A Recession for Australia?

Australia enters into its 24th straight year of economic expansion in 2015, with its citizens among the world’s richest. But with the mining boom ending, the exchange rate diving, and joblessness increasing, commentators have begun to utter the dreaded “R” word: recession.

“Australia has run out of luck,” claims market strategist Gerard Minack, who has assigned a 40 per cent probability of recession for the world’s 12th-biggest economy in 2015.

“Under almost any scenario the outlook is for a lower Australian dollar, lower interest rates and underperforming equities,” Minack told ABC News.

“If there is a recession expect sharp outright losses in equities, notably banks, and significant falls in house prices.”

The former Morgan Stanley global strategist has pointed to weak domestic demand, falling mining investment, a declining manufacturing sector and shrinking bureaucracy as all adding up to a gloomier picture.

Minack’s forecast was technically proved accurate last December, when gross domestic product (GDP) data for the September quarter 2014 showed the nation had posted two straight quarters of negative income growth.

Real net national disposable income, a measure of what Australian consumers, businesses and governments receive in exchange for their goods and services, contracted by 0.3 percent in the quarter after falling by 0.2 percent in the June quarter. This reflected slumping commodity prices, with sharp falls in the prices of key exports such as iron ore and coal pushing down the terms of trade, a measure of the value of exports compared to imports, which fell by 3.5 percent and nearly 9 percent year-on-year.

According to ANZ economist Felicity Emmett, nominal GDP contracted by 0.1 percent in the quarter, a “disappointing result” for the economy.

“Soft income growth will weigh on profits, wages and public revenues, and flow through to softer consumer spending, business investment and public demand,” Emmett said.

“Moreover, the drag from the wind-back in mining investment still has a long way to run and is likely to be much sharper over coming quarters as large-scale LNG [liquefied natural gas] projects approach completion.”

The Australian dollar sank to new four-year lows following release of the data, which officially showed the national economy grew by 0.3 percent in the September quarter for an annual rate of 2.7 percent. This was below economists’ forecasts for a 0.7 percent quarterly expansion and 3.1 percent for the year, as well as lagging a 15-year average of 3.1 percent growth.

Recession Triggers

While recessions are notoriously difficult to predict, according to Business Spectator columnist Callam Pickering the Australian economy faces risks in all of its key sectors.

“If Australia does suffer a recession in the next few years it will most likely begin in one of three areas: the property market, our major banks or our mining sector. If I was a betting man I’d put my money on either the property market or the mining sector, with the financial sector suffering a second-order shock,” he said.

Pickering noted that the nation’s property sector has suffered three downturns over the past decade, with weak income growth a threat to rising property prices. The big banks’ exposure to property makes them vulnerable, with Australia’s big four banks “among the most leveraged in the world.” And lower commodity prices, hit by a downturn in Chinese demand, have weighed on the mining sector, forcing a slowdown in business investment.

“The reality is that while a recession is far from certain, it is more likely now that it has been at any point since the early 1990s,” he warned.

The same message has been propounded by analyst Lindsay David, who in his book, Australia: Boom to Bust, claims that the nation’s recent housing boom has made it “a giant Lehman Brothers.” 

According to David, Australians are living in a “Disneyland” fantasy by ignoring a housing bubble which has seen the median house price to income reach nine times in Sydney, compared to 7.3 times in London, 6.2 times in New York and 4.4 in Tokyo. Australia’s real estate bubble could burst suddenly if China’s economy were to crash, simultaneously hitting bankers, miners and households.

Fitch Ratings has warned that housing affordability has reached its peak in Australia, with growth in property prices slowing to about 4 percent in 2015.

“People just can’t afford to pay much more for housing,” Fitch Australia’s Ben McCarthy told the Australian Financial Review. “At 4 percent growth, prices will still rise higher than people’s incomes. This will be driven by the demand in the market but this will slow over time.”

According to the credit-rating agency, Australian property is already among the most expensive in the world, although mortgage arrears remain below 1 percent.

Meanwhile, the mining outlook has weakened on the back of slower growth in China, the world’s biggest consumer of resources. The Australian government’s official forecaster recently cut its iron ore price forecast by a third, with price falls for iron ore and coal hitting employment and tax revenues.

Falling oil prices have also forced the shelving of proposed multi-billion dollar LNG projects, which had been seen as a source of potential resources investment growth. 
Australian consumers are also unlikely to open their wallets, with wages growth slowing to 2.6 percent a year, its weakest rate since 1998. According to a HSBC survey, Australians’ savings rates are among the worst in the world, with a 13-year gap between estimated retirement span and savings.

Stimulus Measures?

The slowdown has led to calls by analysts for more stimulus to avoid a repetition of the previous recession in the early 1990s.

However, more stimulus is exactly what Canberra had been hoping to avoid when it announced plans in May 2014 to balance the federal budget by 2019. In December, Federal Treasurer Joe Hockey admitted a A$10 billion ($8.2 billion) blowout in the forecast budget deficit and a A$32 billion reduction in tax revenues over the next four years, blaming shrinking export income and political opposition to planned fiscal tightening.

