NFA focused investors such as ourselves, with net foreign liabilities to GDP of -81.5% (Stratton Street’s estimates), remains a country to avoid. It runs twin deficits and since 2009 Australia’s debt to GDP has risen faster than any of the other AAA sovereign credits. That said, gross government debt to GDP at 34.5% (Fitch) remains below the median for AAA at 42.8% and is one factor giving the ratings agencies comfort.
The May 3 budget forecast the government deficit at AUD 37.1bn or ~2.2% of GDP for the fiscal 2016-17 year and that Australia will return to a fiscal surplus by FY 2021. The ratings agencies have viewed the budget as a ‘ratings neutral event’ but we note the forecasts are based on pretty wishful assumptions.
The budget relies on some generous economic growth and commodity price estimates to bolster the tax revenue line. GDP growth while forecast at 2.5% for the 2016-17 budget year is then expected to accelerate to ~3% from 2017-18: this looks to be somewhat hopeful given China’s slower growth outlook coupled with weak growth back home. But the budget is looking for a recovery in wage growth (running at 2.1% yoy in Q1 CY16) and business investment is expected to fall 5% in 2016-17 but then remain flat in the subsequent year which looks punchy against the ABS capital expenditure survey which looks for a 7% decline in non-mining private capex in 2017.
Moreover, the budget’s FY2016-17 iron ore price assumption has been revised up to USD55/t (FOB) from the mid-year estimate of USD39/t (FOB) which is optimistic given China is growing more slowly and supply has increased significantly. While this is below the current spot price broker expectations are generally for the price to weaken with more bearish estimates such of Goldman looking for USD 35/t (62% Fe China CFR) or USD 29/t (Australia FOB) for 2017. Even the Treasury cite volatility in commodity prices is a “key risk” to their forecasts. Note that a USD 10/t change in the iron ore price will add/reduce the government tax receipts by AUD 1.4bn in 2016-17 assuming an exchange rate of US 77 cents.
Government spending projections do not show meaningful fiscal consolidation. This is compounded by the difficulty of getting legislation passed by the senate. This budget relies on AUD 13bn of expenditure cuts and AUD 1.5bn of revenue increases that are yet to be passed by the senate. It remains to be seen whether the double dissolution election improves this situation. Equally government has commitments on education, health and social spending allow only modest reductions in expenditure over the period out to FY 2019-20.
Post GFC central bank rate cuts have provided a liquidity lifeline to the “paintbrush” countries but the deficits and elevated debt levels have not gone away. As we have highlighted before, the McKinsey Global Institute (MGI) Report of February 2015 showed there has not been any deleveraging since 2008, other than in a few small cases. Between 2007 and 2Q 2014 global debt increased by USD 57tn raising the ratio of global debt to GDP to 286 percent. They note “that high debt is associated with slower GDP growth and higher risk of financial crises.”