More Australian government bonds? Yes please!

By Cecile Lefort - Analysis

SYDNEY (Reuters) - When governments set out to borrow more it can give investors indigestion, but in Australia's case hungry bond-buyers would welcome a deeper hole in state finances and the safe, but rare, debt it brings.

Australian government bonds are something of a scarce commodity in a country that has run budget surpluses for years and effectively paid off all its debt, but there are growing signs investors may finally get what they wished for.

The Australian government is still counting on a small budget surplus of A$5.4 billion ($3.53 billion) for 2008/09, despite slashing its surplus forecast last month due to the global financial crisis.

However, Prime Minister Kevin Rudd warned he would be prepared to allow a deficit if more spending was needed to stimulate economic growth and many analysts see a budget deficit in the near future.

"The government is likely to run a budget deficit in 2008/09 and likely a bigger one in 2009/10, so it will have to issue more bonds," said Sally Auld, a strategist at JPMorgan.

She predicts a A$5 billion budget deficit for next year and between A$10-A$15 billion the following year.

The government in Canberra said over the weekend it would spend an extra A$15 billion on hospitals and schools, which would come on top of A$10.4 billion stimulus package announced earlier.

RARITY

But in contrast to other governments that may struggle to fund economic rescue efforts in markets saturated with government debt, running a deficit does not seem to be a big problem in Australia because of the scarcity value of Australian bonds.

"One of the problems in Australia in recent years is the insufficiency of government bonds," said Andrew Kennedy, a trader at ABN AMRO in Sydney.

"Supply hasn't met the growing demand," he added.

In part this was because years of diminished supply had shrunk the outstanding bond pool to levels that no longer provided a deep, liquid risk-free yield curve.

"Liquidity was becoming a problem for some issues," said Melbourne-based Lance Pupelis, head of income at Aviva Investors who manages a A$4 billion ($2.62 billion) bond portfolio.

"A short-term move to deficit requiring bonds funding would be welcome," Pupelis added.

Australia has just A$50 billion of government bonds outstanding, a drop in the ocean compared to the $6.4 trillion of U.S. government debt held by the public.