“In the last six months unforeseen events have hit the Australian economy. In particular, we are now witnessing the largest fall in the terms of trade since records began in 1959,” Hockey said in a statement. 

“To try and recover these falling revenues now, through new or higher taxes would unquestionably harm the Australian economy,” Hockey said, predicting the budget would not return to surplus until 2020.

In its latest economic survey of Australia released in December, the OECD warned of a “difficult rebalancing process” as the nation adjusted to a weaker growth period following the end of the mining boom.

While forecasting output growth of around 2.5 percent in 2015, the Paris-based organization said the projection could prove overly optimistic.

“The balance of risks facing the Australian economy contains more substantial downside than upside uncertainties. External risks, chiefly from commodity markets, combined with speculative activity in the housing sector and uncertainties in the responsiveness of non-resource sectors, could conspire to generate a period of weak macroeconomic activity,” the OECD warned.

The forced rebalancing of the Australian economy has been highlighted by a shift in wealth from resources-focused states such as Western Australia and Queensland to New South Wales (NSW), which according to Commonwealth Securities now shares top honor as the leading state with the Northern Territory (NT).

“That transition is happening…Growth in retail sales in the non-mining states has picked up pretty sharply, particularly in NSW, and it’s slowed sharply in the mining states of Western Australia, Northern Territory and Queensland,” ANZ senior economist Justin Fabo told The Diplomat in an October 2014 interview.

“The other thing clearly showing the transition is population growth, which is slowing in Queensland, WA and the NT, particularly from rapid rates in WA, but it’s picking up in NSW and Victoria. So we are seeing that switch in the growth drivers happening. The key question is how quickly it happens.”

Despite previously predicting an official interest rate hike in 2015, in a January 15 research note ANZ Research said the Reserve Bank of Australia likely would now cut rates by another 0.5 percentage point in the first half of the year to reach 2 percent, due to weaker growth data, softer non-mining activity and lower energy prices.

ANZ said it had cut its growth forecast for 2015 from the 3 percent estimated in November to 2.5 percent, with expected GDP growth of 3.2 percent in 2016. It said the 10-year Australian government bond yield would fall to 2.1 percent by year-end, taking it below the equivalent U.S. Treasury yield, with the Australian dollar weakening further to reach US$0.74 by the end of 2015.

“A sustained upswing in the Australian economy will be led by non-mining investment spending, stronger rates of employment growth and an improvement in consumption growth. Right now the economy is suffering from an income problem and a large wind-down of mining capital investment. These headwinds are likely to continue well into 2015,” it warned.

Yet amid the gloom, due to high property prices, Australians remain the world’s richest with median wealth of more than $225,000 in June 2014, according to Credit Suisse. The investment bank noted a “rapid and almost uninterrupted accumulation of wealth over the past 14 years,” with the net wealth of the average Aussie quadrupling since 2000, from $103,151 to $431,000, second only to the Swiss at $581,000.

The tumbling Australian dollar has benefited exporters such as farmers and miners as well as the education and tourism sectors, with lower oil prices helping consumers and businesses. While China is the nation’s top trading partner, increased global growth led by the United States and signs of revival in Japan and the Eurozone are expected to provide a more positive global backdrop in 2015, while Australian exports should be aided by free trade deals with China, Japan and South Korea.

After finally jumping above the U.S. jobless level in July 2014, Australia’s unemployment rate actually fell in December to 6.1 percent, reducing pressure on the central bank to cut rates. 

Resources companies are also counting on a cyclical rebound by 2016 or 2017, with China’s and India’s continued industrialization seen as a driving force, along with gains in select commodities.

“China continues to industrialize and urbanize along with the rest of emerging Asia, and we seek a positive outlook for our flagship Cyclone zircon project in Western Australia,” Neil McIntyre, chief executive of Diatreme Resources, told The Diplomat.

“Anecdotally, we are also seeing renewed Japanese investor interest in Australia’s resources sector, with Japanese companies looking to expand their overseas investments to secure energy supplies.”

McIntyre said Australian miners were also benefitting from the weaker Australian dollar, with most minerals exports priced in U.S. dollars.
Carpentaria Exploration managing director Quentin Hill was also confident, saying: “We believe the medium to long-term fundamentals for iron ore remain strong, especially for higher grade products. Chinese steelmakers are seeking to improve efficiency and reduce emissions and this has led to increasing price premiums being paid for lump ore, high-grade fines and pellets over the 62 percent iron index. These materials provide a very large efficiency dividend for steel mills over the lower grade, less efficient sinter feed iron ore fines that make up a large part of the seaborne trade.

“We expect this trend to continue in the longer term as the use of electric arc furnaces that utilize a mix of scrap iron and very high grade iron ores increases at a faster rate than traditional blast furnaces.”

Yet amid mixed signals on the Australian economy, economists have questioned whether the nation’s winning streak can continue.

ANZ’s Fabo said the average was around one recession “every eight to 10 years,” making the current growth period unusually long.

“So if we got to the end of this decade without another recession, that’d be record-beating stuff. If we do go through a recession, the key one is how deep – you don’t want it to be too deep,” he added.

A 30-year winning run for the Lucky Country? That would be lucky indeed.