Australia: Economic rebalancing will boost growth Asia Pacific Economic Outlook, Q1 2016
The composition of the Australian economy is gradually shifting from export-driven activities to those driven by domestic demand and from the resources to the nonresources sectors. These shifts, in response to declining mining investment and a fall in commodity prices, are expected to help the economy sustain growth.
After moderate growth in the first half of 2015, Australia’s economy gathered pace. GDP grew at 2.5 percent year over year owing to strong growth in exports and solid consumer spending offsetting the heavy drag from slumping business investment.1 Mining activity was up 5.2 percent quarter over quarter, helping net exports to contribute 1.5 percentage points to GDP growth. However, investments remained weak, while construction tied to mining plunged 7.1 percent quarter over quarter. Australia’s economy has grown more modestly recently due to the slowdown in the Chinese economy, which has curbed demand for Australia’s commodity exports. Yet, the latest GDP release suggests some improvement.
A high unemployment rate and slow wage growth indicate that excess capacity exists in the labor market, which is expected to tighten in the months ahead, as indicated by the increasing number of job vacancies and advertisements.
Lately, the composition of economic activity has been changing. There is evidence that the economy is gradually moving away from being export-driven to domestic demand-driven and from the resource to the non-resource sector. These gradual shifts, in response to declining mining investment and the recent fall in commodity prices, are expected to help the economy sustain growth at a desirable pace.
Drivers of growth
Low interest rates have supported strong growth in private consumption expenditure and dwelling investment in Australia. Although still below the historical average, private consumption expenditure grew at a robust pace of 2.7 percent in Q3. Growth in dwelling investment, too, remained healthy at 10.3 percent.
Both these components of GDP are expected to drive domestic demand and, thereby, growth. Retail sales, motor vehicle sales, and surveys of consumers’ perception of their own finances indicated that consumption is expected to remain strong in the coming quarters.2 The number of multi-high-density dwelling approvals have been increasing at an impressive rate, indicating dwelling investment in the pipeline is likely to significantly contribute to growth. However, there are a few risks in the housing sector, as a few forward-looking indicators provide mixed signals. While residential building approvals are already high, house prices also are picking up quickly. In addition, banks’ lending standards have been tightening lately, to check housing credit growth. In other words, dwelling investment growth might increase, but at a moderate pace.
Economic activity in the services sector has been gathering momentum, while growth in the goods-related sectors (excluding the mining industry) has remained stagnant. Growth in household services and business services has improved considerably in the past few years, as suggested by the recent pickup in employment and the number of job vacancies in these sectors. According to the Australian Bureau of Statistics (ABS) capital expenditure survey of firms, measures of business conditions in the non-mining sectors are clearly above their long-run averages, primarily in the services sector.3 Exchange rate depreciation, too, has supported growth in services exports.
Nonresidential investment, however, will likely remain subdued in the next year. Setting aside the expected fall in mining investment, growth in non-mining business investment does not look promising either, as indicated by the ABS capital expenditure survey and the low level of nonresidential building approvals.4 In addition, declining corporate profits and low capacity utilization may have an adverse impact on investment decisions. The services sector tends to be less capital intensive. As a result, growth in this sector has translated to more employment and limited capital investment. That said, there are a few signs that non-mining business investment may pick up, owing to low corporate borrowing rates, rising business credit, and improving conditions in goods-related industries. However, the strength and timing of the recovery remain uncertain.
Labor market and inflation
Employment in goods-related industries remains weak; it has been falling in the mining sector and has stagnated in the construction sector. However, the shift in the composition of economic activity toward labor-intensive services has supported overall employment growth, which has outpaced population growth over the past year, according to government estimates.5 In addition, stagnant wage growth in relation to the unemployment rate has encouraged firms to employ people rather than invest in capital.
However, despite rising employment, the unemployment rate has remained stable, in the range of 6.00–6.25 percent, in this period. This is because, with rising labor demand, the supply of labor has also increased. The participation rate has trended up due to rising employment prospects and the government’s recent initiative that requires recipients of unemployment benefits to search for work more intensively than in the past. A high unemployment rate and slow wage growth indicate that excess capacity exists in the labor market, which is expected to tighten in the months ahead, as indicated by the increasing number of job vacancies and advertisements.
Headline inflation has remained subdued due to slower wage growth, lower fuel and utility prices, and overall weakness in economic activity. It is expected to remain so, although continued expansion in the housing market and a weak currency pose risks.
Growth outlook and policy actions
Australia’s growth in the near future depends significantly on the economic outlook of China, global trade, and both their implications on commodity demand and prices. Vulnerability in the financial sector and a decline in China’s demand for Australia’s exports present significant downside risks for the latter’s growth outlook. A shift in economic activity may help the economy to partially counter the impact of external risks, but growth in the consumer spending, dwelling investment, and services sectors will likely depend on the pace at which the labor market improves. Apart from the expected tightening of the labor market in the months ahead, a mismatch in required skills and job locations, as well as a prolonged period of weak labor market conditions, will likely hinder a substantial pickup over the medium term.
Overall, economic growth is projected to be within the range of 2.4–2.8 percent in 2015–16.6 The authorities have initiated a number of policies to support domestic demand, including a further easing of monetary policy in recent months. The monetary policy stance in the future will depend on the Reserve Bank of Australia’s assessment of the economic outlook. While policy rate reductions may not translate fully to more economic activity—rather, there is a possibility that further easing may exacerbate the risk of a house price bubble—significant external risks are likely to deter the bank from increasing interest rates anytime soon.