Analysis of Australia Financial System

Abstract

The submitted report is based on the Australian economy where it analyses the Australian financial system in regard to the Global Financial Crisis. The report gives the reasons why the GFC occurred in the first place, their effects and measures taken by the Australian government in managing the crisis. The monetary policy used is also given.

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The report aims to explore the Australian financial systems in respect to the global financial crisis. It also explored various measures applied by the government. The findings are that the Australian government was able to use financial stimulus programs and monetary policy to manage the crisis.

Executive summary

The recent uncertainties experienced by the financial markets have seen many financial institutions, banks and companies collapse. Governments have been assisted to rescue their failing economies from the Global Financial Crisis that started in 2007. The worsening of the stock markets in 2007 and 2008 has seen most of the financial stock markets fail. ASX 200 was affected as the Australian inflation, rate of unemployment, and price of houses increased. However, the Australia’s economy did not hit rock bottom as it had measures that ensured it remained stable.

Before the crisis, the Australia’s economy has strong economy, sound financial institutions and regulatory mechanisms compared to UK and US. This ensured that it did not feel the same pinch felt by other states. The Reserve Bank of Australia maintained high interest rates to counter inflation. It also initiated strong monetary and fiscal policies that ensured that the economy was not adversely affected. Through financial stimulus programs, the Australian government was able to stimulate its economy.

Introduction

The global financial crisis (GFS) started in the late 2007 but came into full force in 2008 (Shah 2010). They started in the US credit crunch crisis after therefore was less confidence by investors as sub-prime mortgages that led to liquidity crisis. This affected the coupled by inflation and uncertainties brought about by the financial crisis in Europe and US, many markets and financial markets have been affected immensely. The effects of the global financial crisis effects started to be felt in the mid 2007 and 2008. Most of the stock markets in the world have fallen; big financial institutions and banks have also collapsed because of the global financial crisis. Many companies collapsed during the crisis time while others have merged so as sustain market share. Governments in Europe in collaboration with international monetary fund and the European Union have been in the forefront to rescue some of the affected countries. The euro zone has been most affected region as the region was adversely hit by the global financial crisis. For example, Ireland and Greece have been the most recent states in the Europe and members of the European Union that have been the latest countries to be bailed out through rescue packages by the IMF and the wealthiest members of the European Union (Shah 2010). The effects have not been felt by the financial markets, financial institutions, companies and governments alone. Although most of the largest economies in the world were caught in the global financial crisis, Australia was not hit so much. However, the effect has been felt in the Australian financial system as its stock markets have declined. Since 2007, Australia became ensnared in the financial crisis that was as a result of fall in US property prices. The report identifies and discusses various measures that were taken by the Australian government in managing the global financial crisis.

Background Information

The Australian financial system has managed to withstand the global financial crisis making it fair on well. The worsening of the stock markets in September 2008 affected most of the stock markets in the world making some crash while others becoming highly volatile. This reduced the consumer confidence as their purchasing power and the ability to pay bills and mortgages. However, the Australian financial markets were more covered compared by other economies in the world from the issues resulting from sub-prime mortgage value in the U.S (Canster Cannex 2008). Although the Australian economy was well covered, the effects were felt in Australia. For example, the residential property market has not been performing well as it has been slow, and the rate of unemployment has been increasing.

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Australia unemployment rate
Figure 1: Australia unemployment rate

The unemployment rate remains at 5.3% in 2011 although during the crisis in 2008 was at 4.1% even when most of the nations were recording high unemployment rates (Trading Economies 2011). Nonetheless, the effect on the Australian economy has not resulted to a rock bottom as it has been able to sustain on well. The ASX 200 has been affected and has not been doing well as it has been rising and falling since July 2007.

Graph
Figure 2: S&P/ASX 200 (XJO) Index 5 Years Chart

From figure 1 above, the ASX 200 was performing on well until it was hit by the credit crunch crisis in July 2007 were it dropped then rose towards 2008. It then dropped drastically at the beginning of 2008 with little upheavals of rising and falls. However, in the mid 2008, it declined to early 2009 although it did not hit the rock bottom of the ASX 200. However, after hitting lowest level in 2009 it moved again upwards because of the mining sector stability that boosted the economy. It has since then been fairing on well although not that good.

The Australian GDP rate has not been left out by the global financial crisis also although it has been somehow stable.

