RESERVE BANK GOVERNOR DISCUSSES ECONOMY

C O N F I D E N T I A L CANBERRA 000135


DEPARTMENT FOR EAP, EAP/ANP, E, EEB, AND EEB/OMA
DEPARTMENT PLEASE PASS USDA FOR WAINIO
TREASURY FOR CHRISTOPHER WINSHIP
NSC FOR LOI

E.O. 12958: DECL: 02/09/2019
TAGS: EFIN ECON AS
SUBJECT: RESERVE BANK GOVERNOR DISCUSSES ECONOMY

REF: A. CANBERRA 116

B. 2008 CANBERRA 1036

Classified By: Charge Daniel Clune for reasons 1.4 (b/d).


1. (C) Summary: Reserve Bank of Australia Governor Glenn
Stevens told Charge that Australia will face a difficult 2009
as the result of an unprecedented worldwide loss of
confidence by consumers and businesses. The RBA and the
Australian Government are taking aggressive measures to
stimulate the slowing domestic economy, according to Stevens,
who said PM Rudd,s A$42 billion (USD 26 billion) stimulus
plan (ref A) is about right in terms of size in the face of a
very fast and steep fall in global demand. The RBA,s rapid
interest rate cuts (a full 4.0% since September) have also
helped maintain demand, as did the Government,s A$10.7
billion in cash payments in December, of which Stevens
believes half was spent. The RBA Governor said that
Australia,s financial system remains in good shape and that
the four major banks have already met most of their off-shore
financing requirements for 2009. He said that the downturn
would drive up unemployment and cut 2009 growth to 0.5%,
while the end of the commodity boom would cause a significant
unwinding in Australia,s terms of trade and a noticeable
fall in real incomes. Despite these challenges, Stevens
stressed Australia,s continuing scope for further action
based on the RBA,s room for further interest rate cuts and
what he expects will be the strong demand for Australian
Government debt as the Government moves into deficit
spending. He cautioned that regardless of what Australia
does, the near-term state of its economy will depend on the
depth of the downturns in China and the United States. End
Summary

Australia's Economic Ride About to Get Rougher
-------------- -


2. (C) Charge and Econcouns met in Sydney February 6 with
Glenn Stevens, Governor of the Reserve Bank of Australia.
Stephens was joined by Kate Ford, his Economics Assistant.
Stephens said that the global financial system appears to be
stabilizing since the &unprecedented8 period between
September 15 and October 15, 2008. He said that he was
surprised at the speed with which emerging market countries
had been affected by the global financial crisis and at the
massive fall in global demand. In particular, Stephens cited
the near-collapse of Chinese growth as a surprise, saying
that it probably was close to negative in the fourth quarter
of 2008. Expressing cautious optimism that the worst of the
financial crisis may be over, with the return of credit
spreads to more normal levels, Stephens said that the
challenge for 2009 would be how countries manage the economic
impact of unprecedented falls in global demand.


3. (C) Australia has been in the comparatively lucky position
of being spared the first wave of damage due to the relative
strength of its financial system and the earlier impact of
Qstrength of its financial system and the earlier impact of
the resources boom. Unemployment remains at the historically
low level of 4.5%, though Stephens expect this to climb
sharply in the coming months. This ability to observe the
impact of the crisis in other countries has allowed
Australian policy-makers to try to head off the worst by
prompt action, though Stevens allowed that it is impossible
to know if this will be enough to prevent a very serious
recession.


4. (C) The coming 12-18 months will be difficult for economic
policy-makers around the world, Stephens said. He emphasized
that Australia remains in comparatively good position for the
following reasons:

-- The RBA's 3.25% interest rate leaves room for further
cuts;

-- The Government entered the crisis with a net asset
position and a large budget surplus, leaving it in
comparatively good position to take further action after
committing close to 5% of GDP to stimulate demand over two
years;

-- The financial system remains healthy and has access to
global capital markets.

All could change depending on the depth of the crisis, but
whatever happens in Australia is likely to be less severe
than in many other developed countries.

Stimulus Debate
--------------


5. (C) The RBA has moved quickly to use monetary policy to
stimulate the economy through five consecutive interest rate
cuts totaling 400 basis points since September, with the most
recent being a 100 basis point cut to 3.25% on February 3.
Stephens said this has delivered significant relief to
consumers but has had little impact on business confidence.
(nb: the vast majority of Australian mortgages are have
variable interest rates that reset the next month after a
change in the official interest rate. end nb.) The
Government's A$10.7 billion stimulus package announced in
October 2008 (ref b) appears to have also helped, with
Stephens, highlighting the December increase in retail sales
(3.7% higher than December 2007) as well as the steady
unemployment rate. He estimated that about half of the
amount of direct payments to lower and middle-income
Australian families with children and to retirees appears to
have been spent (which would equate to about 0.5% of GDP).
The Government's second stimulus package worth A$42 billion
announced by PM Rudd on February 2 is about the right
magnitude, Stephens commented, adding that he had hoped that
the combination of this plan and the RBA's 100 basis point
interest rate cut the next day would create a "wow factor"
that might help restore confidence.


6. (C) Noting the debate in Australia over the need for
deficit spending to fund the package given the fall in tax
revenue, Stephens said that the projection that net debt will
reach 20% of GDP in the next five years does not concern him
very much. Markets had historically shown considerable
appetite for Australian Government debt and that this would
be a manageable amount in the short to medium term. Slower
longer-term global economic growth would raise more
questions, as this might signal a structural reduction in the
Government's tax revenues that might lead markets to
reexamine their appetite for Australian securities. The real
question is the quality of the measures -- do they include
investments that will lift longer-term productive capacity.
Asked about the possible impact of significant Government
debt issuance on the Australian dollar, Stephens doubted that
there would be much of an effect in the short term.
Governments as a whole continue to be able to borrow cheaply,
and while the amount of government debt on issue globally is
Qand while the amount of government debt on issue globally is
increasing rapidly, Australia has a good reputation on
international markets. Also, Australian interest rates
remain higher than in other developed countries.

Current Account Deficit and the Banks
--------------


7. (C) Though Australia's comparatively large current account
deficit (CAD) is frequently raised by the IMF as a potential
problem, Stephens expressed confidence that it remains
manageable in the near term. The CAD will probably not
increase much despite the fall in export earnings because
slower domestic demand will reduce demand for imports.
Australia's CAD is largely funded by the country's four major
banks, but Stephens said that obtaining funding this has not
been a problem. After U.S. banks, Australia's four major
banks have been the most active on global credit markets and
have successfully raised between $50-60 billion in offshore
term funding in the past several months. Their ability to do
this has been strengthened by the Australian Government's
guarantee, which has brought down their borrowing costs.
Stephens said that this amount represents almost all of their
funding requirements for 2009, meaning that Australia is
largely insulated from potential danger from its CAD for the
rest of the year.

It's All About China and the United States
--------------


8. (C) While 2009 will be difficult for Australia regardless
of what happens around the world, developments in the United
States and China will play the greatest role in shaping
Australia's economic future. The speed and degree to which
both countries return to growth will determine the extent of
the downturn and shape the prospects for a return to growth
for Australia. Stephens expressed hope that the United
States and China will strengthen cooperation on economic
issues, saying that this would both support growth as well as
increase confidence.

Clune