Not even the IMF is worried by our debt

Not down to our last dollar: The International Monetary Fund says it is not particularly worried by our net foreign debt.
Not down to our last dollar: The International Monetary Fund says it is not particularly worried by our net foreign debt.

In its latest report on Australia, the International Monetary Fund says it isn't worried by our net foreign debt, now just a squeak short of $1 trillion. Just as well, since none of us ever worries about it either.

Still, it's nice to have the fund's judgment that “the external position of Australia in 2017 was assessed to be broadly consistent with medium-term fundamentals and desirable policies”. Australia's negative “net international investment position” – our net foreign debt plus net foreign equity investment – has varied between 40 and 60 per cent of gross domestic product since 1988, it says. At the end of 2016, it was equivalent to 58 per cent. That's high.

So why's the fund so relaxed? Because, it says, both the level and the trajectory of our net international investment position are “sustainable”.

The fund derives comfort from the knowledge our foreign liabilities (both debt and equity) are largely in Australian dollars, whereas our foreign assets are denominated in foreign currencies. Get it? In a globalised world of floating currencies and free capital flows, the big risk for an economy heavily indebted to the rest of the world is a sudden loss of confidence by its foreign creditors, which would be manifest in a sudden drop in its exchange rate (as experienced at the turn of the century, when the Aussie briefly fell below US50¢). But when our foreign liabilities are expressed in Aussie dollars, the depreciation doesn't increase their Australian-dollar value, whereas it does increase the $A value of our foreign assets, leaving our foreign liabilities reduced.

The broader conclusion is an indebted country able to borrow abroad in its own currency has a lot less to worry about. And the fact foreigners are willing to lend to us in our own currency is a sign of their confidence in our good economic management.

And, of course, a big drop in our dollar does improve the international price competitiveness of our export and import-competing industries. The fund estimates that, after the heights it reached in 2011 when prices for our coal and iron ore exports were at their peak, our “real effective exchange rate” (the Aussie's average value against all our major trading partners' currencies, adjusted for the difference between inflation rates) depreciated by 17 per cent between 2012 and 2015. Since then it's appreciated about 5 per cent. The fund calculates that, by then, it was about 17 per cent above its 30-year average, leaving it between zero and 10 per cent higher than it probably should be, making it “somewhat overvalued”. The fund says our gross foreign liabilities (debt plus equity) break down into about a quarter as “foreign direct investment”, about half as portfolio investment and a quarter of odds and sods. So the mining investment boom was mainly funded directly by the foreign mining companies themselves, including by ploughing back much of the huge profits they made while export prices were sky high. But this was happening when, after the global financial crisis, our banks were increasing the stability of their funding by borrowing more from local depositors and less from overseas financial markets.

What most people don't know is that most of our net foreign debt is owed by our banks, though that's less true than it was, particularly because recent years have seen more central banks buying Australian government bonds from their original Aussie holders.

Though the central bankers like our higher interest rates, it's another indication that the rest of the world isn't too worried about our financial stability.

Ross Gittins is a Fairfax economics editor.