Wednesday, July 22, 2015

Could Australia lose its AAA rating? | Housing seen as key

This commentary is from the archive, as your commentator is on holiday. It first appeared in March 2015

A big hitter in Australian economic circles, David Murray, former chief executive of the Commonwealth Bank and leader of a recent Australian government-sponsored financial system enquiry, has come out strongly against the situation that allows for the tendency of house prices in Australia to continue to rise.

As regular readers of the OmiCronFX  commentary will note, the recent surprise decision of the Reserve Bank of Australia (RBA), to refrain from a much expected cut in core interest rates, was also because of the fear that even lower rates could further increase the likelihood of a bubble in the residential property market Down Under.

According to Mr. Murray, the main criterion for retention of the triple-A rating on Australian government debt, so prized because of the small number of sovereign nations in that particular club, is that total government debt should not exceed 30% of GDP.

Housing seen as key

In Australia, many investors are prepared to borrow to purchase houses to rent them out even though they know that the rental income will not cover the interest being paid. They are prepared to do this for two reasons – (1) they expect the capital appreciation of the properties to supply their profits, and (2) because favourable tax treatment of the income and expenditure on the investments allows them to offset some, if not all, of the shortfall. Borrowing for asset purchase under these conditions is known as “negative gearing”. However, the resulting demand for housing continues to drive up prices.

The tax treatment, in particular, has the effect of raising the borrowing of Australian states, and the nation as a whole, which, according to Mr. Murray, is pushing government and government guaranteed borrowings towards levels that could impact the credit rating of the country. He is calling for the tax treatment to be changed and for the government agency concerned, the Australian Prudential Regulation Authority (APRA), to introduce measures that will restrict borrowings in the buy-to-let segment of the market.

If these measures were to be implemented effectively the RBA could once again consider lowering core interest rates, and thereby allow the Aussie dollar to fall to a more sustainable level (instead of apparently depending on the actions of the US Federal Reserve to weaken the Aussie). If Mr. Murray is correct, and the triple-A rating is lost, it will mean that the international rating agencies will have done this job for them because in that eventuality, as far as the Aussie dollar is concerned, it would be a case of “look out below”.

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