The questions over the outlook for Australia’s growth and the chance of recession have been more widely discussed recently after the weak 0.2% print of Q2 GDP.
That saw the year on year growth rate for the nation fall to 2.0% and it was followed by the negative print for July retail sales which heightened concerns about the outlook
But weak growth in the past does not mean weak growth in the future nor that Australia will fall into recession, according to Michael Blythe, the chief economist of Australia’s biggest bank – the CBA.
Blythe says that a lot of the “continual focus on downside risks” stems from the “persistent theme” in recent years centred around a “belief that it is all too good to last”.
That’s after 24 years of “continuous economic growth” which included periods such as the “Asian crisis, the tech wreck, (and) the global financial crisis” which were widely expected to tip Australia into recession but did not. That, Blythe says, means “the pessimists have been wrong”.
To make the point further Blythe highlights that if you “back an economist into a corner and demand a recession probability estimate … the answer will almost certainly be 20%. It is the default forecast.”
A 20% recession risk does, however, imply an “80% chance” of dodging any recession bullet, Blythe added.
Blythe asks the question if Australia can “dodge a bullet again” and offers 8 reasons why “some of the arguments for recession look weak on closer examination”.
The policy interest rate sits at a record low of 2%. The RBA routinely notes that low interest rates are acting to support borrowing and spending and that the availability of credit is not a constraint. The AUD may have taken longer to adjust than expected. But monetary conditions overall are very stimulatory and consistent with a sizeable lift in economic growth momentum.
It will be difficult for the economy to slide into recession when significant stimulus is already in place. The usual policy recognition, response and reaction lags will not apply.
Considerable policy firepower remains. Australian interest rates are well above the near-zero settings in the major economies. They can be cut further.
The Budget is in deficit but debt is low and fiscal policy can be ramped up if needed.
The fiscal drag is easing. The pace of Budget repair has been slowed. And the Government’s fiscal strategy has been adjusted. The economy’s impact on tax receipts is being allowed to flow through to the bottom line without offset ting spending cuts.
More importantly, the AUD has now fallen to levels that will assist economic growth and buffer Australian incomes. The Aussie would almost certainly move lower still if a major China/global shock emerges.
RBA research suggests a 10% AUD depreciation will stimulate GDP growth by ½-1ppt over two years. So the 16% fall in the AUD trade-weighted index over the past year has the potential to add 1¼% to GDP growth in the period ahead.
The more immediate impact is the offset provided to lower USD commodity prices from a lower currency. The CBA Commodity Price Index, for example, has fallen by 21% in USD terms over the past year. But the Index is up by 1% in local currency terms. And in the end it is AUD prices that drive Australian incomes.
Canada and Brazil are in recession. While they are significant commodity producers, their recessions appear to reflect transitory factors (eg destocking in Canada) or other issues (eg a policy morass in Brazil). There seems no guilt by association for Australia.
The biggest mining construction boom in 150 years is over. And mining capex is set to drop by 3½-4% of GDP by the time the cycle is complete. It is at least as big a drag on the economy as the feared US ‘fiscal cliff’ was a few years ago.
We have never been concerned about the GDP growth implications of falling mining capex. This construction boom was different in that it was dominated by liquefied natural gas (LNG). About half of LNG capex went on imports. So in GDP growth terms there is an automatic 50% offset to falling capex from lower imports. Half the pain will be exported to those countries that provide us with the capital goods!
On the other side of the equation, the expansion in the mining capital stock is driving a major boom in resource exports. These exports will easily offset the rest of the mining capex cliff.
There also seems to be a general perception that the capex cliff still lies in front of us. And that we will be swept off at any moment. The reality is that mining capex peaked at the end of 2012. The decline to date is about 2% of GDP. On that metric we are about half way down the cliff. RBA Deputy Governor Lowe endorsed this view recently in a speech where he noted ‘we are currently roughly halfway through the decline in mining investment’.
And it is a case of so far, so good. The decline in mining capex in GDP terms has been more than offset by rising resource exports and rising activity in the non-mining economy.
The real economic risk is the job losses associated with the mining construction downturn. Those losses explain the focus on a growth transition to other forms of construction activity–residential, non-mining and public infrastructure.
The results are mixed. A major residential construction boom is underway. But non-mining construction activity has remained fairly limp. And the drop in public infrastructure spending is nothing less than disappointing. Nevertheless, more construction jobs outside of mining have been created than lost in the mining downturn. So again it is a case of so far, so good.
More encouragingly, the recent round of State Budgets points to a lift in infrastructure spending in 2015/16. And some of the initiatives in the Commonwealth Budget in May do appear to be breaking parts of the logjam holding back non-mining capex.
Non-mining capex and infrastructure spending may have disappointed for now. But some parts of the economic story that weren’t in the transition narrative may surprise on the upside. Non-resource exports and the consumer may fill in some of the hole.
The number of exporters doesn’t normally vary much from year to year. But there was a significant spike up in the number of companies exporting in 2013/14. The spike is all the more interesting because it occurred at a time when the AUD was still relatively high. The AUD averaged USD0.92 in 2013/14. The larger part of the drop in the currency has happened since then.
The export response suggests the AUD was not as big a restraint on the economy that policy makers feared. And the further drop in the Aussie to USD0.70 should push the trend along. Non-resource exports may surprise on the upside.
Weak income growth and changed household attitudes to spending/saving/borrowing were expected to weigh on consumer spending. But an array of forces is improving the consumer backdrop:
- there is a flow on from other parts of the economy–new housing construction is boosting housing-related spending;
- there is a diversion of spending from offshore back onshore – courtesy of the lower AUD;
there is a wealth effect from higher house prices–studies show each $1 change
in housing wealth moves consumer spending by about 3¢;
- there is a disposable income boost from lower petrol prices–everyone benefits unlike rate cuts that help only mortgagees;
- there is a fiscal boost – some Budget measures add to household spending power.
The chart below turns these various stimuli into interest-rate-cut equivalents. The drop in petrol prices, for example, is equivalent to a 25bpt rate cut. In total, there is more than 200bpts worth of stimulus available to households. Consumer spending may surprise on the upside.
The weakness in household incomes is widely seen as a threat to consumer spending. But one benefit of the extended period of weak wages growth is that real labour costs are very subdued. One consequence is some support for labour demand despite weak production growth.
The other labour-market-friendly development reflects the odd feature of mining employment. The fly-in fly-out workers are losing their jobs in the Pilbara, for example. But they are becoming unemployed in Sydney and Melbourne where many of them live. And that is where the job creation is occurring. We are also exporting part of the problem as those on 457 visas move on to the next big project and New Zealanders return home.
Another benefits to flow from labour cost restraint is that it is helping to turn the nominal depreciation in the exchange rate into a real depreciation as well. The real TWI, as at mid 2015, was 13% below the average level over the 2011-2013 period. Australia’s trade competitiveness is improving as a result.
Income weakness does look like the one real source of recession risk.
There are two channels:
Income weakness brings a focus on cost containment
Income weakness also encourages the pursuit of yiled and capital gain:
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