Economic Data – Page 259 – Digital Finance Analytics (DFA) Blog

RBA Says Negative Gearing Should Be Reviewed

In the RBA’s submission to the Inquiry on Home Ownership, they argue that negative gearing for investment property should be reviewed, because it has the potential to raise risks in the market, lift prices and distort the market.

Housing, particularly owner-‐occupied housing, receives preferential taxation treatment in many countries, and Australia is no exception. Australia’s taxation system is also relatively generous to small investors in buy-‐to-‐let property compared with some other countries, because investors can deduct losses from their investments against wage income as well as other property income, and because capital gains are taxed at concessional rates. However, there are some other countries where the tax preference for investor property is even stronger than in Australia.

Geared investment increases with age and income, though we should be cautious, as the ATO data is of course income for tax purposes, post offsets.

The Bank believes that there is a case for reviewing negative gearing, but not in isolation. Its interaction with other aspects of the tax system should be taken into account. The ability to deduct legitimate expenses incurred in the course of earning income is an important principle in Australia’s taxation system, and interest payments are no exception to this. To the extent that negative gearing induces landlords to accept a lower rental yield than otherwise (at least while continued capital gains are expected), it may be helpful for housing affordability for tenants. It is worth noting, however, that the interaction of negative gearing with other parts of the taxation system may have the effect of encouraging leveraged investment in property.

Interesting given the UK budget announcement last week to reduce negative gearing there, for the same reasons. So, is economic logic and political positioning pulling in two different directions? The evidence that removal of negative gearing would drive rents up is shaky at best, and the weight of argument is definitely for reform.

You can hear my thoughts on ABC Radio National’s AM Programme this morning.

Five misconceptions about the Greek debt crisis

From The Conversation.

It is widely accepted that the Greek bailout and austerity package has led to wealth flowing from Greece to its European creditors, benefiting foreign banks at the expense of Greeks, that its debt is unprecedented and unsustainable, that its recession is the unprecedented result of reforms that cannot succeed, and that Greece’s exit from the Eurozone would be calamitous.

Amazingly, none of the statements above are strictly true, leading much of the public discussion of Greece to be unusually detached from the facts.

In this article, I outline my reasons for no longer believing these claims – which I had been led to believe were true when I began to try to understand the Greek debt crisis. This is not meant as a comprehensive guide: I do not presume to make policy recommendations, but do hope that it will help readers better understand some of the issues at stake.

1. The bailouts have extracted resources from Greece

A common belief in discussions of the Greek economy is that the eurozone “has become an extractive project that imposes austerity on poor nations in order to collect debts on behalf of rich ones”. A recent study of capital flows to and from Greece by economists Jeremy Bulow and Kenneth Rogoff debunks this. As the tables below show, capital flows into Greece have not just remained positive, but have increased since the first bailout in 2010. 2014’s flow is slightly negative, partly as the Greek government chose to miss reform targets, preventing release of bailout funds.

Jeremy Bulow, Kenneth Rogoff

Jeremy Bulow, Kenneth Rogoff

2. Bailouts benefit foreign banks more than Greeks

Another misconception is that: “It is not the people of Greece who have benefited from bailout loans … but the European and Greek banks which recklessly lent money to the Greek State.” This was the charge of the Jubilee Debt Campaign, which campaigns for further debt relief for Greece. They report that €252 billion has been lent to Greece by the “Troika” (the EU, the European Central Bank and the IMF) since 2010, which they claim has been used as follows:

€35 billion in “sweeteners” to get the private sector to accept the 2012 debt restructuring

€48 billion to bail out Greek banks following the restructuring

€149 billion on paying the original debts and interest.

These add up to €232 billion, causing Jubilee to conclude that “less than 10% of the money has reached the people of Greece”.

This conclusion incorrectly assumes that none of the recipients of the €232 billion are “people of Greece”. But if the “sweeteners” were for the Greek private sector, they benefited Greeks; bailing out Greek banks directly helps Greeks who have bank deposits, who hold shares in banks (whether directly or via their pensions), and who work for banks.

The best data that I’ve seen suggests that Greek banks may have held just under half the Greek government debt before the 2012 restructuring – twice as much as any other country. Thus, payments to creditors also reached Greeks. Finally, even payments to foreign creditors benefit Greeks by removing obligations from Greeks to pay.

Perhaps the most amazing estimate to come from Bulow and Rogoff’s study is that Greek citizens have “withdrawn over a hundred billion euros from the banking system” since 2010: where has that money gone?

