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Australias economy needs torebalance from mining to non-mining
led growth
The process is being made moreurgent by the slowdown in China and
the fall in commodity prices
But we think Australia will avoid asignificant downturn or a recession,
helped by a weakening AUD
Mind the mining gap
Australias growth has been uneven in recent years; with the
mining sector booming, other sectors were held back. As the
mining story slows, other sectors need to pick up to support
Australias growth (we have been calling thisAustralias great
rebalancing act, 7 December 2012).
There are some early signs that rebalancing is gradually
happening, although it has been slower than expected. This
reflects that it has been hampered by the AUD, which had
remained high until recently, and by households that have
continued to save more than expected. Asias growth has
also been weaker than expected, dampening confidence (see
ourAsian Economics Quarterly Q3 2013: Asias bitter
medicine, 9 July).
We remain optimistic that Australia will pull off its
rebalancing, although growth is likely to be below trend this
year (2.5%), before heading towards trend next year (2.8%).
The RBA may cut rates further to support this rebalancing.
Our optimism reflects that: Australias main trading partnersare still the worlds fastest-growing economies; there are few
imbalances in the local economy; the bulk of the local
economy is outside of mining; policymakers still have room
to move on the monetary and fiscal policy fronts; and the
AUD could fall further if necessary.
Key risks are a sharp fall in commodity prices, due to slower
Asian growth, or a ramp-up in global commodity supply.
However, we remain confident that local policymakers have
room to loosen policy and the flexible AUD could provide
support in the face of a negative global surprise. While a
recession can never be completely ruled out, we think
Australias R-word is more likely to be rebalancing.
Economics
Australia
Australias R-word:Rebalancing notRecession
10 July 2013
Paul Bloxham
Chief Economist, Australia & New Zealand
HSBC Bank Australia Limited
+61 2 9255 2635 [email protected]
Adam Richardson
Economist
HSBC Bank Australia Limited
+61 2 9006 5848 [email protected]
View HSBC Global Research at: http://www.research.hsbc.com
Issuer of report: HSBC Bank Australia Limited
Disclaimer & DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix, and with theDisclaimer, which forms part of it
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Mining booms three stages
Australias economy has been supported in recent
years by a mining boom. This has been a key
reason for the economys outperformance
compared with the rest of the developed world.
The boom can be thought of as occurring in three
overlapping stages (we outlined these in
Downunder digest: Reports of the mining booms
death greatly exaggerated, 26 July 2012). First,
commodity prices rise, boosting incomes. Second,
the high level of commodity prices motivates
mining companies to invest significant amounts in
new capacity. Finally, there is a ramp-up in
resources exports as new capacity comes online.
The first stage is over, the second stage is winding
down, but the third stage is only just ramping up.
Commodity prices havepeaked, so the first stageis over
The first stage occurred between 2003 and 2011,
with a brief interruption during the global financial
crisis in 2008. Thanks to Chinas large boost to
government spending after the global financial
crisis, commodity prices bounced back in 2009,
after a brief and sharp fall in 2008 (Chart 1).
1. Commodity prices have passed the peak, but are still high
Source: RBA
Mining slowing, notcollapsing
Mining investment is near its peak as a share of the Australian
economy, as fewer new mining construction projects are started
Looking beyond this, the economy will get support from rising
resource exports, as new projects come online
But, unsurprisingly, the overall mining contribution to growth will
be less than it has been in recent years, when it had been an
extraordinarily large share of Australias GDP growth story
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At the peak, in mid-2011, the average price of the
basket of commodities that Australia exports was
370% higher than it was in 2000 in USD terms.
Commodity prices have fallen by 27% since then,
though they remain historically high, at around
240% above the level they were at in 2000 in
USD terms.
A significant AUD appreciation between Q1 2009
and Q2 2011 helped Australia to absorb the positive
shock to local incomes from the rise in commodityprices, particularly the jump in prices after the global
financial crisis. As a result, commodity prices rose
by less in AUD terms over recent years than they
had prior to the global financial crisis, dampening
the impact on local incomes.
The first stage boosted Australias income growth
most significantly in the mid-2000s. Nominal
GDP grew by 8.0% a year from 2004 to 2007
(Chart 2). It slowed to 6.4% between 2008 and
2011, and we expect nominal GDP growth will
track below its long-run average in the coming
four years, at closer to 5%, as global growth is
more constrained and Australias terms of trade
are expected to gradually decline. The first stage
of the mining boom is over.
2. Nominal GDP is slowing as the commodity price boom is over
Source: ABS, HSBC estimates
Investment boom plateauing,so the second stage is ending,too
In response to the high level of commodity prices,
mining companies increased their investment in
the resources sector. In 2008, this saw engineering
construction contribute about 1ppt to Australias
GDP growth and provide significant support for
the economy in the face of the global financial
crisis. This was a big deal at the time, but therewas significantly more to come.
