Wealthy Nations Daily Update - Australia

Australia is currently AAA rated by all 3 rating agencies. But as we are in the midst of a commodity rout, whether this is sustainable is an interesting case. For us, Australia fails the ‘wealthy nation’ test with net foreign liabilities at 81.5% of GDP which is well in excess of our 50% of GDP cut-off, the threshold that IMF research indicates is associated with increasing risk of external crises.

Despite the fall in commodity prices and its association with this cycle the Australian economy has continued its unblemished record of over 24 years growth without a recession; GDP grew 0.9% in the September quarter recovering from only 0.3% growth in the previous quarter. This was certainly a better outcome than most analysts were expecting; growth was helped by the largest quarterly surge in exports since 2000 which added 1% to GDP; factoring in weakness in imports net exports added 1.5% to GDP. Iron ore prices have fallen but volumes have picked up as new projects/expansions have come on-stream. However, the domestic growth contributors made for grimmer reading; non-dwelling construction fell 4.2% qoq thereby subtracting 0.4% from GDP and machinery and equipment subtracting a further 0.2%.

Glenn Stevens, the RBA Governor, in a speech on 2 December noted: “Today the price of iron ore is about US$40 per tonne, and coking coal around US$75. At a national level, Australia's terms of trade, having been through an extraordinary surge, have fallen by a third and are still declining.” Interestingly, he notes putting the latest resources boom into perspective; “For the fifty years up to 2005, resources sector investment had averaged just over 1½ per cent of national GDP. Periodically, in a boom it tended to reach a peak of perhaps 3 per cent of GDP. This peak was about 8 per cent – nearly three times the size of the ‘normal’ peak, and easily the biggest such surge for over a century. The resources sector was doing 40 per cent of the nation's total business capital spending.”

Some commentators are calling for a recession. Yanis Varoufakis, Greece’s outspoken ex-Finance Minister, who has been on a global lecturing tour returning to the University of Sydney where he had lectured in economics between 1988 and 2002 stated: “There will be a recession in Australia, because of the collapse of investment and because of the collapse of animal spirits – and this is because of what’s happening in China.” He attributes this to the unbalanced growth model “There has been a significant reduction in investment in things that maybe were over-invested anyway, like mining, but there hasn’t been a transfer of that investment into other sectors.” Glenn Stevens noted that historically “these types of events” have been “very disruptive” resulting in “major slowdowns or recessions” but this cycle appears more contained and currently the RBA forecasts still call for a “continuation of moderate growth” forecasting 2-3 percent growth for the year to June 2016, and a slight pick up the following year.

Nevertheless, even if Australia avoids recession, the budget deficit figures are deteriorating and the government is likely to downgrade its forecasts at the 15 December budget update as the budget estimates assume an iron-ore price of US$48 per tonne. A US$10 fall in the iron ore price is estimated to reduce government revenue by A$2.5bn. The Deloitte Access Economics report estimates that Scott Morrison, the Treasurer, is likely to unveil an A$5.2bn downgrade to the 2015-2016 budget of A$35.1bn (2.1% of GDP) taking it to A$40.3bn. Over the next 4 years the ‘blow-out’ over the budget forecasts could be as much as A$38bn. They attribute this to the China slowdown “pummelling” corporate profits noting “company taxes in 2015-2016 will be a bare 5% above their pre-GFC peak.” Added to this, the senate has yet to pass some spending cuts that are part of the assumptions as the ruling Liberal/National Party coalition is short of a senate majority.

S&P noted in their July 2014 review that “We could lower the ratings if external imbalances were to grow significantly more than we currently expect,…..We could also lower the ratings if significantly weaker than expected budget performance leads to net general government debt rising above 30% of GDP.” General government debt to GDP was 32.7% for 2014 on Moody’s figures (June fiscal year end). However, at this stage all the rating agencies all retain a stable outlook and any negative adjustment is likely to be made first to the outlook rather than the rating itself.