3. A debt-to-GDP ratio of 180% is unsustainable

Japanese prime minister, Shinzo Abe, has said he will work with the G7 and other Asian countries to ensure economic and financial market stability as the eurozone grapples with Greece’s debt crisis. This news is unremarkable and unsurprising: the third-largest economy in the world is standing by to help. Unreported is that Japan has the world’s highest debt-to-GDP ratio, at about 240% – much higher than Greece’s.

Furthermore, Japan does not seem to have any easy measures for quickly reducing this: unemployment is already low, leaving little slack in the labour market. And, as one of the world’s least corrupt countries, its unofficial sector is small, leaving little hope that actual GDP is much higher than official GDP. Japan faces serious economic challenges (including two decades almost without growth), but no one sees it as other than stable.

By contrast, there are many ways that Greece could quickly reduce its debt-to-GDP ratio: its unofficial economy is estimated at 25% of its official economy; while some officially unemployed Greeks may be working unofficially, many are not – so labour market reforms could spur rapid growth.

There’s an open debate on how to interpret debt-to-GDP ratios and higher numbers are certainly worrying. Yet, Japan suggests there is no magic number: how a country can manage its debt depends on the circumstances and choices of that country.

4. Greece’s transition recession is unusually long

The graph below shows real GDP as a percentage of 1989 GDP in post-Soviet transition economies. Produced by economists Nauro Campos and Abrizio Coricelli, it shows that going through a political and economic transition simultaneously, without a coherent reform strategy, can be disastrous for economic growth. After the collapse of the Soviet Union, post-Soviet countries suffered decreases in official output for years, in spite of international support, including help from the European Bank for Reconstruction and Development. Twelve years after 1989, only six of the 25 countries had official GDP figures above their 1989 levels.

GDP in post-Soviet states in the decade after the collapse of the Soviet Union. Nauro Campos and Abrizio Coricelli

Greece’s political transitions between democratically elected governments have been less fundamental than the post-Soviet transitions, but its commitment to reform has been questionable throughout. Its poor performance in privatisating inefficient state-owned enterprises has drawn particular attention: the following graph shows privatisation not only well behind schedule, but falling further behind all the time. This deprives the Greek state of revenues, and the Greek people of more efficient services.

IMF

Greece finally seemed to have turned back up in 2014: having fallen by about 20% since its peak in 2008, real GDP grew, officially ending the recession; the government balanced its books before debt payments, and had earned a primary surplus in 2013; unemployment fell; the government was able to borrow on the regular markets, rather than via support packages.

Thus, one of the tragedies of the present situation is that protracted negotiations over the country’s bailout conditions may have just increased the overall cost of the transition process.

5. Greece is too big to fail

The idea that Greece is too big to fail and will have significant knock-on effects for global financial markets has been used in some of the brinkmanship at play in the country’s debt negotiations – including by former finance minister Yanis Varoufakis.

But, while the Greek debt crisis has increased uncertainty and any further default or uncontrolled exit from the euro will pose costs, the markets do not seem terribly roiled by the prospect of its default. This is not surprising: Greece makes up about 2% of Europe’s population and GDP; Europe’s economy is stronger than it was in 2010-2012.

An underappreciated aspect of the “too big to fail” idea is what it does to an economy’s prospects. Indeed, one of the leading explanations of Soviet economic decline is the “soft budget constraint”. Soviet firms tended to be much larger than their Western counterparts, giving each considerable power to renegotiate its production plans – without more resources, it could threaten to harm other sectors in the economy, which had few alternative suppliers to turn to.

This seems to be the concern expressed by many of the other European countries: at the eurozone’s inception, the open question was whether the Bundesbank’s credible, low-inflation, low-interest rate standard would prevail. Or whether the eurozone would end up converging on one of the less credible, high-inflation and high-interest rate standards. If the moving appeals of a country comprising 2% of Europe can successfully soften Europe’s budget constraint, then it can be expected that any larger country will be able to as well, if they can demonstrate a severe enough crisis.

Were Greece to become the first country to leave the eurozone, it would give us invaluable real experience in a fairly controlled context; this would improve eurozone policy when faced with similar situations in the future.

