When superannuation was just a twinkle in the eye of Treasurer Paul Keating, in the years after the floating of the dollar, the Australian economy was vulnerable to sharp swings in global capital flows.
Australia’s traditional role as a net importer of capital made its economy vulnerable to the shifting sentiments of foreign investors prompting Keating’s famous warning of the country’s potential to become a “banana republic.” Fast forward to 2023, the role of the superannuation sector – now worth $3.5 trillion or 140 per cent of the country’s GDP – as a significant source of domestic capital, has been well recognised.
But as the sector continues to grow, its impact on Australia’s balance of payments, capital flows and net foreign debt is also being recognised.
In a speech to the CFA Societies Australian Investment Conference in Sydney last week, the head of the Reserve Bank’s international department, Penny Smith, noted the sharp fall in Australia’s net foreign liabilities in recent years. This has fallen from a peak of 63 per cent of GDP in 2016 to only 32 per cent today.
While Smith argued that “a net foreign liability or asset position is not necessarily good or bad,” the reality is that having less net foreign debt makes a country more economically secure and less vulnerable to external shocks than more.
Smith noted that Australia has shifted from being a capital importer, which it has been for most of its modern day period, to a capital exporter.
A key factor in the shift, she acknowledges, is the rise of the superannuation sector whose growth in recent years has accelerated with the move of the superannuation guarantee – which is now at 11 per cent – towards 12 per cent by 2025. This has allowed the development of a large pool of domestic capital which is now increasingly seeking a new home overseas.
“Australia’s superannuation guarantee has supported a trend increase in household saving over many years,” she said.
Thanks to superannuation, Australia’s net savings have been above net investments since 2019.
In a big departure from history, she noted, Australia now has current account surpluses and net capital outflows for the first time in over 40 years.
Big as the mining boom
Some of this is due to the end of the big inward investments made during the “mining boom”. But it is clear that super funds are playing a big role in Australia’s capital account and its financial interactions with the rest of the world.
Offshore investments by super funds have seen a continued increase in Australia’s net holding of foreign equities.
In the early nineties, Australia’s gross foreign equity holdings were around 10 per cent of GDP. These are now up to around 85 per cent, with Australia’s net foreign equity position moving from negative to positive over the period.
As Smith notes, the decision to put money overseas has been a sensible one, with the price of US shares (which make up around half of Australia’s offshore equity portfolio assets), having risen by 150 per cent over the past decade, compared with only a 30 per cent rise in Australian shares over the same period – a return further boosted by the big fall in the exchange rate.
If truth were told, the outflow of capital from Australia as a result of offshore investments by super would have had a depressing effect on the exchange rate – although the rate itself is determined by many other more significant factors including relative interest rates and the outlook for commodity prices.
The economic impact of the rise of super funds on the capital account is being watched by long time industry observers.
“Australia is now a net exporter of capital to the rest of the world,” says the chair of the Conexus Institute advisory board, Jeremy Cooper, who led a review of superannuation settings for the Rudd government . “We are a Southern hemisphere Switzerland.”
Cooper notes that Australia’s net foreign equity asset position of $347.3 billion at 30 June 2023, means that Australia owns more shares in overseas countries than overseas investors own in shares of Australian companies.
“With the recent fall in the value of the Australian dollar against the $US in particular, investors like super funds holding overseas assets have benefited from a corresponding rise in the value of those assets in Australian dollar terms,” he says.
He notes that Australia’s current account surplus was at $7.7 billion at June this year.
“When compulsory super started in 1993, we were worried about our current account deficit of around 5 per cent of GDP. We thought super would ultimately reduce this by increasing national savings. We were right.
“A current account deficit results from there being more investment in an economy than there are savings. You have to import capital to make up the gap. Now that there isn’t a gap, we export our excess savings to invest overseas. Super has played a big part in making this happen.”
‘Hysterical in hindsight’
Australian Retirement Trust’s chief economist, Brian Parker, said the concern in the eighties about Australia’s dependence on foreign capital “looks a little hysterical with hindsight.”
“Being less dependent on foreign capital does make you less vulnerable to external shocks, but we benefitted from that capital inflow, being able to fund higher levels of investment than would otherwise be the case,” Parker says.
But he says the situation has changed dramatically with Australian super funds now being significant investors offshore.
“When I first started in the industry, Australian funds were relatively minor players on the world stage,” he says. “You just didn’t get the kind of access that we do now. Australian funds now have the kind of scale that gets you in to see pretty much anyone you need to see and get seats at more tables.
“As funds continue to grow that access and the investment opportunities it provides ultimately benefit member returns.”
Alex Joiner, the chief economist at IFM Investors, adds: “Capital is becoming one of Australia’s key exports. We are becoming much less reliant on global capital markets, which makes Australia less susceptible to a financial crisis that would see those markets dry up.”
Joiner says APRA regulated super funds – which make up around $2.5 trillion of total super fund assets- now have just under 40 per cent of their total assets offshore.
“There is no doubt these flows will only get larger as the $3.5 trillion system expands to, on some estimates, to as much as $9-10 trillion by 2040,” he said.
“Australian markets, and indeed the Australian economy, can simply not absorb all this capital and it must flow offshore.”
He points out that most of the flows so far have gone into offshore equities, with Australians banks and governments still heavily reliant on global markets for their debt.
But he says the new factor to watch is the direct investment in offshore infrastructure assets, an area which the $215 billion IFM has specialised in.
“This is significant and an important differentiator for these funds,” he says.
“But it is, as yet, not moving the needle in the broader sense as there is a huge amount of global real investment in the Australian economy, particularly in sectors like resources.”
Outflows overshadow returns
Foreign ownership of Australian assets including in mining companies has seen a dramatic widening of the net income deficit as foreign companies repatriate dividends offshore from their Australian investments with commodity prices still high.
Joiner argues that this outflow has overshadowed the positive returns Australian superannuants have been receiving from their funds’ offshore investments.
“Australia being a borrower from the rest of the world is now changing as more capital goes overseas,” he says. “Increasingly we will get a return on these investments that will benefit the current account deficit.
“The not-for-profit or industry funds are at the forefront of these trends with around $450 billion already generating returns in global markets [according to APRA data].
“The weaker Australian dollar does impact the values of overseas assets although hedge ratios are relatively high (depending on the fund, industry funds tend to have higher hedge ratios across asset classes than others) as super funds look to manage this risk. “
He says the positive impact of the weaker Australian dollar against the US dollar has been reduced by the diversification across assets, particularly in the infrastructure space.
“Investors, like IFM, choose to diversify global infrastructure portfolios across countries to diversify against economic and geopolitical risk, this also diversifies currency risk.
“The superannuation system has evolved us from a nation of borrowers to one of savers and this will be a benefit to the economy over the medium term.”