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Economics Legislation Committee
Australian Office of Financial Management

Australian Office of Financial Management


CHAIR: Good evening, Mr Nicholl and officers from the Australian Office of Financial Management. Thank you for joining us at this late hour. You usually are the latest but you are not tonight. I invite you to make an opening statement, if you care to do so.

Mr Nicholl : No, thank you, Senator.

CHAIR: I will ask a couple of quick questions—the general ones that I normally do. What is the most recent total value of Commonwealth government securities on issue?

Mr Nicholl : As at Friday, $327.3 billion, which comprises a bit over $300 billion in nominal Treasury bonds, $23.2 billion in inflation indexed bonds, $4 billion in Treasury notes and about $19 billion in other securities.

CHAIR: And I imagine, as is usually the case, there is an ongoing program of securities that are turning over which you are putting out the market?

Mr Nicholl : Yes, tomorrow and Friday there will be auctions, each of $700 million. So by Friday we can add $1.4 billion to that number I just read out.

CHAIR: Okay, so there was nothing coming off at the same time; it is just money going on?

Mr Nicholl : There is a maturity on 15 June, and I think that is $13.3 billion or $13.4 billion.

CHAIR: That would have been my next question. I imagine Mr Bath might have the answer handy. What is happening with the yields? The graphs that you usually prepare are very handy for that. Do you have that this time.

Mr Nicholl : As it happens, we don't. We have overlooked updating it.

CHAIR: Well, give us a verbal description.

Mr Bath : Our longest bond, which is a 19-year bond with a 2033 maturity is yielding about 4¼ per cent at the moment.

CHAIR: What I am interested in is trends.

Mr Bath : Since we last met in, I think, February, yields have generally fallen by around about 30 or 40 basis points. So the 10-year-bond yield is about 3.7 per cent at the moment. It was a little over four per cent. So maybe 40 basis points we have had a rally. Essentially Australian government bonds have tracked pretty closely to bond yields in the US and other parts of the world. This is a global phenomenon that has occurred over the last few months—in particular, the last month we have seen yields for quite significantly. A large proportion of that rally that I talked about since February has occurred in the last month.

CHAIR: But, as you say, it is a global trend; it is not related specifically to any characteristics of the Australian economy or the Australian government at this point?

Mr Bath : I think that is a fair comment. In 10-year bonds in particular I think the Australian government bonds have tracked pretty closely to the US. We are about 120 basis points, give or take, over the US ten-year bond and we have tracked around there for quite some time.

Mr Nicholl : Senator, if you recall that chart that we bring, with the coloured lines which track the individual yields, when the lines are spread far apart, that means the yield curve is fairly steep. If we had brought you an update tonight, you would have seen the lines very tightly packed together, which means that the yield curve has actually flattened quite a lot.

Mr Bath : Short bond yields have not moved a whole lot, because, essentially, the market is consensus driven in terms of views on the Reserve Bank's next move. Without giving you our view on what the Reserve Bank's next move is, the market is not pricing in a whole lot of movement in the near term. The short end has been anchored around 2½ per cent, but, as I said, the long end has rallied. That means that those lines will compress, or, in our language, it means that the yield curve has flattened.

CHAIR: Senator Dastyari may have questions on that as well, but could you briefly provide an update on the current holdings of RMBS and where that is at at the moment.

Mr Bath : As at the end of May, which was last Friday, the portfolio stood at about $6.6 billion. I do not think we have had any amortisations in the last couple of days, so that would still be about the right number.

CHAIR: How long is it since you actually reduced the holdings?

Mr Bath : In any given month, we will get repayments of principal of between $100 million and $300 million as a natural consequence of the amortisation that occurs with this portfolio. I think last month would have been around $100 million in pass-through of capital back to us. Prior to that, in late February, early March, we actually sold about $350-odd million of notes as well.

CHAIR: I presume that the RMBS market itself is not requiring the AOFM's involvement at all. Correct me if I am wrong on that.

Mr Bath : That is correct.

CHAIR: What is happening with the market itself? Do you have any information on the quantum that is being written?

Mr Bath : There has been a fair bit of issuance this year. It is probably fair to say that it has not maintained the pace that we saw in 2013 calendar year. There was about $23½ billion, by our reckoning, in calendar year 2013. There has been about $10 billion year to date. That is at last Friday. That includes about $2½ billion that actually priced last Friday. Westpac, one of the larger banks, accounts for a quarter of that in one transaction. You get these lumpy transactions, of even $3 billion, that can distort those sorts of numbers quite significantly. There is a deal on the market at the moment, from ING bank, that I think was launched at half a billion dollars. From all reports, that is going very well and may upsize, so that $10 billion might become as much as $11 billion in the next couple of days. And there are a few other smaller deals floating around. So deals are happening at good levels. The Westpac deal that I referred to printed its top tranche, its A note, at 78 basis points over the bank bill rate. That is a new low for paper that has a weighted average life of 2.8 years since the global financial crisis. I think Commonwealth Bank printed, in March, a similar note, at about 80 basis points, and Westpac printed a similar note again last September, at about 85 basis points.