Australia Inflation Rate
Figure 3: Australia Inflation Rate

From figure 2 above, it is the Australian economy has not been doing on well as the GDP has not been stable since last quarter of 2007. It has dropped until it sunk in 2009, rose and dropped in the second quarter of 2011. This has been caused by the economic contraction of 1.2% as a result of the economic uncertainty, increase in interest rates as well as the decline in the asset prices. This drop was the largest for Australian economy in 20years leading to corporate bankruptcies and losses affecting the economy negatively. The background information gives a basis the GFC in respect to the Australian global system on how it has been affected.

Analysis

Why Australia manage to withstand the GFC impact in comparison to other economies

There are a multitude of factors that helps explain why the Australian economy has not been badly hit by the global financial crisis, compared with other countries. In the months leading to the global financial crisis, several economic and financial circumstances helped to insulate the country from the worst effects of the crisis felt by other overseas countries. Some of these important dimensions include:

Robust financial institutions

Even before the global financial crisis began, the Australian banking system was profitable and well capitalized. Throughout the crisis, banks in Australia managed to retain their profitability and AA rating. Even as the cost of funds and share prices of Australian banks have been affected by market gyrations in Europe and the United States, nonetheless, the local financial system has managed to hold up well. The high credit ratings of Australian banks are a pointer to the prudent regulation that the banking system has been exposed to, securitization and less aggressive lending (Thomas 2009, p.22). In addition, the economic regulators in Australia must have learned lessons following the heavy losses that were incurred by the economy during the early 1990s economic recession. The ‘four pillars’ policy adopted by Australia has protected the country’s major banks from stiff competition that might have persuaded them to embrace more risky (that is, aggressive lending practices (Thomas 2009, p.22).

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Sound financial regulation

During the late 1980s, Australia witnessed rapid growth in credit lending. This was after the financial system in the country had been deregulated, paving way for corporate distress and asset-price deflation when the country was hit by an economic recess in the early 1990s. Banks were cautious and they would no longer allow their credit standards to fall way too low. Regulatory authorities in the banking system also learned valuable lessons such as the dangers associated with exposing a single asset class (such as commercial property) excessively. The potential for leverage is one of the more recent experiences that enabled regulatory authorities and banks in Australia to remain alert in case the economy was hit by a crisis.

Strong economy

Although the Australian economy was also affected by the global financial crisis, its economy continued to fair on well compared to other developed economies. For example in 2009, the economy of Australia was able to grow by a 0.4% where it was among the two nations among the advanced 33 nations that we’re able to grow (Kennedy 2009, p.2). This can be articulated to the measures and policy enhanced by the Australian government, the good and stable financial baking sector as well as the strong trading blocks in Asia especially China. Going into the global financial crisis, Australia had a sound economy and this enabled the country to endure the crisis better compared with other advanced global economies. Raw materials such as minerals were in high demand, and this brought about a continued upswing in the prices of global commodities. Consequently, by early 2008, employment in the country had reduced to 3.9% (RBA 2009). The Reserve Bank of Australia had to deal with rising inflation, and this resulted in tight monetary policy. Consequently, when the global financial crisis finally broke out, the RBA already had a lot of ground to reduce interest rates.

Comparison of GDP and debt in different countries
Figure 4: comparison of GDP and debt in different countries. Source: IMF (2009), HM Treasury 2009 and Treasury

From the chart above, it is evident that Australia has the lowest net debt compared to other nations like the UK, Canada, Japan and US.

With strong economy and the financial institutions, the economy was less likely to be hit by the financial crisis. It should be noted that most of the banks had retained their profits during the whole period of the global financial crisis. The property industry has remained stable in Australia compared to this of US and UK. The lending practices by the Australian financial institutions were more protected, as they did not give much credit for the residential property markets. The housing boom hardly hit Australia like the US where the sub-prime mortgage value was high resulting to much more credit.

Credit by sector
Figure 5: Credit by sector. Source: RBA Financial Aggregates

Although, it was feared that the global financial crisis would have much impact on the housing sector, because of cushioning and managed interest rates, the Australia’s housing credit grew by 8.2% in 2009 (Henry 2010).

