Australia: Gearing up for better days, but challenges linger Asia Pacific Economic Outlook, Q3 2017

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With exports driving growth last year and signs of global recovery becoming more visible, Australia seems to be moving toward better days. However, the economy has been facing challenges related to its labor market and domestic demand.

Introduction

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With signs of global recovery recently becoming more visible, Australia is probably moving toward better days ahead. Despite a weak Q3, the economy grew at 2.5 percent in 2016.1 Exports were the primary driver of growth in the economy last year. With iron ore, coal, and liquefied natural gas (LNG) constituting 54 percent of exports in 2016, Australia’s exports benefitted from the steady revival of commodity prices through the year. China’s rising demand for commodities and a gradual recovery in global growth resulted in a strong pickup in export volume as well. In addition, the continued depreciation of the Australian dollar (AUD) since 2014 has boosted services exports, especially in tourism and education, resulting in an improved services trade balance.

The strong momentum in exports has continued in 2017 as well and is expected to remain throughout this year. With LNG capacity set to increase over the next couple of years, export volumes will likely be supported by increased production. Iron ore export volumes are likely to improve, supported by low-cost producers. The Australian dollar is expected to remain competitive and will likely boost the services sector further. All these bode well for the trade balance, which went into a surplus in November 2016 and touched a record-high value in February this year. The surplus has remained elevated since then.

Still battling the same challenges

Australia’s economic performance is highly dependent on commodity exports, making it vulnerable to fluctuations in commodity prices. The increase in global commodity prices in 2016 contributed to a pickup in economic growth; with prices expected to remain stagnant in the coming years, there are downside risks to the nation’s growth, inflation, and currency. Additionally, Australia depends greatly on China for its exports, making it vulnerable to the latter’s economic performance. The latest data suggest that China’s growth has slowed from its recent bounce, and the economy may see a further slowdown.

The economy, which has not seen a recession in the past 25 years, has been facing challenges in improving its labor market and domestic demand for a while now.

The economy, which has not seen a recession in the past 25 years, has been facing challenges in improving its labor market and domestic demand for a while now. The labor market remains weak, as the unemployment rate has steadily edged up in recent months to 5.9 percent. Growth in part-time employment remains high, and average work hours are at historical low levels. Wage growth has continued to slow over the past few years, as spare capacity in the labor market due to structural changes in the economy and technology disruptions is weakening workers’ bargaining power. Stagnant household disposable income has resulted in a steady decline in the savings rate.

The weakness in the labor market has been impacting household spending; recent monthly reports indicate slowing retail trade and residential construction activity in Q1 2017. Dwelling unit approvals have fallen, and residential investment spending is low. While low interest rates should continue to support demand for housing, the ability of households to borrow is limited due to their existing high debt. In addition, new prudential measures by the government might lead to a tightening in lending standards and slow credit growth. A slowing labor-intensive construction sector will likely put further pressure on the labor market.

Growth in private business investment has been in negative territory since Q1 2013. Until Q3 2016, contractions were increasing with every passing quarter, as investment in nonmining sectors has failed to compensate for the slack created by falling investment in the mining and energy extraction sector. However, the contraction has been decreasing in the last two quarters. Most of the decline in mining investment may have already happened, which implies that the drag on GDP growth will dissipate over the next couple of years.

Among all the investment-grade nations, Australia has one of the worst net foreign liabilities (debt and investment). A significant proportion of the external debt has been intermediated by banks to fund unproductive household borrowing and housing investment during the 1990s and 2000s. Rapid growth in credit has led to rising household debt and house prices posing risks to banks’ balance sheets, financial stability, and, thereby, real economic growth.

The big budget

The government, which was elected last year, addressed a few of these challenges and announced several policy initiatives during this year’s budget. In order to check the deteriorating fiscal balance, it emphasized that it would need to improve its financial capacity. The government announced that it would target a fiscal balance surplus of AUD 7.4 billion in 2020–21, and it would no longer borrow to pay for everyday expenses from 2018–19.2 Accordingly, new levies were imposed on banks, companies employing foreign skilled workers, and Medicare, which are expected to increase revenue by AUD 14 billion over the next four years.

While the government announced a few cuts to welfare, it also allocated a significant amount to be spent on infrastructure, social security, and education.

While the government announced a few cuts to welfare, it also allocated a significant amount to be spent on infrastructure, social security, and education. The government pledged to spend AUD 75 billion on infrastructure over the next decade. The plan includes upgrades to highways, roads, and national rail programs across the country, as well as boosting solar and hydroelectric power. The government plans to build a second international airport in Sydney.3

Several measures were announced to tighten immigration rules for temporary skilled migrants, such as imposing levies on companies employing them, to increase job opportunities for Australians. There has been increased pressure on the government for a while on the issue of rising immigration. However, Australia still remains more open to globalization and free trade than many other countries.

A few tough rules were announced for foreign investors investing in the housing market in order to check house prices, which have been rising again since late 2016. At the same time, first-time home buyers were offered the option to save for a home using their superannuation fund. These measures may increase affordability and ensure a sustained boost to the housing market.

The budget, with a theme of “fairness, security, and opportunity,�? is likely to have some positive impact on the housing and labor market in the long run. However, the economy needs structural changes to counter the challenges it faces. Although it is likely to grow the fastest among all the Organisation for Economic Co-operation and Development countries in the next few years, risks to the performance will likely be to the downside.