Downturn but no recession for Australia

BIS Shrapnel believes the Australian economy will not fall into recession, despite the dismal growth in real GDP in the September quarter.

BIS Shrapnel believes the Australian economy will not fall into recession, despite the dismal growth in real GDP in the September quarter.

According to BIS Shrapnel’s latest Economic Outlook bulletin, the measures taken by the Reserve Bank of Australia and the Federal Government will reboot the flailing economy.

“The aggressive reduction in interest rates, now down three per cent from early September, and the Federal Government’s strong fiscal stimulus package in December, are geared to restart the economy,” says BIS Shrapnel economist and bulletin author, Rachael Logie.

“Increases in household disposable income will eventually outweigh the discretionary saving associated with fear of loss of income.”

Logie says there is simply no good reason for Australia to fall into recession, however if the negative sentiment continues, we could talk ourselves into one.

“Australia is not in the same dire position as other developed western countries,” explained Logie.

“The US, UK, parts of Europe and Japan are being caught with over-investment, a collapse in property prices and bank balance sheets, problems of bank insolvency and weakening construction, which will mean periods of declining growth for these regions.

“The Australian banking system faces no such problem. They have lost most of their competitors and will face only minor impacts from direct exposure to overseas problems.

“Further, Australian residential property markets are not over supplied, and after the current shock, prices and construction will rise, not fall.

“For now, affordability is improving due to interest rate cuts. Rents continue to rise, and with governments contributing to first home owner deposits, investment in housing is starting to become attractive again.

”BIS Shrapnel believes the Australian economy will be boosted in the short-term by the strength of investment as the current round of projects are finished, the drought eases and exports strengthen as extra capacity from the minerals boom comes on-stream.”

The real problem, Logie says, is a lack of confidence, which is affecting both household and business expenditure.

“Australian households became increasingly uncertain with four interest rate rises in the eight months to April 2008 and rocketing petrol prices, which severely affected their disposable income,” said Logie.

“The events of the financial crisis did nothing to allay those fears and households were flung into precautionary savings mode, petrified of losing their jobs.”

However, Logie says the pre-conditions of the recovery of consumption expenditure are already in place.

“Reduced interest rates and falling petrol prices are pumping disposable income into households, especially across the mortgage belt.

“The Australian economy will reach a point when the increased income outweighs the fear of job loss,” Logie said.

BIS Shrapnel acknowledges that employment will certainly weaken in the next six months, however this will be because employment will not keep pace with new additions to the workforce, meaning it will be harder for new entrants to get a job.

“It is only a matter of time before households start to spend again,” predicts Logie.

“Once confident of job security, and with income growing strongly, they will start to spend again.”

BIS Shrapnel believes the collapse of business confidence, due to fears of recession, has been heightened by the credit squeeze and the collapse of share markets, while current problems obtaining debt and equity finance will affect the next round of investment projects.

“Banks are withdrawing credit from development and investment, particularly in property,” says Logie.

“They think this climate is like the late 80s and early 90s, when the collapse in property prices caused significant write-offs and solvency problems in the banking system.

“That may be the case overseas, but not in Australia. Indeed, having lost their competition, the banks will come out of this stronger than ever.”

BIS Shrapnel says the real concern is in the medium-term. The stalling of the next round of projects will start to affect work done on building and minerals investment two to three years from now.

The issue is the magnitude and duration of the downturn in minerals investment, and the impact on the sectors and regions which service it. However, this can be offset as non-residential building recovers and infrastructure spending remains strong, provided that state and federal governments hold their nerve.

Meanwhile, BIS Shrapnel predicts recovery in the residential property market and residential construction should lead a strengthening of growth a year from now.“Construction activity is a primary driver of economic growth,” explains Logie.

“It is mainly domestically serviced and has a strong multiplier to the rest of the economy. Unlike the overseas recession economies, Australia will experience rolling investment cycles, the net effect of which will drive our growth prospects.”

BIS Shrapnel concludes that the Australian economy should skid through this short-term setback with a relatively shallow downturn due to declining interest rates and the fiscal stimulus, which are putting cash into the mortgage belt.

The company also says once Australians are confident that we are not facing the same nature of problems as overseas economies, consumer expenditure will recover.

“Consumer demand will remain flat in the first half of next year, but recover in the second half, while non-dwelling investment will hold for another year as we finish the current round of projects. By that time the recovery in residential construction will be coming through,” concludes Logie.

Email rlogie@bis.com.au for more information.