BIS Shrapnel expect a fall in business investment will continue to constrain growth for some years. Last week, the Reserve Bank of Australia appeared before the House of Representatives Standing Committee on Economics saying that the outlook for the economy is ‘near-term weakness’ but Australia is ‘well placed to benefit from a renewed expansion’.
BIS Shrapnel agree that Australia does not have the same issues as other developed nations as a result of the global financial crisis. Australia is experiencing a credit squeeze not a financial crisis, but the shortage of both debt and equity funding will be disastrous for business investment.
According to Dr Frank Gelber, Chief Economist, BIS Shrapnel, companies need to look beyond the current situation to understand how the Australian economy will fare over the next five years.
BIS Shrapnel’s Long Term Forecasts, February 2009 Update argues the financial crisis in many developed countries means they will experience sharp recession followed by prolonged weakness. Australia, on the other hand, will experience a relatively moderate downturn, which will be followed by lingering weakness as falls in business investment constrain growth.
Initiated by last year's rise in interest rates, but now driven by the collapse in confidence, both consumers and businesses have gone into precautionary saving mode. Households are not spending for fear of unemployment and businesses are cutting costs.
BIS Shrapnel believe that the downturn in Australia will not be nearly as bad as other overseas developed economies. The financial crisis in overseas, where a collapse in asset values, required banks to write off substantial bad debts causing a loss of bank equity. Many developed western economies such as the US, the UK, Germany and Japan are experiencing sharp recessions with the prospect of protracted weakness as they refinance their banking systems and work their way through the millstone of bad debt.
According to BIS Shrapnel, Australia would normally see a quick rebound as lower interest rates pump income into the mortgage belt, confidence recovers, undersupplied housing markets rebound and households start to spend again, particularly with the government cash injections.
Investment, and particularly construction, is the primary growth driver for the economy. There are factors offsetting the weakness of business investment. The ‘Ruddbank’ can help to put the finger in the dyke to contain the leakage of overseas bank funding. But that is just a stopgap – the real need is for equity finance.
Government infrastructure spending has a much greater role to play in filling the gap left by the fall in business investment. According to BIS Shrapnel, the question is how long it will take to get these projects off the ground and how determined the government will be in the face of an escalating deficit.
BIS Shrapnel believe that the short-term weakening of the economy has been self-inflicted. Australia’s short-term prospects will depend on how strong the downturn caused by precautionary saving and the credit squeeze will be.
According to BIS Shrapnel, there are four factors that are to be considered when analysing the medium-term strength of the Australian economy:
- The impact of a lower Australian dollar on domestically produced goods and services, the strength of domestically produced tradeables and the corresponding weakness of import-related businesses – the retail sector will do it tough while the dollar stays low;
- The influence of stimulatory interest rates on the undersupplied housing market and the timing of the housing recovery;
- The impact of falling business investment in general, and the collapse of minerals investment in particular, over the next three years; and
- How much government infrastructure spending will offset weakening business investment.
The result is that Australia will experience a moderate downturn followed by protracted weakness as reduced investment constrains growth. Whether or not there is a technical ‘recession’ is not the point to get hung up on, but this is a substantial downturn.
Businesses need to survive the current shock but they also need to look beyond it and understand where they fit into the changing structure of the economy, particularly the shift away from imports and back to domestic production which will be underwritten by the lower Australian dollar.
BIS Shrapnel conclude that the strength of the economy over the next five years will depend on the extent to which strong housing and government spending on infrastructure will offset falling business investment.
These and other issues will be discussed at the forthcoming 90th series of BIS Shrapnel’s Business Forecasting Conferences held around Australia in March. The series of half-day briefings on the Australian economy, building and property markets will provide a clear overview of the economic and industry outlook to June 2010.