December 2015
Consumer Sentiment Surveys
There are two main consumer sentiment surveys in Australia. The headline indices that summarise the survey results appear to provide relevant and timely information about economic developments, particularly around turning points. However, in some cases, particular components of the aggregate indices are more useful. This is true of the components that track households' perceptions of their current personal finances compared with a year prior and, to a lesser extent, the components tracking households' perceptions of buying conditions for major household items.
Firm-level Capacity Utilisation and the Implications for Investment, Labour and Prices
Business surveys provide a timely read of the average rate of capacity utilisation at Australian firms. However, discussions with company managers in the Reserve Bank's business liaison program reveal considerable variation in how ‘capacity utilisation’ is interpreted. This variation is important, as it affects the interpretation of survey measures of capacity utilisation and their implications for firms' resourcing needs and pricing decisions. For firms in the more capital-intensive goods-related industries, a high level of capacity utilisation may reveal an impetus to hire more labour and to invest in the capital stock, while for services firms it is more likely to reflect an incentive to hire more labour only. Consequently, movements in aggregate measures of capacity utilisation are likely to contain information about the labour market, while the implications for business investment are likely to be identified at a more granular level. Much of the recent increase in survey measures of capacity utilisation has been driven by services firms. In contrast, capacity utilisation remains relatively low for firms in goods-related industries, which may help to explain why aggregate capital expenditure has remained subdued.
Assessing China's Merchandise Trade Data Using Mirror Statistics
Given their timeliness, Chinese trade data have the potential to provide a useful early read on conditions in the Australian and global traded sectors. However, the reliability of China's merchandise trade data has come under scrutiny in recent years, particularly following reports of over-invoicing of exports to Hong Kong. This article considers the accuracy of China's trade data by comparing the merchandise trade statistics with the reciprocal trade statistics or ‘mirror’ statistics published by its major trading partners (MTPs). In broad terms, growth in trade suggested by the mirror statistics aligns relatively closely with published Chinese data, though the Chinese figures are found to imply more volatile and somewhat higher growth in exports over the past three years than the corresponding trading partner data. While this largely reflects differences with mirror statistics for Hong Kong, it is also due to discrepancies with data from other economies, primarily in the Asian region.
Trends in Australian Corporate Financing
The aggregate funding behaviour of the Australian non-financial corporate sector has been fairly steady over the period since the global financial crisis. However, this masks the quite divergent experiences of the resources and non-resources sectors. Substantial net investment by resources companies has been funded primarily by operating cash flows, while external funding has been modest, mainly comprising borrowing to offset the effect of movements in commodity prices on internal funding. Net investment by non-resources companies has been relatively subdued, with internal funds broadly sufficient to meet this expenditure. Overall, leverage for Australian-listed companies remains relatively low, internal funding continues to cover the bulk of financing needs and companies generally appear to retain good access to external finance in its various forms.
Chinese Capital Flows and Capital Account Liberalisation
Chinese private capital flows are dominated by foreign direct investment and banking-related flows, with portfolio flows remaining relatively small (as a share of GDP). Of these components, banking-related flows account for the majority of the cyclical variation in total flows and seem to be driven by expected changes in the exchange rate. Both the composition of capital flows and the factors that drive their variation are likely to change as the Chinese authorities gradually open the capital account in line with their stated intention. Given the size of China's economy, the implications of a continued opening of its capital account and a significant increase in capital flows are potentially very large. They include a greater influence of global financial conditions on China (and vice versa), a change in the composition of China's net foreign assets, and a change in the nature of the economic and financial risks facing China.
