Australia | Mar 10 2009
By Andrew Nelson
By now I’m sure we can all agree that the Australian economy is in a sharp downturn after what was a sustained period of resilient growth, with both the rise and fall tracking the global commodity cycle. It’s old news now, but just to set the stage, real GDP fell by 0.5% in Q408, which was the first contraction in eight years and brought full-year 2008 growth down to 2.1% from 4% in 2007. This, and more sees Standard Chartered pencil in minus 1.2% GDP growth for 2009 but a positive 2.8% for 2010.
After being worried to distraction by rampant inflation earlier in the year, the consumer price rise read has now come back from its peak of 5% in Q308 to 3.7% in Q4. CPI inflation remains above the RBA’s target of 2-3%. However, notes Standard Chartered Regional Economist Simon Wong, given the current trajectory, this is unlikely to remain the case for long. He expects inflation to drop below 3% some time in 2009. His 2009 forecast is for a yearly rate of 2.9%, dropping to 2% for 2010.
Wong notes the RBA was well ahead of the curve and was thus able to begin its monetary easing cycle early, cutting the cash target rate from 7.25% in early September 2008 to 3.25% currently. He expects the RBA to cut rates further, taking the target rate down to a low of 2% by mid-year. The official cash rate is then expected to being kept on hold for the rest of the year. On his numbers, the rate will tick back up to 3.5% in 2010.
In another pre-emptive attempt to halt the rate of economic decline, Wong notes that fiscal policy has been relaxed aggressively. The government introduced a stimulus package of $42bn in February, on top of $44.7bn of already announced measures that had been fed out since September 2008. The new package, which will be implemented over a two-year period, amounts to 1.3% of GDP this fiscal year and 2% next. However, Wong notes, this government largesse will reverse a seven-year streak of fiscal surpluses and will deliver deficits of around $25-$35bn in the next three fiscal years.
Business conditions are worsening despite the government’s strong policy assistance. Wong notes Australia has relied heavily on capital inflows to finance a strong build-up in its private sector balance sheet in recent past years. As a result the country is now highly exposed to the recent tightening in global credit markets. The surge in leverage, especially within the household sector, has paralleled that of the US, and there is a clear risk of sharp and destabilising balance-sheet adjustments going forward, says Wong.
Add to that fact that Australia is a major exporter of commodities and nobody is buying them. While the trade balance improved last year on the back of that big spike in commodity prices, the bursting of the commodity bubble means it is unlikely to be sustained in 2009, as real underlying demand has collapsed. In fact, exports accounted for about 20% of GDP until 2008, when their share jumped to nearly 25% on the last big run in commodity prices.
While weakening demand provides a powerful disinflationary force, it is partly offset by recent sharp AUD weakening, which will inflate import prices. The AUD dropped drastically in H208, as both the commodity price boom and the Reserve Bank of Australia (RBA) monetary tightening cycle were reversed. AUD depreciation has already exceeded previous cycles, notes Wong, but he thinks further downside is still likely in the near term, as the fundamental outlook remains bleak. Standard Chartered expect a US$0.72 average for 2009, lifting up to US$0.85c for 2010.
Wong points out the current Labor administration of Prime Minister Kevin Rudd has managed to maintain its popularity amid the current economic slowdown. Much of this he attributes to its seemingly proactive stance of pushing for macroeconomic easing at the first signs of trouble.
But the economic headwinds will intensify in 2009, which leads Wong to speculate that the Labor Party may call for an early election to take advantage of its current advantage before further signs of economic distress kick in. Wong thinks there is a strong case for doing so, given the need to avoid a repeat of recent filibustering as experienced with the latest stimulus plan in the Upper House, where the party does not hold a majority.