A housing crash or resource bust could end Australia’s 26-year-long economic winning streak, amid “unprecedented” household debt levels, the OECD has warned in its latest assessment. With apologies to Clint Eastwood’s “Dirty Harry” character, Canberra might ask itself the question: Do you still feel lucky?
Released a day after gross domestic product (GDP) data showed the “Lucky Country” avoided recession in 2016, the OECD’s report makes for worrying reading for policymakers in the world’s 12th largest economy.
House Price, Debt Surge
“House prices and household debt have reached unprecedented highs,” the Paris-based international economic organization said, pointing to a 250 percent rise in prices in real terms since the mid-1990s.
“Furthermore, the ratio of house prices to incomes has undergone further increase in recent years, straining affordability, especially for first-time buyers in Sydney…A continued rise in the market, fueled by both investor and owner-occupier demand, may end in a significant downward correction that spreads to the rest of the economy,” it said.
As noted previously by Pacific Money, Sydney has been rated the second-most unaffordable city in the world by U.S. consultancy Demographia, while other major Australian cities have also been described as “severely unaffordable.”
Amid record low official interest rates, house prices in Australia’s largest cities of Sydney and Melbourne have continued to post double-digit increases. In Sydney, prices were showing an 18 percent annual rise as of the end of February, its highest growth rate since 2002, when the housing boom of the early century started to slow.
Prices in its southern neighbor of Melbourne were up by 13 percent, although other cities were showing more modest rises, with Brisbane up by 2.2 percent and Darwin and Perth actually contracting.
As a consequence of the housing boom, Australia’s ratio of household debt to GDP has reached 123 percent, an all-time high and the third-highest in the world behind Denmark (124 percent) and Switzerland (128 percent), according to the Bank of International Settlements.
Analysis by the Australian Financial Review has shown that more than a million home owners would suffer mortgage stress should interest rates climb by just three percentage points to a more “normal” level. Such a rise would take the Reserve Bank of Australia’s (RBA’s) official cash rate from its current “emergency low” of just 1.5 percent to 4.5 percent, still below the 4.75 percent rate it held back in 2011.
“If the cash rate goes to 6 percent then you would expect to see a lot [of] people in strife. Particularly with wage growth and inflation at such low levels, so that does increase vulnerability to rises to interest rates,” the University of Melbourne’s Professor Roger Wilkins told the financial daily.
Resource Shock?
The OECD also cited Australia’s vulnerability to a renewed plunge in global iron ore or coal prices, two of the nation’s key exports, which could spark reduced investment, job losses and lower income. With Chinese demand driving prices, any further downturn in the world’s second-largest economy could hit resource prices as well as affecting Australia’s trade in services, including the recent surge in Chinese tourism.
“Although there are a number of factors likely to mitigate the systemic impact of these vulnerabilities, including large aggregate mortgage prepayment buffers and recently tightened macro-prudential measures, a fall in house prices and/or demand could have significant macroeconomic implications. Specifically, the market may not ease gently but develop into a rout on prices and demand,” the OECD said.
“Externally, Australia, as always, is exposed to the vagaries of global commodity markets and this might include a renewed plunge in prices (or positively, a strong resurgence),” it added.
While the economic organization said Australia remained “well positioned to handle shocks,” it noted a “non-negligible risk of downturn” based on its leading indicators of past downturns and recessions.
The OECD also said Australia shared the global risk of a “low-growth trap” due to falling productivity, amplified by the increased aging of society. Despite high immigration, the number of Australians aged over 65 is expected to more than double by 2055.
Meanwhile, income inequality has increased, with higher-income households having benefited disproportionately from the nation’s long period of economic growth. Real incomes for the top quintile of households grew by more than 40 percent between 2004 and 2014, while those for the lowest quintile only increased by around 25 percent.
In addition, large socioeconomic gaps exist between Australia’s indigenous population and the rest of the nation, with further efforts needed to reduce gender imbalances, the OECD said.
Nevertheless, the organization still predicted GDP growth of 2.6 percent in 2017, rising to 3.1 percent in 2018, helped by low interest rates, a weaker currency and increased exports.
Growth Turnaround
On March 1, December quarter GDP data showed a turnaround from the previous quarter, with the economy growing by 1.1 percent in the quarter and by 2.4 percent for calendar 2016, a fact highlighted by Australian Treasurer Scott Morrison.
“Once again, Australia is growing faster than every G7 economy. Our growth continues to be above the OECD average and confirms the successful change that is occurring in our economy as we move from the largest resources investment boom in our history to broader-based growth,” Morrison said.
The turnaround from the September quarter’s 0.5 percent contraction was aided by higher household consumption, up 0.9 percent in the December quarter; dwelling investment, up 1.2 percent; and business investment, up almost 2 percent. However, employee compensation declined by 0.5 percent, reflecting continued subdued wages, which the treasurer described as “disappointing.”
ANZ Research said the strength in consumer spending “is not sustainable… given high levels of household debt and ongoing low wages growth.” It also said housing may have peaked, while a stronger than expected currency could hit exports.
Inflation also remains weak, with an annualized rise of just 0.9 percent in the “consumption deflator,” while wages actually were 0.3 percent lower than a year earlier along with lower nominal labor costs. The Australian bank’s economists said this suggested “an absence of domestic inflationary pressures and confirming that the RBA is on hold for some time.”
The OECD urged Canberra to rely more heavily on fiscal policy to shield the economy from a downturn, as well as maintaining tight “macro-prudential measures” such as curbs on investment lending, to cool the housing boom. It also suggested a further hike in consumption tax to reduce reliance on income taxes, along with reforms to spur productivity, such as measures to enhance competition and encourage labor mobility.
“Compared with other OECD countries, Australia’s tax burden, public spending and public debt are low,” the organization noted. “Following the global financial crisis, the authorities provided timely fiscal support that helped Australia avoid a recession – one of the few OECD countries to do so,” it said.
Having weathered the global downturn to post its 26th straight year of economic expansion, the worry for Australia’s policymakers is that the good times will not last forever without further action on reform. As Dirty Harry said, “You’ve gotta ask yourself one question: Do I feel lucky? Well, do ya, punk?”