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Economic conditions a ticking time-bomb

Glenn Freeman  |  23 Aug 2017Text size  Decrease  Increase  |  

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A snap-back in official interest rates would expose clear winners and losers among Australian businesses, says a Nikko AM portfolio manager.

 

In line with other developed market economies, Australia's interest rates have been at historic lows for years now. Debt levels have soared as interest rates have fallen, with debt currently around two-and-a-half times global gross domestic product figures.

"While interest rates remain low, business conditions are going to be strong, households are going to continue borrowing, and really the economy is probably going to continue the way that it has ... the question mark that hangs over the top of this is what happens when interest rates begin to rise," says Chris Rands, portfolio manager, fixed income, Nikko AM.

Though the level of exposure among consumers is higher than for businesses, a high proportion of businesses are also over-leveraged. Rands believes low borrowing rates are likely helping these "zombie" companies stay alive, "because there's no borrowing costs".

"When interest rates move back up, you'll see clear winners and clear losers. But it's not really until rates begin to rise that you'll see them, because capital's free at the moment," he says.

He refers to a June 2017 study released by the Bank for International Settlements, which shows many companies are only servicing their debt rather than repaying interest: "When they look at that metric around the world, they're seeing that it's risen from about 5 per cent in 2007, to about 10 per cent now, so there are a lot of companies just hanging on."

They call that the "gamble of resurrection," with companies presuming that if they can "hang on long enough, maybe the economy will turn back into what it used to be, and I'll be able to rise from this mess that I've created for myself".

"The problem is that the longer you stay in this sort of environment, the worse that it gets and eventually it just catches up with you," Rands says.

In addition to this phenomenon, Australian businesses have the same issue as many other developed markets, with stagnant demographics.

"If you look forward, the developed market is getting very cold, very quickly in terms of demographics, because there's really no new consumers coming into those markets," he says.

"As China continues to grow ... we're going to see millions of new consumers, and there's going to be millions more consumers coming from India too. Now in Australia ... when you look at some the statistics around tourism, education, healthcare, a lot of that is now going into Asia."

If Australian companies, and those who invest in them, are going to leverage some of this growth, Rands believes the identification of winners and losers is increasingly important.

"You need to look at which industries and sectors to target for growth, because we have this fantastic opportunity sitting across the water, and understanding that is going to be a big part of understanding where our growth is going to come from."

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Glenn Freeman is a senior editor at Morningstar.

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