PIMCO has released an interesting note prognosticating on whether Australia can successfully navigate the mining capex cliff. According to PIMCO:
Recent data suggest that mining investment is tapering, with the sector detracting from real growth in the first half of 2013.
We see three possible growth scenarios…
First, the good growth outcome the RBA is shooting for: Companies outside the mining sector begin to invest in their businesses again, allowing for a smooth handoff of growth from the mining sector. Unfortunately, we have yet to see this process take place, with real growth in non-mining business investment actually contracting over the year to June 2013 (Figure 4)…
Second, a bad growth outcome could eventuate in which demand continues to slow as the global mining sector tapers and no new domestic balance sheet steps forward to drive future growth. The first half of 2013 falls into this category, with the RBA responding by lowering the cash rate by 0.50% so far this year.
And finally, an ugly growth outcome could transpire where an unintended balance sheet steps forward attracted by low interest rates. In Australia, this would be the household sector, which remains highly levered by global comparisons. This ugly growth outcome would involve a temporary near-term boost to growth, but the increased leverage on household balance sheets from already elevated levels would create longer-term risks to the outlook…
Until we see meaningful signs of a growth handoff from the mining sector to a new balance sheet that has the capacity to expand, our base case calls for sub-trend growth and low interest rates, supporting bond prices over the cyclical horizon.
Overall, PIMCO’s analysis seems sensible. The capex cliff is huge and the void looks unlikely to be filled sufficiently to prevent growth from slowing and unemployment rising. Accordingly, the RBA will be required to maintain current low interest rate settings, and may even cut further in the event that domestic conditions worsened. However, without macroprudential curbs on higher risk mortgage lending, these low rates are also likely to feed house price inflation and rising debt levels, worsening domestic imbalances and potentially setting Australia up for more pain down the road.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
