An interesting debate has been unfolding in recent months as the high Australian dollar continues to take its toll on import competing manufacturing industries, with job losses and business closures escalating. This has led to growing criticism of the way key policymakers, namely the Reserve Bank of Australia (which sets monetary policy) and the Government (responsible for fiscal policy) have been handling the economy.
State of the Economy
Before we wade into the debate, it is important to gain perspective on the performance of the economy. Key recent economic data releases are as follows:
The economy grew by a modest 0.4% in the December quarter and by 2.3% over the year. Given that trend growth is about 3% per annum, the current rate of growth is below average. Yet this conclusion is somewhat misleading because economic growth consists of domestic growth plus external trade (the value of exports less imports). An analysis of this data provides a different outcome:
|Economic Growth, calendar year ending 31 December 2011:||%|
|Domestic growth (gross national expenditure):||4.8%|
|Plus: Exports minus imports||(2.5%)|
|Economic Growth (GDP)||2.3%|
This data shows that domestic demand remains moderately strong. Imports have been abnormally large (primarily due to the large value of capital imports being used to assist with the construction of the vast amount of resource projects underway) which has reduced the headline growth figure.
Household consumption spending increased by 0.5% over the December quarter and by 3.5% over the year. The average rate of growth over the last 12 years has been around 3.4% so it is very close to trend (although below the rates of growth experienced pre GFC). This is an interesting finding because the argument most often used to support the view that the economy is in a rut is the rate of retail sales. While it is true that retail sales levels remain below trend (retail sales rose 0.3% in January), they form only a part of household consumption. Households are increasingly reducing their spending on clothing and footwear and allocating more to overseas holidays and services (whether this proves to be a temporary shift in preferences remains to be seen).
With an increasing number of manufacturing jobs being made redundant, the most obvious data point that would reflect that trend would be in the unemployment rate. Although there was a rise of 0.1% in February to 5.2%, a definitive trend of higher unemployment has yet to emerge. This may indicate that a large percentage of displaced workers are finding new employment in those areas of the economy that are still growing (mining and health services).
Business and Household Credit
One area of the economy that unquestionably remains in the doldrums is business credit, which fell by 0.2% over January and grew by only 1.4% over the year. Personal credit too remains very weak, falling by 0.2% in January and by 1.3% over the year. Housing credit has been somewhat better, rising by 0.5% over January and 5.3% over the year, but this too remains well below average. After years of excessive leverage, we continue to view these outcomes positively. Although low levels of credit do not assist economic growth, businesses and households need to improve their balance sheets by reducing debt to more sustainable levels. On average, most large companies and the majority of small businesses have done a good job of improving their balance sheets already. Indebted households though have a long way to go.
National disposable incomes fell by 0.9% over the December quarter but still managed to rise by 4.9% over the calendar year. As disposable incomes are rising at a faster rate than private consumption expenditure (which was 3.5% over the year), the difference shows up in the savings ratio (+9.0% in the December quarter, which remains well above the 10 year average of +4.5%).
The Consumer Price Index remains the key headline measure for inflation. This index rose by 0.6% in December and by 3.1% over the year. While this is just outside the RBA's inflation target of 2 – 3%per 3 annum, the RBA's preferred measure of underlying inflation (the trimmed mean) rose by 2.6% over the year (almost in the middle of the range).
The slowdown in China will continue to reduce the terms of trade and possibly delay some mining projects that are in the planning phase. A slowing growth profile in the mining sector may well lead to some easing in the Australian dollar, which should provide some minor relief to manufacturers. Consumers, still battling high levels of household debt, will continue to be cautious but further rate relief may not be far away which should support modest rates of consumption. Overall, the sheer number of mining projects under construction will still support a moderate rate of growth, albeit a rate that is likely to be below trend (between 2-3%).
Without doubt the biggest losers from the high Australian dollar have been import competing tourism and manufacturing industries. The high dollar has made it difficult for them to compete with overseas competitors. This in turn has generated criticism of the both the RBA (by not lowering interest rates by enough) and the Government (by introducing new taxes at a time when manufacturing can least afford it) in not doing enough to protect these industries.
Critics argue that the RBA has not gone far enough to lower interest rates which would, in part, put some downward pressure on the AUD and reduce borrowing costs (for business this means lower costs; for consumers this means more disposable income that could be allocated to buying goods produced by manufacturers).
In responding to this argument, we need to remember that the RBA's core objective is price stability. In 1993, this was defined publicly by the then Governor, Bernie Fraser, as a rate of inflation which was held to an average of 2-3 per cent per annum. In the last few years the RBA has been concerned that the mining boom and the huge level of planned investment expenditure in the pipeline could well translate into an outbreak of inflation. Recent inflation data would suggest that inflation remains contained and with growth in China now showing definite signs of easing (which has translated into lower commodity prices and may end up in reducing investment expectations in that sector), there is now some scope to potentially reduce rates modestly from here. Yet this assumes that growth will moderate from here - but the data (particularly unemployment and domestic demand figures) does not yet confirm that a slowdown is actually evident - so the criticism of the RBA (in our opinion) is largely unjustified.
Addressing the criticism levelled at the Government for introducing new taxes at the time when manufacturing can least afford it is more complicated. Of course raising taxes to fund expenditure 4 commitments is never easy or popular – but a necessary pre-condition to avoid the solvency problems that many other governments are in. Opinion will always differ on the best mix of taxes to fund expenditures. The court of public opinion will ultimately rule on this at the next election.
- International Economy - Economic & Market Outlook - As at 31 March 2012
- Australian Equities - Market Outlook - As at 31 March 2012
- International Equities - Market Outlook - As at 31 March 2012
- Australian Real Estate Investment Trusts (Listed Property or "AREITs") - Market Outlook - As at 31 March 2012
- Fixed Interest - Market Outlook - As at 31 March 2012
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