Source: The Australian
BUSINESSES exposed to the international marketplace are having a hard time with the Australian dollar trading above US105c, but the economy is much the richer for the rerating by global capital of Australian investment opportunities.
Foreign investment is pouring into Australia at a faster rate than ever before, at a time when globally, foreign direct investment flows are either flat or declining.
To date, the money is overwhelmingly going to resource projects, but an analysis of Australia’s appeal to foreign investors by ANZ foreign currency strategist Andrew Salter shows real estate is a major destination with potential to become much larger.
Mergers and acquisitions, which have been quiet for the past year, could also attract a lot more global capital over the year ahead.
There is a temptation to see the high value of the currency as something that world markets have “done to us” and a product of the manipulation of their own currencies.
While it is true that, for example, Switzerland’s effort to cap its exchange rate has led to a huge build-up in its foreign exchange reserves, some of which have found their way to Australia, we are the real winners from the capital inflow, which supports stronger investment, growth and lower interest rates.
The rapid growth of foreign investment has been the hallmark of globalisation. As nations have lowered their barriers to foreign investment and capital flow, businesses have sought profit worldwide. Foreign investment has been a key driver of growth for the emerging economies. While making the most of different national comparative advantage, it also transfers skills and technology.
Salter cites United Nations Commission on Trade and Development figures showing that foreign direct investment has been growing at a compound growth rate of 12.25 per cent for 40 years, long enough to lift the global volume from $US13 billion to hit a peak in 2007 of $US2 trillion.
The global financial crisis has brought the total back to $US1.3 trillion ($1.23 trillion), mainly as a result of a massive fall in Europe’s share since 2005, when it represented more than 75 per cent of developed country outflows, to less than 40 per cent now. In major economies, risk-averse business has been more inclined to keep its capital at home since the crisis.
Emerging nations led by China are becoming more important sources of outbound direct investment.
For Australia, Salter says net foreign direct investment inflows are now at a 50-year high of 2 per cent of GDP. The totals are boosted by reinvestment of dividends and a big slice of what the Australian Bureau of Statistics counts as direct investment is inter-company loans.
But the strength of foreign direct investment is enabling Australia to finance its thirst for investment at a time when the banks are winding back their reliance upon international capital markets to fund themselves.
Salter says it is not possible to draw direct statistical links between the flow of foreign direct investment and the strength of the currency – global currency markets are a vast cauldron in which many influences are mixed. But they are best seen as two aspects of the same phenomenon: the rerating of Australia by global capital markets.
The Australian dollar has been trading above parity for two years, with an average of US103.5c – 40 per cent above the post-float average.
The strength of the currency in the face of declining terms of trade through most of last year shows investors are not just coming to Australia for the allure of its commodities.
Historically low yields in the advanced economies have led to the reappraisal by global investors of Australian opportunities, as has Australia’s maintenance of a AAA credit rating from all the major agencies at a time when the creditworthiness of many other nations is being marked down.
The attraction of the Australian market is seen in strong demand by foreign central banks for Australian government bonds, including many central banks that would never previously have contemplated holding such a peripheral currency in their foreign exchange reserves. The global interest in Australian government bonds adds to the low rates across the yield curve.
While investment in government bonds remains a key source of foreign capital, portfolio inflows have been softer over the past year. This has mostly been because banks have been shifting their funding source from global wholesale markets to domestic deposits, as much as they can, while flows to the sharemarket were quiet for much of last year.
Direct investment has been by far the chief source of capital inflow over the last year, accounting for three-quarters of the gap between savings and investment. Balance of payments figures suggest almost all the surge in direct investment last year is related to the resource sector. The largely foreign-owned LNG sector, with $90 billion in committed investment this year and next, accounts for the lion’s share.
However, the tally of investment proposals kept by the Foreign Investment Review Board tells a different story, recording that in 2011-12 the value of resource proposals approved was eclipsed by real estate investments.
The FIRB figures underline the strength of foreign investment in the commercial property sector.
JPMorgan property analyst Rob Stanton says yields on prime office property in Australia are between 200 and 300 basis points higher in Sydney, Brisbane and Melbourne than in the world’s major cities.
Foreign investors have been key participants in Australia’s prime property market for at least the last 18 months, with sovereign wealth funds and big funds management institutions looking for quality assets. Funds are coming from Singapore, Canada, The Netherlands, the Gulf and South Korea, among other places.
It is investment that has supported a 40 per cent rise in property trust rolling returns.
It is not yet translating into greater commercial construction, with the white-collar workforce contracting and retail property dealing with weak retail sales.
The next big source for foreign investment could be fuelling mergers and acquisitions. With advanced country central banks committed to keeping rates close to zero for at least the next year, there are vast volumes of cash looking for a profitable home. Australian company balance sheets are in good shape but equity valuations remain below pre-crisis levels.