Domestic Economy Set For Weakest Four-Year Period Since The 1990s Recession

Australia’s economy will experience historically tough times over the next few years, according to leading industry analyst and economic forecaster BIS Shrapnel.

This is the key message from BIS Shrapnel’s Long Term Forecast 2014-2029 report and the company’s forthcoming Business Forecasting Conferences in September.

According to the report, domestic demand (i.e. local consumption and investment expenditure) will experience its weakest four-year period since the early 1990s recession, averaging only two per cent per annum to 2017/18.

While total output or GDP will average three per cent annually, thanks to strong mining production and exports, employment growth will act to stymie domestic demand.

“Employment growth will be soft,” warned Richard Robinson, senior economist at BIS Shrapnel. “We expect that only 668,000 jobs will be created over these next four years. It’s little better than the last four years, and it will hardly make a dent in unemployment numbers.”

Slow And Difficult Transition Back To A Balanced Economy

“It will be a slow and difficult transition from an economy driven by the huge resources construction boom, which largely underwrote our solid economic performance over the last decade,” said Robinson.  

“At the same time, the high dollar undermined the competitiveness of domestic trade-exposed industry, inducing structural change as we tilted the economy towards servicing high levels of mining investment – or, put another way, as we “made room” for the resources investment boom.”

This boom has now peaked, and its decline over the next four years will be a major negative to growth, somewhat offset by increased mining output and exports flowing from that boom.

“Ever since the GFC hit, non-mining business enterprises have been facing weak demand, weak profits and weak confidence.”

“We are looking for the next growth drivers to come through and take over from mining investment,” said Robinson.

“But we think the next set of drivers will be slow to come through. The rebalancing, the dismantling of the capacity to service high levels of minerals investment and redeploying resources to the non-mining sectors, and hence the reversing of high Australian dollar-induced structural change to more broadly-based growth, will take time.”

Stubbornly High Dollar Is The Major Roadblock To Pickup In Growth

The critical spark needed to trigger the next structural shift back towards balanced growth will again be the currency.

What’s required is a significant decline in the dollar. BIS Shrapnel believes that the dollar is reasonably valued from the point of view of competitive domestic trade-exposed industry when it is valued at around US 75 cents. But the company warns that it may take years for the value to drop.

“This boom has now peaked, and its decline over the next four years will be a major negative to growth.”

“Our forecast is that the dollar will decline, but that it will take three to four years to get below US 80 cents,” said Robinson. “The sooner the better, but Australia is too popular as an investment destination for its own good.” 

BIS Shrapnel’s fear is that the dollar will remain too high for some time, undermining the strength of recovery in non-mining business investment and delaying the next phase of growth.

The Next Structural Shift Will Come, But That Is Still 12 To 18 Months Away

GDP growth will slow over the next 12 to 18 months and remain stuck in a 2.5 per cent to three per cent band — well below its potential growth rate of 3.25 per cent — with the stubbornly high dollar providing a major roadblock to reversing the process of structural change away from declining mining investment to more broadly based growth, according to BIS Shrapnel forecasts.   

Domestic demand growth will remain just below 1.5 per cent in 2014/15, similar to 2013/14.  

“There were some signs of a pickup in non-mining business investment in the latest ABS capex surveys but these industries are coming off the bottom of the cycle after the post-GFC collapse,” said Robinson. 

“We expect that only 668,000 jobs will be created over these next four years… and it will hardly make a dent in unemployment numbers.”

Ever since the GFC hit, non-mining business enterprises have been facing weak demand, weak profits and weak confidence.

Even the stronger ones have been cutting costs, preserving cash and deferring investment and new hirings. Investment in these industries has been struggling to pick up from cyclical troughs, with only some pockets of growth and deferred spending evident in the last capital expenditure survey.

“We expect a similar pattern in the next survey, to be released this week”, said Robinson.

It will be tightening capacity — as the dollar gradually falls — and improved confidence that drives a recovery in non-mining business investment.

“But that, we believe, is at least 12 to 18 months away,” said Robinson.

Meanwhile, public investment has been falling and continues to fall as governments focus on budgets. BIS Shrapnel expects another year or so of declining activity before the next round of projects boosts activity.

At the same time, the government expects the fiscal contraction from their budget to detract around 0.5 per cent from GDP in each of the next four years.

Furthermore, the public reaction to the Abbott Government’s first budget has also impacted on consumer confidence, with muted household spending likely to further delay non-mining business investment.

Nevertheless, most of the budget measures have passed, and although there is still ongoing wrangling in the Senate over some remaining measures, recent business confidence surveys indicate an improvement in business sentiment.  

In The Interim, Exports And Housing Will Be Key Drivers Of Growth

The ingredients of positive growth (albeit below long-run average) remain in place. Real GDP growth in the short term will be driven by net exports and housing investment.

“We expect the world economy to continue to gather momentum and not pull the rug from under us,” said Robinson.

“Countries important to us, especially China, are expected to continue to grow at a solid pace. Meanwhile, imports will be soft in the near term, consistent with declining mining investment as well as weak domestic demand. We anticipate net exports will add at least one per cent to growth over each of the next four years.”

“Loss of jobs associated with mining investment will keep employment growth subdued.”

Further, the long-awaited recovery in dwelling investment is now entrenched. Having been delayed due to weak housing market sentiment and excessive caution by investors, the expectation of low interest rates for an extended period, combined with a substantial deficiency of residential stock, is driving a solid increase in dwellings building.

This will help build momentum from here. However, this recovery will not be uniform across the country, with sizeable stock deficiencies set to drive certain markets – in particular, in parts of Queensland and New South Wales.

Private non-dwelling building should also post growth — albeit moderate — over the next few years with major projects in the retail, warehouses and accommodation sectors offset by declines after the current boom in hospital building.

However, The Next Four Years Will Be Tough

The cumulative 40 per cent decline in resources investment over the next four years, coupled with a stalling in the upturn in dwelling and private non-dwelling building construction and only a moderate rise in public investment, will see total investment actually lower in 2017/18 than current levels, in real terms.

Put simply, there will not be enough non-mining investment to replace the loss of mining investment over the next four years.

While GDP growth will look good, boosted by minerals production, the labour market will remain weak in the near-term.

Loss of jobs associated with mining investment will keep employment growth subdued. Hence, BIS Shrapnel expects interest rates to remain at current low levels over 2014/15, with only modest rate rises in this next cycle. 

“BIS Shrapnel’s fear is that the dollar will remain too high for some time, undermining the strength of recovery…”

Households have built up a considerable savings buffer after several years of high savings rates. While household income growth is now softening due to weak wages and employment growth, improved financial security will see consumer spending continue to pick up modestly over the next few years.

“The upshot is that we are a long way from stable, balanced growth or what feels like a healthy economy,” said Robinson.

“The mining boom brought with it a negative structural shift in the non-mining-related part of the economy. And that will reverse. Certainly, continuation of strong cycles in investment will continue to drive cyclical shifts in the economy.

“But most importantly, a lower dollar will allow Australia to build its industrial and services base with a resumption of non-mining investment underwriting a stronger economy in the medium-term.”

Indeed, the report predicts strong growth will again resume from later this decade, with GDP and domestic demand growth lifting to around 3.5 per cent in 2018/19 and strengthening through early next decade.

The expected lower dollar (below US 80 cents) will be a key element of that stronger growth profile, with another round of mining projects, further public investment and a renewed upturn in housing and non-dwelling building all contributing.