The global financial crisis of 2008-09 temporarily
disrupted progress, but the ramp-up in investment
that followed in 2011 and 2012 was much larger
than the previous boost. It was led by a substantial
pick-up in the construction of Liquefied Natural
Gas (LNG) projects in Australia. In 2011 and
2012, engineering construction grew by around
40% a year and contributed over half of all GDP
growth in the economy. This is despite the mining
sector (including the sectors immediately
downstream from the mining investment boom)
accounting for less than 20% of the overall
economy (Chart 3).
3. Mining investment contribution slowed after the boom
Source: ABS
This stage of the mining story is now slowing. We
believe this should not be a surprise, given the
extraordinary pace of growth in mining
investment over the past couple of years. For
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investment to continue to grow would have
required more and more new (and larger) projects
to enter the pipeline. This would have been
unrealistic, in our view. Indeed, because Australia
has been doing so much investment, the cost of
new investment has risen substantially as
companies have been competing for labour and
capital, which has also discouraged new
investment proposals.
Mining investment is set to peak as a share of the
Australian economy this year. The precise timing
is difficult to determine due to the lumpy nature of
these large projects. A guide to the likely timing
of the peak is the Australian capital expenditure
survey, which aggregates responses from firms
about investment spending plans. The RBA has
also provided its own forecasts, based on publicly
available information, as well as its own
confidential liaison. Both, the last set of available
RBA forecasts and the numbers from the last
capital expenditure survey suggest that mining
investment will plateau over the coming year,
rather than peak and fall sharply (Chart 4).
4. Investment should plateau, but not plummet
Source: ABS, RBA, HSBC estimates
Beyond this period, we expect mining investment
will fall and be a drag on economic growth.
However, this does not imply that mining is
necessarily an overall drag on the economy. After
all, this capacity has been built for a reason to
boost Australias resources exports.
Third stage is yet to come, asthe export boom is justramping up
The third stage of the mining story is only just
ramping up. Of the three key commodities in
Australias resources story, iron ore and coal exports
have already begun to ramp up, while LNG has yet
to pick up strongly. However, the large driver of the
forthcoming increase in resources exports is
expected to be LNG (Chart 5). After all, aroundthree-quarters of the capacity build in recent years
has been to produce LNG. Government estimates
based on capacity under construction suggest that
exports of LNG will rise by around 400% between
2014 and 2018.
5. Massive ramp-up in resource exports is just starting
Source: Australian Treasury
Putting it all togetherAdding up the overall mining story suggests we
have passed the peak of the positive contribution
of mining to Australias economic growth, but
there is likely to be modest support for growth yet
to come. This slowdown is expected because the
first and second stages of the mining boom are
likely to have provided a larger boost to growth
than the expected boost from the third stage.
In real terms we expect the mining sector willcontinue to make a modest contribution to overall
GDP growth. This is mostly because resources
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exports are a much larger share of GDP than mining
investment: so while mining investment is set to
decline in coming years, we expect this to be more
than offset by a rise in resources exports (Chart 6).
6. Mining sector should contribute positively in real terms
Source: ABS, HSBC estimates
But this is not the full story. A large part of the
boost to the economy from the mining run-up in
recent years came from rising commodity prices
(stage one of the mining boom). If there was alarge fall in commodity prices, this would be a
drag on the nominal economy. That is, the run-up
in commodity prices boosts incomes, but a fall in
prices would work in the other direction.
Much depends on the commodity price outlook.
We remain of the view that commodity prices will
not fall back to the low levels of the 1980s and
1990s. We discuss this view in detail:
Commodities and the global economy: Are
current high prices the new normal?, 8 August
2012. In short, we expect the shifting composition
of global growth towards the emerging world
means global growth is now more commodity
intensive as these economies have substantial
infrastructure requirements.
However, we do expect commodity prices have
passed their peaks, which means that they are now
a modest drag on income growth. Our working
assumption for Australias terms of trade is that
they remain structurally high. We expect them to
cycle around a new higher mean than in the past,
but to edge downwards over the next couple of
years (Chart 7). Clearly, this is an important
assumption and we discuss the risks in the final
chapter, below.
7. Commodity prices to cycle around a new higher mean
Source: ABS, HSBC estimates
With this working assumption for the terms of
trade, we believe that the mining sectors nominal
share of the Australian economy is likely to edge
downwards in the next few years, although it is
expected to remain significantly higher than it was
in the 1990s and early 2000s (Chart 8). In broad
terms, this shift in Australias economy matches
the shift in the composition of global growth to
being more driven by emerging economies. For
Australia, the investment share is forecast to fall,
but this is expected to be largely offset by a rise in
export values.
8. In nominal terms, mining is expected to edge downwards
Source:ABS, HSBC estimates
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Overall, our central view remains that mining is
slowing, not collapsing, with the forthcoming fall
in mining investment expected to be more than
offset (in real terms) by a rise in exports, as new
capacity comes online.
