Australia’s reliance on commodities has always created stop-go business conditions, says Monica Woodley. But Julia Gillard’s government is working on a better recipe
Here’s another one for you acronym watchers. Russ Koesterich, the managing director and chief investment strategist at iShares, is currently tipping what he calls the CASSH countries – Canada, Australia Singapore, Switzerland and Hong Kong – as one of the most attractive investment choices for 2012. With low systematic credit risk, small debts, no government addictions to deficits, and with markets competing on a global scale, he reckons that this very special group of countries has potential for strong future growth – not just this year but on a multi-year basis.
Indeed. And high up in that list is Australia, whose eminently palatable combination of responsible government and world competitiveness makes it well worth a closer look. There are problems, for sure, and some of them are potentially serious. But there’s also a will to get it right. The question is, where does Canberra stand on the scale between the BRICs and the PIIGS?
Well, Australia’s finances are certainly considerably better than most developed markets. Compared to Europe, where even “safe” countries like the UK have budget deficits of 8.3%, Australia’s deficit came in at just 3% in 2011 and is expected to fall a little over 1% in 2012.
Then there’s the fact that the country’s pensions system is in much better shape than other developed countries. After a decade of compulsory contributions, Australian workers now have over $1.2 trillion of funds, which means that they have more invested in managed funds per capita than any other country. This is going to make a massive difference to future public finances, as other developed countries struggle to keep their pension obligations – which are ballooning as baby-boomers start retiring – under control.
And whilst it might not have the eye-watering GDP growth witnessed recently in emerging markets, the Australian economy still expanded by 2.3% in 2011. This was short of the 2.75% forecast by the Reserve Bank of Australia, for reasons we’ll explore shortly, but it was still better than most other developed economies. Koesterich says all CASSH countries have the potential to grow somewhere between one and a half and two times as fast as the larger developed countries, on average.
Coping with the Commodity Cycle
As every history book will tell you, economic growth in Australia has always been driven by its role as a key exporter of commodities to emerging markets – including, notably, China. Mining companies are riding high on the commodities boom, and the terms of Australia’s trade—the price of its exports, relative to the cost of its imports—improved by a whopping 42% between 2004 and 2011.
Glenn Stevens, governor of the Reserve Bank of Australia (central bank), puts that concept into very easy-to-understand terms. Five years ago, he says, a shipload of iron ore bought 2,200 flat-screen TVs. Now buys 22,000 of them. No commodities boom in Australia this strong has ever lasted this long.
But, as everyone knows, even strong commodities booms are never a steady, ever-upward trajectory. Figures from the National Australia Bank’s Monthly Business Survey show that the mining sector appears to have felt the impact of a slight fall in global commodity prices during February, with business conditions deteriorating marginally.
That might not be such bad news as it sounds, however. The country’s strong commodity export performance has strengthened the Australian dollar beyond what we might otherwise have expected – a fact which has made life difficult for sectors beyond mining, which need to keep prices competitive to survive. The snag, however, is that right now a strong domestic currency is needed to keep inflation in check. Because prices are rising fast in Australia’s booming industries and regions, the RBA’s ability to meet its inflation targets will depend only if prices elsewhere can be persuaded to fall. If it fails, we might see a repeat of the cyclical inflationary busts that have been associated with previous commodity booms.The last hedonistic burst in the 1980s resulted in a bust that took five years and a lot of to hard work to clear.
But the authorities haven’t been relying solely on domestic demand. Over the 18 months to March 2011, the central bank raised its key interest rate by 1.75 percentage points from 3.0% to 4.75%, before backing off in December to today’s typical 4.25% level, in the teeth of complaints from manufacturing and construction firms about the unfavourable position it was putting them in.
Consumers have found themselves in much the same sort of bind, except that they haven’t felt the benefit of December’s rate cuts. Borrowing costs for most borrowers actually rose again in February, as the country’s commercial banks raised their rates. And with housing loans at 7.5% and unsecured personal loans at 14% plus, things are tougher than at almost any time since the late 1990s.
