Transcript of Question & Answer Session Capital Flows and the Australian Dollar

I’m going to ask Guy the first question just to kick it off. There was an article on the front of today’s Fin[ancial] Review, which I know was a bit of a Fairfax beat up potentially about the Triple A rating, and Costa at our table asked a question about the Triple A rating while we were eating, and where you see that for Australia? Whether we are at risk, and sort of what that might mean currency wise if – well not so much if we are to be downgraded - but if there was some noise around the country’s rating.

Okay. The … I mean I don’t despite what you might read in the papers I don’t think there’s much risk of that, I don’t necessarily always have a particularly high opinion of rating agencies to be frank, but if you look at, and it reflects exactly on what I was showing during the talk, so we’ve had yes Australia has used its capital in flow for the last couple of hundred years. At the moment actually we have got less capital inflow than we’ve had most of those, certainly the last 30 or 40 years, and there’s a reasonable chance as I was saying at the end of the speech there’s going to be less rather than more capital inflow going forward. So that’s not so much of an issue. If you look at the state of our fiscal position and not staying well clear of anything to do with the most recent Budget, but relative to anywhere else in the world, pretty much, and relative even to our own history and anyone else’s history in the world, is the Australian Government, both at Commonwealth and at State level which is not carrying all that much debt. So on any of those matrix you’d have to be really surprised if a rating downgrade was anywhere near in offing. And if you map that to the local situation here, I mean the State Government here in South Australia is Powley well knows, is borrowing basically as cheap as it’s ever been able to in its whole history. So notwithstanding the fact that South Australia doesn’t have a Triple A rating, is still able to issue as much debt as they want to, well not quite as much as they want … Issue debt without worrying about being able to fund it, and about as lower interest rate has ever been the case in the State’s history, and so the Government yes needs to maintain a prudent fiscal start, but I don’t think it should be too hung up about what exactly the rating happens to be.

Michael Dorsey from Funds SA. You talked about the reduction in the composition of the flows from the banking sector to potentially Sovereign Wealth Institution et cetera, how does their hedging policy impact on the Australian dollar? For example the banks traditionally hedge their currency exposure whereas foreign investors, bond holders, would typically be over hedged.

So we … That’s a really good question. So we have that … We have a debate about that internally and don’t necessarily come up with a consistent, the same answer. What I would say … I mean so yes you’re right the banks hedge, which means, so the banks when they borrow US dollars will swap that back into Australian dollars, because that’s what they want to lend to their customers. Whereas if I’m foreigner and I’m buying Australian Government Bond, I actually want to hold on to the Australian dollars. But when the banks hedge their borrowing, so when they’re swapping their US dollars into Australian dollars, someone else is on the other side of that wanting to hold that Australian dollar exposure. So there’s still someone out there who wants that net Australian dollar exposure. So I don’t think that the hedge … I mean as I said in the end what determines the currency is the net appetite of the rest of the world to hold Australian dollar assets. How they exactly do that I don’t think makes too much difference to the overall level of the currency. So I don’t think the different hedging policies of the banks and the sovereign asset buyers makes all that much difference. But it’s … as I said that’s my view, I said there are other people who work with me who don’t hold exactly that same, so it’s a good question.

Thanks Guy. Joe Burt from Bank SA. It’s a similar question, I was prepared to ask you a question about speculative positioning in the A dollar, and off shore futures contracts and other things, but in light of your presentation I … Perhaps how would you talk from a central bank perspective in holding foreign reserves? The increase in our bond holdings off shore between 10, 11 and 12 was while the A dollar was above parity, and hence probably a good reason to drive it higher. Since then and now the yield curve has steepened, the A dollar has fallen, as a central banker holding these Australian assets clearly you’re losing on market price on the yield and also holding on the A dollar. What goes through the central bank in terms of when does it important to cut and run from a traders perspective or from yourself how you might think of that thank you?

