costello facces 'banana republic' - the australian

Costello faces 'banana republic'

By David Uren
March 02, 2005

PETER Costello has been forced to defend his handling of the economy as new figures show Australia's deficit to the world has risen above the level that prompted Paul Keating's infamous "banana republic" warning.

As economists estimated the current account deficit, at a record $15.2 billion, was equivalent to 7.1 per cent of gross domestic product in the December quarter, the Treasurer conceded: "We need to lift exports."
But he insisted the economy was in better shape than when Mr Keating, as treasurer, sparked a run on the currency after a deficit of 6.1 per cent of GDP led him to warn of Australia becoming a banana republic.

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"Our economy is in a much stronger position than it was back in the days of Paul Keating," Mr Costello said.

"We have a much lower inflation rate, much lower interest rates and we have a much better commonwealth financial position. But don't underestimate the significance of these figures."

The Reserve Bank, which is expected to announce a rise in interest rates this morning, has ruled out using rates to try to reduce the current account deficit.

Some economists suggested the bank's expected decision to raise interest rates today might make the current account deficit worse.

Mr Costello signalled that he would welcome a fall in the value of the Australian dollar, saying its strength was making life difficult for exporters. He did not think high interest rates would push the currency higher - a point disputed in financial markets.

Labor Treasury spokesman Wayne Swan said the deficit showed the nation was living beyond its means. "We're not paying our way," he said. "We can't continue to spend more than we're earning."

The run of deficits has resulted in Australia's foreign debt snowballing to $422 billion, and it is now a record 51 per cent of GDP.

Foreign debt rose by $1 billion a week throughout last year. Interest costs on the debt reached $5.1 billion in the December quarter - a 19 per cent increase from the previous year.

But Mr Costello said servicing the debt was costing 9.3 per cent of Australia's export income, much less than in the early 1990s when high interest rates pushed the cost of foreign debt up to 20 per cent of exports.

But Mr Swan quoted the International Monetary Fund warning that Australia's debt made it vulnerable to changes by foreign investors.

"International lenders could force up the price they're charging us for loans, or stop lending at all," he said.

Several economists warned that the strength of the Australian dollar would not last.

Westpac senior economist Justin Smirk said the rise in the current account deficit and the prospect of meagre growth in the December quarter had to be approaching the "pain threshold" for foreign investors.

"The days of a strong Australian dollar do appear numbered," he said.

BT Financial Group senior economist Tracey McNaughton said that the bigger the deficit gets, the more Australians have to rely on the "kindness of strangers" to fund it.

She said the Reserve Bank and Treasury head Ken Henry were concerned Australia might suffer the same kind of currency fall as the US.

But the head of Macquarie Bank's foreign exchange division, Geoff Bowmer, said the expected increase in interest rates should keep foreign money flowing in.

He said a return of 5.5 per cent in Australian dollars appeared worth the risk, despite the current account deficit, to Japanese investors who had zero interest rates at home.

The ballooning current account deficit has forced Mr Costello on to the defensive about the economy for the first time since growth fell following the introduction of the GST.

He sought to deflect blame on to state governments, claiming they were causing bottlenecks in ports by lack of investment in infrastructure.

He also said the deficit was partly caused by the higher profits of the Australian operations of multinational companies, with repatriated dividends jumping by almost $1 billion in the December quarter.