Author: Colin Rowat, Senior Lecturer in Economics at University of Birmingham

Lending Finance For May – Investment Property Lending Still Hot

The ABS released their overall lending data for May 2015. It shows the same old story. Significant growth in investment lending, especially driven by NSW. The total value of owner occupied housing commitments excluding alterations and additions rose 0.4% in trend terms. Investment lending was 1.0% up in the month, and refinance up 1.6%. The trend series for the value of total personal finance commitments rose 0.8%. Fixed lending commitments rose 1.7%, while revolving credit commitments fell 0.3%. The trend series for the value of total commercial finance commitments rose 1.5%. Fixed lending commitments rose 1.9% and revolving credit commitments rose 0.3%. The trend series for the value of total lease finance commitments rose 1.1% in May 2015 and the seasonally adjusted series rose 0.7%, after a fall of 1.5% in April 2015.

The housing data shows that investment lending is still hot. Refinancing is also on the up.

The state data shows that NSW investment lending set a new record on both volume and value.

What’s the turmoil in the Chinese stock market all about?

From The Conversation.

The Chinese stock markets have experienced significant turmoil in recent weeks, with the Shanghai Composite Index – the country’s major reference – falling by 32% since June 12. But this fall was preceded by an equally sharp rise of 150% over the previous nine months. In the 20 years since I have been working in finance, I’ve never seen anything like this. So what is going on with the Chinese stock market?

There are several reasons for this unusual behaviour: firstly, when I teach stock market investment to my Chinese students, I always remind them that the Shanghai stock exchange should be thought of more as a casino, rather than as a proper stock market. In normal stock markets, share prices are – or, at least, should be – linked to the economic performance of the underlying companies. Not so in China, where the popularity of the stock market directly correlated with the fall in casino popularity.

Stocks and casinos

In China, given the low credibility of the financial statements published by listed companies, investors need to rely on other tools to predict share price performance. These tools include a heavy reliance on technical analysis and charts – a method that tends to predict future share price based purely on the company’s past performance, with no regards to its fundamentals. Even the name of the company is often neglected; all that matters is the historic price performance.

While this technique is also used in Western markets, my experience in China is that it is the predominant method for investment. Hence the disconnect between a share’s price movements and economic fundamentals.

There has been, however, a strong correlation between the stock market’s performance and the revenues of the casinos in Macau. While gambling revenues were growing at a fast pace in Macau, people largely ignored the stock market – whose performance was, largely, uninteresting for a number of years. But since China’s president, Xi Jinping, launched a campaign against corruption, gambling activity has started to decline. This was when the stock market started to move up. Coincidence?

Real estate

The other reason why the stock market experienced a sharp increase between September 2014 and June 2015 relates to the Chinese real estate market. In recent years, investment in real estate has been the only way for ordinary citizens to get returns higher than the paltry 3% offered by bank deposits (yes, 3% is paltry in an economy that grows at more than 10% a year in nominal terms). But high capital requirements and growing regulations on the purchase of real estate has meant that benefiting from this growing market has been increasingly difficult for ordinary citizens.

Macau: the traditional home of Chinese gambling. Shutterstock

Commercial banks therefore – in an effort to mimic real-estate returns – started to offer so-called “wealth management products”, which are basically funds that invest in the real estate market. These funds were then repackaged and resold in the retail market. Chinese individuals would take their savings out of current accounts and placed them into these wealth management products and achieve returns similar to those available to buyers of real estate.

This was the modus operandi until the beginning of 2014, at which point the economy and the real estate markets started to show signs of weakness. The once-easy money coming from the property market started to disappear and people with wealth management products started to get into financial trouble and some of them even defaulted on their payments (the government bailed them out, so no individual was at a loss).

Monetary policy

From November 2014 the Chinese central bank, worried about the slowing economy, decided to institute an aggressive monetary policy to rapidly lower interest rates with the aim of stimulating the economy, which also caused current account rates to decline. This created a perverse scenario where individuals who were already seeking returns higher than those offered by current accounts were then denied the opportunity to get them through real estate because of the falling market. As a result, deposit rates were cut further and the return on current accounts became even more dissatisfying. Commercial banks found themselves in a quandary.

The Shanghai Composite Index’s growth and decline in recent months. Yahoo finance

With the casino route closed and real estate off the table, what was left? The Shanghai and Shenzhen stock markets: the two main stock markets that had remained dormant for years.

Banks then turned the old real estate wealth management products into investment vehicles to purchase shares directly on the stock markets. A large portion of customer deposits were then directly invested in the stock market, which then surged on the back of that demand.

An empty bubble?

Meanwhile, however, nothing happened to the earnings forecasts of the underlying companies. In fact, if anything, they should have been revised down because of the deteriorating macroeconomic condition of the Chinese domestic economy. But of course, as we said before, no one really looks at earnings and price ratios.