Measures Taken by the Australian Government to Manage the GFC

How the government responded to the global financial crisis

In response to the global financial crisis, the Australian government drafted a stimulus program to cushion the economy against the effects of this crisis (Kolb 2010, 541; Hart & Tindall 2009, P. 340). When it became apparent that the global financial crisis would indeed impact on the Australian economy, the Government felt the need to take proactive measures to cushion the economy from the effects of the global financial crisis. To cushion the Australia’s economy from the global recession, the Australian government acted through various regulatory measures (Sherry 2009). It put a 100% guarantee on deposits made as a measure of ensuring that depositors were not discouraged from banking. The government also developed financial claims scheme and Australian business investment partnership (ABIP) that would act as a vehicle in finance purchase as well as the financing of commercial properties (Sherry 2009). Later in October 2008, the Government announced that it would assume the responsibility of guaranteeing banks in the country. In addition, the Australian Government announced wholesale funding from banks in the country, at a fee. No such action had ever been taken by the government in the history of Australia. The Australian Government had to therefore assume the risk of easing business and consumer concerns regarding the financial sector, as well as the economic conditions. The environment was risk and volatile and this could have resulted in irrational and disorderly behavior. This could have had a negative impact on investments made by the private sector. The government therefore deemed it necessary to assume private sector risk as a way for calming the situation.

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The Australian government also planned to spend over $10.4 billion in its first phase stimulus package (Sherry 2009). This was aimed at reducing the inflation rate in the Australian economy as it was the major problem. In 2009, the Australian government injected $47 billion as part of the stimulus package that would boost the economy from the effects of the global financial crisis. The funds were allocated as follows.

Table 1: Rescue program. Source: Hawker-Britton (2008).

Amount in billions Purpose
$14.7 Meant for schools
$ 6.6 For construction of more than 20000 homes
$3.9 For the insulation of 2.7m homes
$890 Repair of infrastructure and roads
$2.7 Tax breaks
$12.7 Cash bonuses, with $950 to be issued to each tax payer who was earning less than $80,000

The Reserve Bank of Australia (RBA) also maintained its interest rates as high as possible at 4.75% (Ross 2011). This increased the exchange rate of the Australian dollar more than the US dollar.

Interest rates
Figure 6: Interest rates. Source: Trading economies
S/Australia foreign exchange rate
Figure 8: US/Australia foreign exchange rate (DEXUSAL). Source: Forex Blog (2011).

The high Australian dollar is being supported by the high interest rates making it more favourable than the US dollar. This has been necessitated by RBA the move to have the dollar unchanged.

The interest rates were to reduce the borrowing rates as it reduced the credit offered to the borrowers hence maintaining the high inflation rate. The high interest rates increased the Australian key commodities prices which were sustained by the high growth rate in China ensuring steady Australian economy (Trading Economies 2011). However, this affected the purchasing power of the Australians as most could not afford the expensive priced commodities. With low purchasing power, the Australians cannot borrow because of high interest rates thus stabilizing the credit rate. However, the national income growth rate for Australia has continued to increase and do well compared to the productivity rate which has been reported as weak (Ross 2011). The government has also been increasing the interest rates since the onset of the global financial crisis. The increase was to counter the increasing inflation through the dampening of the demand to slow the Australian economy to one which is more sustainable (Access Economics for Anglicare Australia, Catholic Social Services Australia, Salvation Army & Uniting Care Australia 2008, p13.).

Commodities Index versus the AUSD/USD
Figure 8: Commodities Index versus the AUSD/USD. Source: Kritzer (2011)

Australia monetary policy

The monetary policy of the Australia shifted from the contractionary to expansionary one (Access Economics for Anglicare Australia, Catholic Social Services Australia, The Salvation Army & Uniting Care Australia 2008, p14). The government put efforts and mechanisms in place to ensure that it constrained its demand to contain the increased inflation. This was achieved through the boost of demand to stimulate the Australian economic activities to enhance a productive economic capacity in the long term. With its trading partner’s economic growth increasing, the Australian government was able to increase the interest rates through the Reserve Bank of Australia. The tight monetary policy initiated by the Reserve Bank of Australia, was initiated to battle out the rising inflation rate (Thomas 2009, p.22). For instance, because of the space left for interest rates cut, the cash rate of Australia was 7.25% in 2008 but it was lowered downwards to 3% to accommodate the high inflation rate.

Compared to other nations’ monetary policies, the Australian monetary policy gave room for interest rates adjustments depending on the intensity of global financial crisis. The fiscal position of the Australian government has been strong leaving room for injection of huge fiscal stimulus (Thomas 2009, p.22). With its high interest rates and the domestic extended economic growth as well as gains from its commodities market booms from its trading partners, Australia has been able to clear its debts (Thomas 2009, p.22). The public net debt was reduced to zero while most of other economies like the US continued to increase. However, because of the stimulus measures that were emergent and the deteriorating budget balance, the net debt is believed to remain high.