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Non-mining was held back
The non-mining sectors of the Australian
economy have generally been held back in recent
years to make way for the mining boom.
Above-neutral interest rates in 2011 were part of
the story, as they held back the household sector.
The other key factor holding back the non-mining
sectors had been the high AUD. Until mid-April
2013 the AUD had been around 30-year highs on
a trade-weighted basis, despite falls in the terms
of trade through last year, which typically should
see the AUD decline.
Official data make it difficult to track conditions
in the mining versus non-mining sectors on a
timely basis, but it is possible to come up with
estimates using annual GDP numbers and a
technique developed by the RBA. We use this
method in Chart 9, which shows clearly that
growth in the non-mining sectors of the Australian
economy has been well below average in the pastfew years as the mining sector has been the main
driver of growth.
9. Growth in the past couple of years was uneven
Source: ABS
Given the slowdown in the mining sector this
year, other sectors of the economy need to pick up
and take over as drivers of local growth.
Importantly, over 80% of Australias economy is
not directly exposed to the mining boom. The
bulk of the Australian economy is services, as is
the case in most developed nations (Chart 10).
Many of these sectors are interest rate and
exchange rate sensitive and there are already signs
that conditions are gradually improving in these
sectors, given the low RBA cash rate. The recent
Growth should continueto rebalance
As mining slows, we expect the other sectors, which account for
around 80% of the economy, to take over as drivers of growth
Some of the interest rate-sensitive sectors of the economy,
including housing, have already started to lift
The recent AUD depreciation should help rebalance growth, as it
makes the trade-exposed sectors more competitive
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fall in the AUD is expected to provide further
support for exchange rate-sensitive sectors.
10. The bulk of the economy is services, not mining
Source: RBA
Rates right for rebalancing
Monetary policy settings are currently primed to
lift the non-mining sectors of the economy. The
RBA has already delivered 200 basis points of
cuts in the past two years, which have largely
been passed through into lower borrowing costs
for businesses and households (Chart 11). The
cash rate is at its lowest level in over 53 years and
mortgage rates are 120bps below average.
11. Mortgage rates are now at well below neutral levels
Source: RBA
Our empirical modelling suggests that cash rate
changes typically have a significant impact of
growth in Australia (seeDownunder digest:
Australias powerful policy tools, 13 January
2012), in contrast to many other developed
economies where conventional policy options are
no longer available. Estimates suggest that a
100bps cut in the cash rate boosts GDP by +0.9%,
chiefly through higher household consumption
and dwelling investment (Chart 12).
12. Australias cash rate setting is powerful
Source: HSBC estimates
In addition to the role of interest rates, the
currency is also likely to support a rebalancing of
the Australian economy. The AUD has fallen
significantly in recent months.
During the mining investment boom, the
exchange rate appreciation played a buffering
role, dampening the positive shock to local
incomes and spreading the benefits of high
commodity prices by boosting the purchasing
power of households over internationally
produced goods, services and assets, effectively
pushing local demand offshore.
As mining investment cools, the exchange rate
will likely again play its traditional buffering role.
A lower exchange rate should help to rebalance
production towards the domestic economy.
A lower currency improves the competitiveness of
Australias exporters and relative price shifts
encourage greater consumption spending withinAustralia, while the tourism and education sectors
will also get a boost from a lower exchange rate.
0
2
4
6
8
10
12
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Cash rate Effective mortgage rate
% Variable mortgage rates and nominal cash rate
Responses to 100 bp Cut in Cash RateImpact after 6 quarters
0.90.5
8.7
0
2
4
6
8
GDP
(expenditure)
Household
Consumption
Dwelling
investment
%
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This mechanism was somewhat stymied in late
2012 and early 2013 as the AUD remained around
30-year highs (Chart 13), despite commodity
prices having fallen through 2012.
13. Australias great shock absorber is working again
Source: RBA
To some degree, the AUD was being artificially
held up by capital flowing to Australia in search
of an alternative safe haven to the US bond
market. Since mid-April the AUD has depreciated
and hasmoved back towards commodity pricelevels. Australias shock absorber is once again
working to support the rebalancing of growth in
the economy.
Evidence of rebalancing
Housing market is lifting
A key channel through which low interest ratesare expected to lift the economy is the impact on
new household borrowing. A recent solid rise in
housing loan approvals provides evidence that
monetary policy is getting some traction. The rise
in housing lending is reflected in a lift in activity
in the established housing market. National
housing prices have risen by 5% since their trough
in May 2012 (Chart 14).
14. Housing prices have risen over the past year
Source: RP-Data-Rismark
Housing construction rising
As well as a lift in house prices, housing
construction has also begun to rise from low
levels. Building approvals have picked up since
their trough in early 2012, with annual growth in
building approvals currently sitting at 6% in trend
terms (Chart 15).