Due to the desire to maximise returns, many individuals then used leverage so that the inflow of money in the stock market was even higher. For example, if someone wishes to purchase shares for a total value of 100RMB, but only has available cash in his deposit account of, say, 60RMB, he could borrow the remaining 40RMB from the brokerage house. By doing this, the original source of 60RMB was turned into an upward push of the stock price equivalent to the full 100RMB. This drove strong share price growth between September 2014 and June 12 2015.

What happened on June 12 2015? Nothing. Just some smarter investors (generally large institutional investors, which represent 20% of all market volumes) started to sell and the rest of the market followed suit. Fear got hold of small investors (who represent 80% of the market) and selling accelerated, with margin calls making those selling do so even faster, and here we are today – a 32% drop and counting since the peak of mid-June.

In the past few days, the Chinese government has adopted a number of measures to try to mitigate this crash. The market finally reacted positively to a relaxation of restrictions on margin requirements. But this measure simply transfers the risks from investors to brokerage houses – it does not change the fact that the market has increased by 70% over the last year. The bubble, if it is a bubble, still has a long way to go.

Author: Michele Geraci, Head of China Economic Policy Programme, Assistant Professor in Finance at University of Nottingham

IMF World Economic Update

The latest IMF World Economic Update just released, highlights slower growth in Emerging Markets, but a gradual pickup in Advanced Economies.

Global growth is projected at 3.3 percent in 2015, marginally lower than in 2014, with a gradual pickup in advanced economies and a slowdown in emerging market and developing economies. In 2016, growth is expected to strengthen to 3.8 percent.

A setback to activity in the first quarter of 2015, mostly in North America, has resulted in a small downward revision to global growth for 2015 relative to the April 2015 World Economic Outlook (WEO). Nevertheless, the underlying drivers for a gradual acceleration in economic activity in advanced economies—easy financial conditions, more neutral fiscal policy in the euro area, lower fuel prices, and improving confidence and labor market conditions—remain intact.

In emerging market economies, the continued growth slowdown reflects several factors, including lower commodity prices and tighter external financial conditions, structural bottlenecks, rebalancing in China, and economic distress related to geopolitical factors. A rebound in activity in a number of distressed economies is expected to result in a pickup in growth in 2016.

The distribution of risks to global economic activity is still tilted to the downside. Near-term risks include increased financial market volatility and disruptive asset price shifts, while lower potential output growth remains an important medium-term risk in both advanced and emerging market economies. Lower commodity prices also pose risks to the outlook in low-income developing economies after many years of strong growth.

Risks to the Forecast

The distribution of risks to the near-term outlook for global growth is broadly unchanged from that in the April 2015 WEO and is slightly tilted to the downside. The main risks highlighted in April remain relevant. In view of the muted consumption response so far, a greater boost from lower oil prices is still an upside risk, especially in advanced economies.

Disruptive asset price shifts and a further increase in financial market volatility remain an important downside risk. Term and risk premiums on longer-term bonds are still very low, and there is a possibility of markets reacting strongly to surprises in this context. Such asset price shifts also bear risks of capital flow reversals in emerging market economies. Developments in Greece have, so far, not resulted in any significant contagion. Timely policy action should help to manage such risks if they were to materialize. Nevertheless, recent increases in sovereign bond yields in some euro area economies reduce upside risks to activity in these economies, and some risks of a reemergence of financial stress remain. Further U.S. dollar appreciation poses risks of balance sheet and funding risks for dollar debtors, especially in some emerging market economies. Other risks include low medium-term growth or a slow return to full employment amid very low inflation and crisis legacies in advanced economies, greater difficulties in China’s transition to a new growth model, as illustrated by the recent financial market turbulence, and spillovers to economic activity from increased geopolitical tensions in Ukraine, the Middle East, or parts of Africa.

Link to Web Cast

ASIC Investigating Financial Benchmarks

ASIC is investigating a range of financial institutions to determine whether or not there has been benchmark-related misconduct in Australia’s financial markets. Their inquiries are still underway and, given the size and complexity of the relevant markets, will take some time to complete. They are looking at the activity of Australian financial institutions domestically and overseas, as well as foreign financial institutions that are active in Australia.

Benchmarks are of critical importance to a wide range of users in financial markets and throughout the broader economy. Different benchmarks affect the pricing of key financial products such as credit facilities offered by financial institutions, corporate debt securities, exchange-traded funds (ETFs), FX and interest rate derivatives, commodity derivatives, equity and bond index futures and other investments and risk management products.

