FYI | Oct 21 2008
By Chris Shaw
Flowing from the meltdown of the global financial sector there has been a rapid deceleration of growth in the so-called real economy of goods, services, production and trade. ANZ Banking Group senior economist Julie Toth notes this has the US and Europe either in or about to enter a recession, while the Asian region is also showing slowing growth.
Toth cautions that in such an environment, while Australia is better placed than most other developed economies to deal with the expected economic environment, it is not immune from a deterioration in conditions. Recent data supports such a view, as they indicate the domestic economy is slowing rapidly leading into 2009, which is expected to be the trough for growth globally before signs of a weak recovery emerge in 2010.
On the plus side, Toth notes Australia is not likely to enter into a recession but rather will have to endure several years of below trend growth. ANZ is forecasting GDP growth of only 1.8% in 2009 and 1.9% in 2010, both of which are less than half the 4.2% growth recorded in 2007.
This lower rate of growth means lower levels of spending by both households and businesses, which in turn will see employment growth slow and the unemployment rate tick higher, potentially to above 5% in 2009 and more than 6% in 2010. Such an outcome will impact on confidence and this process is already underway, with Toth pointing out lower confidence means changes to spending decisions and these are yet to fully flow through to the broader economy.
Looking at different sectors of the economy, Toth notes the financial services sector has largely been in the frontline given it was problems in that sector that sparked the current crisis. This is reflected by the fact gross operating surplus for the sector has fallen in each of the past three quarters, the first time this has happened since 1998. No improvement in this measure is likely until late in 2009, on the bank’s estimates, as demand for credit will be lower and wholesale credit costs will be higher, which implies a squeeze on margins.
Apart from the financial sector, Toth notes Australian private sector corporate profit growth remained solid having grown at double digit rates for six successive quarters until the middle of the year, but is now falling quickly. So, while some growth will still be recorded in 2008 given the strong first half, a minor decrease is expected in 2009 and then a modest recovery in 2010.
The good news is while Australian corporate debt has risen over the past year, it remains at what Toth estimates are manageable levels. Figures at the end of June show national aggregate corporate interest cover of around 4.5 times, the lowest level since 1995/96. Corporate gearing levels are also relatively comfortable at around 80%.
In terms of spending intentions, Toth expects a decline in coming months as businesses adjust to new conditions by cutting expenditure, though her estimates call for business credit growth to remain positive into 2009.
Taking a broader look at the Australian economy, Toth makes the point while the global credit crisis will impact, there are other industry specific factors that various sectors of the economy will have to face in the coming years and months. These range from drought and climate change for the agricultural sector to carbon schemes for energy producers and higher costs for manufacturers.
For the financial companies, the current environment means more financial losses are to come as the financial crisis plays out. For Toth, this means more job losses in the sector are also to be expected, particularly as the industry has an above average level of full time positions and given employment is a lagging indicator.
Exporters need to be divided into categories, as commodity exporters have enjoyed the price boom but are now seeing prices fall on the back of falling global demand, while manufacturing exporters have in recent years delivered steady growth in both volumes and value.
Service exporters too had been delivering stronger numbers, but in business-related rather than tourism-related sectors, all of which adds up to a positive turn in Australia’s terms of trade. Now that conditions have changed, this means access to credit and finance will become difficult for some companies and slower global growth will mean weaker demand. Toth points out this will be somewhat offset by a weaker Australian dollar and this will help the sector’s competitiveness against global rivals.
In the building sector, the slower rate of business investment and lending means a deceleration in construction growth, with the bank not forecasting any pick up in residential construction activity until 2010. This means the shortage of housing nationwide should intensify as supply falls even further short of demand.
Around $90 billion is spent annually on plant and equipment investment and as Toth points out, this is important as this investment flows through to future growth and development. Such spending is forecast to grow by a little over 10% this year, though as Toth notes just a few months ago intended investment by business was more than 20%, highlighting how quickly corporations have reacted to the changed conditions.
To reflect this the bank is now forecasting a 4% contraction in such spending in the September quarter, followed by flat or zero growth through 2009 as companies deal with a tougher operating environment. Those likely to be hit hardest in such a scenario are the suppliers of items where changes can be postponed or replaced by used items, such as commercial vehicles, standard manufacturing and agricultural equipment and office and communications equipment.
For businesses supplying other businesses with materials, stock and other specialist services there are already some signs of a slowdown and as business conditions are deteriorating, the bank expects spending on business equipment will follow suit.
The financial health of households is important to the financial health of businesses, as household consumption accounts for around 60% of Australia’s GDP and here the trend is also down. Toth notes total real household consumption has slowed quickly in the past year and actually contracted by 0.1% in the June quarter, its first contraction since 1993.
This contraction was primarily in the more discretionary categories such as tobacco and operation of vehicles, while Toth suggests the most vulnerable sectors are the auto, retail and hospitality sectors given their reliance on such spending.
The outlook for the sector overall remains subdued given expectations of increasing unemployment and slower activity, with the back suggesting consumption is expected to fall out of favour while debt consolidation and reduction and saving become of greater priority to households.