15. Housing construction is gradually lifting
Source: ABS
Dwelling investment has the potential to be a key
contributor to growth over the next few years as
a number of factors lend support to the sector (see
Downunder digest: Australias housing pick-up,
19 March 2013). Mortgage rates are at low levels
and the recent rise in house prices will likelyencourage further investment in housing
construction, as development returns rise. In
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addition, we have been through a period of
underinvestment in housing, as construction has
slowed in recent years. Coupled with continued
population growth, demand for new housing is
likely to remain robust (Chart 16).
16. Strong growth in dwelling investment is expected
Source: ABS, HSBC estimates
A rise in dwelling investment will, however, not
be enough. Household consumption also needs to
lift if Australias growth is to rebalance and head
back towards its trend pace.
Rebalancing has been slowerthan expected in some areas
Consumer should revive
Policy should be effective in boosting household
consumption. The cut in policy rates has already
provided a lift to disposable income. With around
90% of households on floating mortgage rates, thedrop in the cash rate has seen required mortgage
payments ease (Chart 17). Higher housing
construction should also see a rise in
consumption, supporting demand for durable
goods to fill new houses. The rise in housing
prices is also helping to lift household wealth, as
around three-fifths of Australian household assets
are the value of houses (seeDownunder digest:
Australias consumer revival, 23 April 2013).
17. Interest paid has fallen, boosting disposable income
Source: ABS, HSBC estimates
However, we have yet to see a significant rise in
household spending. Despite the 200 basis points
in cuts that the RBA has provided, the saving rate
has remained elevated (Chart 18) and
consumption has yet to rise substantially. We still
expect a pick-up in household consumption in
coming quarters, and we have been somewhat
surprised that this has not already occurred.
18. Household saving has remained stubbornly high
Source: ABS
A number of factors may have weighed on
household spending activity. In particular,
conditions in the labour market remain loose,
constraining household sector confidence.
Continued weakness in global activity has also
likely added to household cautiousness (Chart 19).
Households appear to be continuing to repay debts
ahead of required rates, constraining their
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willingness to spend. Continued household
cautiousness is a downside risk to our forecasts.
19. Consumer sentiment dipped, after lifting in early 2013
Source: Thomson Reuters Datastream
Businesses still unhappy
Business confidence has remained subdued,
despite the loosening in financial conditions that
has been delivered recently (Chart 20). Political
developments are likely to be playing a role, with
uncertainty over post-election policies an
election is due before 30 November 2013
complicating the outlook for Australian firms.
20. Business confidence has remained subdued
Source: Thomson Reuters Datastream
Businesses have also held back on hiring recently.
The unemployment rate is currently around 5.5%,
while jobs growth has only averaged around
24,000 a month since the beginning of 2013,
which is not quite enough to match the increase in
the labour force. This has seen the unemployment
rate gradually drift higher since the middle of
2012 (Chart 21). With the unemployment rate
above the full employment level, wage growth has
been subdued, and an elevated unemployment rate
is a factor holding back household confidence.
21. Labour market remains loose, subduing confidence
Source: ABS
Looking forward, policy settings are expected to be
effective in boosting employment. A lower AUD
coupled with lower borrowing costs should see
business confidence begin to improve which
should see firms committing to greater levels of
hiring. After tracking broadly sideways in recentyears, there are already some signs of improvement
in employment in the more exchange rate-sensitive
industries of the Australian economy (Chart 22).
A lower exchange rate should see increased activity
and employment in industries such as tourism, retail
and manufacturing.
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22. Some rebalancing is occurring in the labour market
Source: ABS
Tourism expected to recover
The tourism industry is also expected to recover.
There are some early signs of improvement,
reflecting a strong rise in tourist arrivals from
Asia, particularly China, as the expanding Asian
middle classes can afford to travel abroad and are
coming to Australia (Chart 23). Chinese arrivals
have risen by 85% over the past three years or so.
These trends are expected to continue.
23. Chinese arrivals into Australia are picking up strongly
Source: ABS
The number of Australias departing for
international trips is also expected to level out in
coming months as the lower AUD discourages
international travel (Chart 24).
24. Net outbound flow of tourists is levelling out
Source: ABS
Few structural impediments toprevent rebalancing
Part of our optimism about Australias rebalancing
prospects reflects that we dont think the overall
economy has substantial structural imbalances.
Indeed, inflation and wages have eased in the
broader economy in the past couple of years,
despite the mining boom. There are few signs of
asset price misalignments. In general, there have
been few signs of irrational exuberance in the
Australian economy in recent years.
Importantly, it is therefore only growth that is the
increment of change that has been uneven in recent
years, not the overall level or structure of the
economy. For this reason, it is only growth that
needs to rebalance, not the overall economy. Thissituation makes Australia different to some other
economies that are seeking to rebalance, where the
imbalances are in the structure of their economies.
