Federal Treasurer Wayne Swan has seized on positive comments about Australia’s economy in an International Monetary Fund report as evidence the country can endure another global financial crisis.
The report says Chinese demand for resources continues to drive growth in the local economy, and predicts that “strong commodity demand is expected to be long lasting because of favourable prospects for sustained growth in emerging Asia”.
But with the local sharemarket beginning the week by falling almost 2%, it is clear that the crisis engulfing global markets has serious implications for Australia.
University of Queensland’s Professor John Quiggin, Australian National University’s Professor Bob Gregory, and Monash University’s John Vaz explain that Australia’s economic outlook could be less certain than the IMF suggests.
Can Australia rely on Chinese demand for its resources to see it through another global financial crisis?
John Quiggin: I think it would be accurate to say that China is robust compared to the economic situation in the US and Europe.
There are some vulnerabilities in the Chinese economy, so it’s difficult to predict for certain how long that demand will last.
But I don’t necessarily think a downturn in the US will stop the Chinese economy in its tracks.
So while we need to prepare for an eventual decline in commodity demand, I don’t there’s any reason to see a decline as a likely feature of a crisis in Europe and the US.
We managed a good fiscal stimulus last time, we the economy has essentially stabilised and the debt-to-GDP ratio has peaked. So there’s room for another fiscal stimulus if we need it, and room for interest rate cuts.
Bob Gregory: If China slows up, then the price of resources will fall. The exchange rate will go as well. But what the IMF and the Reserve Bank and Treasury are all saying is that this really won’t affect investment that much in the mining industry because the mining industry is looking a long way ahead and is committed.
To the extent that there are bumps, those bumps will not affect mining and investment activity – it will affect the rest of the economy. My guess is that the rest of the economy will probably be OK.
What matters for the domestic economy is not our exports per se, but the price we are getting for them (which affects share prices and superannuation) and the activity that is going on in building for new mines.
If China goes down, well, all the building is going to go on and so if it does spill over to the rest of the economy, it is going to be the financial part.
China impacts on the Australian economy in two ways. One is the preparing for digging holes, through investment. It will take a big shock for that to shift.
The second way it affects the economy is through the share prices. Those will go up and down, but mainly because of the global situation.
John Vaz: There are two issues with regard to China. One is their bubble and the overheating of the economy. They are trying to tighten up their monetary policy, which could slow their economy down, which slows down demand for our resources.
The second issue is maintaining a growth rate that allows more socio-economic groups to benefit from the boom. The majority of China, in the provinces and so on, have not benefited from their boom.
So China is trying to balance hot growth and inflation and the bubbles that occur when you get very rapid growth.
If that happens, the consequences will be straightforward: there will be a fall-off in demand from China for those products we export to them.
That’s not the only issue. It also depends on demand for China’s exports.
If there’s some sort of global recession, then China may have this other pressure to deal with. The overheating may be cooled off because of a fall-off in demand for their products in manufacturing. That’s an unknown at this point in time.
If all this happens and China slows down, what does it mean for Australia?
We could have recession, potentially, at the extreme end of things. We could have problems maintaining the target of surplus that the government is talking about because that relies on a tax take, which depends on activity in the economy.
The IMF recommends the Reserve Bank actually lift interest rates. In light of the unfolding crisis, is that such a good idea?
John Quiggin: I assume the report was prepared some time ago, so at the time there might not have been the prospect of an immediate and sharp downturn globally.
The view would have been that it was important for Australia to get its fiscal and monetary policies back to a conservative setting.
But I would imagine that everybody, including the Reserve Bank, would be changing that view in light of what happened at the end of last week.
Many people were expecting an interest rate increase last Tuesday, but now more or less the same people are predicting interest rate cuts for the rest of the year.
So I think this demonstrates the report was prepared before the current crisis emerged. Obviously the problems were there, but they have worsened in the past week.
John Vaz: It’s a tough one because you have this two speed economy. To deal with the problems in inflation, the only tool the Reserve Bank has is interest rates. It’s one big hammer to crush a very small nut. It’s a very blunt instrument.
