The plot thickens

by David Taylor

It’s becoming more and more obvious that Australia’s economy is growing tired. After a decade-long mining boom, the economy is worn out and in need of a fresh start. As of yet, there’s no clear indication as to where that fresh start may come from. Far from sugar coating the problem, the two major bodies responsible for economic policy in this country are fessing up. The game’s up.

The confessions started late last year when the federal government conceded it will not live up to its budget surplus promise. It was clear a budget surplus was out of reach well before December, but all credit to the government for holding onto the promise until it was bordering on the absurd.

To put it simply, the government is spending more than it’s earning. At this point in the economic cycle, that’s precisely how it should be too. The economy is in need of stimulus. I speak regularly with the chief economist of the Bank of America Merrill Lynch Australia, Saul Eslake, and he argues that as the effectiveness of monetary policy begins to fade, the responsibility does rest with the government to cradle the economy.

One of the government’s many policy failures these past 12 months has been the implementation of the minerals resource rent tax (MRRT). Late last week the Federal Treasurer, Wayne Swan, announced that after 6 months, the tax had netted the government just $126 million. Last October the government gave a budget update. In that update it estimated around $2 billion would be collected in revenue from the tax. Now, I’m not a brilliant mathematician, but those two numbers are a long way from one another.

The two responses were very predictable. The government argued that the opposition hyped up how much the tax would actually bring in and then claimed it would lead to a huge economic leakage out of the resources sector. Meanwhile an industry analyst I spoke to last Friday said the revenue collapse was largely to do with the sharp drop in the price of iron ore last year (from around $140 to around $90 US/tonne). The Fat Prophets researcher said the government’s been caught out by the big miners taking advantage of tax breaks received through the development of new projects, and the dramatic fall in the price of coal. He said it was unlikely the government would receive any additional revenue from the coal industry this financial year.

The simple truth is that the government missed the boast on one of the greatest mining booms the country has ever seen.

You could in fact argue that it was a legitimate policy – depending of course on your political persuasion. The fact is that the government’s view was that the wealth dug up by the country’s miners belonged to all Australians. A tax on the miners would help redistribute income away from those who were comparatively well off, to those in more need of assistance. It’s not a Liberal view, but it’s a view, and it’s valid – especially for those on the receiving end of the cash that haven’t done anything for it in return. Legitimate policy or not, it was poorly timed. If anything, the Howard government would have been in a better position to implement the tax, but the Coalition held the view that bigger, stronger, more profitable miners would bring heavy amounts of direct foreign investment into the country and that would help contribute to higher living standards for all Australians.

I still find it curious though how badly the government misjudged how much money would come through its doors. A poorly estimated figure in July could be forgiven… but by October it should have been clear the revenue targets set would not be reached. Graciously though, the federal treasurer has come clean and owned up to the shortfall. At least now too he is speaking more and more of the risks facing the global economy and how much they are threatening Australia’s growth.

The Reserve Bank is the other major body opening up about Australia’s economic realities: a weaker labour market, lower inflation, and lower economic growth.

Sometimes it’s hard to see change when things happen so slowly, but make no mistake the Australian economy is transitioning from healthy, robust economic growth, to something less attractive. What that is exactly I really don’t think anyone can say. That’s partly because the drama playing out on the world economic stage is some way off its final act.

The Reserve Bank seems to be following the script. It decided to leave the cash rate on hold at 3 per cent last Tuesday. That was widely expected. The reasons were straight forward. While Australia’s growth rate remains below trend, the global economy had stabilised, and there’s some evidence that dwelling construction is picking up. In addition to that, inflation sits at a level that will allow the Reserve Bank to cut rates again if domestic demand deteriorates further from here.

The last Friday the central bank went further. It released its Quarterly Statement on Monetary Policy. Now bear with me here. I know that sounds like an incredibly boring document, but this time around it had something important to tell us.

You see it revealed that the Reserve Bank had lowered its forecast for economic growth in 2013 from 2.75 per cent to 2.5 per cent. The bank has conceded that the non-mining sectors of the economy have not yet, and probably won’t for some time, fill the growth hole left by the retiring resources boom. Don’t be misled, the resources sector is still powering along, and the associated investment boom is still growing, but both are showing signs that they will slow down in coming months. While the Reserve Bank waits patiently for another sector, or sectors, to fill the space, it will keep on cutting its economic growth forecasts.

The danger for policy makers is that they may end up being squeezed. What do I mean by that? Simply that it’s one thing for the economy to be left without a major sources of growth, but it’s entirely another to then have the weight of the world’s economic problems bearing down on you. That would indeed happen if any number of exogenous shocks took hold of global financial markets in the near term.

The story does have one silver lining in it. The economic events of the past 10 days (including data showing the country’s retail sector contracted - of all times - during the Christmas period), sent the Australian dollar down below 103 US cents. Any relief on that front will be welcomed by industry. Many Australian manufacturing companies would prefer the dollar be well below parity with the US dollar. The chief executive of Qantas, Alan Joyce, recently said he would prefer it fall to around 70 or 80 US cents. So a fall of just 2 cents will hardly provide material support for the economy, but at least it’s a sign that the dollar isn’t too sticky at its current levels.

Another welcome piece of economic data last week was from China. Its trade figures came in better than expected. That perhaps was part of the reason the dollar didn’t fall below 102.5 US cents.

In many ways the Australian economy is still far better off than many others right around world, but it does face its own challenges. I am relieved that both the Federal government and the Reserve Bank are being straight forward about how the business cycle is progressing. Anything else would be self-defeating. I do get the sense though policy makers are preparing markets for leaner times ahead.

The economic story may be slow-going, but you’d be wise to follow the narrative. The plot’s certainly set to thicken as more confessions come to light.

David Taylor


The content in my blog is non advisory, please do not interpret this as advice in any way shape or form. These are just my thoughts and nothing I say should be acted upon.

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