It’s been Australia’s great economic saviour – a decade-old mining boom stretching from the Pilbara region of Western Australia to Gladstone in Queensland. It ensured Australia’s relatively safe passage through the height of the global financial crisis. There’s new evidence though that the nation is approaching a critical turning point in the investment cycle that’s set to create serious problems for the economy.
Here are the nuts and bolts of it:
China’s insatiable demand for the country’s raw materials has seen dramatic increases in the prices of iron ore and coal over the past 5 to 10 years. Those price increases are now starting to taper off but the government says that’s not a problem. It says there’s still a number of “mega projects” earmarked for the resources sector that have been approved and will provide the economy with billions of dollar’s worth of investments. In fact according to the Bureau of Resources and Energy Economics, committed investment in resources and energy projects in Australia increased to a record $268.4 billion in October this year. That comprises of around 87 projects that have received a final investment decision. So that’s good right? Well one of the nation’s leading economists says it’s not enough.
Here’s why: Deutsche Bank’s Adam Boyton says record levels of investment are one thing, but what’s behind that investment? … In other words, what’s next?
It comes back to that question of growth. It’s all very well to have huge amounts of money flowing into the economy, but if that pipeline has a finite end, you need something to replace it. At the moment the Australian economy has very little to support it outside the resources sector. But we can get back to that in a moment.
First, it’s important to emphasise the very basic reason why this investment boom is running out of puff. It’s to do with the ‘mining boom’ that preceded it. See if you were selling oranges at a lemonade stand and the prices of those oranges started to rise dramatically, you might consider setting up another stand and hiring more workers. If the prices kept rising you might think about repeating that process over again. But what happens when those prices stop rising or even start to fall? The number of people willing to lend you money so you could set up another stall would fall. Well the price rises the nation enjoyed during the mining boom are starting to settle down (and in the case of iron ore, fall). As a result, the investment pipeline for iron ore, coal, and what’s perceived as the future of Australia’s resources sector – LNG – is looking vulnerable.
Here’s a break-up of the resources investment pipeline to show just how vulnerable the sector is. The numbers speak for themselves. As I mentioned before, the number of committed resources investment projects stands at around $268 million. There’s now around $292 billion worth of projects tied up in the “feasibility” stage, and a further $133 billion of projects that have simply been publicly announced (all figures from the BREE). Here’s the catch. The only investments that an accountant could reasonably book are the committed ones, the rest are questionable. Given prices for commodities are falling, the argument is that at the very least Australia will see less investments proceed through to the committed stage than was previously hoped for.
Deutsche Bank’s Adam Boyton says that’s not good news for growth. And to add insult to injury, a large part of the growth in the value of “committed projects” seen in the past new months is due to cost increases, not project expansions.
But why is growth a problem considering the sheer amount of money that’ll be injected into the economy over the next 6 to 12 months as a result of the investment boom? It’s because there are very few other areas of the economy that are growing fast enough to generate overall GDP growth – the measuring stick for Australia’s economic output.
The retail sector is only growing very modestly, the manufacturing and services sectors are contracting and overall business investment is also forecast to contract next year. Add to that we have a government that’s hell bent of creating a surplus budget which means fiscal policy (or the government’s contribution to economic growth) is effectively subdued.
The Reserve Bank though says it has the answer. It will provide lower interest rates to stimulate consumer spending and says the nation’s construction sector is the most likely of all the sectors to fill the gap in economic growth that will be left by the tapering off of the mining investment boom.
I’ve spoken to two industry experts though that aren’t entirely confident of that proposition. The first was an independent economist from BIS Shrapnel, Tim Hampton. He’s a former central banker from New Zealand. He says while there are signs the construction sector is growing, there’s a real chance the growth in the sector won’t be enough to lift the nation’s overall growth. Even more bearish was the Housing Industry Association’s spokesman, David Bare. He said growth in Australia’s construction sector was likely going to be hurt by government red tape and the rising cost of doing business. He conceded the construction industry was facing real challenges next year.
A quick look at the current cash rate set by the Reserve Bank tells you everything you need to know. It’s just 25 basis points away from the cash rate set during the height of the global financial crisis. The Reserve Bank is all too aware of just how in need the non-mining sectors of the economy are. It’s created this great disconnect – having a thriving mining sector and close to record low interest rates. The Reserve Bank is hoping that at some point, consumers will reach into their pockets and spend. It’s also hoping for a pick-up in the housing market. That would certainly provide some stimulus for both the construction sector and the manufacturing sectors.
At the risk of sounding like a broken record, if the construction (both residential, commercial and engineering) sector does not improve substantially next year, and the pipeline of LNG investment starts to dry up (due to falling prices and a lack of overseas interest), Australia’s economic growth rate (according to Deutsche Bank) will likely halve over the next 12 months or so. If the government insists on returning the budget to surplus, and the Reserve Bank monetary policy lever fails to push consumers back out into the streets, policy makers have a significant challenge on their hands.