So I … One of my responsibilities is manage the currency, the Australian foreign exchange reserves. Now being we’re Australian we obviously can’t hold Australian dollars in our foreign exchange reserves that doesn’t work, but we’d actually love to hold Australian dollars in our foreign exchange reserves, because it actually pays us a yield, instead we have to hold US dollars and Japanese Yen and Euros which don’t pay us anything, so your question would be a problem we’d love to have actually, but to the extent I get into the bides of my counterparts elsewhere around the world, most of them are interested, so they’re very much buy and hold investor, as you said a number of them bought in when the currency was above parity, but I think you know they’re interested in the diversification point of view to which the currency is sort of a bit of a secondary consideration, they’re interested in the yield very much, but the yield is still attractive where it is now and a lot of them don’t unlike us we have to mark to market on a daily basis, a lot of them don’t have to mark to market, so they don’t worry too much about the sell off in yields or any sell off in yields. So I think they’re very much interested in having Aussie dollars as a permanent part of their portfolio which as I said in my speech, I don’t think there’s any risk of that changing any time soon, as long as the Australian economy is still travelling okay and whatever, I just don’t think that’s going to change. As I said if the currency got a lot cheaper they might decide to increase their allocation, but where it is at the moment I don’t see them decreasing it.

I might just jump in there from an anecdotal perspective. SAFA thanks that about 30 per cent of our debt is held off shore, one investor is the Swiss National Bank, so you may remember about two years ago Guy, when the Swiss Franc came under a lot of pressure and the government and the central bank was worried about the appreciation of the Swiss Franc, so the … In terms of doing their own QE, they’ve grown their balance sheet to about $700 billion Euros something …

US dollars.

… US dollars, they’ve now got to invest that money and we think that the Swiss National Bank’s got about $50 billion of A dollar assets they hold in A dollars, because they’ve expanded their balance sheet now they’ve got to invest it; and we know they’re one of the largest holder in SAFA bonds, and they’ve actually set up an office in Singapore now because that’s where they’re investing. They don’t want hold just US dollar assets. So that’s a massive change that’s come about from QE, where certain central banks have had to go and buy you know global assets, and the other thing is they are very attracted to the liquidity in the A dollar, so it’s all about their currency and protecting that. So they lose a percent on the interest rates, or rates back up a percent, they’re not so worried about that as the underlying currency relative to the Euro or the US dollar.

Hello Guy, Cecil from [inaudible] if you will take a question from the media.

Yes.

When you say that the Reserve Bank doesn’t know who owns the Federal Government and State Government debt, if you go to the Government, to Treasury or Office of Financial Management, will they tell you?

No, so they don’t know either. So who knows … So when I … So they obviously have to pay interest on the debt right, so they have to … But they pay that to what’s called a custodian who manages the holdings on behalf of the end investor, and those custodians have non-disclosure agreements where they don’t have to disclose who they’re holding it on behalf of. So they’ll tell the ABS whether it’s a foreigner or a domestic entity who’s holding it, but not who. So neither … And this has come up a few times in the last few years, so neither Treasury or the AOFM have an exact, or us, have an exact idea as to who exactly is holding it. The custodians know, but they have non-disclosure agreements so they’re not to say. As I said we can try and get some handle on it by looking at what information other central banks publish but that’s fairly incomplete. So no it is very much an incomplete picture.

G’day, Bruno Bellon from the Commonwealth Bank. Thank you Guy for the presentation, because it explained very well from a mechanical point of view I suppose what’s been driving the currency and also those things on the outlook as well. I just wanted to ask a question, given that background in terms of there are flows in and out which control, obviously have an impact on the value of the currency, over the past year or so we’ve had the Reserve Bank coming out and offering an opinion in terms of the level of the currency and obviously uncomfortably high has been mentioned a few times. So given that the currency is ultimately determined by mechanical movements, is there much value in a central bank offering an opinion in terms of whether it’s too high, too low, or just right?

