Country Report Australia
Economic growth in Australia decelerates due to lower mining investments. The outlook depends heavily on demand from China for its commodities and the ability to shift to non-mining growth drivers. The Dutch disease makes this move more difficult.
Strengths (+) and weaknesses (-)
(+) Strong public institutions
Governance, rule of law and transparency indicators confirm the stability of the government. The central bank is highly credible in its inflation mandate and its supervisory role.
(+/-) Dependent on China for exports
In 2012, 30% of Australian exports went to China. Although they profited in the past from the fast growing Chinese market and their demand for commodities, it makes the country also vulnerable to a hard landing for both export volumes and prices.
(-) High amount of external debt
Since 1974, Australia had a current account deficit of on average 4% of GDP (mainly driven by capital imports due to high amount of mining investments), resulting in a large negative international investment position (-56.6% of GDP). The net external debt in 2012 was 54% of GDP.
(-) Banking sector is concentrated and still dependent on foreign funding
The four largest banks account for 92% of the total banking system assets and have very similar business models. Residential mortgages (mainly with variable interest rates) are the biggest asset class. Net foreign borrowing declined to 16% of total liabilities (from 26% in 2006).
1. Growth is decelerating due to lower mining investments
In the past years, the Australian economy outperformed other advanced economies. This was mainly due to investments in the natural resources industry. The economic growth is expected to slow down to 2.5% in both 2013 and 2014 (3.6% in 2012), below their potential growth of 3.1% according to the OECD (figure 1). The growth outlook for the coming years depends heavily on the ability of the economy to transform from a reliance on mining investment towards mining exploration. This will increase resources exports and lower imports (since less capital goods are needed). Since the major part of the mining business is foreign-owned, their contribution to national income growth will be low. Also, employment will decrease, since the exploration phase is less labor intensive. Therefore, unemployment is expected to rise (the IMF forecasts 6% in 2014, up from 5.2% in 2012). As a result of the expected slowdown, the fiscal outlook worsens. Whereas the previous government expected the deficit to be eliminated by the fiscal year 2015/2016, the latest fiscal outlook does not expect a fiscal surplus in the near future (2014/2015: -1.9% of GDP; 2015/2015: -1.1% of GDP). The new government plans further fiscal consolidation to lower its budget deficit. In response to the slowing economy, the Reserve Bank of Australia (RBA) lowered its policy rate during the last two years from 4.25% to 2.5%. Both the fiscal and monetary authority still have the space to stimulate the economy in case it performs worse than expected.
2. Dutch disease makes the move to the next phase more difficult
Since mining is going into the exploration phase with less employment and less attribution to the national income, the economy needs to rebalance to non-mining growth drivers. A major obstacle is the past deterioration of international competitiveness of the non-mining industries due to the high exchange rate, high labor costs (Dutch disease) and sluggish labor productivity growth. The past rise in the terms of trade has been misunderstood as a structural change, and therefore the government has been unable to reap the benefits of the commodity windfall. The maturing Chinese economy, together with a big increase in iron ore production worldwide, will likely lead to a deterioration of the export prices. In the future, a more consumption-driven Chinese economy might enable Australia to export more services (tourism, education and business services) and agricultural products. During the mining investment boom, Australia lost its attractiveness as manufacturing base, which likely leads to a permanent loss of employment. Currently, the manufacturing sector contribution to GDP is just 7.5%, which is about half of the average contribution in high-income OECD countries. Car manufacturers like Holden and Toyota ceased operations in Australia.
3. House prices started to increase again
The easing of monetary policy led to a fast increase in housing loans. Finance for investment purposes grew more strongly than finance for owner-occupied housing (figure 2). House prices in the capital cities rose by 7.6% y-o-y in 13Q3. Moreover, compared to its long-term average, the Australian housing market is overvalued both in affordability (price-to-income ratio, 37%) and profitability (price-to-rent ratio, 21%) terms. According to RP Data (a major property information provider in Australia) in 87% of the country it is cheaper to rent than to buy, indicating that investors are entering the market for capital gains. Negatively gearing, investments that generate less revenues than costs of owning and managing the assets, are an indication for speculative demand that could lead to fast price adjustments when economic conditions deteriorate. Part of these investments is done through self-managed superannuation (pension) funds. These funds contain about a third of Australian pension assets, and in the last years started to increase their investment in property (both commercial and residential). This development is partly due to changes in legislation that allowed these funds to borrow more easily. Moreover, tax rules support housing investments, since any losses on rental real estate can be offset against other income.
4. Deleveraging process is still ongoing, resulting in an improving current account
The structural weaknesses of the Australian economy include its persistent current account deficit, though its trade deficit is narrowing sharply; the relatively high household indebtedness; and the banks’ reliance on foreign funding. Fortunately, the private sector is still reducing its debts. The households net saving ratio remained stable around 10% (up from an average 2% over the 10 years before the Global Financial Crisis), which is about twice the average ratio of the OECD-countries. Moreover, the slowdown in private credit growth seems to be of a structural nature. Nevertheless, households’ indebtedness remains at high levels both from a historical and cross-country perspective (113% debt to GDP). The increased private saving results in a lower reliance of banks on offshore funding. Also the slowdown of mining investments and increased commodities exports will likely lead to lower capital inflows and an improved current account going forward.
Australia is one of the wealthiest economies of the world with GDP per head at PPP being 22% higher than the OECD average. The country implemented a large number of reforms in the 1980s and 1990s, making the country more internationally focused, more diverse and more competitive. In the 2000s, economic growth is mainly driven by the natural resources investment boom and the increase in the terms-of-trade. The country did not experience a recession in the last 22 years. It was able to withstand the Global Financial Crisis, since the fiscal position of the government enabled them to implement a major stimulus program.
The country ran a persistent current account deficit since 1973, resulting in a large negative net international investment position (NIIP). Currently, the current account deficit is mainly the result of a large income account deficit. Moreover, since the mid-00’s, the country started to consume less and invest more. This increase in investment will increase Australia’s capacity to export and to pay back its international liabilities in the future.
Australia has a highly stable and well capitalized banking system, though it is very concentrated as well. The four biggest banks have together a market share (assets) of 92% and share the same business model. Historically, the banking sector has been highly reliant on foreign wholesale markets, but due to tighter regulations and increased domestic private savings, the banks have reduced this dependence. Moreover, the Australian regulators are forerunners in implementing Basel-III regulations, e.g. they implemented higher capital requirements for the systemically important institutions. In 2012, the IMF concluded that the banking system can withstand a severe economic shock.