Australian Economic Outlook –Fissures in the Open Cut Mine

In September the Australian public elected a new Liberal/National Government.  The change of government, whether coincidental or not, has already had a profound impact on confidence.  In anticipation of a LNP victory The NAB business confidence survey held just before the election recorded its highest level since May 2011.  Similarly, the Westpac-Melbourne Institute September consumer confidence index, completed just after the election, rose to its highest level in almost three years. 
 
Expectations are clearly high that a change of government can improve Australia’s economic prospects.  There certainly has been a number of encouraging developments in recent months. 
 
The significant cash rate reductions over the past two years have finally started to translate into greater activity in the housing sector.  Over the 12 months to July, growth in home loans (excluding refinancing) grew by 17%.  The value of investor loans is up 25% and owner occupier loans 14%.  This has translated into a much improved outlook for residential construction.  Building approvals rose by over 10% in July and are up 28% over the year. 
 
In addition, according to RP Data, house prices have risen by over 5% for the year to August, and are likely to rise further.  This will no doubt be welcome news to policy makers’ as strength in the housing sector has significant flow on effects through the economy which will help offset at least some of the impending weakness from the end to the mining investment boom.  Normally, strength in house prices coupled with improved share markets will make households feel wealthier and increase their propensity to spend, adding to aggregate demand. 
 
Yet there is a reason why this time growth outcomes may be more lacklustre: 
 
1:  Despite five years of deleveraging, household debt remains very high ( as do housing costs) by any measure and the recent spate of new loans will only add to the problem.  A large part of household income is already allocated to home loan repayments or rent payments, which reduces the ability to spend in other areas.  Of course interest rate cuts have reduced interest commitments but most households have elected to maintain mortgage repayments (hence the stubbornly high savings ratio) rather than spend the difference. 
 
2:  Lower interest rates have reduced retiree incomes and in turn reduced their ability to spend. 
 
3: The above two factors combined, coupled with an uncertain employment outlook have contributed to the rather anaemic retail sales outcomes over the last few years.  To highlight, retail sales were flat in June and rose by just 0.1% in July.  Annual trend growth of 1.6% was the weakest result since at least 1982 (earliest available data). 
 
4: The decade long mining boom is in its last stages.  While it is true that sharp falls in commodity prices last financial year have reversed in recent months as China's leadership tries to revive growth, these gains are likely to be short-lived.  China’s debt-fuelled infrastructure and construction binge that has driven growth over recent years has taken its toll on the finances of local governments, their financing vehicles and State Owned Enterprises.  Materially lower growth is now inevitable.  In turn demand for key inputs for infrastructure and buildings, namely Australian iron ore and coal, will fall.  A fall in demand is likely to be exacerbated by the increase in global supply that has emanated from the investment boom in recent years, probably leading to much lower commodity prices. 
 
5: Recent data shows that the mining investment boom has probably peaked.  Mining investment rose 6.4% in the June quarter but was broadly flat over the year.  2014 FY estimates suggests that investment will stay very high in outright terms as a number of very large projects remain in various stages of progress, but will begin to fall as they complete. 
 
6: As these very large mining and energy projects complete, output and productivity will increase but construction workers will be displaced leading to a likely rise in unemployment.  Job ads have been in decline for some time now (the ANZ job advertisement survey fell 2% in August, the sixth consecutive monthly decline) and unemployment rose in August to 5.8%. 
 
7: The country's narrow manufacturing base remains weak and relatively uncompetitive despite modest falls in the exchange rate.  This is reflected in non-mining investment, which remains very weak (June quarter business spending in the non-mining sector contracted by 5.3% on the prior corresponding period.)
 
8: Recent governments have failed to exercise appropriate fiscal disciplines.  It is incumbent on good government to save money during the good times so that the surplus can cover increased unemployment benefits and fiscal stimulus during the bad times.  Unfortunately recent governments saved little during the mining boom, instead providing generous tax concessions and handouts that are now politically difficult to reverse.  Government taxation receipts remains too low and spending commitments too high to remain sustainable, especially given the spiralling Age Pension and healthcare costs associated with an ageing population.  It is no surprise that government revenues have deteriorated now that the mining boom is ending.  Perversely, the usually fiscally conservative LNP has made an additional AUD19.8 billion of spending promises that it will find challenging to fund in such an environment. 
 
Conclusion
 
Although the mining investment boom has peaked, still very high levels of outright activity in that sector coupled with improved residential construction activity should ensure modest growth outcomes over the next 6 to 12 months.  Yet continued weakness in non-mining sectors is likely to lead to rising unemployment which will continue to temper consumption and ensure growth stays moderately below trend. 
 
Beyond 6 to 12 months, the outlook remains particularly concerning.  The looming end to the mining investment boom , along with an impending slowdown in China's rate of growth as its debt fuelled infrastructure boom unwinds, remain significant challenges to the Australian economy in coming years.
 
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 by phone on +61 2 8236 7700 or alternatively via email at mjfowler@moorestephens.com.au