Transcript of Question & Answer Session Some Implications of the Internationalisation of the Renminbi

So do we have any questions for Phillip? Yes, a question at the back.

Dr Lowe my name is Glenda Kwek, I'm from Fairfax media. In December when the Australian dollar was at 91 cents the Reserve Bank said the currency was uncomfortably high. Do you still think the Australian dollar is uncomfortably high now.

You're quite a long way off topic, but I will answer your question. For much of the past two years the Australian dollar was very high, and it was understandable why it was high. We had a record terms of trade and investment – the business investment ratio as a share of GDP was at the highest level in 100 years and as the Bank has said many, many times the exchange rate's played a very important stabilising role and it did that through the peak of the resources boom. But over the last two years the terms of trade have come off and the prospect for mining investment has declined and the mining investment as a share of GDP is obviously going to decline over the next couple of years. And the point that we had been making for some time was that if the exchange rate is to continue to play a stabilising role which it had done so successfully for 30 years then it would need to come down in time, and we were drawing people's attention to that relationship. And in time the market did adjust and the exchange rate has obviously come down. So that's the broad context in which we have been talking about the exchange rate, it plays a stabilising role, a very important stabilising role, it went up when the terms of trade were high, investment was very high and it needed to come down when the terms of trade declined, investment came down, and it's doing that.

Another question from the back.

Daniel Sheen from GRC Professional Magazine. Another slightly off topic question I'm afraid, but I'm just interested in your current thoughts on house prices in the capital cities and would you – are you considering macroprudential instead of rising rates to cool them?

Well it's clear that in Sydney in particular but also in a number of other cities that house prices have been rising. Now of course this is part of the monetary transmission mechanism. When you have low interest rates it makes it cheaper for people to borrow and people do that and it pushes up house prices and the benefit that we get from that is that that stimulates housing construction, and that certainly seems to be what has been happening. So from that perspective the rise in house prices is a normal part of the transmission mechanism.

I think the concern would be that if the rise in house prices generated speculative buying, like people who thought that house prices would always go up, and clearly that's not the case, and we've seen house prices come down a couple of times in the last four or five years. So I think that's the issue to watch out for: are people buying houses purely for speculative capital gains? If that were to occur on a widespread scale I think that would raise a number of issues and for those who followed the Reserve Bank Board Minutes closely, you'd see that at the Board we have discussed in principal how macroprudential policy would work in Australia.

And I think we've got a question here from Greg Tanzer.

Phillip in your speech, I remember that you made mention that superannuation funds have a need for liquidity that might inhibit the extent to which they can directly invest in long-term assets, and I think you hinted that perhaps that's an area of policy that we could look at a bit more, I was wondering if you had any – if you wanted to unpack that at all?

Well many super funds say that they would like to buy corporate securities and they would like to buy infrastructure-related assets, but one of the things that inhibits them doing that is that they need to keep a large stock of liquid assets in case their unit holders decide to move to another super fund. And that ability to move between superfunds has been allowed for sound public policy reasons, it presumably increases competition and gives people choice. But I think one consequence of it is that it does place a greater premium on illiquid assets, they are less attractive to hold. And at some level it seems, as I said in my remarks, slightly curious that people are putting money away for 20, 30, 40 years and a very vast bulk of people don't switch very often, but superannuation funds are holding very high liquid assets and require a significant premium to buy the illiquid assets.

I'm not sure what the right solution is, but I think it should be on our collective radar screen to see if there is a better way of somehow locking in funds or reducing the liquidity premium that superannuation funds require on these illiquid assets. I don't know what the issue is – I don't know what the solution is but I think it's an issue that we collectively need to look at and obviously it will be part of the Financial System Inquiry.

I think we've got a follow on question from Greg Medcraft.