In Australia, ASIC consider the following benchmarks to be of potential systemic importance:

Bank Bill Swap Rate (BBSW)
the Interbank Overnight Cash Rate (cash rate)
S&P/ASX 200 equity index
ASX Clear (Futures) Pty Ltd’s Commonwealth Government Securities (CGS) yields survey for settling bond futures
Consumer Price Index (CPI).

Internationally, they consider the IBOR interest rate benchmark family and the WM/Reuters and European Central Bank (ECB) foreign exchange (FX) ‘fix’ rates, among other benchmarks, to be systemically important.

Their investigations are informed by the conduct issues relating to financial benchmarks that have been observed overseas and which have formed the basis of significant settlements by financial institutions with foreign financial regulators. For example:

trading designed to move a benchmark rate so that the financial institution derives a benefit (e.g. by increasing the value of a derivative position held by the institution that references the benchmark)
inappropriate handling of client orders or positions (e.g. by deliberately triggering ‘stop-loss’ orders)
inappropriate disclosure of confidential client information (e.g. by disclosing client orders to traders at competing banks); and
inappropriate submitter conduct (e.g. by making submissions in order to reduce the institution’s borrowing costs).

Affordable housing crisis is hurting all of us (except the well-heeled)

From The Conversation. Until recently, affordable housing was mentioned only in conversations involving low-wage or unemployed workers – or the homeless. The only groups that focused on rising rental costs were low-income housing advocacy groups.

That has now changed.

For the first time since possibly the Great Depression, the lack of affordable housing is being viewed as a crisis that affects Americans of all ages, races and income groups.

While the US Supreme Court spotlighted the issue in Thursday’s ruling allowing parties to challenge housing practices even if they do not (or cannot) prove there was intentional bias or discrimination, the mainstream media is finally catching on as well.

In the last three weeks, the Washington Post, New York Times and Wall Street Journal have all sounded the alarm about the country’s looming affordable housing crisis. In addition, well-heeled non-profit groups – like the foundation recently formed by the former CEO of the nation’s largest apartment developer – have begun urging politicians to address the growing problem of rental housing unaffordability.

Growing more somber

Some of the recent media attention on the unaffordability of housing was triggered by the 2015 State of the Nation’s Housing report, just released by the Harvard Joint Center for Housing Studies (JCHS). While the JCHS has issued a similar report every year since 1988, the latest edition opens with an unusually somber tone about the state of housing in this country.

“Homeownership at 20-Year Lows,” bellows the opening line of the 2015 report.

By comparison, the first line in 2013 highlighted the “Housing Market Revival,” while the 2014 report only hinted at the growing problems with “Single-Family Slowdown.”

This change in tone was very slow in coming. The 2013 report optimistically reported that “the long-awaited housing recovery finally took hold in 2012.” The 2014 report, while less rose-tinted, still noted that “the housing market gained steam in early 2013.”

The 2015 report strikes a decidedly different and more alarmist tone by emphasizing that the housing recovery “lost momentum” as homeownership rates continued to fall. This report then chronicles the increase in the number of renters who are “cost-burdened” and cannot find affordable housing and the number of minority neighborhoods that still have not recovered from the recession.

Who’s struggling

While news sources have intermittently reported on housing affordability issues since the recession, what is new about the current affordable housing reports is who is struggling to find affordable housing. It’s no longer just millennials or the poor or homeless people.

Prior accounts have described the low homeownership rates of cash-starved millennials who live with their parents because of high student loan debt and low-wage jobs.

The recent New York Times article discusses former homeowners who are now forced to rent because they lost their homes to foreclosure and cannot qualify for a mortgage loan because of blemished credit. Likewise, the Washington Post article discusses middle- and even upper-income renters and the fact that many parents of millennials are now struggling to find affordable housing.

The JCHS report explains that homeownership rates for Americans aged 35 to 44 have now dropped to levels not seen since the 1960s. In describing the housing affordability crisis for renters, the report shows that from 2004 to 2014, older Americans (aged 45 to 64) became renters at greater rates than millennials households under the age of 35.

Today’s rental crisis

Housing affordability is no longer limited to the lowest-paid workers. The JCHS report stresses that renters whose earnings place them in the highest-income quartile now account for more than 20% of new renters.

Renters are no longer the low-income, working-class Americans typically featured in news reports. Today’s rental crisis is now affecting just about everyone but the really rich.

The Wall Street Journal article assumes that policymakers are either blissfully unaware of the affordable housing crisis, or they are unwilling to do anything about it.

