Australian Economic Outlook – Winter of our Discontent

Overview
 
The latest national accounts show that the Australian economy grew by 0.6% in the March quarter and by 2.5% over the year.  The main contributors to growth over the year have been mining (0.8 pp), financial and insurance services (0.6pp), and healthcare (0.4pp).  Annual growth in household consumption over the year to March was 2.0%, below its long run average of 3.4%.  After peaking at 24.9% over the year to September 2011 business investment was just 0.7% over the year to March 2013.  Business investment however remains at very high outright levels although it is now clear that the mining investment cycle has peaked.  Nonetheless many mining projects remain in various stages of completion and will continue to contribute to overall growth over the next 1 to 2 years.
 
In recent months the Australian economy has confounded expectations by showing surprising resilience.  Despite well-publicised job losses in manufacturing the unemployment rate fell from 5.6% in April to 5.5% in May.  Yet it is clear that the Australian economy is reaching a critical inflection point. 
 
Over the last 18 years the Australian economy has been fortunate to benefit from a number of extraordinary events.  In the mid to late 90’s the economy was buoyed by the duality of the technology boom and the debt-fuelled housing boom.  When the tech boom ended the Australian economy barely missed a beat as the housing boom continued and China's rapid industrialisation saw demand for our commodities soar.  This led to the decade long mining and mining investment boom.  Now that this boom is finally beginning to peter out, challenges will become more evident.
 
Over-investment in China in infrastructure and housing is almost certain to subdue demand in the commodity sector for some time.  In turn more mining projects are likely to be deferred or shelved. 
By and large, manufacturing and tourism has been impacted by the high Australian dollar.  The recent fall in the Australian dollar will provide some assistance in coming quarters but a more significant fall is probably required.
 
Rates have been lowered aggressively over the last 20 months in order to promote growth outside the mining sector, especially in housing where new dwelling construction provides a significant flow on effect to other industries (including whitegoods, electrical, furniture and homeware retailers).  Recent data shows that these lower interest rates are beginning to have an impact.  Business credit (ex-mining) growth has picked up a little but remains very low in the wake of weak confidence and uncertainty.  Owner occupier housing credit has grown by 4% over the year to May while investor housing credit has grown by 5.5% over the year to May.  Yet this trend also remains well below the 20 year average. 
 
This is because the credit fuelled housing boom caused a massive increase in household debt (in particular, between 1996 and 2004).  Household debt to disposable income remains higher than in the US before the sub-prime crisis.  This debt continues to limit household spending and will continue to do so for perhaps the next five or so years.  Much of the improvement in disposable income caused by the lower interest rates has been used by mortgage holders to reduce their mortgage rather than increase spending.  This is reflected in the stubbornly high savings ratio.  While debt remains high and the employment outlook uncertain, we expect this trend to continue.  Lower interest rates have the added impact of forcing self-funded retires and those nearing retirement to actually save more to provide sufficient income for their living needs.  This in turn has a negative contribution to consumption and growth.
 
Conclusion
 
In conclusion, Australia is perhaps enjoying its last moments (the next 12 months are likely to enjoy modest growth as mining projects continue to completion) of sunshine before the economic storm clouds roll in.  If the economy has struggled to reach trend growth in the last two years while mining investment has been at record highs, then it is clear that the growth potential of the economy is likely to fall substantially once this boom subsides.  The reality is that structural imbalances take time to mend.  Until household debt falls meaningfully and government debt (while low compared to the rest of the developed world) gets to a politically acceptable level then it is likely that the rate of growth will be below trend for some time.
 
Martin Fowler is a director of Moore Stephens Sydney Wealth Management where he provides financial advice to high net wealth individuals and conducts research into the social impact of economic policy.  He is also a director of Whitefield Limited, an investment company listed on the Australian Stock Exchange.
 
Martin can be contacted by phone on +61 2 8236 7700 or alternatively via email at mjfowler@moorestephens.com.au