While some commentators argue that there are
imbalances, we disagree with many of these
arguments. First, in our view, Australia does not
have a housing bubble. Second, while household
debt levels are fairly high, they have been broadly
stable for the past seven years and household debt is
fairly well allocated to households that can afford to
service it. Third, the mining investment that has been
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undertaken is, in our view, an appropriate allocation
of capital, given our outlook for resources demand as
emerging economies continue to drive global
growth. Finally, inflation has been low across the
economy, which is another sign that there have been
limited excesses as a result of the mining boom.
No housing bubble
We have long held the view that Australia does not
have a housing price bubble (seeDownunder digest:
Australian housing outlook positive, 12 July 2012,andAustralias place in the world, 15 March 2011).
While Australian house prices are fairly high, they
are high for structural reasons that reflect
underlying economic fundamentals. These include
that supply is low relative to demand for housing,
partly reflecting urban structure and zoning
restrictions. These constraints limit the quantity of
well located housing in Australian cities and
these supply impediments are only resolved
slowly. Solid population growth and low housing
construction suggest that there is an undersupply
of housing in Australia. A sharp fall in housing
prices would be necessary to establish that
Australia has a housing bubble, and we see a
sharp fall as highly unlikely.
It is worth keeping in mind that while Australian
housing prices are fairly high, they are at
comparable levels to a range of similar
economies. The Australian house price-to-income
ratio is similar to Belgium, the United Kingdom,
New Zealand and Canada, and only a slightly
above the level in Italy and Germany (Chart 25).
25. Australian dwelling prices similar to other countries
Source: RBA
Household debt well allocated
While aggregate household debt is fairly high in
Australia, the key to assessing vulnerability is to
look at the allocation of this household debt. In
Australias case, household debt is well allocated
to households that are likely to be able to continue
to service it. The bulk of debt is held by wealthy
households, with a limited number of highlyindebted and financially vulnerable households.
Around 75% of all household debt is held by the
highest 40% of income earners (Chart 26).
26. Most of the debt is held by wealthy households
Source: RBA
Micro survey data show that Australia also only
has a small proportion of mortgages with very
high loan-to-valuation ratios, high servicing
burdens and low incomes. In 2011, only around
15% of indebted owner-occupiers had a housing
Household Debt by Income Group
0
10
20
30
40
50
Lowest 2 3 4 Highest
%
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gearing ratio greater than 80%. The subset of
households that also had high debt servicing ratios
of greater than 50% of their incomes was low, at
3.5% of all mortgages. Even within this group,
almost half report in surveys that they have built
up some buffer by being ahead on their mortgage
repayments. Australia also never had sub-prime
loans and has a full recourse mortgage system,
which encourages households to only take on
debts they can afford.
Australians have taken the opportunity to
consolidate their balance sheets somewhat in recent
years, with debt-to-income ratios stabilising and
household saving rising (Chart 27). This implies that
the quantity of new and inherently more risky
lending growth has been modest, with households
holding more mature loans and many of them well
ahead on their debt repayments.
27. Household debt has been steady since 2006
Source: ABS, RBA
Mining capital well allocated
During any boom in a sector of an economy, there
are risks of a sharp correction if expectations run
ahead of fundamentals. In our view, however,
rather than a misallocation of resources, the
mining investment boom appears to represent a
rational response to the price signals provided by
the market.
A run-up in the prices of Australias natural
resources saw firms build up productive capacity
in Australia with mining capital allocated based
on the medium-term outlook for resources
demand. As such, rather than an irrational bubble,
the mining investment boom provides both an
initial boost to growth and improves the
medium-term prospects for Australian activity,
through providing a sustained increase in
Australian resources production.
While there have been substantial cost overruns in
many of Australias mining construction projects,
much of this has reflected that Australia has been
trying to do an extraordinary amount of work in a
relatively short period of time. This has meant
demand for skilled labour and capital in the
mining industry has risen well ahead of available
supply and driven up costs. Likewise, as mining
investment is now slowing down, there are
already early signs that many of those costs arefalling. The bottom line remains that Australia is a
low-cost producer of a range of commodities,
even if it has been a high-cost investment
destination in recent years. As we move into the
production phase, Australia is expected to
continue to have an absolute advantage in the
production of most commodities. We discuss this
topic further in the risks chapter, below.
Inflation is lowDespite a mining boom, Australias inflation and
wages growth has been subdued. Overall inflation
is currently at the bottom end of the target band
(Chart 28). Most mining booms in Australias
history saw inflation rise rapidly, leaving
policymakers with less flexibility to respond after
the boom had ended. This time around, inflation is
low, which is also a sign that there have been few
excesses in the broader economy as a result of
this mining boom.