Unlike the US and European, the Australian banks were not affected much by the sub-prime mortgage backed securities (Canster Cannex 2008). However, the institutions that were affected more were the ones that depended on government refinancing to clear their enormous debts. With the net foreign debt level of more than $500 billion which was equivalent to more than the Australia’s GDP by 50%, the banks were forced to pay high rates which pushed the interest rates higher. The reserve bank of Australia responded to the increasing credit by injecting more finances to the economy (Kolb 2010, 541). Although Australia has housing problems, the banks responded by raising the mortgage rates above Reserve Bank of Australia moves intending to reduce the funding costs in the mortgage-backed securities. The challenges on funding faced by the Australian banks led to decline and fear by the government that they would experience a run by the depositors. To alleviate this, the government responded with plans of guaranteeing a maximum of $20,000 to retail deposits for three years. This ensured that no capital injections were required as the banks could operate with no fear of collapsing.

Conclusion

The Australian economy has not been worse off in terms of the effects inflicted by the global financial crisis. However, the crisis did cause some consequences to the Australia’s financial systems. For instance, the ASX 200 has not been doing well compared to other years. The economic uncertainty in Europe and U.S, the global recession coupled by the recessionary trends globally and inflation have led to the fall in the demand for stocks. The prices of the stocks are influenced by the profitability of the different firms and the ability of the firms to pay out dividends. There has been some decline although not like in the US and the UK stock and Financial Markets. The property market has not been left out as the prices of houses have gone up. The global financial crisis has also seen the increase of interest rates and the foreign exchange rates. This has reduced the purchasing power of the Australians and reduced foreign investments based in UK and USA.

The GFC also affected the economy as the rate of unemployment has increased up to 5.3% from 4.1% in 2009. This has been caused by the high standards of living and high inflation rates. The Australian dollar has also been overvalued by more than 38% compared to the US. This has led to price cuts, competitions increase, and declining sales in non-commodities products as the prices of commodities products have increased steadily. It also affected the tourism industry because of the increased interest rates and foreign exchange rate (OECD 1999, p.126)

Australia interest rates
Figure 9: Australia interest rates. Source: Forex Blog (2011).

The strength of the Australian dollar and high interest rates has negative effect as they discourage foreign investors because it makes the stock markets cheap. On the other hand, weakening of the Australian dollar has positive effect on ASX 200 because Australia is a capital importer. Weak Australian dollar makes the stock market cheap encouraging foreign investors.

However, the Australian government has been able to avert more severe consequences like the ones that affected Europe and the UK through various stimulus programs and monetary policy.

References List

Access Economics for Anglicare Australia, Catholic Social Services Australia, The Salvation Army & Uniting Care Australia. 2008, The impact of financial global crisis on social services in Australia. Web.

.Atkinson, G. 2011, ASX All Ordinaries, ASX 200, ETF Gold & Dow Jones charts for 2010. Web.

Canster Cannex. 2011, Global Financial Crisis – What caused it and how the world responded

Forex Blog. 2011, Archive form the Australian dollar category.

Hawker-Britton. 2008, Government response to the global financial crisis. Web.

Hart, P. & Tindall, K.. 2009, Framing the global economic downturn: crisis rhetoric and the politics of recessions, Acton, A.C.T. ANU E Press.

Henry, D. 2010, The Australian financial system-Emerging from the global financial crisis. Web.

Kennedy, S. 2009, Australia’s response to the global financial crisis. Web.

Kolb, R. W. 2010, Lessons from the financial crisis: causes, consequences, and our economic future, Hoboken, Wiley

Kritzer, A. 2011, Aussie May Have Peaked in 2010.

OECD. 1999, Asia and the global crisis: the industrial dimension. Paris, OECD.

Ross, E. 2011, RBA Keeps Rates Unchanged on U.S. and Europe Concerns. Web.

Stutchbury, M. 2010, OECD calls for tighter monetary and fiscal policy, The Wall Street Journal. Web.

Sherry, N. 2009, Australia’s Policy Response to the Global Financial Crisis. Web.

Thomas, R. 2009, Navigating Reform: Australia and the Global Financial Crisis. Web.

Trading Economics. 2011, Australia Unemployment Rate.

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