Australian Economic Outlook: April 2013

The Australian economy grew by 0.6% in the December quarter and by 3.1% over the year. Mining was the largest contributor to growth over the year (0.9 percentage points (pp)), followed by Financial Services (0.4pp) and Health Care and Social Services (0.4pp).

Household consumption rose by 2.8% over the year, below the longer run average of 3.4%. The strongest gains in this category came from growth in motor vehicle sales (up 22.9% over the year) and healthcare (up 10.5% over the year). In contrast spending at hotels, cafes and restaurants fell by 1.1% over the year. Business investment was up 8.2% over the year, but this most likely marks a short term peak, as investment during the December quarter was down 5.5%, reflecting the fact that the very strong investment in the mining sector in recent years has finally begun to slow, albeit from very elevated levels.  Indeed, this is also symptomatic of the recent fall in commodity prices, with the terms of trade now 16.5% below its peak in September 2011.
 
Outlook
 
The outlook for the Australian economy remains somewhat mixed. On the one hand a number of very large mining and energy projects remain in various stages of completion and still have some years to run that will continue to be supportive of growth. Yet rates of growth in non-residential construction are likely to decline in coming years as they are coming off such high bases. The challenge for the Australian economy is whether the slack from the impending slowdown in the mining and energy sectors can be taken up by other areas of the economy.
 
In recent years the ageing population has provided a boost to the healthcare sector that has been a very strong employer. It is likely that gains in this sector are likely to continue, especially as baby boomer demand for retirement villages, nursing homes and corresponding medical services will only increase in coming years.  
 
Yet this sector alone cannot prove to be the salvation. The RBA is intimately aware of this problem, and have been lowering rates for some time to prompt growth in household consumption and residential construction. We have noted many times in recent years how the growth rates of household consumption in the 10 years prior to the GFC were artificially buoyed by debt and were unsustainable (individuals taking advantage of asset price inflation – house price gains far exceeding gains in household income -  by drawing down against their mortgages to partially fund extra consumption). In the absence of strong house price gains in recent years, this practice has all but ended, as reflected in the very high rates of household savings. Again, while lower interest rates may lead to a modest improvement in household consumption, the growth rate is likely to remain below the 15 year average.
 
Nonetheless, we expect the modest gains in household consumption in recent months to continue over the year. All other things being equal, these gains can feed through to higher revenues for business which can promote increased output, which can lead to increased employment and investment. But for now we expect these gains to be limited by a confluence of events that are currently restricting growth. These include:
 
-       The high Australian dollar continues to impede growth in the manufacturing and tourism sectors.AUD$ has been large benefactor of strong sovereign credit rating (perceived safe haven augmented by Euro area ongoing debt issues and QE) and attractive interest rate differentials that has resulted in large foreign inflows (in particular, Government bond purchases) While we believe the Australian dollar is overvalued on a purchasing power parity basis, the timing of any fall is most likely to occur on any weakening of growth.
 
-       Tax receipts expected by both State (lower mining royalties, GST revenues and stamp duty receipts from fewer real estate transactions) and Federal Governments (lower corporate tax and mining tax revenues) have fallen well below expectations. Political pressure to restrain spending will limit the ability of all levels of government to contribute to growth in coming quarters.
 
-       Very high household debt will continue to limit credit growth and activity in the residential construction sector. Recent interest rate reductions however should stimulate a slightly higher level of activity in this sector than has been seen in recent years.
 
 
-       A continuing trend towards moving administrative functions offshore to exploit cheaper sources of labour. While this trend can enhance corporate profitability (in the short run), the trend could prove to be ultimately counter productive if the reduction in employment ends up being sufficiently large (all other things being equal) to reduce overall household incomes and, by extension, demand.
 
 
Conclusion
 
The short term outlook for the Australian economy remains positive overall. Although mining investment is slowing, it is coming off a high base. Employment and household incomes should remain sufficiently strong over the year to generate a growth rate of around 3.0%. Yet beyond the short term outlook, obvious cracks start to appear in the veneer of the Australian economy.  The Government's fiscal position will limit its ability to use fiscal policy to stimulate the economy and still high levels of household debt may limit the effectiveness of further monetary policy stimulus as individuals choose to reduce debt (as evidenced by the high household savings rate) rather than take on more. Yet it is the end of the mining construction boom in coming years coupled with high real wages (Australian minimum wages are around $16 per hour, compared to about $8 per hour in the United States and $1.50 in China) and declining productivity (output per unit of input) that will continue to impact Australia’s overall competitiveness on the international stage that is most concerning.
 
When addressing the issue of where the growth might come to replace the mining boom, the RBA Governor, Glenn Stevens, recently told the AFR during an interview on 19 December 2012 , “ I think we always get this question: ‘where will the growth come from?’, and most of the time it comes.”
Let’s ‘hope’ he is right.
 
Martin Fowler is a director of Moore Stephens Sydney Wealth Management where he provides financial advice to high net wealth individuals and conducts research into the social impact of economic policy. He is also a director of Whitefield Limited, an investment company listed on the Australian Stock Exchange.
 
Martin can be contacted via email at Mjfowler@Moorestephens.Com.Au or alternatively by phoning +61 2 8236 7700.