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28. Inflation is in the lower part of the RBAs target range
Source: ABS
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China and Asia
Australias relative success in recent years can be
partly attributed to its strong ties to Asia. Around
70% of Australias exports go to Asia and
commodities constitute the bulk of these exports.
As we set out in the first section, Australias
mining boom has been a key driver of its recent
strong economic performance.
Commodity demand
A sharper downturn in Asia, which sees a fall incommodity demand, is a key downside risk to
Australias outlook. For further discussion of the
risks to the Asian growth outlook see:Asias
bitter medicine, 9 July 2013.
Chinas current slowdown presents some risk in
this regard. In the short run, there is some risk that
Chinas current focus on faster reforms sees less
fixed asset investment than we currently forecast
(see Hongbin Qu, China: Faster reform, slower
growth, 19 June 2013). However, our medium-
term view remains positive. In our view, China
has significant infrastructure yet to build in the
medium term, which should support medium-term
demand for commodities (see Hongbin Qu, China
Inside Out: Yes, China still needs infrastructure,
5 October 2012).
The infrastructure story also extends beyond
China to across the Asian region. Countries where
there is significant infrastructure yet to be built
include India, Indonesia and the Philippines (see
Ronald Man,Bridging the gap, 20 May 2013).
While China is approaching similar levels of per
capita steel consumption as the West, India, for
example, has barely started (Chart 29).
Risks and challenges
Australia is highly dependent on Asia, given that 70% of its
exports go there, which means weaker Asian growth is a key risk
Despite the mining slowdown, we see Australia as unlikely to have
a significant downturn, given our outlook for Asia and because
policymakers have room to move to support growth if needed
The challenge for policymakers is managing the economy in the
wake of the mining boom, which would have been easier if more
had been saved or productivity-enhancing reforms occurred earlier
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29. Steel consumption ramp-up in India is yet to come
Source: RBA
Importantly, much of Australias recent
investment has been in capacity to produce LNG,
and thus energy. Over three-quarters of the
resources investment boom in Australia has been
in capacity to produce LNG. Australia is therefore
set to become a large global energy producer.
The prospects for energy demand are promising,
with a number of Asian developing economies
still at very low levels of per capita energy
consumption. Chinas energy consumption is still
at low levels relative to developed economies and
India is at very low levels (Chart 30). Japan is also
in the process of substituting nuclear power
generation, having shut down 48 of its 50 nuclear
power plants following the March 2011 nuclear
disaster at Fukushima.
30. Energy consumption is still low in China and India
Source: RBA
The LNG outlook is also more stable as all seven
LNG projects currently under construction have
forward sold LNG on long-term contracts to
various Asian nations.
Commodity supply
Another risk for Australia is that the significant
global investment in the resources sector in recent
years leads to a glut of supply, which puts
downward pressure on commodity prices. Our
central view remains that there is only enoughsupply of commodities due to come online to
meet demand at prices that are well above their
1980s and 1990s levels (see Commodities and the
global economy: Are current high prices the new
normal?, 8 August 2012). But there is a risk that
more supply comes online and suppresses prices.
While this is a credible risk, it is important to keep
in mind that Australia is a low-cost producer of a
broad range of commodities. As such, in many
cases Australia would continue to export rising
quantities of commodities, even if the prices were
lower than expected. For iron ore, which is
Australias largest commodity export, the large
producers are very low on the global cost curve
(Chart 31). The same applies for many of the
large coal producers, although not all.
31. Australian iron ore at the low end of the cost curve
Source: AME, HSBC estimates
0
20
40
60
80
100
120140
0 600 1,200 1,800
Cumulative Coste d Production by Company
R
eal(2010)C
ashC
osts
(U
SD
/t)
ValeRio BHP
Chineseproducers
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US shale gas
For LNG, a significant possible threat to supply is
from US shale gas. However, as we noted above,
the LNG story should be more stable than other
commodities as the product is forward sold on
long-term contracts.
Australias domestic economy is also somewhat
protected by the high foreign involvement in the
mining industry. Australias mining sector is
80% foreign-owned and the concentration offoreign involvement in the LNG sector is even
more highly concentrated. Australias seven major
LNG projects are being built by consortia of
global multinationals, including Chevron, Exxon,
Mobil, Shell and Conoco-Phillips. When the
resources boom was ramping up, the leakage of
demand offshore was a source of local angst, as it
meant less support for local demand. Likewise, as
the mining story slows, foreign involvement
should be a source of some comfort, as it has arisk-sharing effect.
Risk of recession is low
Some commentators have started to note that as
the mining investment boom comes to an end, the
risk of a recession in Australia is increasing. Even
the newly appointed Prime Minister Rudd and his
Treasurer Bowen are noting risks of a recession,
which is a significant shift in rhetoric from that of
the previous leadership who were more upbeatabout economic prospects. While a recession can
never be completely ruled out, we remain of the
view that a recession is unlikely in the next couple
of years.