CHAIR: If the deals are happening, and they seem to be happening reasonably successfully, is the fall in overall quantum because there are not that many deals being sought, which could then be a reflection of the fact that financial institutions do not have as great a need for funding?

Mr Bath : It is a combination of things. The phenomenon you just described is part of it. System growth, as we call it—the rate of home lending—has been reasonably muted. That is part of it. So the demand for funds from the financial intermediaries has remained weak. A second thing to note is that, late last calendar year, there was a flurry of activity, and banks tend not to come back within six months or nine months of their previous activity.

CHAIR: We might see it again later in the year?

Mr Bath : You may see a pick-up that echoes last year's activity late this calendar year. I think it is also fair to say that the compression in spreads in Australian mortgage-backed securities has not kept pace with the compression in spreads of other credit securities. In the same way that there has been a global phenomenon towards lower bond yields in the last few months there has also been a global phenomenon towards lower spreads in what I would call credit product or high-yielding product, such as financial paper or bank paper, be it senior unsecured paper, covered bonds or mortgaged backed securities. It is probably fair to say that regarding mortgage backed securities, while the spreads have compressed in recent months and indeed have hit new lows post GFC, they have not compressed as much as, say, senior unsecured bank paper.

Senator DASTYARI: What drives the international demand for Australian bonds? Is the strong demand for Australian bonds? How is that impacted?

Mr Nicholl : We have seen very strong demand for Australian bonds over the last three or four years or more. What drives that demand? There are whole number of factors. If you look at our market, we have seen a large presence of what we call reserve managers come into the market over the last four years—central banks and sovereign wealth funds. They are looking for ways to diversify their asset management. All of them have AAA mandates and, as we are AAA sovereign, we fit that category. Also, because the Australian dollar has become a lot more liquid in local currency markets, it is an attractive currency for them to purchase. When they purchase the currency you will then find that they buy the sovereign paper and, as they become more familiar with the market, they will buy semigovernments, SSAs and sometimes even corporates.

Senator DASTYARI: To generalise—and maybe this is over generalising; these are my words—is it fair to say that we are seen as an attractive, safe destination?

Mr Nicholl : Yes. Our yields are high relative to other AAA sovereigns, too. So if you are going to earn a higher return in a AAA you would buy Australia over Canada or other AAAs.

Senator DASTYARI: Who are the major purchasers of Australian government bonds? You mentioned foreign sovereigns before. Are they largely who buy our bonds?

Mr Nicholl : We do not have exact data on who buys our bonds. We can form a view, having spoken to a lot of reserve managers and fund managers. We have come to the view internally that about half of our offshore ownership, or maybe a bit more, is probably in the hands of central banks and sovereign wealth funds. The geographic spread of that is really quite diverse. We are talking about right around the world—through the Middle East, throughout the whole Asian region, right across Europe.

Senator DASTYARI: So there is not one foreign sovereign that is predominantly buying Australian bonds. You are saying that it is quite spread throughout the world?

Mr Nicholl : It could be, but we do not know who that is in particular.

Senator DASTYARI: You said before you do not have reason to believe that is the case.

Mr Nicholl : There are some reserve managers who are managing very large reserves, a half a trillion or more, and depending on what the allocations are into Australian dollars that could represent relatively large holdings in our market. But we do not have exact data on what they hold, unless they choose to tell us.

Senator DASTYARI: This is probably simple stuff; I apologise. How has demand changed pre and post GFC? Post GFC was there an increase in demand for Australian bonds?

Mr Nicholl : There seems to have been. If you look at the amount of outstandings, prior to the GFC it was about $50 or $55 billion, and the number I just read out was $328 billion. We have gone from $55 billion to $328 billion in a period where yields have been at historic lows. To me that demonstrates there has been very strong demand for Australian paper. It is not just because it is AAA; part of the reason is that the market has also grown in size. Investors have found more liquidity in the market. By liquidity I mean they can buy and sell relatively large parcels without moving prices against themselves when they do that.

