The Crest of the Commonwealth of Australia Treasury Portfolio Ministers
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Wayne Swan

Deputy Prime Minister and Treasurer

3 December 2007 - 27 June 2013

18 March 2008

NO.006

Global Market Turbulence and the Australian Economy

Ministerial Statement to the House of Representatives

Canberra

18 March 2008

Mr Speaker

The world has witnessed substantial financial market turbulence since it began in August last year, making its presence felt across markets, across nations, and across continents.

It is of course most evident in the United States, but it affects all of us to a greater or lesser degree, including the hard working families of Australia.

As global financial market turbulence has become more prolonged, Australians have become more concerned about the dimensions and possible consequences of this uncertainty.

Later this week the House will rise, and when we next meet it will be to consider the first Budget of the Rudd Government.

Accordingly I seek the indulgence of this House at this time to review the character, magnitude and status of recent global financial turbulence.

I will inform the House how the Commonwealth Government and the relevant regulatory authorities and agencies within my portfolio are assessing the risks and monitoring these developments.

And I will offer this assessment, Mr Speaker, in the wider context of where the Australian economy has come from, where it is now, and where we hope to go.

Mr Speaker

When these developments began to unfold eight months ago the central concern was around the size of the write-downs that major global banks would have to accept from the rapidly rising default rates in US sub prime mortgages.

Within a very short time, however, it became an issue of uncertainty about the credit risks embedded in packages of mortgages bundled together by financial institutions and sold into global financial markets.

Sources of funding dried up and the market in sub prime mortgages virtually closed.

Shortly thereafter the entire residential mortgage backed securities market ceased to function with the depth and liquidity that had made these securities among the most widely held financial assets over the last decade.

With financial institutions here and elsewhere unable to raise as much funds through securitisation, and uncertainty as to the extent of exposures to losses on these assets, they began to hold on to the cash they had.

Banks here and elsewhere became more reluctant to lend to each other, except in the very short term.

Central banks in all major advanced economies, including our own, responded by offering to lend cash to banks on a much larger scale than usual, accepting as security a wider range of financial assets.

Toward the end of last year it appeared the crisis was beginning to ease as the US Federal Reserve responded by cutting the cash rate and supporting the liquidity of financial institutions.

However, as financial institutions sought to finalise positions prior to Christmas, spreads began to widen once more.

As we entered the new year, renewed concerns in financial markets were coupled with increasingly convincing signs that economic activity in the US was sharply slowing.

Equity prices across the world declined, as did the US dollar, and banks once again became reluctant to part with cash.

The US Federal Reserve responded with a large cut in the cash rate in January, and more recently has taken action to provide further liquidity to the market.

The prolonged uncertainty took its toll as exposed financial institutions, those with illiquid assets and short term liabilities, came under increasing pressure.

In Australia we experienced a fresh episode of funding dislocation this year, which we've seen in a wider premium of wholesale market rates over the cash rate.

In the US market, concern moved on from household mortgages, to the risks of dealing with investment banks which might have difficulty accessing liquidity.

Just this week the US's fifth largest investment bank was absorbed into a larger competitor after it encountered mounting liquidity problems.

Mr Speaker

I do not want to downplay the severity of the global financial developments.

Nor do I wish to say that they have no impact on us.

On the contrary there is no doubt Australia's financial system has been affected by the global financial circumstances.

The residential mortgage backed securities market is no longer functioning in an effective way.

This is true more generally for most asset-backed paper markets, here and elsewhere.

Where Australian financial institutions had been very successful in bundling streams of mortgage income to sell as securities offshore, they now have been obliged to seek other sources of funding.

In recent weeks there has been renewed stress in global short-term bank funding markets.

This is in addition to the continued difficulties in term and securitisation markets, which have functioned under considerable strains for some months.

Funding costs have continued to increase.

Though markedly narrower than it was a week ago, the spread between the Australian 90-day bank bill rate and the cash rate is still around 60 basis points – somewhat wider than the usual spread.

Australian banks have continued to issue in offshore markets, though at higher spreads than were previously the case.

This has led to higher costs of borrowing for businesses and higher mortgage rates for households.

