Australia: Steady outlook as mining boom tapers off

Download for Kindle

Australia: Steady outlook as mining boom tapers off

Australia: Steady outlook as mining boom tapers off

Asia Pacific Economic Outlook, June 2014

Australia’s economy grew at its fastest pace since Q4 2012, primarily due to net exports. However, a big economic challenge is a structural decline in the Australian mining industry.

Australia_mining

Australia’s economic growth picked up pace in Q4 2013 and grew 2.8 percent year over year after averaging 2.3 percent in the first three quarters of 2013. The economy grew at its fastest pace since Q4 2012, primarily due to net exports. Depreciation of the Australian dollar helped boost exports and restrain imports in 2013.

According to the latest data releases, trade balances continued to improve in the first three months of 2014. However, a fall in mining exports caused Australia’s trade surplus to narrow in March and resulted in a downward revision of export estimates for February. Yet the trend continued to remain strong in the first three months of 2014, indicating a solid contribution from net exports to economic growth in Q1 2014 as well. More importantly, the latest export data indicate that the transition from mining investment to production is gathering momentum despite moderation in Chinese economic growth.

Consumer spending, too, has contributed to growth; there has been a steady increase in household spending over the past six months, and retail sales have been rising since August 2013. The latest monthly indicators suggest that the momentum of strong consumption demand has continued in the first few months of 2014 as well. Household spending was 5.5 percent year over year in the first two months of 2014, up from 4.7 percent in Q4 2013. The AFGC CHEP Retail Index was also 5.8 percent higher in March 2014 compared with the same month last year, and this is its highest level in more than four years.1 The improvement in retail sales was broad based; sales increased consistently across all sectors since mid-2013 as retailers benefited from an extended period of low interest rates and a rise in housing prices.

Limited downside risks

Downside economic risks are low compared with those of many advanced industrial nations due to steady economic growth, a low inflation rate, and a relatively healthy fiscal account. However, there are a few challenges that the economy faces. One of the biggest challenges is a structural decline in the Australian mining industry as the mining boom shows signs of tapering off. Slowing demand from China (which is Australia’s biggest trading partner), falling commodity prices, and higher cost of production are resulting in heavy losses to the industry. Many projects are becoming unviable. The industry has already suspended a few mining operations and is set to close many mines. While mining will continue to remain the most vibrant sector of the economy, overall activity in this sector will likely be impacted by lower investment.

Labor market conditions are relatively soft; total employment grew 0.7 percent year over year in Q4 2013, the slowest growth since 2010. The latest labor market data show that the unemployment rate touched 6 percent in Q1 2014, which is the highest level since 2003. With growth in the mining industry likely to stagnate and even possibly decline in the coming years, employment growth in this labor-intensive sector is expected to fall. On the other hand, growth in the non-mining sector is showing signs of improvement. However, sustainability of growth will remain a cause for concern in the near future. Overall employment in Australia will likely increase, but at a gradual pace.

Household spending has remained robust so far due to low borrowing costs and improved household wealth, supported by an increase in house prices. However, low lending rates have resulted in a sharp rise in risky home loans. Australia’s household debt has been steadily rising and recently hit a record high of 177 percent of annual disposable income. If adjusted for inflation, household liability to banks and other lenders is at its highest level since 1988 and is highly unsustainable. These highly leveraged households are extremely vulnerable to a rise in interest rates and financial or housing shocks. In other words, while household spending has supported growth in recent times and is expected to be a big contributor in the future as well, its sustainability is vulnerable to financial risks of households.

Policies that might impact downside risks

The new Liberal-National coalition government has committed to steering the budget slowly back to surplus. This implies that government expenditure may not contribute much to growth in the coming years. The government also has decided not to provide financial assistance to firms in struggling sectors. The rationale behind this decision is to channelize resources into sectors where the country has a comparative advantage, which in turn could boost economic productivity.

Such policies will help the mining sector, while loss-making manufacturing industries such as automobiles and airlines will eventually close down their production in Australia. For instance, a few major foreign-based automobile companies have recently announced the end of local production in Australia. Recently, the government introduced the sale amendment bills of the national airline Qantas to remove limits on foreign ownership and eliminate stipulations that require much of the airline facilities and staff to be based in Australia.

These policies will have significant implications on the labor market as well as on the growth potential of the economy. Presently, mining is a critical sector and will be one of the biggest contributors to Australia’s economic growth for the coming decades. However, channelizing economic resources to a sector that has reached its peak and whose growth may gradually come down in the next few years may not be appropriate. Again, the rise in the unemployment rate and fall in total employment due to fewer manufacturing opportunities may worsen the labor market situation.

The Reserve Bank of Australia (RBA) left the official cash rate unchanged at a historically low rate of 2.50 percent in its recent monetary policy meeting. This flagged the end of the rate-cutting cycle that saw the cash rate fall from 4.75 percent in November 2010 to the current rate of 2.50 percent. While low rates have helped improve household consumption and house prices, they have also aggravated the household debt situation, as pointed out earlier. Moreover, low rates have failed to improve business investment in the economy, which has been steadily falling since mid-2012. While the consumer price inflation rate of 2.9 percent is just within the RBA’s target range, low rates, a weak domestic currency, and a moderate growth outlook may soon result in prices rising beyond the RBA’s comfort zone. Therefore, any further rate cut may not be rational, and the decision to leave the official interest rate unchanged is a welcome relief for households. At the same time, an immediate tightening of monetary policy may not be prudent because it may throw a wrench in the economic growth momentum. In short, the pace and the timing of the interest rate hike will be critical for the economy.

Growth outlook

The International Monetary Fund (IMF) expects Australia’s economy to grow at a gradual pace and has reduced its growth forecast to 2.6 percent in 2014 and 2.7 percent in 2015. It had previously expected growth to be 2.8 percent and 2.9 percent, respectively. According to the IMF, Australia’s economy is likely to grow below trend as the investment phase of the mining boom reaches its peak and begins to decline.2 On the other hand, the RBA’s views are slightly more optimistic. According to the bank, growth is expected to pick up in 2014 owing to a weaker currency and stronger activity in the housing and retail sectors.3 The economy will grow in the range of 2.25–3.25 percent this year, up from the 2–3 percent range forecasted in its last statement on monetary policy in November 2013. Growth will likely gather pace over the next couple of years.

Endnotes

View all endnotes
  1. Analysis is conducted by Deloitte Analytics, and the commentary is from Australian Food and Grocery Council (AFGC), which represents Australia’s $108 billion food and grocery manufacturing sector. The AFGC CHEP Retail Index offers new insight into the performance of Australia’s retail market. For more information, visit http://www.deloitte.com/au/chep-index.
  2. International Monetary Fund, World economic outlook: Recovery strengthens, remains uneven, April 2014, http://www.imf.org/external/Pubs/ft/weo/2014/01/.
  3. Reserve Bank of Australia, “Statement by Glenn Stevens, governor: Monetary policy decision,” May 6, 2014, http://www.rba.gov.au/media-releases/2014/mr-14-07.html.

About The Author

Dr. Rumki Majumdar

Dr. Rumki Majumdar is a macroeconomist and a manager at Deloitte Research, Deloitte Services LP.

Asia Pacific Economic Outlook, June 2014: Australia
Cover Image by Jessica McCourt (Cover), Stephanie Dalton Cowan (Australia)