ECONOMIC UPDATE AUSTRALIA THE BOTTOM LINE China’s slowdown continues to pressure Australia’s economy – keeping our own growth below trend. Then again, “below trend” isn’t a bad outcome at the tail end of Australia’s biggest ever boom. Even better, some parts of the economic landscape (such as jobs) are in good shape, although others (such as the Federal Budget) are more directly pressured by China’s woes. That combination is keeping interest rates low here in Australia, and it is projected to lead to ongoing weakness in the Australian dollar. But the pressures on the Budget mean that policy changes – such as the potential for tax reform – will have to be conducted amid a difficult backdrop. The key factor to watch will be China: Australia won’t be immune if China’s slowdown sharpens, but equally would benefit were Chinese growth to be stronger than expected.
THE OUTLOOK FOR THE AUSTRALIAN ECONOMY Global economic growth remains in the slow lane. The United States has largely recovered from the aftermath of the global financial crisis, with the rise in US interest rates late last year a show of confidence in its outlook. However, the slowdown in China is far more important for Australia, as China is Australia’s major trading partner. Concern about the slowdown in China’s economy and financial system instability has seen global stockmarkets on the backfoot. Additionally, reduced Chinese demand has caused the price of our major exports (such as iron ore) to fall substantially. Reductions in commodity prices are a mixed bag for the rest of the globe. Other commodity producers such as Brazil, South Africa and Canada are feeling the pinch, while lower commodity prices (including lower oil prices) being excellent news for the globe’s consumers (such as Japan, India and much of Europe). Economic growth in Australia is expected to remain below trend (long run average) through 2016. Mining-related construction activity continues to slow, and the fall in commodity prices creates a situation in which production growth that is “slightly below trend” is occurring at the same time as national income growth that is “well below trend”. On the other hand, low interest rates have led to record housing construction and provided continuing support to retail spending, while the lower $A is bringing tourists to our shores
Follow and tweet us @Chartered_Accts
charteredaccountantsanz.com
and helping a number of other exporters as well. Overall, the Australian economy is expected to grow by 1.9% in 2016, an outcome that would be slightly lower than the growth in 2015. Australia is currently facing a period of lower wage growth than has been seen in decades, and wage gains may remain subdued through 2016. Low wage growth has helped job growth to stay strong, bringing more people into the workforce and keeping unemployment below 6%. Labour costs are also a driving force behind inflation so, with low wage growth, inflation is largely being kept well in check. Overall, inflation poses few risks to the Australian economy currently, with the price pressures resulting from a lower Australian dollar being largely offset by weak wage growth and low petrol prices. Low interest rates, and consequentially low mortgage rates, have resulted in house prices continuing to rise. Price gains in Sydney and Melbourne have been particularly strong, but home ownership is becoming increasingly unaffordable as prices rise while income growth remains weak. Because interest rates are unlikely to fall much further and housing supply is slowly growing to meet demand, price rises are projected to moderate over 2016, a trend already witnessed towards the end of 2015. Overall, slowing population growth, tighter restrictions on investor lending, big increases in residential construction and potential homeowners looking to buy in better value markets mean that it is likely the house price boom has peaked. The slowdown in the Australian economy due to falling miningrelated construction moved the Reserve Bank of Australia to cut interest rates in an attempt to stimulate other parts of the economy. To a degree this has worked, with the housing construction and retail sectors the prime beneficiaries of cheap credit, and the cash rate remains at the historic low of 2%. The consensus view among market forecasters is for the Reserve Bank to leave interest rates on hold through the start of 2016, though the RBA itself is clearly open to rate cuts if they are seen as warranted, which is reflected in the market pricing in at least one rate cut by the third quarter of 2016. The Australian dollar ($) has behaved largely as expected, falling further throughout 2015. With global commodity prices expected to get worse before they get better, it is likely that we’ll see a renewed drop in the $A throughout 2016, levelling off at around $US 67 cents before making a modest recovery.
RISK FACTORS The Australian economy faces several risks as it enters 2016, with the slowdown in China sitting squarely at the top. The Chinese investment boom has slowed, and that nation’s move towards a modern retail-led economy will not bring the same degree of benefits to Australia, at least in the short term. The resultant lack of income growth within the Australian economy also poses risks down the track. Most notably, low commodity prices – those for the likes of coal, iron ore, oil and gas – suggest that the incentives for miners to “build the next mine” are relatively low.
STATE OF THE STATES New South Wales, Victoria and (to a lesser degree) Tasmania have been the big beneficiaries of the changing flows in the Australian economy. House price rises have been strongest in Sydney and Melbourne and the lower $A has boosted activity in the tourism and education
sectors and provided some shelter to the nation’s hard hit manufacturers. However, the prolonged downturn in manufacturing in South Australia means that the state is not benefiting to the same degree as the other non-resource rich states. Growth in the ACT remains subdued due to restraints on Commonwealth Government spending. The resource rich jurisdictions of Queensland, Western Australia and the Northern Territory face big reductions in mining-related construction activity which have propelled their economies in recent times. While export volumes will continue to grow due to increased production capacity in minerals and energy, this will not provide the same domestic benefit – this is reflected in the substantial differences between the “spending” (red markers in Chart 1.1) and “production” (blue bars in Chart 1.1) measures for these states on the chart. Low interest rates and the low $A will offset this somewhat, particularly in Queensland due to its large tourism sector.
