Business Outlook: China’s tricky transition
Deloitte Access Economics
27 October 2014: The game plan has been for strengthening rich world growth to take up some slack from emerging economies, allowing for a return to above trend growth both globally and among Australia’s major trading partners. Yet the Eurozone is lumbering, while Japan’s tax increase has sapped strength from its recovery and left it once more all-too-close to recession. At the same time China’s transition remains quite worrying, with its faltering property prices, its dodgy finance companies and its over-reliance on infrastructure leaving China with a struggle to hit its short term growth targets. At least the US is now accelerating once more. And whether or not it is sensible policy, the extra stimulus China has rolled out should help for a while there, too.
- Australia’s transition through the mining boom is going well – mining-related construction work may be fading, but resource exports are climbing fast, while low interest rates have coaxed some better news for retailers as well as a very welcome recovery in housing construction. That relatively smooth baton pass between growth drivers has kept overall Australian economic growth close to trend. Yet although production is growing at trend rates, our incomes are limping. A fast fall in commodity prices has crimped national income. And, in turn, that pressure on incomes is likely to worsen negatives (such as the fall in mining-related construction) and to sap some of the strength from positives (weak wage growth will keep retail on a tight leash, while low commodity prices may trim the top off rising resource export volumes). That leaves us projecting growth to mosey along at less than trend until late 2015.
- The economy is taking pressure off the drivers of inflation, including wage gains, which are at record lows. But the $A has been pushing up import prices. To date that tug of war has seen underlying inflation edge up to 2¾%. Yet despite the potential for more price pressures from a still falling $A, there just isn’t enough tinder to suggest anything other than a moderate inflation outlook. The economy will grow at or below trend, and wage growth will remain modest as Australia works its way back to better cost competitiveness.
- Australia’s banks are taking advantage of cheap global funding to cut fixed term mortgage rates. Along with concern over housing prices, that says the RBA won’t cut the cash rate below its current lows. Yet equally there will be no rush to raise rates – China is too wobbly and the ‘construction cliff’ too big for the Reserve to take away the singing sauce until well into 2015. Cracks are finally showing in the $A. It remains modestly higher than today’s fundamentals, and higher still versus where those fundamentals may trend to over time. That may not last.
- Manufacturing is now a shrinking share of China’s economy, so the migration of people from the country to the city has slowed, while the one child policy means its working age population is falling. Add in a deflating housing bubble and the risk that dodgy finance companies fold, and the growth in China’s demand for commodities has dropped. No wonder commodity prices are tanking, flipping Australia back into trade deficit. We see more price falls ahead, though we still also see commodities keeping most of their post-2003 price gains. (Let’s hope we’re right. If China’s property bubble unwinds faster than we expect, then that would mean big trouble for Australia.)
- The shift from the construction to the production phase of the resources boom isn’t job friendly and, despite its recent falls, nor is the $A. Yet there’s good news in low interest rates, which are widely underestimated as a powerful prod to job gains. Retail and housing construction – two key ‘interest rate sensitive’ parts of the economy – are relatively labour intensive, and both are gathering steam. Moreover, although job growth isn’t great, the mix of slowing population growth and continuing retirement among a number of baby boomers will continue to restrain the overall impact on unemployment rates of that modest job growth.
- Although the iron ore price collapse of 2014 doesn’t really worsen the dollars in the Budget heaps (Treasury’s forecasts for nominal growth, the key driver of revenues, were already conservative), they are a stark reminder that the economic downdrafts hitting the Federal Budget aren’t going away. Sadly, nor are the policy negatives. The May 2014 Budget has struggled to get through a Senate more intent on scoring populist points than on fundamental fiscal repair. Luckily the one big deal that got through – the mining tax package – managed to do so without much cost to the bottom line. Even so, the small savings the Budget had hoped to make in the short term look to have been lost to Senate obstructionism. The fiscal repair task that lies ahead may not be urgent, but it remains huge.
The big levers of sectoral growth are on the move
- There’s action afoot: fading Chinese growth mean each of the three biggest drivers of relative industry performance (commodity prices, interest rates and exchange rates) are on the move. Rotten commodity prices will throw more rocks in the path of mining-related construction and mining, though at least mining will keep raising output as past investments come onstream.
- But China’s woes won’t only produce losers. They should also cement low interest rates lasting for longer here in Australia (the Reserve Bank should deal with its concerns over housing prices by regulating back lending practices, not by raising rates). And those low interest rates will continue to underpin good news in the finance sector, in retail sales, in real estate and in housing construction.
- Similarly, a lower exchange rate reduces pressures on farmers, manufacturers and even the miners themselves (though not by nearly enough for the latter given what’s happened to commodity prices).
- All these changes continue to eat away at the ‘two speed’ split in Australia’s sectoral landscape. Yet there are two problems: first, the narrowing growth differentials owe more to strong sectors slowing rather than weaker ones accelerating and second that some sectors – transport and the utilities among them – remain in the slow lane.
Queensland and the Northern Territory top the State leader board
- Australia’s State economic drivers are in transition as resource-related construction slows while lower interest and exchange rates stimulate sectors such as retail, housing construction and tourism. Those changes imply a resulting transition in the State leaderboard. Yet although that transition is already happening, it isn’t immediate. That is why resource-related construction work will keep Queensland and the Northern Territory near the top of the State league ladder for output growth in 2014-15.
- Yet Western Australia is already slowing as the construction cliff increasingly bites, while NSW, Victoria and Tasmania are on their way up the relative growth ranks.
- It’s NSW’s time to shine. Low interest rates are supporting retailers and a rising tide of advisory work for the State’s business sector. The housing market is also hot, with a big lift in homebuilding underway helping to underpin a broadly favourable growth outlook.
- Victoria’s economy isn’t as pressured as some might think. Yes, manufacturers are still doing it tough and homebuilding doesn’t have the same upside potential as elsewhere. Yet interest and exchange rate trends and solid population gains will keep the overall outlook solid.
- Queensland is dealing with painful falls in coal prices, but the mega-gas projects underway will delay the impact of the ‘construction cliff’, and will generate big export dividends. A lower $A will also help tourism, while low interest rates are reviving the State’s homebuilding sector.
- South Australia’s economy is in the slow lane. More pain is on the horizon as it stares the closure of car manufacturing in the face, while a chunk of the submarine manufacturing task might also go the same way. At least low interest rates and falls in the $A provide some relief.
- Western Australia faces big challenges from a looming construction cliff. Although the baton pass from construction to exports has been smooth so far, the State’s economy is slowing and a further recent slump in the iron ore price highlights the ongoing risks.
- Tasmania’s economy is finally picking up after a few years in the doldrums, with a wide range of indicators now looking substantially healthier than they were. Yet prospects in the Apple Isle won’t outpace those nationally over time, even if they are slowly improving.
- The Northern Territory’s economy is at the top of the State leaderboard. That’s not a big surprise as the huge Ichthys project is currently in its construction phase. Yet that won’t last forever, and the sheer size of that’s project footprint will eventually leave a big hole to fill.
- Public sector job cuts are hitting home in Canberra where there is now plenty of weakness across a bunch of economic indicators. The news could get worse from here if the Feds look for alternative savings following the blockage of key Budget measures by the Senate.
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