Friday, 30 May 2014

Australia may escape a recession as mining boom fades

Conventional wisdom predicts an imminent economic decline for struggling Australia, but a closer look suggests the Lucky Country might actually fare better than many would think.

After more than two decades of uninterrupted income growth, low unemployment and low inflation, the boom times have come and gone. The Reserve Bank of Australia (RBA) forecasts Australia’s growth as slowing to 2.6% in 2014.

The country’s mining sector is contracting as Asian demand tapers off. As a result, growing levels of unemployment could become an issue because jobs are still largely unavailable in alternative sectors such as commodities, services and tourism.
Coupled with the slowdown, the strong Australian dollar refuses to budge from its heights despite the RBA cutting interest rates to record lows in an effort to depreciate the currency.

However, so long as the dollar does not lift appreciably again this year, low interest rates are having the ancillary effect of stimulating residential construction and investment and could help mitigate the mining slowdown.

Because of this, Australia finds itself in a relatively healthy position. The supreme challenge facing the country now is managing their emergence from the mining boom.

How they got into this position is relatively straightforward.

The mining boom beginning early 2001 strengthened the Australian dollar, damaging other industries in its wake. Today the dollar remains high, but the low–hanging fruit of easy resource extraction is falling away.

Although it is still a heavy importer, Asian growth slowed, especially in China. China’s rapid growth and seemingly insatiable demand floated Australia above the global recession as China purchased enormous quantities of coal, iron ore, energy and agricultural commodities.

Popping the mining bubble increased pressure on the Australian dollar, and impacted debt levels. That effect in particular could go either way for the economy.

Because of the pressure, the Australian dollar should stay unexpectedly strong this year, holding its enviable status as a safe haven currency. Of course, a strong currency will also hurt export markets, exacerbating any effects of the fading mining boom.

To soften the fall, the RBA suggest a currency depreciation of between 15% and 20% may be required. They predict this will encourage competitiveness and grow the tourism, retail, and industrial sectors.

This might work, but in Canberra, the Australian government is trying a few tricks of their own to counter the worst consequences of the fading economy.

Australian Prime Minister Tony Abbott revealed his budget earlier in May promising both spending cuts and a temporary increase of taxes. He explained that raising the tax rate was aimed at reducing the $AUS28 billion deficit for 2014–2015.

Addressing the deficit should be applauded, but Mr Abbott campaigned on a promise of no new taxes and “no surprises”. The budget appears to directly counter those vows and he will now have to answer public dissatisfaction and widespread criticism.

The now–retired economist Gerard Minack also talked earlier this year about the importance of lowering interest rates to help rebalance economic growth.

The RBA recommends “a period of stability” over the next few months, whereas Mr Minack and others predict interest rates could be lowered. Although he did warn this move will increase inflation and house prices as a by-product.

Despite the RBA’s recommendation, there will be good reasons for further interest rate cuts: weaker business investment would be one signal. Another would be if the dollar continues to strengthen and doesn’t respond to rate cuts.

On top of this, if the mining sector forecasts further weakening then cuts would definitely be in the queue. The country is in the enviable position of being able to drop interest rates further, but they may not be able to go too much lower than they already are.

Record low rates are already having a positive effect, but not on the intended target. Instead, residential construction – which is predicted to grow over the next three quarters – is getting the most benefit from low rates.

Higher levels of residential construction will be useful for any transition away from mining. Magnifying this effect both national employment and unemployment figures are heading up, reversing the trend of last year.

Growth of residential construction could soak up some of these unemployed workers, potentially enough to delay the worst effects of the slowing mining sector. It will also encourage greater private borrowing. RBA governor Glenn Stevens recently warned borrowers to take care with increased leverage, particularly in Sydney and Melbourne.

And just as with New Zealand, statistics now show a swell in foreign purchases of residential housing. Chinese buyers account for one in eight new houses nationwide. That figure could rise to 30% by 2020, according to a Credit Suisse report.

The RBA’s predictions aside, the markets now expect interest rates to rise this year instead, and the respected Wall St economist Mr Minack concurs. Despite the looming problems, Australia has plenty of ammunition to fight off a recession. The market appears to be betting on an Australian surprise to transition successfully away from mining and into other sectors.

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