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Business Outlook: Eyes on China


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28 April 2014: Growth is slowing in Asia, as China takes baby steps towards some much needed reforms, as other emerging economies lament the gradual loss of cheap money from the US Fed, and as the initial impact of Japan’s shock therapy wears off and tax hikes sap some of its strength.  That Asian weakness poses problems for Australia, as we’ve relied on our healthy neighbours for some time.  Yet what passes for weakness in Asia would count as great growth in the rest of the world.  Besides, elsewhere the global news is mostly good, with the US and UK going from strength to strength, and Europe going from, well, dire to weak.  The upshot is a modest lift in global growth, albeit with that gathering of pace more evident in 2015 than in 2014.

Don’t get lost in the gloom of unemployment being at a decade high amid high profile job losses.  Sustained low interest rates are having their not-so-wicked way with the willingness of families to spend, boosting retail to its best result in years.  And the recovery in home building may not accelerate at the ‘pocket rocket’ pace of times past, but it too is set to soar.  At the same time the export phase of the construction boom is accelerating on schedule, the national appetite for imports is dimming, and Canberra is going slow on the return to surplus.   Taken together, that’s loads of good news for Australia.  And it’s getting better.  Yet it is up against a big opponent in the construction cliff.  The fall-off in resource-related construction is about to gather pace.  So while the good news is our growth forecasts have edged up of late amid the strengthening response of retail spending and home building to record low interest rates, the bad news is that we still see growth stuck a tad below trend through to late 2015.  That’s a view we’ve held for some time, and although a recent run of data has been particularly good, it’s a view we maintain.

There’s two strikes against the inflation outlook:  (1) the $A is adding to consumer prices, and there’s probably more pain to come, while (2) one offs (gas and cigarette prices up, but the carbon tax removal cutting electricity costs) will boost inflation.  But that’s it:  the other inflation news is good.  Wage growth is as weak as it gets, and business conditions are flat enough that they won’t prove a problem either, thereby leaving us still unfazed by short term inflation risks.

Governments from Washington to Wellington are bracing for higher credit costs. Yet it will be a slow burn – we project the cost of credit will increase pretty gradually, even in the US.  There’s a bunch of powerful reasons to believe the Reserve Bank will raise rates by late 2014:  growth has been better than expected while inflation has been worse, housing prices have jumped, and the cash rate is at all time lows.  Those factors all make the RBA toey.  Yet we still see the first Australian rate rise as coming well into 2015, mainly as the winding back of resource-related construction is enough of a growth negative to keep inflation on a leash, and hence the RBA too.  And we remain of the view that the $A’s glide path to US 80 cents by 2017 remains intact.

A slower China means lower prices for coal and iron ore, worsening the trade balance.  But a maturing resource construction boom not only pays off in export quantities, it is also combining with the lower $A to dull our appetite for imports – thereby improving the trade figures. So far that tug of war has cut the current account deficit, though commodity price wobbles continue.

Don’t sweat the horror headlines about job losses. Although it has slowed sharply, the job market is still growing.

There are two important points.  First, growth in the supply of workers has also slowed due to boomer retirement. 

That’s why weak job growth hasn’t meant much extra unemployment.  Second, the tide is turning.  At the same time that the headlines were hogged by job losses, the $A fell and lower interest rates began to show up as better news in retail and housing construction. That suggests the worst of the current job cycle may be behind us.

The Federal Budget is broken, but nobody has been willing to tell that to Mr and Mrs Suburbs.  So chances are that
May’s Budget may be one in which the Government talks big but acts rather smaller than its own rhetoric, cutting back rather less than it should, and justifying such a ‘softly, softly’ approach on the grounds that the economy is too fragile to withstand larger cuts.  That approach would merely repeat the experience that Australia had under the previous Government, who also liked to talk big but act small. To be clear, we wouldn’t argue for big cuts tomorrow:  that would indeed unnecessarily hurt the economy.  However, the Government should release the Commission of Audit, start making its case to the electorate for cuts (and tax increases), announce those measures in May’s Budget, and have them taking effect over a number of years.

