Corporate debt
Whilst it’s true much of the high debt levels currently in our economy are borne by households rather than governments or businesses, it is vitally important now to keep a close eye on corporate debt.
With households borrowing record amounts of money compared to their incomes and assets, they are becoming hyper-sensitive to interest rate changes. If corporate debt where to follow a similar pattern of soaking up liquidity, then it would also be sensitive to changes in economic conditions.
At the moment, inflation is strong, corporate profits are high and debts fairly low, but rising. However, there has been recent attention given to private equity and hedge funds coming into Australia to buy up assets (companies) on the cheap, restructure them in the hope they become more valuable, and sell them on for a profit. For example, the proposed Qantas take-over is relying on borrowed money to finance most of the sale. That’s a pretty big risk if something goes wrong.
Hopefully, corporate debt won’t take off in Australia, but we must be vigilant. The last time we had a house-price boom, followed by corporate-property boom and corporate-debt binge, was in the late 1980s, ending up in the inevitable 1991 recession. With household debts so high, rising corporate debts will make our economy very sensitive to any disturbances or interruptions that may spark off a mini financial crisis and end the golden period of growth that started in the early 1990s.
Should this situation emerge, both households and businesses would be hyper-sensitive to interest rake hikes, since the borrowing is occurring in a period of historically low interest rates. The Reserve Bank would find addressing this situation on its own very difficult if things got out of hand. High rates to cool the financial sector would be needed, but this would risk the onset of a recession and the interest rate transmission lag would make it impossible to respond fast enough should it all come tumbling down.
It is important that should corporate debt accelerate, ways are found to reduce the amount of funds companies can borrow for investment, as a proportion of their assets. Regulating, and reducing, this proportion would be sensible during a boom, since appreciating asset prices generally inflate the value of collateral (as well as investor confidence). Prudential supervision and lending standards should also be strengthened in such a situation.
I am not suggesting that draconian restrictions be placed on the borrowing activities of ‘consenting adults.’ Rather, some measures may be needed. It is imperative, given Australia’s current economic situation, for legislators and regulators to pay a very close eye to corporate debt.