Phil thanks for your speech it was very good, a topic close to my heart actually. I was just thinking laterally whether, given the I guess the structural limitations on the Australian superannuation funds to – the disincentive for them to invest in illiquid bonds whether you've given some – any consideration to the idea that perhaps – you know with the United States we signed a free trade agreement in 2007 just before the crisis, and ASIC, we signed an MOU with the SEC back then, we've never actually done anything under it. And I guess one of my thoughts is whether in fact with debt capital markets whether in fact exploring a passporting arrangement whereby it would be basically open to US issuers to issue easily into this market and equally Australian issuers to issue into the US market, and investors, could be a better lateral solution because it seemed to me that on the investor side, investors – say self-managed super funds are –would get access to a market that is deeply liquid, has duration, where they can take duration risk, different liquidity – sorry different credit risk, more diversity perhaps in the economy. And then on the other side for Australian issuers again if you can actually have essentially a very seamless flow between Australia and America for issuers – smaller issuers with a deeper market, longer duration, perhaps more credit intensive, this would seem to me perhaps a game changer that perhaps we're looking for where we could actually get that free flow between us and the US debt capital markets which you know is the biggest debt capital market in the world. So just a – I guess a lateral thought perhaps on whether you have actually contemplated that one at all.

Well you know a lot more about this topic than I do so I'd just prefaced my remarks with that comment. But what you're saying I see as part of building this infrastructure that would support a stronger corporate bond market. I'm not convinced that it's kind of a magic bullet though, because I think kind of the big overlay here is that the Australian banking sector, it's highly rated, it can raise funds relatively cheaply and lend those to the corporate sector. Now some corporates, but not very many, can do that more cheaply than our banks and while it's only a relatively few companies that can do it, the corporate bond market I don't think is ever going to be that vibrant. It's – where you see vibrancy in the corporate bond market is where the banks – either their own cost of funding is very high or they don't want to lend. And I think that's the kind of overlay and so we shouldn't – in my own view we shouldn't lament too long the fact that our corporate bond market is not as vibrant as it is somewhere else because it's a sign of health of our banking system, but we should still work on these infrastructure issues that you've identified.

Well I think the only issue is, is that you know with the change in banking regulations, particularly the liquidity ratio, you know the banks are quite challenged because of the liquidity ratio in terms of obviously advancing for long durations, so I do think if you want – again there's quite a structural incentive in there for banks to try and get probably their corporate customers to go into the bond market. So I think you've got a bit of a game changer in that there is an incentive now for long duration probably to enter the capital market, so I think – but I agree with you it's not a single bullet, I think it's a matter of building alternative solutions, I agree.

Because the super sector and other holders of these securities require a premium for the lack of liquidity. But the person on the other side, that is the borrower, doesn't want to pay the premium for the lack of liquidity, because liquidity doesn't really matter – they don't really care about liquidity and so there's this kind of mismatch. So somehow I think improving liquidity of the bonds or making the super sector – coming up with a set of arrangements in which the super sector is less desirous of liquidity would also help.

I think that's why I'm attracted to the US capital markets though because there you've got credit investors that actually quite like a lack of liquidity because they're buying for 10, 20, 30 years, they don't have a liquidity issue but they appreciate in the credit quality, so that's why I'm just thinking laterally I think that's something that probably should be explored a little more that's all, a better match.

Yep I agree.

I think well we've got one last question, this gentleman over there and then I think we probably should wrap up.

Yeah hi my name is Akash Deokar, I'm from Promontory. Just on the liquidity side, my question to Dr Lowe is would products like liquidity source that were designed in the UK but subsequently prohibited by the Bank of England would be the way to solve the liquidity problems? So for example, you could have a superannuation fund investing in a corporate bond but they can actually structure a swap, so they can actually access liquidity from the banks. And would RBA actually support those sort of products going forward?

Well that would be a private sector initiative I presume with banks providing those types of facilities to the superannuation sector. So if that emerged I think that would be a sensible development. The issue I think is that these things come at a cost and someone has to pay ultimately, so if you can move the provider of liquidity to someone who is more naturally inclined to do it, there may be gains in trade between various private sector entities, but it's not an issue that the central bank would be directly involved in.