US Dollar Debt of Emerging Market Firms
US dollar-denominated borrowings by emerging market (EM) corporations have increased rapidly in recent years, raising concerns about possible currency mismatch risk. This article uses firm-level data from the top 100 EM corporate bond issuers and Bank for International Settlements data on cross-border bank lending at the economy level to gauge such risk. These data indicate that around two-thirds of the largest issuers of US dollar-denominated corporate bonds are at least in part naturally hedged (based on company-specific information), and a significant share of the remaining borrowers are state-owned enterprises. The largest recipients of foreign currency bank loans by country also appear to derive significant US dollar export revenues. This suggests that most EM corporations that have borrowed in US dollars are well placed to weather an appreciation of the US dollar, particularly given the possibility that some have hedged their exposures via financial markets. However, Chinese property developers may be an exception and some EM resource companies may face difficulties as a result of the current low global commodity prices. Corporations will also face higher financing costs on their US dollar-denominated debt as the US Federal Reserve moves to increase its policy rate.
Total Loss-absorbing Capacity
Total loss-absorbing capacity (TLAC) is a key part of the G20's regulatory reform agenda to address the problems associated with financial institutions that are ‘too big to fail’. By strengthening the loss-absorbing and recapitalisation capacity of global systemically important banks (G-SIBs), the TLAC standard is intended to help ensure that these large, interconnected and complex financial institutions can be resolved in an orderly manner if they fail, without the need for financial support using public funds.
CCPs and Banks: Different Risks, Different Regulations
Recent debate on the adequacy of regulatory standards for central counterparties (CCPs) has often drawn on the experience of bank regulation. This article draws out the essential differences between CCPs and banks, considering the implications of these differences for the regulatory approach. It argues that banks and CCPs affect systemic stability in different ways, with a CCP's systemic importance largely derived from its central role and a bank's systemic importance typically derived from the size and breadth of its activities. Any refinements to regulatory standards for CCPs that are drawn from bank regulation should not overlook these differences.
September 2015
Banknote Stakeholder Engagement
The Reserve Bank has a responsibility to ensure confidence in Australia's banknotes as a secure method of payment and a store of wealth. One of the ways in which the Bank does this is by providing education and training to people who handle cash regularly in their jobs, and the public in general, so that they can easily check the authenticity of their banknotes. In the lead-up to the next generation of Australian banknotes, this work will be crucial to ensure public confidence in the new banknote series. It is also important to engage with key stakeholders who produce and use machines that will accept the new banknotes. This article outlines the work that the Bank has undertaken to establish suitable communication channels and engage with key stakeholders in preparation for the Next Generation Banknote (NGB) program.
Housing Wealth Effects: Evidence from New Vehicle Registrations
This article investigates the relationship between housing wealth and consumption using postcode-level variation in housing prices and new passenger vehicle registrations as a proxy for consumption at a postcode level. It is estimated that a one per cent increase in housing wealth is associated with about half a per cent increase in new passenger vehicle registrations – the consumption indicator. But because new vehicle consumption is likely to be particularly sensitive to changes in housing wealth, the results suggest a relatively modest relationship between housing wealth and total consumption.
Long-run Trends in Housing Price Growth
This article examines the factors driving long-run trends in Australian housing price growth over the past three decades. During the 1980s, housing prices grew broadly in line with general price inflation in the economy. The period from the 1990s until the mid 2000s saw relatively strong housing price growth associated with a significant increase in the debt-to-income ratio of Australian households. Since the mid 2000s, strong population growth has played an increasing role in explaining housing price growth.
Lower Bulk Commodity Prices and Their Effect on Economic Activity
Recent declines in bulk commodity prices have reduced the growth of household income, company profits and government revenues. The declines have been associated with a contraction in mining investment and, by lowering the growth of aggregate demand, have restrained non-mining business investment. At the same time, a number of factors are helping to offset the effects of declining commodity prices. These include accommodative monetary policy and the depreciation of the exchange rate. Also, after saving some of the mining boom proceeds, households appear to be reducing their rates of saving to maintain consumption.