Politicians have not been willing to make changes to popular housing laws or policies that benefit upper-income homeowners, like the mortgage interest deduction. And they haven’t been willing to provide additional relief to lower-income renters by, for example, expanding the low income tax credit.

Politicians may be unwilling to do anything to solve the affordable housing crisis. But, after these recent reports, they can no longer say they don’t know the crisis exists.

Author: Mechele Dickerson, Professor of Law at University of Texas at Austin

Household Net Worth now over $8 Trillion, but Savings down

The ABS released the latest national accounts, to March 2015. The Household Finance and Wealth data confirms again what we know, overall household net worth is up (thanks to asset appreciation) but savings are down.

At the end of March quarter 2015, household net worth was $8,090.9b, made up predominantly of $5,451.8b of land and dwelling assets and $4,131.0b of financial assets, less $2,121.6b of household liabilities. During the quarter, household net worth increased by $231.5b, driven mainly by holding gains of $207.0b. Financial assets ($129.0b) and land and dwellings ($79.8b) were the drivers of holding gains this quarter, with financial assets seeing the largest quarterly holding gains on record. The large increase in holding gains from financial assets was driven by net equity in reserves ($90.6b) and equities ($36.2b).

The increase of $17.6b in transactions in net worth was driven by $9.7b increase in net capital formation of land and dwellings; and net financial transactions of $7.3b, of which transactions in financial assets were $30.8b and liabilities were $23.5b. The March quarter 2015 transactions in financial assets were driven by $13.8b of transactions in net equity in reserves of pension funds and $11.2b of transactions in deposits. Transactions in liabilities in March quarter 2015 were driven by transactions of $24.3b in long term loan borrowing.

Both household assets and liabilities continued to grow over March quarter 2015, resulting in 2.9% growth in household net worth. Net worth has continued to grow over the last eight quarters, passing the $8 trillion mark in March quarter 2015.

Household financial assets grew faster than both residential land and dwelling assets and liabilities, growing by 4.0% ($159.8b), 1.9% ($96.1b) and 1.4% ($30.2b) respectively. Insurance technical reserves – superannuation, and shares and other equities were the key drivers of growth in financial assets this quarter. Insurance technical reserves – superannuation grew by 4.8% ($104.9b), recording its highest quarterly percentage growth since the June quarter 2012 growth of 8.4% ($131.4b). Shares and other equity grew 5.7% ($37.1b), recording its highest quarterly percentage growth since the March quarter 2013 growth of 6.1% ($32.4b).

The financial ratios graphs presented here are derived from the household balance sheet, financial account and income account. The interest payable to income ratio represents the proportion of household gross disposable income that is required to meet interest payments. Interest payable in the graph is the “adjusted interest payable”. It includes the financial intermediation services indirectly measured (FISIM) on the dwelling loan plus the dwelling interest payable from the household income account. It therefore represents the total nominal amounts paid as interest by the household sector. The interest payable to income ratio is relatively volatile in the short term, however some long term trends may be observed. After a period of volatility during the Global Financial Crisis, the ratio stabilised from March 2010 onwards, settling into a gradual downward trend. The ratio at March quarter 2015 was 11.1%, an increase of 0.6p.p from the December quarter ratio of 10.5%.

The mortgage debt to residential land and dwellings ratio shows the extent that household residential real estate assets are geared. The ratio has declined since peaking at 30.6% in September quarter 2012, but has remained unchanged since December 2014 at 29.2%, indicating that household mortgage debt grew at the same rate as residential real estate owned by the household sector for the past two quarters.

The debt to assets ratio gives an indication of the extent that the overall household balance sheet is geared. That is the degree to which assets are dependent on debt. At 31 March 2015, household debt was equal to 20.8% of assets, dropping below 21% for the first time since December quarter 2010.

The debt to liquid assets ratio reflects the ability of the household sector to extinguish debts in a short period of time using their readily available, or liquid, assets. The following are classified as liquid assets: currency and deposits, short and long term debt securities, and equities. The ratio of household debt to liquid assets fell from 134.1% at 31 December 2014 to 131.8% per cent at 31 March 2015, the third consecutive quarter of decline and the lowest ratio since September quarter 2008.