Sectoral growth prospects limited…

Turning to sectoral growth prospects, there’s wailing and gnashing of teeth around a bunch of manufacturing closures in cars, aluminium and petrol refineries.  That’s understandable.  Three years from now, we forecast machinery and equipment (the industry which covers car and car parts manufacturing) will have shrunk notably, with the news little better in textiles or in printing.  Equally this isn’t another global financial crisis as far as manufacturers are concerned:  we project manufacturing as a whole to be merely stagnant, not falling under a bus.

Yet it won’t only be manufacturing facing stagnation in the next three years.  Construction won’t go anywhere fast, with weakening engineering work around mining projects offsetting rising housing construction.  And the utilities are at a standstill – prices are up and big customers (such as aluminium refineries) are amid some very tough times.  Similarly, despite the drought, the farm sector has had a good year, meaning that its output may not better that level soon.

One dog isn’t barking.  The public sector isn’t on our ‘stagnant list’.  Yes, there will be cutbacks.  Yet they’ll sit atop extra Federal spending promised for parental leave, schools and disability insurance, and the admin needs of these will generate growth, as will State spending.

There’s good news too.  Although coal is making losses and mining profits are a shadow of their glory days, mining output will surge.  It already is, and the next few years will see iron ore, coal and gas output leap considerably.  That will benefit other industries, including transport.

And several service sectors will also do well – for example, health care will run mining a close race in the output growth stakes, while low interest rates are helping along the finance sector.

The ‘two speed split’ in State performance to narrow a bit further in the short-term…

Australia is an economy in transition, with its economic strength gradually shifting from the resource States back towards the south and east.  Yet that transition will be patchy, particularly thanks to the resilience of project spending in Queensland and the Top End.  That will give growth in these two regions an Indian summer.  And the transition is also patchy because the job killing abilities of the $A have cast a long shadow – for example, car manufacturing will still be shedding jobs in 2017.  Even so, these dice have now been thrown, and we continue to expect the ‘two speed split’ in State performance to narrow a bit further in the next few years.

  • NSW is inching its way up the growth league ladder.  Low interest rates and a strong recovery in NSW housing construction have combined with problems for Victoria (due to the $A) and the resource States (due to the construction cliff) to boost NSW’s relative rank.
  • Victorians have been reading horror headlines – Ford!  Toyota!  Alcoa!  Yet the outlook isn’t nearly as bad as those headlines may make it seem.  The $A’s recent fall is bigger and better news for job prospects in Victoria than the known negatives of a series of upcoming closures.
  • Queensland has still got gas in its tank (with the mega gas developments still underway), and is also projected to be an outperformer in both retail and housing construction, with our forecasts seeing the State accounting for a rising share of these growing national markets.
  • South Australia’s economy was already struggling when news of Holden’s 2017 closure of its Elizabeth manufacturing operations hit the headlines.  However, and as is true of Victoria, we project the lower $A and low interest rates will keep the home fires burning.
  • Western Australia’s mining construction boom is losing steam, as are its population growth and hotel occupancy rates, leaving the unemployment rate rising.  Yet we see the slowdown as short-lived, with rising exports getting State economic growth back to trend by 2016-17.
  • Tasmania has turned the corner – retail sales growth is back with a vengeance, population gains are lifting and unemployment is falling.  Yet the good news needs to be taken in context:  the State’s demographics are doleful, and there are some notable medium term challenges.
  • The Northern Territory is in the prime of its business cycle, showing great strength.  Yet that strength will be hard to maintain – the current level of project spending is enormous, and although there are new projects jostling in the pipeline, they may not match the Inpex effect.
  • Canberra’s job gains are still outpacing those nationally – we kid you not.  But there’s already pain in the job loss pipeline, plus the risk the imminent Federal Budget adds to the pressures on an economy already feeling the squeeze  from a shrinking housing construction sector.

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