Australia's unorthodox recipe for beating recession

Office workers walk past the Reserve Bank of Australia (RBA) building in central Sydney June 2, 2009.

SYDNEY (Reuters) - Australia has surprised the world and avoided recession, but some of the reasons for its remarkable achievement are far from flattering.

In fact, Australia appears to have turned economic vices into virtues, providing a case study of how an economy can actually prosper because of its weaknesses, not despite them.

Australia's poor savings record, its under-competitive banking system and its heavy reliance on the most basic of exports -- such as coal and iron ore -- have all been cited as explanations for some of the "lucky country's" good fortune.

Those observations are difficult to be heard over the self-congratulation that greeted this month's remarkable news that the economy grew by 0.4 percent in the first quarter, but the signs are clear enough.

Former Reserve Bank of Australia governor Ian Macfarlane was the first to speak an uncomfortable truth when he told a conference this year that Australia's meager savings rate and less-than-aggressive banks had both helped it weather the storm.

In explaining how Australia's big banks had dodged disaster, without suffering so much as a credit downgrade, Macfarlane said the banks' lack of competition and high profitability had kept them off the risky path that led foreign rivals to the precipice.

In addition, he said, a long-standing government policy forbidding mergers among the four major local banks meant that they could graze contentedly on the home market, untroubled by predators, while elsewhere the feast was about to turn to famine.

"It's hard to avoid the conclusion that the difference was that there was no competition for corporate control in Australia, which saved us from the worst excesses that characterized banking systems overseas," Macfarlane said.

The so-called "Four Pillars" policy, originally designed to boost competition but instead blamed for preserving a banking oligopoly, is now seen as more entrenched than ever, thanks to its perceived role in preventing a crisis.

Australia's banks have acted as a circuit-breaker for the economy, but they have at least one major weakness that cannot be happily ignored: their offshore debts, which amount to more than 40 percent of gross domestic product, according to Fitch data.

The government moved swiftly at the height of the global financial crisis to guarantee all of the banks' offshore debt. With their liabilities guaranteed, and their assets held well away from the sub-prime fire, they were the economy's linchpin.

SAVING THE DAY, BY NOT SAVING

Australia's household savings record is also among the worst of rich countries, but Macfarlane, now a director for No. 4 local lender Australia and New Zealand Banking Group, says that, too, helped save the day for local banks.

Households saved around 2.7 percent of disposable income in the year to March 2009, up from 1.4 percent in the previous 12 months but still near the bottom of the world savings ladder.

Fortunately, as it turned out, this meant Australian banks did not have a rapidly growing surplus of deposits and had little temptation to invest them offshore -- such as in sub-prime debt, then the craze among European rivals with much fuller pockets.

"We have no doubt that if Australian bankers had found themselves with a surplus of domestic deposits, they also would have acquired a lot of dubious foreign assets," Macfarlane said.

Deposits account for a healthy 43 percent of Australian bank funding, whereas in Germany, which sank into deep recession and bailed out several of its banks, deposits at some crippled lenders were just as plentiful and growing at a much faster rate.

Bavarian public-sector bank BayernLB, for example, invested in "structured credit securities" and lost heavily.

LIFE IN THE SLOW LANE

Economist Ian Harper, who took part in a landmark 1990s inquiry into Australian banking, joked during the crisis that Australian banks were like an old man living in a house without electricity, boasting of having never been electrocuted.

But the banks now look like having the last laugh.

Instead of being the banking world's Rip Van Winkle, destined to wake up one day to find rivals have passed them by, they are coming out of recession with relatively strong balance sheets, raising cash and showing an appetite for acquisitions.

Regulators in other countries even seem to want to join Australia in banking's slower lane where constraints on mergers and tame competition are no longer seen as economic handbrakes.

"In terms of competition in the banking sector, regulators world-wide are arriving at that as a desirable destination," said Brian Redican, senior economist with Macquarie Bank.

"That's where a lot of people are pushing: for higher regulation and more intrusive regulation."

SELL ROCKS, NOT FLAT-SCREENS

Australia's other well-known Achilles heel, its heavy reliance on raw-material exports and lack of a major high-end manufacturing base, also appears to have worked in its favor.

Central bank governor Glenn Stevens noted in a speech this month that major exporters of high-value products, such as Japan and Germany, had been hit hardest by global recession. In Asia, economies working on the production line for consumer goods like computers and flat-screen TVs also suffered a heavy blow.

But the going has not been nearly as tough at the bottom end of the value chain, where Australia relies on farm and mining-based commodities for about half of its total exports.

Stevens explained that volumes of Australian commodity exports had held up well. And even though prices had tumbled, he added, they remained high by historical standards.

So is Australia's recipe for beating recession to save less, limit competition and don't venture too far up the value chain?

No, says Macquarie's Redican, but it has helped, along with massive fiscal stimulus, prudent monetary policy and reasonably sober lending practices in the home mortgage market.

"I don't think they were sufficient to prevent the Australian economy falling into recession," he said. "But it has moderated the impact of the global recession."

(Graphics by Catherine Trevethan; Editing by Kim Coghill)