Source: Deloitte Access Economics
Follow and tweet us @Chartered_Accts
charteredaccountantsanz.com
2016 POLICY OUTLOOK The process of financial regulatory reform will continue through 2016. As global standard setting bodies continue to progress their post-GFC reform agenda in a bid to address “too big to fail”, the Australian regulators and our banking sector will be preparing for local implementation. The Australian Prudential Regulation Authority (APRA) will continue its work to ensure that banks have sufficient liquidity across their funding profile. Another aspect will be the continuing calibration of capital standards, part of ensuring that they have “unquestionably strong” capital ratios. Through 2016, the Basel Committee on Banking Supervision will be finalising its proposed revisions to banks’ approaches to calculating risk-weighted assets across major risk areas, including for residential mortgage exposures. Yet while capital and liquidity standards work to reduce the probability of failure, there can be no guarantees. APRA will be consulting industry to ensure that banks have sufficient loss absorbency to enable authorities to implement an orderly resolution in the event of failure. These reforms will have implications for both commercial and personal lending markets, which could have a bearing on the economy. In addition to the global reforms, Australia’s financial sector has been subject to extensive review over the past few years. While the Financial System Inquiry’s (FSI) recommendations on resilience of the banking sector will align with these global initiatives, the FSI’s recommendations had implications for the broader financial system. The Government’s response to a number of FSI recommendations are also on the agenda for 2016, which will have implications for financial advisors and recipients of financial advice. These include introducing a professional standards framework to raise the competency of financial advisers. More broadly, the Australian Securities & Investments Commission (ASIC) will be focusing its efforts on concerns around conduct and culture, in the context of consumer and investor protection and market integrity. The behaviour of “gatekeepers” – such as promoters of investment products – is expected to be paid particular attention. Investor responsibility remains a “cornerstone” for financial markets, and improving disclosure for retail consumers will be on the work program for industry and regulators; with work currently underway in the general insurance industry. The Australian Government was able to further its free trade agenda in 2015 through the conclusion of negotiations with eleven other nations on the Trans Pacific Partnership (TPP). This added to free trade agreements (FTAs) which had already been agreed to with China, Japan and South Korea over the previous two years. 2016 will see the TPP come into force, which will provide additional opportunities for Australian businesses to export to and operate in overseas markets.
Follow and tweet us @Chartered_Accts
charteredaccountantsanz.com
Continued sub-par growth for the Australian economy in 2016 is further bad news for the Federal Budget. Lower than expected revenue growth due to weak income growth across the economy is pushing a return to surplus back even further in time. That backdrop means that the Government’s ability to make substantial changes on the tax or spending side may remain a political challenge. Before the end of 2016 we will be expecting the Government’s announcements on tax reform. The weakness of the Commonwealth Budget may shape this outcome, potentially providing a framework for significant structural reform. Possible reform areas include changes to the GST, personal and company income taxes and the tax preferred treatment of superannuation. There is also the possibility of a change in the distribution of taxation revenue between the Commonwealth and State governments. Treasurer Scott Morrison has indicated publicly that any proposed changes to the tax system would be presented to the electorate before the election later this year. A 2016 election based around opposing views on tax is expected.
IMPLICATIONS FOR BUSINESS As businesses navigate the challenges from the changing economic and policy environment, their advisors will have a continuing role in supporting their clients. The lower $A will help export industries compete against overseas peers, opening up new opportunities for small and medium enterprises to increase market share domestically or export abroad. This is great news for the tourism sector in particular, which had struggled in recent years amid a high $A. Tourism operators, hotels and other tourist accommodation providers will benefit from the increased numbers of tourists expected to visit Australia in 2016. There will also be spillover effects for the retail and food and beverage industries due to higher patronage. In addition, the large number of overseas students choosing to study in Australia in 2016 will provide significant benefit to education providers – particularly in the big cities of Sydney, Melbourne and Brisbane. Education is already Australia’s largest service export and, as countries in our region continue to grow richer, this sector is expected to further grow in importance. The lower $A will make it easier for Australian industry to exploit new export opportunities made possible by the signing of FTAs with some of our major trading partners. The agribusiness sector in particular is expected to benefit due to better market access in major overseas markets. Lower interest rates for longer means strong activity in housing construction, property services and retail trade in particular, while also reducing financing costs for many businesses operating in other sectors of the economy.
The strength of housing markets across Australia will benefit real estate agents and residential construction firms. Although housing price growth has eased – and will presumably ease further in 2016 – residential sales values and volumes remain robust and housing construction is at elevated levels, particularly in Melbourne and Sydney. The substantial investor activity in the housing market to date also means that there will be strong demand for property managers and other associated services throughout 2016. More broadly, lower domestic interest rates and continued cheap global credit will see the finance and insurance sector outperform the overall economy. Cheaper credit encourages risk taking, and so both borrowing and lending. That said, due to tighter government restrictions on lending for investment in housing, there will be a shift from investor lending to owneroccupiers and other business lending in 2016. Other business service providers including lawyers and accountants will also benefit from the increase in property transactions, as well the elevated amount of corporate merger and acquisitions activity. The substantial falls in commodity prices over recent times have placed serious pressure on to miners. Affected entities are broader than only mining-related firms, as firms that operate in areas with a lot of mining employment including food retailers, accommodation providers for fly-in-fly-out workers and other personal service providers will likely see less business. The long term trend towards greater health and aged care spending will continue through 2016 due to the continued ageing of the Australian population. The health and aged care sector has been a top performer in recent times with the benefits in increased activity being spread out across Australia. Changing demographics also mean new opportunities for existing businesses operating in other sectors of the economy. Firms which are able to tailor their products to the growing number of older Australians may be able to attract significant new business. This is just as relevant for Chartered Accountants themselves as well as their clients.
Follow and tweet us @Chartered_Accts
charteredaccountantsanz.com