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Australia, Politics and Portfolios

By David Dittman on January 6, 2012

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Based on a bit of feedback we’ve received a lot of Americans–particularly those whose major introduction has come via Australian Edge, an advisory that debuted only in September 2011–have formed generally negative impressions about the domestic political situation Down Under.

Many compare Australia to Canada at the time of the October 2006 Halloween Massacre, when Prime Minister Stephen Harper, through Finance Minister Jim Flaherty, destroyed about USD20 billion of investor wealth overnight with a campaign-promise-breaking decision to begin taxing income trusts in January 2011. What’s happened at the hands of Australian Prime Minister Julia Gillard this year is worse, they write.

At issue are two new taxes introduced by Ms. Gillard and passed by parliamentary coalitions in the second half of 2011, one that puts a price on carbon emissions and will lead to development of a cap-and-trade scheme similar to Europe’s, another aimed specifically at the “super profits” earned by coal and iron ore miners/producers.

These new impositions are accompanied by government give-backs designed to make the transition to a low-carbon future smoother for business; there are rebates and other devices to help consumers cope with higher energy prices as well. And the latter tax was hammered in close negotiation with major Australia-focused mining companies, including BHP Billiton Ltd (ASX: BHP, NYSE: BHP), Rio Tinto Ltd (ASX: RIO, NYSE: RIO) and Xstrata Plc (London: XTA, OTC: XSRAF, ADR: XSRAY).

This has rankled many smaller miners, perhaps rightfully so, at least if you accept at face value their assertion that the tax will fall disproportionately on their narrower shoulders. The net impact on any single company is yet to be determined, but that hasn’t stopped a vocal group, stoked by Fortescue Metals Group Ltd (ASX: FMG, OTC: FSUMF, ADR: FSUMY) Chairman and Founder Andrew John Henry “Twiggy” Forrest, who may be just playing along with his smaller rivals out of a sense of duty to his iconoclastic reputation but is certainly keeping the issue alive in the media.

That’s despite the fact that most miners, big and small, favor the certainty of moving forward under this new regime over the promise of continuing uncertainty that would accompany successful repeal, as opposition politicians, encouraged by “Twiggy,” among others, continue to run on.

Though Australia’s wisdom in jumping out so far ahead of most of the rest of the world is questionable–only Europe with its cap-and-trade system, which Australia’s will emulate beginning in 2015, when it transitions from the AUD23 per ton levy to a floating-rate mechanism–you could argue that companies that call the Lucky Country home will have a head start once the world finally recognizes the need to internalize some of the major costs of doing business the fossil fuel way.

Here’s the “alarm” sounded by one major global house, Deutsche Bank AG: “The carbon price is expected to have a moderate negative (fiscal year 2013) earnings impact on some emissions-intensive companies.”

As for the mining tax, formally the Minerals Resources Rent Tax (MRRT), “We’re not expecting to pay significant amounts of MRRT ourselves, and we find it hard to believe that [other] major miners are in any different position,” said the man who does the taxes for Twiggy’s company, Marcus Hughes, to a parliamentary committee in Canberra in November.

Reaction on the political front has been loud and emotional, and Ms. Gillard’s future in the game remains in doubt. Opposition leader Tony Abbott has staked a lot of his federal ambition on a campaign to re-open these issues, but Australians generally support the new taxes.

Ultimately the costs for this tax are likely to be borne by countries that import large quantities of Australian coal and iron ore, specifically China and to a lesser degree India. These are the consumers to whom Australian producers will pass costs. They don’t like it, but it’s simply another variable in a complex global pricing equation.

It’s a fair guess that Australia will fall a couple places in The Heritage Foundation’s 2012 ranking of countries according to “economic freedom.” The think tank released its findings for this year when it thought carbon-tax legislation was on hold because of “political opposition” and well before the mining “super tax” passed Australia’s lower house of parliament. These factors weren’t ignored in the calculation of the country’s overall “fiscal freedom” score, which was 61.3 out of a possible 100. The global average is 76.3; Australia’s poor showing is exacerbated by relatively high income and corporate tax rates.

But the factors that drove the country’s No. 3 showing in the 2011 appraisal by one of Washington, DC’s leading factories of conservative scholarship–including longstanding openness to global trade and investment, generally even application of transparent and efficient regulations, an independent judiciary that protects property rights, and levels of corruption–are largely intact.

The primary threats from abroad to Australia’s continuing prosperity in 2012 are Europe, China and the US–the three variables around which so much revolves. Headline-writers continue to make easy work of turning Europe’s saga into the virtual hand on the yo-yo, pulling the market higher when Merkel and Sarkozy have nice talks, dropping it when random German bankers drop hints that no support from the Deutsche Bundesbank is forthcoming.

Australia’s Big Four banks are under increased scrutiny because of their reliance on the wholesale funding market. Should the crisis in the eurozone devolve to cause a 2008-style credit crunch their borrowing costs would rise. Several Australian bank executives have said offshore funding markets have been extremely tight since mid-November, as debt investors sweat out Europe’s banking sector.

The Reserve Bank of Australia, in minutes from its Dec. 6, 2011, board meeting, its most recent, noted that although pressures exist, a funding crisis for the local banks isn’t yet on the horizon: “While Australian banks had found long-term debt markets dislocated, there were no signs of strain in local money markets through November and banks have also been able to access short-term offshore markets with relative ease.”

The central bank noted local banks continued to be beneficiaries of the shift of US investors away from European bank debt, while deposit growth has also been running well in excess of lending growth.

The RBA cut its target overnight interest rate by 25 basis points to 4.25 percent at that meeting, which leaves it plenty of room to use traditional monetary policy tools if necessary to offset a precipitous decline in aggregate demand.

It should be noted, too, that Australia–despite its recently won reputation on these shores for its “socialism,” etc., boasts one of the lowest net debt-to-gross domestic product ratios among economies developed or developing in the world. New fiscal stimulus measures undertaken by previous Prime Minister Kevin Rudd can therefore be repeated without dragging Australia into European-style mire.

Monetary and fiscal flexibility should protect Australia from a worse-than-forecast slowdown in China. At present we, based on input from our colleague Yiannis Mostrous, anticipate growth in the Middle Kingdom to approximate 8 percent in 2012. Our base-case scenario is that Chinese officials will do what it takes to guarantee a soft landing, using the several critical tools at their disposal, including further easing of bank reserve requirements.

Despite the impressions created by recent developments, Australia remains one of the most investor-friendly jurisdictions on the planet.

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