Household net saving was $16.4b for the quarter, decreasing from $22.8b in the December quarter. Despite the decrease in net saving, household net worth increased by $231.5b to $8,090.9b in March quarter 2015. With the inclusion of real net wealth effects, net saving increased to $215.9b for the quarter. The largest driver of the increase in other changes in real net wealth was real holding gains, which made up $192.2b of the $199.6b increase. Real holding gains for financial assets was $121.4b, which overtook land and dwellings as the biggest driver of real holding gains this quarter, and is the highest recorded holding gain for financial assets in the series.

IMF Warning To Australia – Ambitious Reform Needed

The IMF released their Concluding Statement of the 2015 Article IV Mission today.

Australians have enjoyed exceptionally strong income growth for the last couple of decades. But the waning of the resource investment boom and the recent sharp fall in the terms of trade have brought this to a halt. Incomes should start rising again as the terms of trade stabilize, but likely more slowly than in the past. Improving this outlook requires policymakers being on the front foot to enable Australia to make the most of its considerable potential. This means supporting aggregate demand in the shorter term and boosting productivity in the longer term. And ensuring banks are unquestionably strong would reduce vulnerabilities. Such an ambitious reform agenda would require strong and sustained commitment.

Outperformance fading

Australia has grown almost twice as fast as its peers in the last two decades. This reflected both strong policy frameworks (such as the floating exchange rate and flexible labor market) and the boom in global demand for its resources. But output growth has been below trend for two years, unemployment has risen to six percent, and real incomes have declined. While moving from the investment to the production phase of the resource boom was always going to be bumpy and the economy is handling this transition relatively well, the recent sharp fall in resource prices has made it more difficult.

Weaker medium-term growth prospects

Over the next couple of years, activity should gradually pick up and narrow the output gap, supported by strong resource exports, accommodative monetary policy, and rising confidence. But over the medium term and without reform, growth is likely to converge to a slower potential rate, reflecting less capital accumulation and only modest productivity growth. This lower potential would still mean income growth in line with other advanced countries, but significantly slower than Australians have been used to over the last two decades. Slower growth would also make fiscal consolidation more difficult. The risks around this outlook seem somewhat skewed to the downside, in particular:

• On the downside, the envisaged pick up in non-resource business investment may remain elusive, a house price correction could knock confidence and demand, and China could slow more sharply.

• On the upside, domestic demand could respond more quickly to recent monetary policy stimulus, and the exchange rate could depreciate further, stimulating the tradable sector.

Policies to re-energize growth

This weaker outlook can be avoided. Australia has strong institutions, a flexible economy, and is well placed to seize opportunities created by Asia’s rapid growth and rising middle class, helped by the recent free trade agreements. Policymakers should build on these strengths by re-invigorating the reform agenda:

• Sustaining demand through the resource boom transition

• Lifting productivity to sustain strong income growth

• Building resilience to reduce the risk of financial disruption

Sustaining demand though the resource boom transition

Keeping monetary policy accommodative

A sizeable output gap, elevated unemployment, subdued inflation pressure, and an exchange rate still on the strong side, call for supportive aggregate demand policies. While monetary policy is already accommodative and may have lost some effectiveness, it should still stand ready to ease further should the recovery fall short of expectations and provided the financial stability risks remain contained.

Prudential policy to address housing risks

APRA has appropriately been taking targeted and gradual action to address areas of risk in the housing market for some time. Banks, however, seem only to have responded more recently and the results are yet to be fully reflected in the lending data. We expect APRA’s approach to succeed, but it may need to be intensified, for example, if investor lending and house price growth do not slow appreciably in the second half of the year. Such intensification could include requiring banks with fast-growing investor lending to hold more capital, raising risk weights on investor lending, and restricting the duration of interest-only loans.

Boosting public investment

A small surplus should remain a medium-term anchor of fiscal policy and budget discipline should be maintained. But the planned pace of consolidation nationally (Commonwealth and States combined) towards this medium-term objective is somewhat more frontloaded than desirable given the weakness of the economy, the size and uncertainty around the resource boom transition, and the possible limits to monetary policy. Increasing public investment (financed by more borrowing rather than offsetting measures) would support aggregate demand and ensure against downside risks. It would also employ resources released by the mining sector, catalyze private investment, boost productivity, take advantage of record-low borrowing rates, and maintain the government’s net worth. Indeed, IMF research suggests that economies like Australia—with an output gap, accommodative monetary policy, and fiscal space—benefit most from debt-financed infrastructure investment, with the growth boost largely containing the impact on the (low) debt-to-GDP ratio.