You have a couple of states benefiting and having problems with inflation and the rest of the states are suffering from a stagnant service sector economy. For example, in Queensland, tourism is down.
I don’t believe the Reserve Bank is likely to raise interest rates before the end of the year. They need more signals that the global position is stable. Although inflation is on the higher side of things, they will not want to push the country into recession by raising rates so the housing sector falls over even more.
I don’t think they will be raising it this year, probably not until they see some signs of robustness of demand coming out of China.
The IMF also recommends Australia should remain committed to a surplus in 2012-13. Is this still an appropriate goal?
John Quiggin: This is the same story as with interest rates – I’m sure this recommendation was made before the situation deteriorated at the end of last week.
Obviously, people haven’t been fully aware of how much the global situation has deteriorated – not even since the last federal budget.
At the last budget I thought it was appropriate to defer the return to surplus. If the US and Europe do manage to pull through all this, then a return to surplus will be appropriate.
A significant point of returning to surplus is having the capacity to pay for an economic stimulus if we need it.
Bob Gregory: The IMF embodies the view, I think, of two or three months ago, which is that the economy is booming and will stay that way.
In that environment, a surplus is good. The real question is suppose things go off track. If they go off track, it is not good policy to be trying to get a surplus if the economy is going to be going down quickly.
The good thing about this report is it tries to look ahead. You don’t want the future view to be flipped up and down by what happens one week to the next. But if that turns out to be a major issue – the question of whether we will stay on track or not – then things could change.
Financial markets and newspapers switch around quickly but economies don’t. If investment in mining boom continues to increase in the way they are predicting, then we will sail through what’s happening round the world.
The IMF continues to recommend the introduction of a mining profits tax. Could this kind of tax help to insulate Australia from a global downturn?
Bob Gregory: Every sensible person believes we should tax mining more. And every sensible person believes we mucked it up when we didn’t. But these things are political.
John Vaz: I think that was a big mistake and a lost opportunity. The government lost that argument because of a poor political position. Overwhelmingly, they were overtaken by the miners.
Rio Tinto last week announced a 30% increase in their quarterly profits. But the whole threat was that if the minerals resource tax comes in, it will really harm us, but they have also announced significant investment in infrastructure going forward.
It’s just one big furphy. It’s all about preserving their own shareholder value. It’s always been about who gets a cut of the pie and gets a large chunk. It’s never been about what’s good for Australia in the long term.
We have lost a wonderful opportunity to get a bit of the cream along the way because we didn’t have enough political will to push it through. In that sense, Australia is plagued and handicapped by a short term election cycle. No-one can take long term decisions.
The report also expressed concern about Australian banks’ reliance on offshore capital markets. Could this reliance worsen the impact of global downturn on the banks?
John Quiggin: There is certainly a risk that this could have implications for the property market, even though we have had some success in rebuilding household balance sheets in the past couple of years.
It would seem that the financial sector as a whole is less dependent on wholesale from funding from overseas than it was before the last crisis, but there is obviously still a risk.
Bob Gregory: It will have some sort of negative effect but because of this mining boom, as long as it goes on, we are pretty well insulated.
Our banking sector seems to be in really good shape and has stayed that way. I am not worried about the banking sector. The property thing is an interesting puzzle because if you lived overseas and you don’t know much about Australia and looked at prices round the world, you would come to the conclusion the property prices in Australia are too high.
We’ve known that since last year, the year before that. Yet nothing seems to be happening. People with mortgages can, by and large, afford their mortgages.
Most people’s view is that our property prices will stay where they are or slowly drift down. If there was a crisis, that would be a huge shock but no one is expecting that.
John Vaz: The banking sector has a lot of pressure on it going forward. They face risk on three fronts: on the demand side (if people are borrowing less) on the cost side (if the cost of money goes up, they will have to increase their interest rates) and on the fund side (if people save more, then it means they are not borrowing and are becoming even more conservative).
What we need to look for in the next few days and weeks is whether we see signs of an emerging global recessionary pressure.