I mean I think our opinion for whatever its worth was just, if we look at the … I mean from a policy point of view a lower exchange rate would I think deliver a more balanced growth outlook for the economy, so part of the reason why we’re saying things like that is you know reflecting on the policy considerations. But it’s also looking at the fact that if the long term drivers of the currency things like the terms of trade in particular, would suggest that you know in the medium term it’s more you know we think the currency is more likely to be lower rather than higher and including sort of things I was talking about today. Whether or not that’s going to be, it’s our opinion and others obviously have different opinions, but it’s as much to make at least people think about it, particularly coming back to the question you might have asked about sort of more shorter term focus on the currency and thinking more about well in the medium term, what are those sort of medium term drivers and what do they suggest about the potential direction of the currency. And those medium term drivers and combine with the sort of stuff I was talking about earlier, very much suggest that it seems like the currency’s more likely to be going down rather than up from here.

Hi Guy, Peter Tyson from JBWere. Thank you for your talk today, it’s left much to ponder on for us. One of the graphs you showed I saw today had the net liability position across all sectors within Australia and it had the graph from 2007 to 2013, it looked like it had gone from kind of high 70s to low 80s, so despite the public increase in net debt position overall it didn’t seem like it had changed too much from an overall picture, just wanted your views on Australia’s liability position overall and how you see that?

So that’s not something which I worry about too much at all, and so the stock is accumulation of a whole bunch of flows and so definitionally, but so the fact that we have used those capital flows to fund investment over any number of years means that the stock of liabilities goes up, but as you said for the last 10 years or so it hasn’t actually changed all that much. So it hasn’t grown relatively to the size of the economy. So I mean nor do I think we’re at a level which is anywhere near worrisome and to the extent that people have less appetite to hold Australian dollar assets, well the currency goes down and at the moment at least that’s a development we’d be reasonably comfortable with. So it’s not … As I said it’s not something which I think is much cause for concern, we’ve had, you will see that level was being maintained for about the past decade or so, notwithstanding in the middle of that period we had a fair amount of global financial turmoil and it really didn’t cause the country any great problems. So the fact … As I said the fact we’ve been through one of the biggest stress tests you could ever throw at a financial system came out the other side without too many dramas, I think it seems to indicate to me that that’s not something we should be particularly concerned about. Certainly coming back to your question you asked me over lunch, Costa it’s not something lose any sleep over at night, I said I lose sleep over two year olds not over foreign liability positions.

And just finally, what’s your NFL team?

The Cowboys, so it’s about as successful as Carlton and manages their draft just as well.

One thing Guy I might ask is … The RBA all of its statistics is generally as percentage of GDP, in the last five years Australia’s GDP has grown faster than our peers on a global basis, so to some extent because of that, has that put upward pressure on the dollar when you consider that our GDP and those ratios have been growing relatively faster than the rest of the world? And that on the flip side in a world where perhaps, as the RBA is expecting the growth is below par or whatever the wording you used, that that potentially allows that dollar to drift off over time.

You can turn that around in terms of, the effect, one of the biggest effects on both our economy and also on the currency over the next little while is probably going to be the stunt of US monetary policy as it has been for the last 20 or 30 years and including over the last five years or so which is again a reflection on the relative strengths of various economies. So the fact that this … One of the other reasons why sovereign asset managers were happy to invest in Australia was, as Powley, said was we actually were doing well, which is a good thing, not a bad thing, and the solution to that is not to drive your economy into the ground to make yourself an unattractive position to invest. But as the rest of the world hopefully becomes a happier place over the next few years, then you’re right, then there’s again some potential for some of those capital flows to go elsewhere in the world rather than to Australia. But as long as in the course of that we still maintaining decent economic outcomes here. As I said the solution to one easy way to stop people investing in you is to have a nasty deep recession, that’s probably not a path we really want to go down just to get a lower currency. So to the extent the high currency reflects the fact that we’re doing better than the rest of the world, then obviously that puts a bit of a dampener on things, but it’s much better to be in that situation than the opposite.