September, 2013

Australia Exposed to Slowing Economies

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Australia Exposed to Slowing Economies

In 2009 Kevin Rudd announced that Australia had avoided the worst of the global financial crisis, Australia’s economy was still growing and the mining industry was booming. Through the mining industry, in particular the coal and iron ore export industries, Australia benefitted from record trade with China and other emerging economies that were using iron ore and coal in record quantities. At the same time the Labor government’s stimulus package was filtering through the Australian economy, further boosting economic growth. So Australia avoided the extended periods of low economic growth or recession that inflicted the US, Japan, and most of Europe after the GFC. There is now a global growth shift occurring and these economies are coming off their lows and entering an upswing in the business cycle. Australia is still linked to China and emerging markets generally through the commodities trade and it is these economies that are now entering a phase of slowing economic growth. So where does this place Australia in terms of its future fiscal position and economic outlook?

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Global Growth Shift

JPMorgan’s senior global economist, Joseph Lupton, believes an exciting “momentum shift” from outright contraction towards economic growth is starting to happen in the developed world for the first time since the financial crisis, but unfortunately Australia’s not part of it.

Speaking during a visit to Sydney, the New York-based economist said unlike the United States, Japan and Europe, Australia is in a period of “deceleration” and faces a “bumpy transition” as Chinese growth slows and the mining investment boom comes to an end.

“Australia, of course, is more linked to the emerging markets cycle and particularly more linked to China, so while the lift in dynamism that we are talking about globally coming from the developed markets is reaching an ‘escape velocity’ if you will, the emerging markets are in a de­celerating mode.” Mr Lupton said.

Central banks and governments of the US, Japan and Europe are making headway in their attempts to spur growth. In the US, the focus has been on the delicate task of balancing the withdrawal of financial and monetary stimulus as the economy picks up, while in Europe a gradual recovery is taking place but uncertainties exist, with unemployment quite high in many areas.

Meanwhile, the Japanese economy has responded well to a raft of monetary and fiscal policy initiatives over the past six months, and more structural reforms are on the cards under Prime Minister Shinzo Abe.

Emerging markets had benefited from the weaker US economy in the wake of the GFC as investors chased better yields in riskier economies and those linked to China’s “double digit” growth of yesterday.

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“Emerging market corporate profitability has also come under a lot of pressure in a world where you have very weak pricing, you’ve had very strong wage growth and margins have been undermined, so emerging markets are struggling a little bit.”

“Capital flows that had been flowing in from the developed markets, particularly the US, are now starting to unwind a little bit as people start to price in an end to easy money,” Mr Lupton said.

US Impact

As the US mounts a recovery, investors have reduced their exposure to emerging market assets and headed back to the world’s largest economy.

Fed chief Ben Bernanke has been saying for some time that plans to start tapering its massive bond-buying program – which has underpinned strength in sharemarkets and aided the US recovery story – are likely later this year and remain conditional on stronger economic growth, especially a pick-up in the jobs market. “I think the Fed is going to be on a path of normalisation, but it will be a slow path. The Fed has signaled they are trying to give themselves a lot of flexibility but it is going to be very data-dependent ‘there is no present course’, to use the words that Bernanke used in his testimony last week.”

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Impact on Australia’s Economic Outlook

The latest Federal budget forecast was for Australia to be in deficit by $19 billion for the 2013 financial year following government announcements of an expected decrease in government revenue of around $20 billion over the next 4 years.

The latest economic growth figures are outlined below:

Australia Exposed4The RBA signaled on July 30 that it intended to move rates lower in its August meeting, and on 6 August it did just that reducing the official cash rate by 25bp to 2.50%.

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The next RBA Board meeting and Official Cash Rate announcement is on 3 September 2013.  As at 12 August, the ASX 30 Day Interbank Cash Rate Futures September 2013 contract was trading at 97.530, indicating a 13% expectation of an interest rate decrease to 2.25% at that next meeting. The table below highlights how market expectations of an interest rate decrease at the next RBA Board meeting has evolved in recent days.

Australia Exposed to Slowing Economies2This cycle of rate reductions must have a limit however, and Governor Glen Stevens has repeatedly stated that interest rates would not go to zero in Australia.  The RBA can only do so much to stimulate the economy through monetary policy, limited by many factors not least of which are inflation targets, which for now are within its preferred range of 2-3%. However with the recent depreciation of the AUD to around USD0.90 there is reason to believe that inflation will move sharply higher later in 2013 as a result of imported inflation. The graph below is clearly showing an uptick in CPI numbers.

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The other limiting factor for monetary policy is the potential to overheat Australia’s housing market. According to the RP Data-Rismark Home Value Index results for June 2013, combined capital city home values increased by 3.8% over the 2012/13 financial year, showing that expansionary monetary policy is beginning to have an impact on the housing market.

With only so much room to move on monetary policy, fiscal policy will need to play a role in boosting Australia’s economic growth should we enter a downturn. Australia’s public debt levels are already high (see graph below) and the government budget has been in deficit since the stimulus package was announced in 2008. If the Australian government is forced into an expansionary fiscal stance by poor economic conditions a significant deterioration in the governments budgetary position would result.

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Australia has a difficult time ahead in that policy-makers, regardless of which government is elected later this year, need to fill the growth gap left by the mining boom as China slows and embarks on a rotation away from heavy industry, fixed-asset investment and commodity-driven growth towards consumption growth. Australia needs to focus on areas away from mining and on supporting growth in non-mining sectors, including manufacturing, services, healthcare and more domestic-driven, consumption-oriented industries like media and telecommunications.  If Australia is to continue its prosperous path, Australians need to put pressure on political and business leaders to focus on these critical issues, which require long term structural change, than the current headline focused policy initiatives currently occupying the national debate.