Australia: an economy in transition
The Australian economy remains resilient. After the mining investment boom, the economy is now primarily driven by net exports and consumption. Meanwhile, the housing market softened due to tightened lending standards to housing investors.
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.
(+) Solid banking sector
Australia’s banking sector is well capitalized, highly profitable and has a low non-performing loans ratio. The banks have reduced their dependence on foreign wholesale funding by increasingly attracting domestic deposits.
(+/-) Dependence on China for exports
In 2013, 36% of Australian exports went to China. Although Australia profited in the past from the fast growing Chinese market and its demand for commodities, this also makes the country vulnerable to a hard Chinese landing via both export volumes and prices.
(-) Large negative net international investment position
Since 1974, Australia had a current account deficit of on average 4% of GDP, resulting in a large negative international investment position (-50.4% of GDP).
1. GDP-growth remains resilient
The Australian economy remains relatively resilient to global weak economic conditions. The economy is expected to have grown by 2.3% in 2015 and to grow by 2.6% in 2016. The main growth drivers are net exports (see development 2) and private consumption. Private consumption remained buoyant on the back of rising house prices and decreasing unemployment (6.1% to 5.8%), even though wage growth is relatively muted (2.3% yoy nominal). The main drag on growth is private investments. Investments by the mining sector declined during the past fiscal year (-17.3%, figure 1), since many mining projects are finished. Going forward, a further decline is expected, since many LNG projects are nearing completion. Disappointing is that also non-mining business investment growth remains soft, even though the central bank decreased its policy rate by 50 bps over 2015 to 2.0%. The exchange rate is still relatively strong. While commodity prices decreased by 29% yoy in December 2015, the real effective exchange rate (REER) depreciated by just 5.5% over the same period.
2. Higher export volumes, but lower export prices
The transition from the mining investment to the exploitation phase resulted in lower imports of machinery and higher export volumes. Even though the main trading partner, China (34% of exports), is slowing down and 64% of Australia’s export products are crude materials and fuels, export volume growth is expected to remain strong going forward. Australia is among the most competitive producers of iron ore worldwide, and so will unlikely cut production in response to the much lower prices. Moreover, in the coming year, LNG facilities are getting into production, which will give an additional boost to export volumes. The sharp decline in terms of trade however resulted in negative real net national disposable income growth in 2015Q3 (-1.2% yoy). Moreover, the trade in goods deficit turned negative again in 2015 (figure 1) due to the lower value of (commodity) exports. It is however expected that the trade in services contributed positively to the current account in 2015.
3. Housing market softened after a regulatory directive by APRA
There are tentative signs that the Australian housing market is finally cooling down. According to Corelogic Inc, house prices decreased 2.3% qoq in Sydney and 1.4% qoq across all capital cities during the last quarter of 2015. Furthermore, auction clearance rates have fallen and rental yields are down in the major cities. Part of the softening housing market can be explained by increased supply, another reason is that lending to investors became more restrictive. The Australian Prudential Regular (APRA) stated it may take action if annual investor housing lending growth is materially higher than 10%. In response, banks tightened serviceability ratios, increased interest rates and lowered maximum LTVs for investor housing loans. High level of investor housing activity can exacerbate housing prices swings due to its more speculative nature and can thus result in an excessive rise in construction. Nevertheless, during the whole of 2015, prices rose 11.5% in Sydney and 7.8% on average in all capital cities, due to a strong first half of the year. Especially the property markets in the two biggest cities, Sydney and Melbourne, showed quick price increases over the past years. Compared to its long-term average, the Australian housing market is overvalued both in affordability (price-to-income ratio, 29%) and profitability (price-to-rent ratio, 46%) terms. IMF noticed that these ratios are however in line with other developed countries and that the price increases in the past decade can be partly explained by financial liberalization and lower interest rates. Since mortgage lending accounts for about 60% of domestic lending, a major house price correction could pose a risk to the financial system. Average LTV-ratios are however modest and the average housing non-performing loans ratio was only 0.6% (mid-2015).
4. Change of prime minister does not mean a major change to policies
Malcolm Turnbull replaced Tony Abbott as Prime-Minister during a leadership challenge in the Liberal party in September. Depute PM Julie Bishop stays in power. In terms of reforms, the priority of the new government will be to introduce a comprehensive tax reform which includes a higher GST (value added tax) in order to reduce corporate and income taxes. Given their lack of majority in the senate, they will need support from the opposition. A further difference to the previous government is that PM Turnbull is less willing to make huge budget cuts in order to reduce the deficit. According to the mid-year economic and fiscal outlook (MYEFO), the fiscal deficit will be slightly larger in the current fiscal year (-2.2% of GDP) than proposed in the budget drafted by the previous government and will stay larger in the coming years. The government expects net government debt to peak in 2017-18 at18.5% of GDP.
 IMF (2015) Australia: Selected Issues (Article IV)
Australia is one of the wealthiest economies in the world with GDP per head at PPP being 22% above the OECD average. The country implemented a large number of reforms in the 1980s and 1990s, making the country more internationally focused, diverse and competitive. In the 2000s, economic growth was mainly driven by the natural resources investment boom and the increase in the terms-of-trade as a result of the rise of China. The last economic recession dates from 1991. The Australian economy was able to withstand the Global Financial Crisis relatively well, since the fiscal position of the government enabled 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 driven by a large income account deficit. Moreover, since the mid-00’s, the country started to consume less and invest more. A major part of these investments are in the mining sector, since Australia is one of the most competitive producers of many commodities. This increase in investment will increase Australia’s capacity to export and to pay back its international liabilities in the future.
Australia has a stable and well capitalised banking system, though it is very concentrated as well. The four biggest banks together have a market share (in 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 since the Global Financial Crisis, 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.