VZCZCXRO2457
RR RUEHPT
DE RUEHBY #1252/01 3450602
ZNR UUUUU ZZH
R 100602Z DEC 08
FM AMEMBASSY CANBERRA
TO RUEHC/SECSTATE WASHDC 0651
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHDN/AMCONSUL SYDNEY 4033
RUEHBN/AMCONSUL MELBOURNE 5823
RUEHPT/AMCONSUL PERTH 4095
RUEHWL/AMEMBASSY WELLINGTON 5549
RUEHKO/AMEMBASSY TOKYO 3319

UNCLAS SECTION 01 OF 02 CANBERRA 001252 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/ANP 
 
TAGS: EFIN ETRD ECON AS
SUBJECT: Pressure on Australia's Current Account Deficit? 
 
REF: CANBERRA 1121 
 
¶1. (SBU) Summary.  Australia's current account deficit (CAD) fell 
sharply to its lowest level in six years from almost A$20 billion in 
the March quarter (7 per cent of GDP) to A$9.8 billion in the June 
quarter (3.2 per cent of GDP) due to a boost to export prices 
(especially coal and iron ore) and a decline in demand for imports. 
Nevertheless, there could be significant difficulties ahead in 
financing the CAD because of the contraction in international 
liquidity. End summary. 
 
PROSPECTS FOR THE CURRENT ACCOUNT DEFICIT 
 
¶2. (SBU) Australian Bureau of Statistics data showed that 
Australia's current account deficit in the September quarter fell to 
A$9.7 billion, half the peak reached in the March quarter, due to 
better export performance based on large increases in prices, not 
volume. Coal prices were 44 per cent higher while the volume of 
shipments was 2 per cent higher. Iron ore exports rose by 1 per cent 
in volume but 12 per cent in price. The Treasury's Mid-year Economic 
Update (ref A) had forecast Australia's current account deficit 
would narrow to 4.5 per cent of GDP in 2008-09, lower than the 5 per 
cent of GDP forecast at Budget in May 2008. 
 
¶3. (SBU) Australia has traditionally run a deficit on the current 
account because of a persistent trade deficit and net income 
transfers to service foreign debt (up seven per cent in the June 
quarter to A$658 billion). Despite the September quarter 
improvement, its position is now looking more vulnerable, due to the 
large net income deficit and the abrupt end of the resources boom. 
After significant increases in US dollar contract prices for iron 
ore (up around 85 per cent) and coal (up between 125 and 240 per 
cent) earlier this year, commodity prices have now severely 
deteriorated with falls in spot prices to around US$50/tonne 
compared to US$120 under contracts.  The contract prices remain in 
force until March 31, somewhat reducing the immediate impact of the 
changes in the spot price.  However, steel producers are reportedly 
trying to delay shipments of iron ore and coking coal based on 
declining production. 
 
¶4. (SBU) Analysts are pessimistic about the trade and CAD outlook. A 
Commonwealth Bank senior economist said: "Looking ahead, any 
substantive and sustained current account improvements will remain 
elusive, mainly because any future trade account improvements due to 
easing capacity constraints and consequent rising export volumes 
will likely be eclipsed by the ongoing large net income deficit." 
Westpac's chief currency strategist said the income deficit rivaled 
only Iceland's and New Zealand's as a share of the total current 
account deficit and he cited signs of stress in funding the deficit. 
 
 
¶5. (SBU) Australia has one of the world's largest current account 
deficits in absolute terms, financed almost wholly through the 
overseas borrowings of Australia's four major banks. Currently, 
Australian banks have to roll over about A$75 billion in short-term 
foreign debt every month and raise a net A$5 billion in new foreign 
funds. Growing difficulty in rolling over medium-term debt will 
increase the banks' dependence on short-term funds. However, even 
short-term funds are in shorter supply and the Japanese financing of 
Australian-dollar-denominated securities (the carry trade) has 
virtually and abruptly ended over the past five months. 
 
¶6. (SBU) Australia's Big Four banks are highly rated internationally 
Q6. (SBU) Australia's Big Four banks are highly rated internationally 
and have relatively little exposure to sub-prime mortgages, which 
represent less than one percent of all Australian mortgages compared 
to over 15 per cent in the US. However, their ability to finance the 
CAD is constrained by a reliance on 'wholesale funding' or borrowing 
from domestic or overseas wholesale money markets. Recently, 
Standard and Poor's said that Australia's AAA international credit 
rating is under pressure from the slowing economy, deteriorating 
fiscal position, contingent liabilities of the bank guarantee and 
the large current account deficit; S&P is reviewing the rating but 
has not assigned a "negative" outlook to it. 
 
¶7. (U) Corporate finance in Australia is similarly affected by 
liquidity constraints. Westpac Bank recently warned that US and 
European banks operating in the region are retreating to their home 
markets and Australian banks do not have the capacity to supplement 
this loss of finance. According to Bloomberg data, about 60 per cent 
of the syndicated loans written in Australia over the past two years 
were provided by about 170 foreign banks and about A$70 billion of 
syndicated facilities are required to refinanced over the next 2 
years. Merrill Lynch reports that about 20 key foreign banks 
(responsible for (A$54 billion in corporate financing) in Australia 
 
CANBERRA 00001252  002 OF 002 
 
 
are rationing credit. 
 
¶8. (SBU) Comment: It is unlikely that the September quarter 
improvement in Australia's CAD can be sustained given falling 
commodity prices and lower world demand. However, falling import 
demand is likely to keep the CAD from climbing back to historical 
highs. The contraction in international liquidity is a serious 
challenge. It is unclear whether even Australia's highly rated banks 
can continue their reliance on 'wholesale funding' or borrowing from 
domestic or overseas wholesale money markets in the current 
financial climate. In 2007, the Reserve Bank intervened briefly to 
finance the CAD during the onset of the sub-prime liquidity crisis, 
but that was only a short-term solution. An alternative strategy 
could be the expansion of Australia's official debt market funded by 
foreign investment. End comment. 
 
MCCALLUM