A starting point for making an assessment about
the probability of recession is to look at
Australias history. In the past 52 years, Australia
has had ten years when it was in a technical
recession a period, which begins with two
consecutive quarterly falls in GDP (Chart 32).
Using this historical experience implies that the
probability of a recession in any one year is
around 20% of course this means that there is an
80% chance of no recession in any year.
32. Australia has had six technical recessions in 52 years
Source: ABS, HSBC
Importantly, we dont see the chances of a
recession as significantly higher than normal. To
see a much greater chance than normal means
arguing that there are significant imbalances that
need to correct which, as we have argued above,
we do not see. Or, that there are reasons to think
that policymakers would be unable to respond
effectively to a downturn which also seems
unlikely in Australias case. As we have noted
above, the RBA has room to move on interest
rates if required and the exchange rate could
depreciate further to act as a shock absorber
against negative foreign shocks.
The governments relatively strong balance sheet
also offers a line of defence for the economy. Net
public debt is low, particularly in comparison to
other advanced economies around the world
(Chart 33). At the same time, the government
remains on a path of consolidation and the fiscal
deficit is relatively small (-1.3% of GDP). The
government could provide support for growth
with fiscal stimulus if necessary.
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33. Public debt is very low, so fiscal policy has room to move
Source: IMF
Of course, a recession can never be completely
ruled out. A recession can occur if there is a
significant downside surprise, which happens
quickly and catches policymakers off guard. The
speed of adjustment matters a great deal. This is
one of the reasons why we do not expect the end
of the mining investment boom to cause a
recession because it is widely forecast to occur,
which means markets and policymakers have time
to respond.
The likely driver of a recession would be a
negative surprise from abroad probably a
sharper-than-expected downturn in Asia. Of
course, a downside surprise from abroad would
also motivate a response from overseas
policymakers. In Chinas case, our Chief China
economist remains of the view that China is
highly unlikely to have a hard landing because
Chinese authorities still have plenty of
ammunition to shore up the countrys economy if
needed. In particular, he notes that China has a
fiscal surplus that has totalled RMB960bn in the
first five months, leaving Chinas fiscal accounts
in a healthy position. He sees the risk that GDP
growth falls below 7% as remote (Hongbin Qu,
China Inside Out: Will the cash crunch lead to a
hard landing?, 26 June 2013).
Challenges for policymakersManaging a smooth end to the mining
investment boom is the key challenge facing
Australian policymakers.
This would have been made easier if more had
been done earlier, when commodity prices were
rising. In particular, it is disappointing that
Australias government budget remains in a
structural surplus despite recent years of strong
nominal GDP growth on the back of rising
commodity prices. Policymakers are considered to
have failed to take full advantage of the mining
boom in terms of improving Australias fiscal
position (though, as we noted above, government
debt is still low by global standards).
The kick the economy got from rising commodity
prices has discouraged a hard look by
policymakers at productivity-enhancing reforms.
Indeed, there has been little progress made inproductivity-enhancing reforms, which can be
thought of as another form of saving or
institutional investment. Both of these were key
risks that we were concerned about when asked
whether Australia had a resources curse (Does
Australia have a resources curse? The challenges
of managing a mining boom, 18 August 2011).
For businesses, recent political developments
have also made the tax and regulatory
environment uncertain, which is likely to be a
drag on confidence. The current government has
had a minority in the lower house, which has
limited its capacity to legislate. A recent change
of leadership of the current government and the
forthcoming federal election, which is required to
occur before 30 November 2013, may have added
to local political uncertainty.
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Given low levels of government debt and a fairly
flexible economy, these issues are not expected to
be too detrimental to Australias growth prospects
though it is fair to say Australias does face
some structural issues that should have been dealt
with when incomes were growing strongly.
In the short run, we believe Australias major
economic challenge is a lack of confidence.
Australias great rebalancing relies on businesses
outside of the mining sector and households beingconfident enough to make investments and spend,
and non-mining businesses confident enough to
hire. Despite already low interest rates,
confidence has remained surprisingly subdued in
the first half of 2013. There have been a number
of reasons for this, including the mining
slowdown, worries about growth in China, the
high level the AUD maintained until recently, and
local political issues leading to policy uncertainty.
With limited help from other policymakers, the
central bank is left with the bulk of the burden of
managing the transition from mining investment-led
growth to growth supported by the non-mining
sectors. To manage this, the RBA has already cut its
cash rate to its lowest level in 53 years to support
rebalancing, but until recently the high AUD was
keeping financial conditions tight, despite the
rate cuts.
The recent fall in the AUD will help supportAustralias great rebalancing. The falling AUD is
also an upside risk to inflation, though at this
stage it is largely offset by a loose labour market,
which is continuing to put downward pressure on
local wages growth. The next move in interest
rates is highly dependent on where the AUD
settles. Current market pricing suggests another
cut is likely in coming months.