That may account for the fact that GDP grew just 0.4% in the fourth quarter of 2011, instead of the expected 0.8% – leading to the lower-than-forecast GDP result of 2.3% for the year as a whole.
Taxing the Bigger Diggers
One convenient way that the government has looked to rebalance the economy – by sharing the wealth of the commodities boom – has been the Minerals Resource Rent Tax (MRRT). This controversial tax, approved in March, will impose a tax of up to 30% on profits made by large coal and iron-ore mining firms above a threshold of A$75 million. It will be implemented from July 1, 2012 and is expected to raise A$11 billion in its first three years. The windfall will be used to fund a cut in corporation tax, higher contributions to pension funds and infrastructure spending.
The final approval of MRRT was a huge victory for the embattled Labor Prime Minister Julia Gillard, who has had a tough time since she swept to power in June 2010 after her leftist rival Kevin Rudd stomped off the political stage to leave her in sole charge. Rudd himself had aroused so much business opposition with the original version of his bill that it had brought an early end to what had actually been a rather do-nothing political record. But Gillard was fnally able to pass a watered-down version by offering concessions to the Greens and independent MPs.
That might not be the end of the story, of course. The leadership of the Liberal-National opposition coalition has pledged to repeal the MRRT if it manages to get re-elected at the next general election, which is due in late 2013. The liberals are also threatening to dump a new carbon tax that Gillard has managed to push through. (Another idea that Rudd proposed but then grievously mismanaged before his eventual fall from grace.)
But as the government gleefully rubs its hands together at the thought of all that lovely revenue coming in from the MRRT, it should pause to consider the potential headwinds facing Australia’s mining industry.
Its main customer, of course, is China, whose seemingly unrelenting economic growth fuelled an infrastructure splurge dependent on the commodities that Australia supplies. But Chinese growth is now slowing as its own exports are hit by Europe’s economic woes: its exports to the EU in March were 3.1% lower than March last year. And although China enjoyed a $5.4bn trade surplus with the EU in March, compared with a $31.5bn deficit in February, that’s not necessarily good news. Beijing’s economy slowed to 8.4% in the fourth quarter of 2011, compared to 8.9% in the same quarter of 2010.
Accordingly, Australia’s exports have been feeling the pinch. Total exports fell by 10.6% in January, according to the Australian Bureau of Statistics, and then by another 1.8% month-on-month in February, to just A$20.4 billion. Almost all of January’s decline had been due to a decline of A$1.1 billion for metal ores and minerals and non-monetary gold. And its total exports to China had fallen by 23% month-on-month. Ouch.
Exports to China don’t look likely to improve any time soon, because China is sitting on a stockpile of copper. The metal’s price, often seen as a bellwether for the global economy, fell by 7% in the first few weeks of April, dropping below $8,000 a tonne for the first time since January. And the Economist Intelligence Unit currently predicts that Australia’s mineral exports will increase by only 9% in 2012, after a 13.7% gain in 2011.
Every Cloud, Etcetera
Whilst a slowdown in the mining sector will undoubtedly hurt in the short term, anything that potentially allows other sectors such as manufacturing a little breathing space to catch up might be better for the country in the long run. And anything that weakens the currency will do exactly that.
A survey of manufacturing CEOs in February found that 93% said their exports cannot compete when the Australian dollar buys more than US$1 – whereas it currently buys US$1.037. A weaker currency? Bring it on. Meanwhile the Australian Manufacturing Workers’ Union has launched a campaign demanding R&D incentives, more apprenticeships, and, crucially, a “buy Australian” requirements for government projects.
Beyond direct support to the manufacturing industry, the government also could help squeezed exporters by saving the proceeds of the commodities boom – reducing inflationary pressure and allowing lower interest rates and a cheaper exchange rate. It is lowering its budget deficit and may even have a surplus in the fiscal year ending June 2013 (dependent on the proceeds from the MRRT). A next step could be a sovereign wealth fund to invest money overseas, giving Australia a diversified source of future income that isn’t entirely dependent on commodities.
All of which would help to cement Australia’s place as a candidate for your clients’ CASSH. If you’ll pardon the expression.
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