Explaining the Slowdown in Global Trade
Following the global financial crisis, global trade contracted sharply and, after an initial recovery, grew at an unusually slow pace relative to global GDP. This article reviews cyclical and structural explanations for this phenomenon, and finds econometric evidence that cyclical factors – namely shifts in the composition of aggregate demand toward less import-intensive components and heightened economic uncertainty – can explain most of the slowdown in trade in a panel of advanced economies. Although the slowdown in aggregate global trade is well explained by the model used, the results vary by country. For Australia, the model performed well until 2012, after which it over-predicted import growth, most likely because it did not adequately capture the import intensity of mining investment and resource exports.
Default Risk Among Australian Listed Corporations
Market-based information can help detect deteriorating corporate health because it incorporates more forward-looking information than other data sources such as financial statements. With this in mind, the Reserve Bank has developed an indicator of financial health based on a contingent claims framework developed by Merton (1974), which is sometimes called a distance-to-default model. The Bank will primarily use the model to assess trends in financial health for the corporate sector as a whole and, in aggregate, the model is able to broadly match the dynamics of the corporate failures data, suggesting that it will be a useful addition to the Bank's existing suite of monitoring tools. The results from the model suggest that corporate financial conditions remain robust, despite some deterioration more recently, which partly reflects the headwinds faced by listed resource companies.
The Life of Australian Banknotes
An assessment of the likely life of a banknote is an important input to a currency issuer's planning. Without accurate predictions of banknote life, there is the potential to incur the economic costs of producing and storing excess banknotes or, conversely, in an extreme case, of not being able to meet the public's demand. The life of a banknote, however, is not directly observed and must be estimated. This article discusses some traditional measures of banknote life and provides some alternative estimates using ‘survival’ modelling.
June 2015
Firms' Investment Decisions and Interest Rates
Firms typically evaluate investment opportunities by calculating expected rates of return and the payback period (the time taken to recoup the capital outlay). Liaison and survey evidence indicate that Australian firms tend to require expected returns on capital expenditure to exceed high ‘hurdle rates’ of return that are often well above the cost of capital and do not change very often. In addition, many firms require the investment outlay to be recouped within a few years, requiring even greater implied rates of return. As a consequence, the capital expenditure decisions of many Australian firms are not directly sensitive to changes in interest rates. Furthermore, although both the hurdle rate of return and the payback period offer an objective decision rule on which to base expenditure decisions, the overall decision process is often highly subjective, so that ‘animal spirits’ can play a significant role.
Why Is Wage Growth So Low?
Wage growth has declined markedly in Australia over the past few years. At the same time, stronger growth in labour productivity has worked to contain growth in labour costs. These developments reflect several factors, including spare capacity in the labour market, a decline in inflation expectations, a lower terms of trade and the need for the real exchange rate to adjust to improve international competitiveness. The size of the decline in wage growth has been larger than simple historical relationships would suggest, which might be explained by various characteristics of the current episode.
Developments in Thermal Coal Markets
Thermal coal prices increased markedly over the decade to 2011, driven by a substantial increase in global demand. That led to significant investments in thermal coal mine and port capacity, particularly in Australia and Indonesia. The resulting increases in the seaborne supply of thermal coal have underpinned a significant fall in global thermal coal prices. However, an easing of the pace of growth of global demand for thermal coal, reflecting a move towards cleaner energy sources and a slowing in the growth of aggregate electricity demand, has also weighed on prices. The outlook for prices and production over the next few years depends on a number of factors, particularly the response of Chinese demand to policy measures.
Potential Growth and Rebalancing in China
In rapidly growing emerging economies such as China, it can be difficult to distinguish changes in long-term trends in growth from short-term macroeconomic cycles. This article provides a narrative account of recent phases in Chinese economic growth, and explores the role of cyclical and structural factors in shaping China's recent growth performance. It reviews evidence documented by Lu and Cai (2014) suggesting that the slowing of GDP growth in recent years has resulted from a decline in the potential growth rate rather than being a cyclical downturn. The article emphasises the positive impact that reforms which raise labour force participation and productivity could have on the growth of potential output in China. It suggests that ‘rebalancing’ the economy's demand from investment and exports towards consumption may not be sufficient to prevent a decline in potential growth but that, at a minimum, such rebalancing would probably be conducive to a more stable macroeconomic cycle.