Commonwealth-State coordination critical

Boosting public investment, especially in the short term given inherent lags, and without waste and compromising governance, will be difficult, not least as most investment is carried out by States whereas the Commonwealth has the most borrowing capacity. The Commonwealth is already doing much to encourage investment with recent initiatives, including co-financing. However, public investment has been a drag on growth in recent quarters and the outlook is not for a sharp pick-up. A strategy for boosting public investment could include:

• Broadening the scope of investments supported by the Commonwealth, for example, to include a wider range of projects, including repairs and maintenance.

• Continuing to establish a pipeline of quality larger projects with transparent cost-benefit analysis, such as that being prepared by Infrastructure Australia. Broad political support for such a pipeline would reduce uncertainty and boost confidence.

• In addition to direct funding arrangements, the Commonwealth could consider guaranteeing States’ borrowing for additional investment—this would keep the accountability with the States, but reduce their concerns about credit ratings and would not affect the Commonwealth’s deficit.

Maintaining budget discipline

While the capital budget should expand, the recurrent budget should not. The government should maintain its envisaged structural consolidation of the recurrent budget. Any slippage would reduce the government’s net worth and could undermine the credibility of the medium-term surplus objective, which continues to serve the country well. Indeed, we see risks that the envisaged consolidation of the recurrent budget will not be achieved (given the tight spending targets, strong revenue projections, and with some measures still unapproved), which may well require additional measures.

Lifting productivity to sustain strong income growth

No silver bullet, but many targets

Maintaining income growth at past rates requires raising total factor productivity growth substantially. This will be challenging as Australia has already undertaken comprehensive productivity-boosting reforms in the 1980-early 2000s and a number of sectors are at, or near, the global productivity frontier. But other sectors have gaps, and these provide an opportunity to catch up—the distribution (including retail, wholesale, and transport) sector suggests most scope. The Competition Policy Review recommended many reforms to strengthen competition and improve efficiency, including in human services and the retail sectors. Filling infrastructure gaps would relieve bottlenecks, as would reducing the long-standing constraints on housing supply (which, critically, requires more responsive planning and zoning). More generally, the Productivity Commission has identified a wide-ranging list of reforms and is a world-class resource that could help guide this policy agenda.

Tax reform—a key policy lever

Though politically challenging, a comprehensive tax reform could both increase growth and generate revenue over time to help return the budget to surplus. A comprehensive and decisive package would be needed to deliver tangible results. The on-going Tax and Federation reviews provide the opportunity to craft such a package, which should include the following inter-connected elements:

• Shifting towards more efficient and simple taxes. In particular: by preventing a large share of individual taxpayers from facing higher tax rates through unchecked bracket creep (which would affect those on lower and middle incomes most), reducing the corporate tax rate to international levels, and eliminating stamp duties and minor taxes. This would be paid for by broadening the base of the GST and possibly raising the rate—while at least fully compensating those on lower incomes—and relying more on a broad-based real-estate tax and excises.

• Ensuring fairness. A number of measures, such as reducing the concessional treatment of superannuation contributions and earnings for those on higher incomes, and the discount on capital gains, would be important for fairness. They would also enhance revenue and could improve housing affordability and financial stability. Adjusting any of these policies would need careful calibration and phasing, and should be introduced in tandem with the measures to enhance efficiency.

• Adjusting federal fiscal relations. Federal-State relations will likely need to be adjusted to facilitate the tax reform. There are many options—one could be for States to receive higher GST revenue and autonomy in return for greater spending responsibilities. This could also help increase spending efficiency.

Building resilience to reduce the risk of financial disruption

Ensuring unquestionably strong banks

Banks are highly rated and profitable, non-performing loans and funding costs are low, and wholesale funding reliance has declined and its maturity lengthened substantially since the global financial crisis. Nonetheless, the system is dominated by four large banks with similar business models which rely significantly on wholesale external borrowing, most lending is housing related, and household debt and house prices are elevated. And although capital ratios have risen since the global financial crisis, this largely reflects a shift towards mortgages and a lowering of risk weights. Implementing the recommendations of the Financial System Inquiry should be a priority.

Raising capital

While international comparisons are fraught with difficulty, Australian banks do not appear to have particularly high capital ratios and the global trend is upwards. More tangibly, the recent APRA stress test indicates that in a severe adverse scenario, bank capital would have to be substantially higher to ensure a fully-functioning system. Putting a floor of 25-30 percent on mortgage risk weights would help, but capital ratios would also need to rise substantially. Given major banks’ high profitability, such ratios can be achieved at little, if any, macroeconomic cost, especially if done gradually, and will make the financial system, the budget, and the economy stronger.