RC could result in ‘unanticipated’ credit tightening: Treasury secretary

Speaking before a Senate committee this week, Treasury secretary John Fraser said that the revelations aired by the royal commission have been “troubling” and “very sad”, though not necessarily surprising.

He pointed out the risk of there being an “unanticipated tightening in financial conditions through reactions to the royal commission”, a sentiment similarly communicated by investment bank UBS, which expects credit growth to “slow sharply”.

In its report, titled Credit Crunch? Seven factors to consider, UBS states that the royal commission’s “rigorous interpretation” of responsible lending is resulting in banks more critically assessing borrowers’ incomes and living expenses, which will continue to impact credit availability.

Bank boards will also likely become more risk-averse following the royal commission, as well as after warnings from Federal Treasurer Scott Morrison of potential “jail time” for bankers who are found to have engaged in misconduct, according to the UBS report.

However, the Treasury secretary noted that it’s “early days yet to make an informed judgement”.

Mr Fraser urged financial institutions to conduct a “proper” review of their lending standards, discrediting the idea of there needing to be a trade-off between “proper behaviour in terms of compliance and risk” and “long-term profit”.

On the other hand, UBS cautioned in a report to its customers that a tightening of mortgage lending standards will have a “material impact on the economy”, noting that property prices are not dictated by the demand for and supply of housing, but rather the demand for and supply of credit.

Additionally, Mr Fraser reiterated the warnings communicated last week by Reserve Bank of Australia governor Philip Lowe, who had said that China’s “highly indebted economy” poses a threat to prosperity in Australia.

“The rapid credit expansion [in China] has raised concerns over the quality of lending in some pockets of the economy over recent years. In addition, a large share of financial market activity occurs in unregulated sectors,” the Treasury secretary said.

“The risks in the Chinese financial system heighten the possibility of financial market volatility and a sharper slowdown in economic growth as Chinese authorities focus on containing risks.

“China’s economic relationship with Australia is extensive and has been deepening over time. The adverse consequences of a shock in China would be felt in Australia, along with the wider world.”

However, Mr Fraser pointed out that “global risks have always been an enduring part of Australia’s economic backdrop” and that the global economy has demonstrated “remarkable resilience in recent years” following the global financial crisis.

He remained optimistic about China’s ability to reform its financial system, noting that the nation’s GDP growth is expected to ease, with a target of around 6.5 per cent. (China’s debt-to-GDP ratio over the last decade has been larger than all other major economies, growing from approximately 140 per cent in 2008 to around 260 per cent in 2017.)

“Further moderation is expected in coming years in line with the focus of authorities on a sustainable path for economic growth,” Mr Fraser said.

The Treasury secretary was largely confident about the future of Australia’s economy, saying that his talks with ratings agencies —  including Fitch and Standard & Poor’s — overseas suggest that the government will be able to maintain its top credit rating.

“A strong fiscal position and our triple-A credit rating from all three major rating agencies remains the best defence against the inevitable economic and financial headwinds,” Mr Fraser said.

He continued that the projected cash balance for the 2017–18 and 2018–19 financial years is “expected to be the strongest since the global financial crisis”.

“The underlying cash balance is now forecast to return to balance in 2019–20 before increasing to projected surpluses of $11.0 billion in 2020–21 and $16.6 billion in 2021–22. Beyond the forward estimates, the underlying cash balance is projected to remain in surplus, reaching a projected surplus exceeding 1 per cent of GDP by 2026–27," Mr Fraser said. 

“As a result of the improved fiscal outlook, net debt is now expected to peak at 18.6 per cent of GDP in 2017–18 before declining in each year of the forward estimates and the medium term, falling to 3.8 per cent of GDP by 2028–29.

Mr Fraser also said that it’s “clear” that Australia will have one of the highest corporate tax rates among ­advanced economies.

“Of the 35 OECD members, only Portugal and France have a higher corporate tax rate than Australia — and the French have already legislated to cut their rates [from 33.3 per cent to 25 per cent] below Australia’s over the next few years,” Mr Fraser said.

Based on all these factors, the Treasury secretary said that he expects the growth that the government has been forecasting in previous years to “materialise over the next few years”, which he also believes will eventuate in higher wages after years of subdued income growth.

[Related: China’s debt a risk to Australia, warns RBA]