Senator DASTYARI: You said before half, or a figure which we are not sure about—we are speculating, and I just want to put on the record that we are speculating—is in the hands of central banks and sovereign wealth funds. You mentioned that they require AAA rating mandates, and that is part of the argument why the AAA credit rating is so important,—

Mr Nicholl : Not all of our investors do; a lot of the reserve—

Senator DASTYARI: But that impacts the net. Your point, I assume, is that naturally, if there is demand for bonds coming from people that have AAA mandated requirements, if we did not have an AAA credit rating then that would necessitate there would be less demand from those. Is that correct?

Mr Nicholl : Yes. Or if you were in a world where all of a sudden the number of AAAs was to reduce quite substantially, it may be the case that they revise their mandates as a result of that.

Senator DASTYARI: Yes. When we talk about the demand from Australian bonds coming from foreign sovereigns, is that because of an insufficient pool of savings here in Australia or is there no relationship between the two?

Mr Nicholl : I do not think it is because there is an insufficient pool of savings. We have got superannuation savings equal to beyond 100 per cent of GDP in Australia. It is a massive amount of capital in Australia that could be invested in the market. But you tend to find that fund managers in Australia would seek higher yield than could be offered in our markets. They tend to buy other things rather than fixed income in particular and, within fixed income, sovereign bonds.

Senator DASTYARI: So the issue of foreign nationals purchasing Australian bonds is not because there is no domestic savings here—it is more to do with the type of people who are looking for these kinds bonds?

Mr Nicholl : Yes, it is a relative value analysis for investors globally.

Senator DASTYARI: Would it be wrong to say that Australia is too exposed to international markets because we do not have a big pool of domestic savings?

Mr Nicholl : No; we have got superannuation funds of around 100 per cent of GDP, which is $1½ trillion. Our market is only $330 billion, so superannuation is significantly bigger than the market even if you include the state governments, which are less than double what we are.

Senator DASTYARI: I have heard others make the argument that we have exposed ourselves too much to foreign nationals and foreign countries, that we are too exposed to foreign national banks and institutions, some of which do not have the independence the Australian thing has. From your take that is not necessarily the case, is it?

Mr Nicholl : No. When you say we have exposed ourselves, what we see in terms of the makeup of investment in our market is not a result of the direction of anything in particular, it is just a market outcome. The superannuation funds are invested in other things like equities. Those funds are going elsewhere—not into our sovereign market, but elsewhere.

Senator DASTYARI: You are saying that there is a big pool of domestic savings, all through superannuation; that there is a high level of demand for Australian bonds—that is for a whole host of reasons, such as AAA credit rating, safe nation, political stability—

Mr Nicholl : Liquidity in currency, liquidity in the market, also.

Senator DASTYARI: Twenty years of strong economic growth; there are a whole host of reasons. You are not, at this stage, concerned that our public debt levels have exposed us to foreign nationals and governments?

Senator Cormann: You are asking him for an opinion.

Senator DASTYARI: Fair enough. I am happy to leave that.

Mr Nicholl : I was going to say our concern is that we can complete our issuance programs in a smooth and effective manner. That would be our concern and we have been able to achieve that, so we see that as a good outcome.

Senator DASTYARI: Minister, is this argument that we are too exposed to international markets, we are too exposed to foreign sovereign governments because we do not have a big pool of domestic savings and we have a large level of Australian public debt your view as well—that it is not an issue?

Senator Cormann: Firstly, the spending growth trajectory that we inherited was unsustainable—it was one of the steepest in the world. Look no further than the relevant IMF report released in February this year. Our government gross debt is among the fastest growing in the world—

Senator DASTYARI: We are not talking about national debt or household debt—

Senator Cormann: You have asked a question and I am answering it.

CHAIR: Senator Dastyari, it is the minister's prerogative to answer the question as he chooses. If you have any issues, you will have an opportunity to ask further questions.

Senator Cormann: There are a couple of points here. First, our debt levels are low compared to other parts of the world, sure, because in 2007 we had no debt. We had no government net debt, we had a strong surplus and we had money in the bank. The trajectory that we have been on since then is very concerning, and I refer you to some comments made recently by none other than Pascal Lamy, a French Socialist, who has pointed out that an economy like Australia, where we are exposed to constant fluctuations in commodity prices and the like, cannot sustain the sort of level of debt that governments in other parts of the world are carrying. We have a relatively small domestic economy and we are trade exposed—the terms of trade are more important for Australia than for other parts of the world. As far as we are concerned, it is not good policy for us to stay on the trajectory that the previous government put us on, which was taking us to $667 billion of debt by 2023-24, and growing. The decisions we have made in this budget will reduce that down to $389 billion of debt by 2023-24, and falling—and that is after we build an assumption into the model that there will be tax cuts to adjust for bracket creep along the way.