Banking Fees in Australia
The Reserve Bank has conducted a survey on bank fees each year since 1997. The results of the most recent survey suggest that banks' fee income from both households and businesses rose moderately in 2014, predominantly as a result of balance sheet growth, rather than increases in fees on loans or deposits. Overall, developments in banks' fee income followed similar patterns to 2013.
Structural Features of Australian Residential Mortgage-backed Securities
This article provides a summary of structural features typically found in Australian residential mortgage-backed securities and their evolution over the past decade. Understanding the structural features of the securities is essential to the effective risk management and valuation of the securities because these features determine how the risks of the securitised mortgages are borne by the different investors in the securities.
Wealth Management Products in China
Wealth management products (WMPs) in China are investments that offer fixed rates of return well above regulated interest rates for deposits and are often used to fund investments in sectors where bank credit is restricted. They are typically actively managed by banks, with other firms commonly used as ‘channels’, but few are recorded on banks' balance sheets. A key concern about such products is the moral hazard created by a history of banks bailing out unguaranteed WMPs.
Recent Developments in Asset Management
The global asset management industry has grown rapidly following the global financial crisis. International standard-setting bodies and national regulators are working to better understand and, if necessary, address potential financial stability risks from this industry. A particular concern is that, in the event of a significant negative shock to current favourable conditions, some funds may experience substantial redemptions, and so be forced to engage in asset ‘fire sales’ that could be destabilising for the financial system. This article provides background on international developments, as well as some Australian context.
Skin in the Game – Central Counterparty Risk Controls and Incentives
The increasing systemic importance of central counterparties (CCPs) has seen recent policy debates focus on the ability of CCPs to withstand a crisis effectively. CCPs maintain prefunded financial resources to cover the potential losses arising from the default of a clearing participant. This article discusses the incentives created by the composition of these resources, and draws out the role of transparency and governance in ensuring these incentives are effective.
March 2015
Australian Banknotes: Assisting People with Vision Impairment
A key function of the Reserve Bank is to design and produce banknotes that meet the needs of all sections of the community. The Bank has consulted a wide range of subject matter experts and stakeholders to ensure that the next generation of Australia's banknotes reflects Australia's cultural identity, is secure and remains functional. One aspect of functionality is that the banknotes are accessible to people with vision impairment. This article outlines the work the Bank has undertaken to meet the needs of the vision-impaired community, from the paper decimal banknote series that was issued in 1966 through to the forthcoming next generation series of banknotes.
The Economic Performance of the States
Over the past decade, the mining investment boom in resource-rich states accounted for much of the difference in the pace of economic growth across states. More recently, there has been a gradual rebalancing of growth, though the transition has been uneven. Housing market activity has picked up and this has been accompanied by stronger consumption growth, particularly in New South Wales and Victoria. State labour market conditions have generally softened and the unemployment rate is elevated in all states.
Insights from the Australian Tourism Industry
Conditions in the tourism industry mirror many of the broader economic trends observed in the rest of the economy because tourism expenditure is discretionary and, like all trade-oriented industries, the tourism industry is exposed to developments in overseas markets and movements in the exchange rate. Over recent years, the Australian tourism industry has experienced challenging conditions. However, the fundamental conditions facing the industry have become more favourable, supported by improved economic conditions in key North Atlantic markets and the depreciation of the Australian dollar, as well as continued strong growth in tourism exports to China. This article examines recent developments in Australia's tourism industry and how these relate to broader economic conditions.