For other arms of policy, we believe the focus
ought to be on lifting Australias productivity
growth, which has been weak recently. Tax and
regulatory reform ought to be high on the
policymakers agenda and be a key part of the
discussion in the lead-up to this years election.
Infrastructure is also a key issue as congestion is
acting as a key constraint on Australias
productivity growth.
Australias R-wordIn our view, Australias R-word is rebalancing,
not recession.
Given our outlook for the global economy and
Asia in particular, and Australias current policy
settings, a rebalancing of Australias growth is far
more likely than a recession. Asias infrastructure
build-out has many years to run yet and its energy
demand is still low and set to rise rapidly.
We remain cautiously optimistic about our outlook
for the Australian economy for three key reasons.
First, despite a slowdown in Asia, Asian economies
are still expected to be the fastest-growing
economies in the world and Australias strongest
ties are to Asia. Second, Australias mining story is
slowing down, not collapsing, with the ramp-up in
resources exports yet to come. Finally, Australias
interest rates and currency are both now supportive
of a rebalancing of Australias growth; and, in our
view, Australias economy does not have obvious
structural imbalances that constrain its ability for
growth to rebalance.
We expect a period of below-trend growth in
2013, but for growth to head towards trend in
2014. We believe the RBA may need to deliver
further stimulus to support growth, but it is also
possible that the AUD depreciates sufficiently to
obviate the need for further rate cuts.
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Source: ABS, RBA, HSBC forecasts
*unless otherwise specified **includes the effect of the carbon tax from Q312
HSBCs forecasts for Australia
_______ Year-average _______ __________________________Year-ended___________________________2012 2013 2014 Q113 Q213e Q313e Q413e Q114e Q214e Q314e
%*AUSTRALIA
GDP 3.6 2.5 2.8 2.5 2.6 2.5 2.7 2.9 2.9 2.8Consumption 3.3 2.2 2.9 2.0 1.9 2.3 2.6 2.8 2.9 3.0Govt consumption 3.1 0.6 2.1 0.5 -0.5 0.8 1.8 1.8 2.1 2.2Investment 8.7 -0.3 3.0 0.9 1.5 0.6 -2.9 3.8 3.7 2.6- Dwelling -3.8 5.0 9.4 2.7 5.6 5.6 6.1 8.7 10.2 10.3- Business 16.5 -0.2 -0.6 2.3 1.4 -1.6 -2.5 1.6 0.1 -1.8- Public 0.7 -4.3 9.8 -5.8 -2.0 4.2 -11.9 7.2 10.4 11.5Final domestic demand 4.7 1.2 2.8 1.1 0.6 1.3 1.9 2.9 3.0 2.7Domestic demand 4.7 0.7 2.8 0.3 0.4 0.6 1.6 3.0 3.0 2.7Exports 6.0 7.6 6.6 8.1 8.0 8.4 6.1 6.5 6.1 6.7Imports 6.4 -0.3 7.0 -3.2 -1.3 1.0 2.2 7.4 7.0 6.8
GDP (% quarter sa) -- -- -- 0.6 0.7 0.7 0.7 0.8 0.7 0.6
CPI** 1.8 2.4 3.0 2.5 2.7 1.9 2.6 2.9 2.9 3.1Trimmed mean** 2.3 2.3 2.8 2.2 2.2 2.3 2.3 2.6 2.8 2.8
Unemployment rate 5.2 5.5 5.4 5.5 5.5 5.5 5.5 5.4 5.4 5.3Labour price index 3.6 3.2 3.5 3.2 3.0 3.1 3.2 3.3 3.4 3.5
Current A/C (%GDP) -3.9 -2.4 -2.5 -2.2 -2.4 -2.5 -2.4 -2.4 -2.4 -2.6Terms of trade -10.4 -2.9 -0.9 -6.2 -6.1 -0.8 2.1 -0.4 0.0 -1.0Budget balance (%GDP) -3.0 -1.5 -1.0 -- -- -- -- --Capital city house prices -0.7 4.9 5.9 2.6 4.2 6.7 6.2 7.3 6.2 5.2Private sector credit 3.8 3.8 6.6 3.2 3.2 3.9 4.9 6.1 6.8 6.8USD/AUD (end period) 1.04 0.90 0.86 1.04 0.96 0.94 0.90 0.89 0.88 0.8790 day bank bill rate 3.19 2.80 3.30 3.30 3.05 2.80 2.80 2.80 2.80 3.05
Cash rate (end period) 3.00 2.50 3.00 3.00 2.75 2.50 2.50 2.50 2.50 2.75
Forecast table
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Paul Bloxham and Adam Richardson
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1 This report is dated as at 10 July 2013.2 All market data included in this report are dated as at close 09 July 2013, unless otherwise indicated in the report.3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
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10 July 2013
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