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Hard Times Ahead For Australia?

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Pacific Money

Hard Times Ahead For Australia?

After 21 straight years of economic expansion, are the good times over for the so-called “lucky country”?

Australians have been warned that lower commodity prices may force them to start tightening their belts. After 21 straight years of economic expansion, are the good times over for the so-called “lucky country”?

The wake-up call came from respected Australian economist Ross Garnaut, a noted Asia-watcher credited with predicting the rise of China and his country’s mining boom.

Speaking at a recent conference on Asia, Garnaut was quoted by the Australian Financial Review saying, “I think we’re going to have a very difficult time adapting to the decline in living standards that’s going to be a necessary part of the adjustment to the end of phase one and two of the boom.”

Christopher Kent, the Reserve Bank of Australia (RBA)’s assistant governor who spoke at the same event, characterized Australia’s mining boom as consisting of a boom in prices, then investment and exports, with the latter two phases still having a way to run.

Garnaut warned that the plunge in the price of Australia’s commodity exports would reduce incomes. However, he said that governments of both political persuasions since 2003 had failed to save enough of the resources boom in budget surpluses to cushion the blow.

Australia’s terms of trade (the ratio of the price of exports to imports) have already dropped 10 percent from their record high in 2011, on the back of plunging prices of coal and iron ore, principally due to reduced Chinese demand.

While prices have since stabilized, sluggish global growth along with the end of China’s boom may lead to sustained price falls.

Surplus commitment

While there have been calls within Australia for looser fiscal policy to offset any downturn, the federal Labor government has committed itself to delivering a budget surplus to demonstrate its financial management credentials, traditionally perceived as an area of weakness for the Labor party.

Ratings agency Standard & Poor’s has reaffirmed the nation’s AAA sovereign rating on the basis of further budget cuts, saying that a stronger balance sheet would give Australia more fiscal flexibility should the external environment further deteriorate.

On September 24th, Treasurer Wayne Swan announced a budget deficit of AUD$43.7 billion for the 2012 financial year — slightly better than forecast, but making it challenging for the government to achieve its promised AUD$1.5 billion surplus for 2013.

Despite the deficit, net government sector debt was reported at AUD$147 billion or 10 percent of gross domestic product, a figure well below the average 83.5 percent for developed economies in 2011. The treasurer promised more budget cuts to deliver the surplus, although economists have warned of a AUD$10 billion budget hit from lower commodity prices.

The centrist Labor government has also been criticized over a raft of recent spending pledges concerning education, national disability insurance, dental care and childcare. Its political opponents have seized upon forecasts of a AUD$120 billion gap in government finances by the end of the decade, with Opposition Leader Tony Abbott spearheading an often strident campaign against the government’s record on economic management.

Growth pipeline

However, while China’s growth is slowing, its continued urbanization and predicted economic growth in other Asian countries such as India, Indonesia and Vietnam may prevent a collapse in Australia’s terms of trade.

Swan has argued that the mining investment and export booms “still have a way to run,” pointing to the highest level of business investment as a proportion of GDP in 40 years, and resource projects in the pipeline with a value of more than AUD$260 billion.

Economists argue that lower commodity prices should also reduce the value of the Australian dollar, aiding tourism and manufacturing and boosting the Australian dollar earnings of miners.

With the government set on delivering a contractionary surplus, the RBA will be expected to offset the shortfall on domestic demand by delivering further interest rate cuts. With the official cash rate currently at 3.5 percent, the RBA has room to move on monetary policy, and the jobless rate remains low at around 5 percent.

The RBA is predicting that Australia’s economic growth will reach 3.5 percent in 2012, while the Treasury forecasts the rate easing from 3.25 percent this financial year to 3 percent in fiscal 2014.

Australia’s economy grew by 3.7 percent in the three months to June 30 from a year earlier, and according to Bloomberg data, will overtake Spain as the world’s 12th largest economy in 2012.

Yet critics have warned that Australia’s “high wage, low productivity” economy may be unsustainable at a time when major trading partners are slowing or struggling to escape recession. Swan and Prime Minister Julia Gillard will be hoping that this time Garnaut has got it wrong, and that changing economic conditions won’t spell the end of their budget surplus — along with the government’s re-election prospects.