The Australian Prudential Regulatory Authority is closely monitoring the impact of developments in our banking sector.

Its focus is on ensuring that all institutions have adequate plans in place if the market turbulence continues.

Despite increased issuance in domestic and international bond markets in the early months of this year by major Australian banks, further instances of market turbulence cannot be ruled out.

Problem loans are still very low by historical and international standards, however, and Australia's corporate debt to equity ratio remains at historically low levels.

The turmoil in global financial markets has not unduly restricted the total supply of finance to our economy, with strong growth in bank lending more than offsetting the reductions in corporate bond issuance, and in lending to households by mortgage originators.

Mr Speaker

As the House will be well aware the Commonwealth Government and its regulatory agencies are charged by this Parliament with the responsibility to protect the stability of the financial system on which this economy depends.

My department, the agencies within my portfolio and the Government have been following the global market developments with an eagle eye.

We are in close and continuous contact with financial markets here and offshore.

I have been in almost-daily discussion on this topic: with our central bank, with the regulatory authorities and the leadership of the financial community.

I have consulted with my counterparts in Europe and North America.

Only last Thursday the Secretary of my Department met with his colleagues in the Australian Council of Financial Regulators to discuss developments.

Mr Speaker

While we are alert to the impacts on our economy, I would point out to the House that the circumstances of our financial institutions are different from those in the US.

While the twelve consecutive rate rises since 2002 have undoubtedly taken a toll on household budgets, we are not experiencing the same levels of mortgage defaults that are now occurring in the US.

While it is important that we recognise the severity, duration and possible consequences of the global financial turbulence, we should also recognise that Australia's circumstances are more favourable than those elsewhere.

We are not in the least complacent about the circumstances of the Australian economy, but we do recognise that we have strengths on which we need to build.

Mr Speaker

The very clear differences between Australia's circumstances and those of some other economies brings me to my second theme.

This is the issue of what economic policy strategy is appropriate in Australia's current circumstances.

One of those circumstances is the financial turbulence which I have already described.

But that is by no means the only circumstance which I am taking into account in shaping policy in the run up to the Budget over the next two months.

I want now to offer the House my assessment of some other important aspects of our economy.

Our economy's strength in recent times has been supported by large rises in the prices of our commodity exports.

Australian output growth through last year was just under 4 per cent.

But while we have high prices for our commodities, over the last few years our export performance has been weak.

It is a surprising but undeniable fact that Australian exports have been growing only slowly over most of this decade, at least in terms of volumes.

Our export volumes have grown at an average annual rate of just 1.9 per cent in the seven years since 2000, compared to an average annual rate of 6.9 per cent over the preceding seven years.

This slowdown in export volumes growth has occurred despite strong world growth over this period and against a backdrop of a once in a generation terms of trade boom.

It is clear this performance is more a reflection of supply side constraints rather than a lack of demand for our exports.

The slow down in export growth also goes hand in hand with the slow down in productivity growth.

Driven by strong global demand for our metals, minerals and energy exports our terms of trade have risen to 50 year highs.

While the resource-rich states of Western Australia and Queensland have experienced the largest direct benefits from the terms of trade, the impact has been felt across the whole of our economy.

The rising terms of trade have provided a significant external stimulus to the economy — adding around 1½ percentage points each year to the growth of Australia's gross domestic income over the last four years.

Demand created by this strong growth in income has outpaced increases in our economy's supply capacity. This has contributed to inflationary pressures.

While there is considerable uncertainty around the medium-term outlook for non-rural commodity prices, recently settled contracts and market expectations for iron ore and coal prices suggest further support for the terms of trade in the period ahead.

While further gains in our terms of trade could be expected to continue to support domestic activity, it also presents further challenges for an economy already pushing up against its capacity.

Mr Speaker

It is sometimes said, including in this place, that an upswing in mining output from Western Australian and Queensland must be at the expense of Victoria and NSW.

It was quite evident in conversation with my state colleagues last week, however, that this will not necessarily be so.

While Queensland and Western Australia are expecting remarkable increases in the production and transport of iron ore and coal in particular, NSW and Victoria aren't despondent about the outlook.

