The Australian banking system is highly reliant on external funding and will likely become dependent on the RBA for liquidity in the near future. Our view is that the RBA will have to become much more activist in supporting its major banks as the structural slowdown in China and the housing market continues.
We believe the RBA will ultimately be forced to take similar action to developed market central banks either by aggressively cutting interest rates or propping up banks through domestic open market operations akin to the liquidity injections seen by the ECB.
Quantitative easing is also a possibility if the RBA is forced to buy bank debt to try to stave off a financial crisis. Under such a scenario, the AUD would fall considerably.
The crisis-stricken economies along the eurozone periphery share one key characteristic: their external debt is too high and their net international investment position (NIIP) – measuring the difference in stock value between assets held abroad and asset held domestically by foreigners – is deeply negative. Yet, a closer look and you will find Australia and its neighbour New Zealand in the same company, with negative NIIP well above countries such as Turkey and Brazil.
Here’s the chart that emphasizes the NIIP point:
When the RBA is ultimately forced to aggressively cut interest rates and supply liquidity, its struggles in maintaining and promoting growth will rival those of the Fed and ECB. Similar to the US and portions of Europe, a primary driver of previous growth and now deflationary force is excess household debt accompanied by a bursting housing bubble. The RBA’s actions will be necessary to try and forestall a banking crisis but will most likely fail in spurring renewed private credit expansion. If the RBA can prevent a major financial crisis, then the severity of the fall will largely be determined by the government’s budget deficit (and fallout from China). If the government attempts to balance its budget or constrict the deficit, Australia may start to truly resemble Europe.
Previously I posed the question, Australia: Market Monetarist Success or Post-Keynesian Failure? Recent data is starting to push the odds in favor of the latter.