Australia: Growing but nervous

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Australia: Growing but nervous

Australia: Growing but nervous

Asia Pacific Economic Outlook, September 2012

Two emerging concerns are looming over Australia’s prospects for modest growth this year: a flagging housing market and an economic slowdown in China.

Two emerging concerns are looming over Australia’s economic outlook this year: a flagging housing market and an economic slowdown in China. Among the advanced economies, Australian households are one of the most highly indebted, and their private consumption dynamics depend on housing prices to a large extent. Analysts believe that unlike other advanced economies, Australia’s housing prices have not bottomed out yet. Additionally, close trade linkages with China and excessive sensitivity to commodity prices suggest that the Australian economy will likely see some discomfort as a result of economic slowdown in China.

Leading indicators suggest that the housing market, an important driver of growth, is headed toward a slowdown. Home prices, which have declined steadily for the last four quarters, have created recessionary conditions in the housing market. Further, data from the Housing Industry Association suggest that new residential housing construction hit an 11-year low during the second quarter of 2012. New homes sales dropped 5.6 percent in July, hitting the second-lowest level on record. While lending and affordability have seen modest improvement, major indicators point to declining activity in the housing sector.

Easing house prices negatively affect consumer confidence and aggravate the housing market’s woes even further. A recent survey by the Westpac Melbourne Institute shows that consumer sentiment dropped by 2.5 percent on a monthly basis in August, marking the first fall since April. Consumers reported a significant decline in willingness to make major purchases in the future, and they remain pessimistic about the economy. Moreover, a significant drop in home prices will likely hurt household finances and could even trigger a deleveraging cycle. Australian households are highly indebted with a debt-to-income ratio of over 150 percent, which exceeds the level experienced in the United States before the subprime crisis. Even though the central bank has relaxed interest rates by 1.3 percent since November last year, households face tighter credit conditions from commercial banks in the country. Private sector banks in Australia are dependent on offshore financing, which is becoming increasingly cautious, given the uncertain global economic outlook.

The Australian government was able to avoid a housing crisis during 2008–2009 by offering grants to first-time home owners. This kept the cost of mortgages low and boosted the housing market’s resistance to an economic crisis. However, since the scheme’s expiration in 2010, home prices have become fragile again, and if the situation were to worsen, depressed activity in the housing sector will likely weigh on the entire economy.

Given Asia’s policy easing and the Eurozone’s uncertain future, the extent of Australia’s downturn and its impact on the economy remains to be seen.

The troubles of the housing sector come amid falling prices for Australia’s commodity exports. The Australian dollar has been trading at record highs, which has made the country’s exports uncompetitive. The strength of the dollar has particularly hurt Australia’s export-related industries such as car manufacturing and steel, which have been forced to seek additional support from the government. Further weakening of the external sector could have a significant impact on the economy as exports traditionally make up 25 percent of Australia’s total GDP.

The island country is especially vulnerable to a decline in demand from its main trading partner, China. Moreover, a slowdown in China’s economy tends to put downward pressure on commodity prices, which could affect Australia’s commodity exports and dampen mining investment. So far, investment in the mining and energy sector has served the Australian economy well.

According to a survey conducted by the Australian Bureau of Statistics in May, total capital expenditure in the country is expected to touch AUD164 billion during 2011–2012, up 27 percent from a year ago. More than half of this total is expected to come from the mining sector. While this represents a sharp upswing of 63 percent from total mining investment in 2010–2011, some analysts observe that a drop in commodity prices may deter future investments in the sector. Given Asia’s policy easing and the Eurozone’s uncertain future, the extent of Australia’s downturn and its impact on the economy remains to be seen. Nevertheless, the Australian economy is set to expand by around 3.2 percent this year, mainly on the back of modest private consumption and mining industry output.

 

About The Author

Neha Jain

Neha Jain is an economist with Deloitte Services LP.

Australia: Growing but nervous
Cover Image by Stephanie Dalton