Australia and the Global LNG Market
Australian exports of liquefied natural gas (LNG) will rise significantly over the next few years as a number of large-scale investment projects reach completion. The bulk of these exports will be to Asian customers under long-term contracts, with their price linked to the price of oil. The Asia-Pacific LNG market over the next decade will be influenced by potential changes to the composition of Asian energy demand, the magnitude of the increase of US LNG exports to Asia and any changes to the traditional oil-based pricing mechanism. The ramp-up in LNG production will boost Australian output and incomes over the next few years; however, the effect on Australia's living standards will be lessened to some extent by the high level of foreign ownership and the relatively low labour intensity of LNG production.
China's Property Sector
Property development, especially of residential property, represents a sizeable share of China's economic activity and has made a considerable contribution to overall growth over recent history. Residential property cycles in China have been larger than cycles in commercial real estate, and may pose risks to activity and financial stability. The current weakness in the property market differs somewhat from previous downturns as there are indications that developers may be much more highly geared than in the past, contributing to financial stability risks. Although urbanisation in China may provide support for property construction in coming years, weakness in the residential property market is likely to persist. Policymakers have taken actions to support activity and confidence in the market, and have scope to respond with further support if needed. However, broader concerns about achieving sustainable growth may limit the scale of any stimulus they are willing to provide to the sector.
Developments in Banks' Funding Costs and Lending Rates
This article updates previous Reserve Bank research on how developments in the composition and pricing of banks' funding have affected their overall cost of funding and the setting of lending rates. The main finding is that the spread between the major banks' outstanding funding costs and the cash rate narrowed a little over 2014. This was due to slightly lower costs of deposits combined with a more favourable mix of deposit funding. The contribution of wholesale funding to the narrowing was marginal as more favourable conditions in long-term debt markets were mostly offset by a rise in the cost of short-term debt. Lending rates declined a little more than funding costs, reflecting competitive pressures.
Market Making in Bond Markets
In November 2014, the Committee on the Global Financial System (CGFS) published a report on developments in market making and proprietary trading in fixed income and related derivative markets (CGFS 2014). The aim of the report was to facilitate a better understanding of how ongoing changes in these activities may affect liquidity in markets and to assess whether these changes are driven by market or regulatory forces. The report found that there have been changes in liquidity conditions across markets, including in Australia, with market activity becoming more concentrated in the most liquid instruments and declining in less liquid ones. These changes in market-making activity have been driven by both market-based developments and regulatory change. To the extent that liquidity risks were underpriced in the period prior to the global financial crisis, many of the subsequent changes in market structure and the increase in liquidity premiums are welcome. However, with the changes still ongoing, bond issuers and investors will be likely to have to make further adjustments to the way in which they operate in fixed income markets and manage liquidity risks.
Shadow Banking – International and Domestic Developments
One of the lessons from the global financial crisis is that systemic risk to the financial system can arise from outside the regular banking system, in so-called ‘shadow banking’. This article reviews post-crisis international and domestic trends in shadow banking, and regulatory efforts to better understand and address potential risks that may arise. In Australia, systemic risks arising from shadow banking appear limited given its relatively small size and minimal links to the banking system, but it remains an area for regulators to monitor and better understand.
The IMF's ‘Surveillance’: How Has It Changed since the Global Financial Crisis?
The International Monetary Fund (IMF) is mandated by its members to oversee the international monetary system. One of the key ways it does this is through bilateral and multilateral ‘surveillance’ – monitoring, analysing and providing advice on the economic and financial policies of its 188 members and the linkages between them. This article discusses three broad issues identified with the IMF's pre-2008 surveillance by the IMF and IMF watchers – analytical weaknesses (though these were not confined to the IMF alone), ineffective communication of key surveillance messages in public reports, and governance issues and practical constraints – and examines the steps taken by the IMF to address them. Significant improvements have been made in addressing analytical weaknesses, and efforts to improve the effectiveness of the IMF's communication are ongoing. However, issues around governance remain unresolved, which risks reducing the credibility and influence of IMF surveillance.
Some graphs in this publication were generated using Mathematica.
ISSN 0725–0320 (Print)
ISSN 1837-7211