You asked me whether I think the level of debt is too high. Yes, it is much higher than what it was when Labor got into government, when there was no net debt and just a small amount of gross debt. The trajectory we were on was concerning. It was unsustainable. It was taking us to government spending as a share of GDP of 26.5 per cent. In those circumstances, if the opposition continues to support the proposition that government budgets should be balanced, that the government should live within its means, obviously balancing a budget when spending is at 26.5 per cent as a share of GDP would require revenue for governments to be in excess of 26.5 per cent as a share of GDP. To put that into context, in the last year of the Howard government spending as a share of GDP was 23.1 per cent. You were putting us on a trajectory to 26.5 per cent. If we were to balance the books by raising revenue to that level, it would hurt the economy, it would cost jobs, and that is not what we think we should be doing. That is why we believe we need to balance the budget more quickly than would have happened under Labor. That is why we believe we need to reduce the level of debt compared to the trajectory that Labor had put us on, which is why we have put forward the budget we have—dare I say, the budget Australia had to have.

Senator DASTYARI: That was not really an answer to my question, but thank you. I appreciate your lecture on your views of the world. I want to ask a specific question going back to the evidence that Mr Nicholl just provided, which was about whether or not Australia is too reliant on offshore lenders. Mr Nicholl's view was that we are not too exposed on that front.

Senator Cormann: Mr Nicholls, quite frankly, does not have a macroeconomic policy judgement here—

Senator DASTYARI: I am asking for your opinion.

Senator Cormann: As I have said to you, my opinion is that the debt trajectory and the spending growth trajectory that the previous government put us on were bad for the economy, were bad for the country, and we had to take corrective action.

Senator DASTYARI: I am not having that debate with you. I am asking whether we are too reliant on offshore lenders. Is your answer that we are or are not too reliant on offshore lenders?

Senator Cormann: We are too reliant on debt and we are too reliant on offshore lenders as a result. It stands to reason that when you are a small economy that is trade exposed it is even more important, as Pascal Lamy, French Socialist and former head of the World Trade Organisation indicated earlier this week, to keep your debt levels low given our, quite frankly, more risky profile than some of the other countries that have been carrying higher debt. The problem is, though, and what your position does not seem to understand, is that the only reason we are not already in a worse position is that our starting position was very strong. If we had had the same starting position pre GFC as some of the countries in Europe, the US and so on, after the trajectory that the previous government put us on we would be in an even worse position now. Our focus is very much is on ensuring that our economy is as strong, as prosperous and as resilient as possible so that if challenges come our way in the future we are in the best possible position to deal with it. Our view is that the decisions made by the previous government have weakened our capacity to deal with challenges that come our way internationally from time to time.

Senator DASTYARI: Is it fair to say that demand for Australian bonds is strong?

Senator Cormann: Sorry?

Senator DASTYARI: Do you accept that demand for Australian bonds is strong?

Senator Cormann: Sure, clearly.

Senator DASTYARI: Do you accept that we have a large domestic pool of savings? I think the figure quoted before was around 100 per cent of GDP.

Senator Cormann: I am not sure what you are trying to prove.

Senator DASTYARI: No, I am asking a question. I am not trying to prove anything.

Senator Cormann: We do have a reasonable level of domestic savings, that is right, but clearly not enough to deal with funding the requirements of government given the unsustainable spending growth trajectory the previous government put us on.

Senator DASTYARI: My question to you is not having a debate about the merit or not-merit of public debt. My question to you is that—

Senator Cormann: I am sure that you want to put that narrow focus, but the truth is—

Senator DASTYARI: Can I ask the question? My question is a very specific question considering, firstly, that demand for Australian bonds is strong; secondly, that there is a wide range of people who are purchasing Australian bonds across foreign nationals and whatnot; and, thirdly, that it is not an issue to do with Australia's savings base. Considering those points, do you feel that we are to exposed to international markets?

Senator Cormann: Let me put a very simple proposition to you in answer to that question. Just because people want to keep lending to you does not mean that it is sensible for you to keep borrowing. That is a very important consideration that is missing from the question you have put to me. Do people want to keep lending to us? Sure. Is that a sensible thing for us to do, to fund consumption? We say no. You might say that is fine. But essentially what has been happening under the previous government is the equivalent of a household putting some of their groceries on the credit card every month, running up the credit card, never paying it off, funding consumption and then taking out a second credit card to pay for the interest on the consumption on the first credit card. Right now we are paying a billion dollars a month just on the interest to fund the debt that the previous government has accumulated, and that debt funded consumption rather than investment in infrastructure. We can go round and round in circles. But the question here is whether we should continue to pay a billion dollars a month on interest or whether we should get our finances back under control so that money can be better spent on more appropriate purposes, for example, hospitals, schools, the defence of our nation and so on. We would say it is the latter.

