Budget surplus will help business

By cutting spending and maintaining a budget surplus, Wayne Swan has likely cemented another rate cut for November. With business debt of around $1 trillion, that will put money in company's pockets.

The Australian business sector has around $730 billion of debt. More specifically, that is the amount of borrowings the business sector has in the form of specific loans with banks and financial institutions.

There is a further amount of business borrowing which is captured in mortgage debt with many small business owners using a line of credit on their house to fund their business. It is not at all clear how much of the $1.25 trillion of mortgage debt is actually business debt but it would likely be of some significance.

Other domestic business debt, which covers borrowings in the form of corporate bonds, private placement with fund managers and the like for the non-financial corporate sector, is estimated by the RBA to be around $125 billion. To avoid the issue of double counting, wholesale bank debt is not included in these figures (banks raise capital from the wholesale market to fund mortgages and some business loans).

Adding all of this up and the amount of domestic business debt is around $1 trillion.

Highlighting this is important because it helps to show how much interest rates matter to business cash flows and profits. Very clearly, a 1 per cent change in borrowing costs is worth around $10 billion a year to the business sector.

According to data from the RBA, in the middle of 2008 the weighted average interest rate on credit outstanding for small business was 10.1 per cent. For large business, the average variable rate was 8.1 per cent and for bank bills, the interest rates was 8.2 per cent.

Fast forward to the latest RBA data, which is only available for June and therefore does not capture the full effects of the June and October cuts in official interest rates, and small businesses are paying an average 7.65 per cent, large businesses are paying 5.65 per cent while large business bank bill yields are 5.7 per cent.

In the last 4 years, using the latest data, the net reduction in interest costs has been around 250 basis points. This yields a saving of around $25 billion a year for the business sector based on current debt levels. When the data for the December quarter are calculated, the total reduction in interest rates since the 2008 peak will be close to 300 basis points, even if there are no further cuts in official interest rates from the RBA.

While there are many reasons behind the reduction in interest rates over that time, one important factor has been the move to tighten fiscal policy and the cuts in government spending.

At various times in recent months the RBA has noted that fiscal policy is "contractionary” and will be cutting GDP growth by a substantial amount in 2012-13. When the RBA digests yesterday's Mid Year Economic and Fiscal Outlook, the RBA's view is unlikely to change given the conformation of a record 4.4 per cent cut in real government spending that will be delivered in 2012-13.

The futures markets continues to price in the cash rate falling to 2.5 per cent in the middle of 2013, from 3.25 per cent now, a scenario that if realised, would see business borrowing rates fall to near record lows.

What this means is that the business sector is one of the major beneficiaries of the fiscal tightening through the cuts in interest costs.

With government tax revenue coming from a mix of personal tax, consumption tax, capital gains tax and company tax, a balanced fiscal consolidation over time will require some contribution from all of these segments.

This makes the business sector’s complaints about the budget measure to alter the frequency of company tax payments unconvincing. At the margin, the change in the timing helps to lock in the fiscal consolidation by keeping the budget in surplus in 2013-14. In doing so, it is contributing to the current low interest rate environment, but at the end of the day, businesses will pay no more tax than before.

One of the trade offs from fiscal consolidation is lower interest rates, the benefits or which are flowing into the business sector. Whichever way it’s viewed, the current level of interest rates is not a constraint to the business sector expanding, hiring and investing. That is a good thing.

With the budget set to remain tight for another year or two, the business sector should continue to benefit from historically low interest rates and an economy growing at a solid 3 per cent.

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