The Daily Update - Australia

Earlier this week Australia released its latest 2017-2018 budget which projects a deficit of AUD29.4bn (1.6% of GDP) a slight increase from the mid-year projection of AUD28.7bn. The budget is mildly contractionary looking to return to surplus (AUD7.4bn or 0.4% of GDP) in 2020-21, possibly cognisant of the requirements to maintain the Aaa rating. While some reports noted the budget targeted an infrastructure program of AUD70bn this is over 10 years so it is more of a support to growth than an immediate boost. The budget assumes real GDP growth of 2.75% in 2017/18 increasing to a 3% run-rate thereafter which could be considered on the punchy side. For example, Moody’s estimates real GDP growth in the 2.5-2.7% range over the next few years. A further debatable assumption is the iron ore price which has been under pressure lately: the budget assumes the iron ore price to average USD66 per tonne out to December and then decline to USD55 per tonne in the March 2018 quarter. But if this price decline were to happen 6 months earlier than expected it would hurt tax receipts by around AUD400m.

Post the budget release Moody’s commented that they still see Australia’s fiscal strength as being ‘very high’ with a budget that focused on bringing the central government budget into balance by the end of the decade. They expect government debt to increase to 42.4% of GDP by FY2018 from 39.7% in FY 2017 which they still see that as fitting with the Aaa median. However, they also note the government projection for ‘a rise in revenues as a share of GDP, a trend that has not materialized in the last three years. At 26% of GDP by FY2021, the revenue-to-GDP ratio would be the highest since FY2006 and above the average of the last 20 years. Instead, we forecast broadly stable revenues as a share of GDP.’

Another issue is the greater reliance on taxes on consumption which could be at risk particularly if the housing market were to slow. Already some are questioning whether consumption is slower after the March retail sales figure which fell 0.1% mom and the savings rate has been falling as consumers have dipped into savings to fund their expenditure; the household savings rate fell to 5.2 percent in Q4 2016 from 6.3 percent in Q3. House affordability remains a topical issue which is hardly surprising given estimates put Sydney’s price to income ratio at an eye-watering 12 times and making it the second least affordable city in the world ahead of Melbourne in fourth place. Measures in the budget look insufficient to address this problem.

Perhaps of more interest was the budget impact on the big four banks and Macquarie Bank which got lumbered with a tax of 6 basis points on liabilities (ex- tier 1 capital and government guaranteed deposits) which penalises banks reliant on wholesale funding sources. The government has estimated that this will raise AUD6.2bn over 4 years or ~5% of the targeted banks’ annual profit after tax. Not surprisingly, the equity share prices took a hit although the for bond investors Fitch sees this as credit negative for the banks ‘but not significantly enough to have an immediate ratings impact’. One issue is will it be passed on to consumers in the form of higher lending rates? Banks have already been facing higher funding costs this year and have raised lending rates out of synch with the RBA but a planned competition review could make this strategy tricky going forward.

But as ever Australia’s Achilles heel is its dependency on overseas capital. On our estimates, Australia’s net foreign liabilities are greater than our cut-off of 50% of GDP, the threshold that IMF research indicates is associated with increasing risk of external crises, making it ‘an avoid’ from an investment point of view. While periods of increased risk appetite, re-leveraging and aggressive central bank QE allows a rising tide to lift all boats investors should be more wary now central banks, most notably the Fed, are starting to take the ‘punch bowl away’: deleveraging means we continue to prefer creditor nations over more heavily indebted ones.

Please read this important information before proceeding. It contains legal and regulatory notices relevant to the information on this site.

This website provides information about Stratton Street Capital LLP ("Stratton Street"). Stratton Street is authorised and regulated by the UK's Financial Conduct Authority. The content of this website has been prepared by Stratton Street from its records and is believed to be accurate but we do not accept any liability or responsibility in respect of the information of any views expressed herein. The information, material and content provided in the pages of this website may be changed at any time by us. Information on this website may be out of date and may not be updated or removed.

The website is provided for the main purpose of providing generic information on Stratton Street and on our investment philosophy for the use of financial professionals in the United Kingdom that qualify as Professional Clients or Eligible Counterparties under the rules of the United Kingdom Financial Conduct Authority (the "FCA"). The information in this website is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. Products and services referred to on this website are offered only at times when, and in jurisdictions where, they may be lawfully offered. The information on this website is not directed to any person in the United States. The provision of the information on this website does not constitute an offer to purchase securities to any person in the United States (other than a professional fiduciary acting for the account of a non-U.S person) or to any U.S. person as such term is defined under the Securities Act of 1933, as amended.

The website is not intended to offer investors the opportunity to invest in any Alternative Investment Fund ("AIF") product. The AIFs managed by Stratton Street are not being marketed in the European Economic Area ("EEA") and any eligible potential investor from the EEA who wishes to obtain information on the AIFs will only be provided with materials upon receipt by Stratton Street of an appropriate reverse solicitation request in accordance with the requirements of the EU Alternative Investment Fund Managers Directive ("AIFMD") and national law in their home jurisdiction. By proceeding you confirm that you are not accessing this website in the context of a potential investment by an EEA investor in the AIFs managed by Stratton Street and that you have read, understood and agree to these terms.

No information contained in this website should be deemed to constitute the provision of financial, investment or other professional advice in any way. The website should not be relied upon as including sufficient information to support any investment decision. If you are in doubt as to the appropriate course of action we recommend that you consult your own independent financial adviser, stockbroker, solicitor, accountant or other professional adviser. Past performance is not necessarily a guide to the future. The value of investments and the income from them may go down as well as up. An application for any investment or service referred to on this site may only be made on the basis of the offer document, key features, prospectus or other applicable terms relating to the specific investment or service.

Where we provide hypertext links to other locations on the Internet, we do so for information purposes only. We are not responsible for the content of any other websites or pages linked to or linking to this website. We have not verified the content of any such websites. Such websites may contain products and services that are not authorised in your jurisdiction. Following links to any other websites or pages shall be at your own risk and we shall not be responsible or liable for any damages or in other way in connection with linking.

By using this site, you should be aware that we may disclose any information that we hold about you to any regulatory authority to which we are subject, or to any person legally empowered to require such information.

This website uses cookies to improve user experience, by clicking the "I Accept" button below means you consent to the use of cookies on our website.