Some talk loosely about a two track economy, but NSW final demand increased by over 4.5 per cent last year, and overseas exports from NSW increased over 4 per cent.

Exports increased more in NSW over that same period than in Victoria, or Queensland or Western Australia and of course well above the national average.

Over the same period Victorian final demand increased over 5 per cent.

Unemployment in NSW is 4.2 per cent and Victoria 4.1 per cent, in both cases the lowest outcomes in 30 years of data.

These are not numbers which suggest considerable gloom in either state.

Mr Speaker, with the right policies, growth in the resource rich states of WA and Queensland does not have to be incompatible with growth in NSW and Victoria.

A good deal of the increased income from mining will be distributed locally, as higher employment and consequently higher local spending.

But some of it will be distributed through the rest of the country as higher government revenue or as returns to shareholders.

Mr Speaker

It is our task to think through these challenges, as we are doing in the run up to the Budget, and get the balance of policy right.

Given the challenges we confront, Mr Speaker, the Rudd Government has twin objectives in economic policy, which it is pursuing with equal vigour.

One is primarily about the next year or two, and the other is primarily about the next decade.

It would be quite wrong to suggest to the House that our first May Budget will accomplish both objectives immediately.

On the contrary, we are now planning architecture of at least three budgets, each closely related to its predecessor, and each taking us a bit further down the road towards our twin objectives.

The first objective is of course the gradual moderation of inflation from the rate of 4 per cent or so which the Reserve Bank expects to see in the year to March, to within the target band.

And we will be doing what we can through Budget policy and through other measures to make the Reserve Bank's job less difficult.

That's why we have a Five Point Plan to fight inflation, which includes a surplus target of at least 1.5 percent of GDP in 2008-09.

The second objective is to modernise our economy.

This includes the removal of constraints in our physical infrastructure of roads, bridges, ports, water and energy.

It includes a big improvement in Australian education, from pre‑school to our centres of higher education, to compete with the best in the world.

It includes more and better training in skills to improve the quality and size of our workforce.

And it includes taxation and child care reforms to lift labour force participation to reward hard working families for their efforts.

These are big jobs Mr Speaker but we are clear about what we want to do and we will deliver on all our election commitments to Australians.

We have already laid foundations with the establishment of Infrastructure Australia, the provision of an additional 450,000 high quality training places, the decision to better resource technical training in schools, and the plans we have in hand with our counterparts in COAG, of which I will have more to say on a later occasion.

Mr Speaker

The Government seeks an effective balance between our two objectives.

We can't rebuild the nation's economic infrastructure in one Budget. Building world class education systems, modernising our infrastructure and tackling skills shortages will take time.

And our new policies will need to be carefully implemented, so that we do not further complicate demand pressures in the economy.

But we also recognise that tackling inflation in the longer run is largely an issue of the capacity and flexibility of the Australian economy.

The underlying trend increase in inflation has been apparent now for some time and it represents a failure of past government to foresee and prepare for the inevitable consequences of the long expansion we have enjoyed.

To control inflation we need a more responsive and flexible economy, and we won't get it without addressing our infrastructure constraints now and into the future, without world class education at every level, without upgrading the skills and quality of our workforce.

So in that sense Mr Speaker our two objectives are mutually reinforcing.

Once a lower rate of inflation is achieved we will have more room to remedy the structural shortcomings which have contributed to its acceleration over recent years.

Mr Speaker, the deteriorating global outlook does present a significant risk to the Australian economy.

Businesses and households are already feeling the effects of higher interest rates which, in part, reflect global financial turmoil.

The outlook for the global economy and uncertainty in global financial markets is beyond our control, but we are vigilant.

And we remain confident that Australia's financial institutions and our regulatory agencies are coping reasonably well with a global challenge of considerable severity.

Developments in global financial markets, combined with significant inflationary pressures in the domestic economy, reinforce our determination to build long-term productivity and growth in our economy.

We are putting all our efforts into modernising our economy, so it's strong enough and flexible enough to meet future challenges — to create the right environment for business to flourish and to deliver for the working families of our nation.