Australia | Apr 13 2010
By Greg Peel
“Yes, I think it is going to be a two-speed economy,” suggested RBA governor Glenn Stevens to the House Economics Committee in February, “I have said publicly that I think all those issues of geographical differences and industry differences are likely to re-emerge with a vengeance”.
Toward the end of the 2004-08 boom period in the resources sector, Australia was clearly suffering from what has been dubbed a “two-speed” economy. Rising commodity prices were pushing up the GDP and inflation, leading ultimately to an RBA cash rate of 7.25%. But it was all happening in Western Australia and Queensland. Back in the more populous southern states, and particularly in an incompetently governed New South Wales, businesses were struggling and household debt burdens were onerous.
Thus every rate rise was another kick in the teeth for those miles from the action, and the low unemployment rate represented a drain on the south-eastern workforce. But the RBA had little choice – monetary policy is a national tool, without discrimination.
The GFC quickly put paid to the issue, but 18 months down the track the GFC is becoming a distant memory, at least for those in Western Australia and Queensland. Not so for NSW, Victoria and elsewhere where business loans are still hard to come by. Commodity prices, particularly in bulk materials, are back in skyrocket mode again.
Glenn Stevens made the point in his statement which accompanied the April interest rate hike. Aside from concern over a house price bubble, Stevens made special mention of Australia's terms of trade as impetus for tighter monetary policy. The China factor is set to push up Australia's GDP and cause inflationary pressure.
Which is not very comforting if you're in Sydney, for example, with an overextended mortgage secured on a deposit from the government and a bank tightening the screws on your business loan.
[Anecdotal evidence from a friend who owns a Sydney pub: He bought the pub pre-GFC on an 80% loan-to-value loan and has never missed an interest payment. His bank now insists he must reduce his LVR to 60%, meaning he must pay up the 20% balance. What if he doesn't have that 20% in pocket right now? Tough.]
Recent data has suggested that Australia's manufacturing and services industries are losing their recovery strength and are at risk of falling back into contraction. The strong Aussie dollar – a legacy of high interest rates (compared to other developed nations) – is killing Australia's once dominant tourism industry. Last week's data also showed the nationwide construction industry has indeed fallen into contraction again. But that reading hid a fundamental factor.
Examination of engineering work data shows Australia is currently experiencing its greatest ever construction boom, the economists at CommSec point out. From what was in February a $47.2bn total of engineering work under way, March saw for the first time the addition of the $43bn Gorgon gas project into the data. The total of $88bn is a record, and three times the size of the corresponding number only three years ago.
Add in commercial and residential construction, and total projects tally to $133bn or just under 11% of GDP, notes CommSec. “Australia has never seen construction work of the size and spread that is currently underway”.
This all sounds wonderful, except for the fact it is all happening in WA and Queensland, and to a lesser extent the Northern Territory. In Sydney and Melbourne, lack of housing construction investment from builders unable to secure funding has meant the least affordable housing on the planet. Economic activity is shifting to these less populous states from the more populous states.
Together, WA and Queensland boast 30% of Australia's population but account for 36% of GDP compared to NSW's 28%, notes CommSec, and rising. The two account for over 60% of all Australian exports and 80% of exports to China. Adding in Gorgon means WA alone accounts for 66% of all new engineering work underway and WA and Queensland combined account for 82%.
Before last decade's resources boom, CPI inflation in Perth and Brisbane usually ran about 0.2-0.3 percentage points below the national average. Just before the GFC, they had hit 0.7 points above.
The resource states are now running in overdrive while NSW in particular is struggling to get out of second gear. This is the “two-speed” economy. The mining boom will push up raw material costs and wages, and thus inflation, only serving to widen the gap between the resource haves and have-nots.
It is a dilemma for the RBA. Even the “normalisation” of interest rates is having an impact on the rest of the economy, before one even considers the extent of pain if the cash rate had to go back to 7%. On the fiscal side of the equation, we await the Henry tax review. But on the monetary side of the equation, perhaps the RBA, as CommSec notes, will be forced to come up with “new policy tools” rather than just blanket rate rises.
Despite the record amount of civil construction projects underway at present, and the promise of a long period of growth in China, the fact remains the pace of growth has now tipped into contraction. And the analysts at BIS Shrapnel see the industry suffering a setback in 2010-11, to the tune of a six percentage point decline.
The simple reason is the lag factor. Rome wasn't built in a day and nor are major public or private construction works. The GFC hit in earnest in late 2008 but in 2009 engineering construction still grew by 15% in Australia as projects previously commissioned were ramping up. But what the GFC did affect was a drop-off or a shelving of new plans. With the notable exception of Gorgon, 2009 featured a general decline in private sector commencements along with an easing in government stimulus works, BIS Shrapnel notes.
Growth in the mining and heavy industry, electricity and road sectors dropped away during the second half of 2009. BIS Shrapnel expects real growth in civil construction will slow to 9% in FY10 and decline further in FY11. But thereafter, the lag factor will once again reinstate growth.
The next cycle in engineering construction is likely to be a strong one, says BIS, lasting into the second half of the decade. Key drivers will be private investment in mining and energy and public investment in passenger rail and telecommunications. But it will not be quite the “boom” experienced in the last five years. Major expansions will be hit by skills shortages, particularly in rail, mining and marine where specialist skills are required. Rising construction costs will also act as a dampener.
