HSBC’s Chief Economist, Paul Bloxham, continued his recent solid work with an interesting Research Note on the resilience of the Australian economy, echoed today by Jessica Irvine.
In the note, Bloxham argues that Australia’s economy is structurally sound, with the massive pipeline of mining investment likely to augment growth over 2012. He also argues that Australia’s conventional policy tools – monetary and fiscal policy – remain potent, owing to Australia’s relatively high cash rate as well as the Government’s strong fiscal position, which leaves ample room for Australia’s authorities to support growth should external conditions deteriorate.
Below is a summary of Mr Bloxham’s report. The full text is viewable below.
Few developed nations can currently claim that conventional policy tools are still effective in responding to a cyclical downturn. Interest rates are close to zero in the US and Japan and heading in that direction in Europe. Fiscal policy has also reached the end of its useful capacity, with fiscal retrenchment now required across the developed world.
Tellingly, HSBC’s recent global economic outlook described the government debt situation as the ‘arithmetic of doom’ (‘When the wheels fall off’, 21 December 2011). Indeed, with interest rates at such low levels, monetary and fiscal policies start to seem like the same thing. If the government can’t spend, via issuing bonds, the central bank is left to buy bonds. Unconventional policies, such as QE, are the remaining policy levers.
Not so in Australia. Unlike many developed economies, which are sailing in uncharted waters, Australia is still in a place it has been before: with the cash rate at 4.25%, budget deficit of 2.5% of GDP (in 2011/12) and net public debt of around 9% of GDP. As a result, Australia’s conventional policy options are still available. And the tools at policymakers’ disposal are powerful, particularly the lever at the hands of the RBA.
We expect the rate cuts from late last year, and further cuts in early 2012, will see a mild rebalancing of growth in 2012. Remember, the weakest sectors have been the interest-rate sensitive ones – housing and retail sales. We expect these sectors to stabilise in 2012.
With the government planning to unwind its fiscal deficit in 2012/13 by the largest amount in over 40 years (a 2.6ppts contraction of GDP) there is significant scope for fiscal slippage – despite political resistance. Plus, low levels of government debt leave scope for an emergency fiscal package if the economy were to slow a lot more than expected.
Then there’s the exchange rate. The AUD typically acts as a significant shock absorber for the economy – both on the way up and down. However, with Australia retaining a strong sovereign rating and Aussie bonds in high demand, it does beg the question as to whether the AUD would help out as much in a global emergency, as it has done in the past.
It’s hard to deny that Australia is the luckiest of countries, thanks in no small part to our direct linkages to China’s booming economy and the surging prices paid for Australia’s two key exports – iron ore and coal – which have propelled Australia’s terms-of-trade to 140-year highs:
Australia’s record terms-of-trade has, in turn, significantly boosted incomes, jobs and, importantly, government revenues, which have grown on the back of higher company tax and mining royalties, not to mention higher personal and consumption tax receipts (Chart from the RBA):
At the same time, Australia’s state and local governments have benefited greatly from surging property-related taxes (particularly stamp duties) emanating from the Australian housing bubble (chart from RPData):
These two factors combined – Australia’s record terms-of-trade and property-related taxes – are primarily responsible for Australia’s enviable fiscal position. However, should commodity prices and/or Australia’s housing market correct suddenly, then the fiscal positions of Australia’s governments are likely to worsen considerably, bringing us back into line with other developed nations.
Although not directly comparable, the Irish Government’s finances appeared healthy prior to their housing crash (charts from the IMF):
Only to then deteriorate sharply following the collapse of property taxes and the costly bail-out of its banks:
I am certainly not predicting that Australia will follow Ireland’s fate; rather that Australian government finances are highly susceptible to a sharp deterioration should commodity prices fall and/or the housing market bust. And should the proverbial hit the fan, Australia’s governments might not be in the position to stimulate to anywhere near the degree suggested by Mr Bloxham, particularly in light of the Australian Government’s role of implicit guarantor of Australia’s banks, which demands a sound budgetary position.
What appears to be a strong position today could, depending on external events, easily turn into a vulnerable position in the near future.