That does not mean that, if wanted to keep borrowing, some people would not like to keep lending to us. Of course they would. They would have a fair level of confidence that they would eventually get paid back. But, as we keep borrowing to fund our lifestyle today, we are forcing our children and grandchildren to pay the cost of our living standards with interest, reducing their opportunity in the process because we are forcing them to pay the cost, to repay that debt with interest that has funded our lifestyle, reducing their lifestyle as a result. That is not a question for Mr Rob Nicholl, who just does the job he is asked to do in terms of ensuring there is appropriate funding for the operation of government. That is a policy question for government, and we have answered that question. At some point you—that is, the Labor Party, the opposition—will have to answer that question, too.

Senator DASTYARI: Putting aside a debate about the merits or otherwise of debt and this and that, that is not where I am going with this. I am sure that you have heard on radio and in other places xenophobic argument, unfortunately, about debt, which is based around the idea that it puts us in the hands of two or three foreign governments and exposes us to international governments and so on. I guess that my take on what I have heard tonight—and I want to know whether this is your view—is that that is not quite the right way of doing it. You can have a debate about whether debt has merit or not, but the idea that somehow the current levels of debt have put us in the hands of half a dozen foreign governments is something that is not quite correct.

Senator Cormann: Firstly, I would reject out of hand any suggestion that any considerations are in any way xenophobic. When this government says—

Senator DASTYARI: I am not saying that—

Senator Cormann: Let me finish. You have asked the question. If the suggestion is that somehow when we say that Australia should be self-reliant, should be in charge of its own destiny—

Senator DASTYARI: I have never said that.

Senator Cormann: There is nothing xenophobic about that.

Senator DASTYARI: I did not say that that was the view of the government. I am saying that that is a view out there about debt. You hear on radio and in other places—

Senator Cormann: No. In 2007 not only did we have no government net debt, not only did we have a $20 billion surplus, not only did we have the money in the bank, but at that time the government was collecting—and I stress here 'collecting'—more than $1 billion in net interest payments on the back of a positive net asset position. We had a positive net asset position in 2007 and, if you look at the tables at the back of the budget papers, the government was receiving more than $1 billion a year in net interest payments.

Senator DASTYARI: Minister, you are avoiding the question.

CHAIR: He has to answer the question, Senator Dastyari.

Senator Cormann: Right now we are in a situation—

Senator DASTYARI: At some point you have to get him to answer the question.

CHAIR: He can answer the question as he chooses and in the most appropriate manner.

Senator Cormann: Right now, we are in a situation where we have to pay—not collect, pay—$1 billion in interest payments a month to service the debt that the previous government left us. Given the exposure that Australia has in a quality-based economy to the global economic conditions and given the importance of the terms of trade—and I have pointed to it before—none other than Pascal Lamy, French socialist, pointed to the fact that Australia could not sensibly carry the same levels of debt that some other countries in Europe have done. The problem is that the trajectory the previous government put us on was taking us there. It was taking us to the same destination. It is not a destination that is in our national interest; it is not where we should be going. If we want to protect our living standards, if we want to build opportunity and prosperity for the future, we have got to get that spending growth trajectory under control. We have got to make sure that we are on a more realistic trajectory and that our spending is more affordable into the future.

CHAIR: I have a follow-up question to some of Senator Dastyari's questions. Mr Nicholl, if demand for our securities is strong, what impact does that have on the yield? In terms of attractiveness for funds managers for superannuation, that would presumably make them less attractive?

Mr Nicholl : It depends on what their investment mandates are and what alternatives they are looking at.

CHAIR: But it offers them a reduced opportunity to get return on their investment. Is that correct?

Mr Nicholl : Yes, all else being equal.

CHAIR: Absolutely so. So in terms of when there is strong demand, all else being equal, it probably renders—depending on their mandate—Commonwealth government bonds even less attractive.

Mr Nicholl : Yes.

CHAIR: There are no further questions?

Senator DASTYARI: I have got heaps of questions, but I think that every question that I ask ends up with a half-hour answer. I am prepared to have a debate with the minister at a separate point about—

Senator Cormann: I want to make sure that the answer—

CHAIR: Order! Order, Senator Dastyari! We can adjourn now, if you like. I believe there are questions for the next witnesses, but if you want to adjourn now we can do that. Thank you to the officers from the Australian Office of Financial Management.