australia’s next growth driver-the rise of the services ... · australia’s next growth driver...
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��� � Australia’s rebalancing act has so far
been driven by a pick-up in housing activity and household demand
� We expect tourism, healthcare, education, business and services to be the next key drivers of growth
� A focus by policymakers on reform and infrastructure investment could support this services-driven growth
Rebalancing act continues As mining investment falls, growth is rebalancing to the other industries. Low interest rates are supporting rising housing prices and construction and encouraging greater household spending. The next stage of the rebalancing act is expected to entail a strong pick-up in the services sectors, which account for the bulk of Australia’s economy.
Domestically, demand for services is set to be driven by low interest rates, rising asset prices, shifting preferences and solid population growth. Foreign demand is also rising, as Asia’s middle class incomes grow and the AUD falls. Tourism and education exports are growing strongly and are set to continue doing so. Recent free trade agreements with China, Korea and Japan should also support rising exports of business services, as well as agricultural products.
Jobs growth, which is running at 1.9% y-o-y, up from 0.5% 18 months ago, is being driven by the services sector, led by healthcare, professional services and tourism. At this stage, however, although non-mining businesses appear to be taking on more workers, they are still cautious about investing. Encouraging a pick-up in non-mining business investment remains a key challenge for Australia.
What would help is a focus on tax and regulatory reform and building infrastructure to improve local competitiveness and support a services-driven upswing in growth. This would support the continued rebalancing of growth, lift productivity and motivate greater private sector investment. Without reform and investment Australia’s potential growth rate could be noticeably lower than in the past. A lower AUD would also help to directly improve local competitiveness.
Macro Economics – Australia
Australia’s next growth driver The rise of the services sector
10 July 2015 Paul Bloxham Chief Economist, Australia and New Zealand HSBC Bank Australia Limited +61 2 9255 2635 [email protected]
Daniel Smith Economist, Australia and New Zealand HSBC Bank Australia Limited +61 2 9006 5729 [email protected]
View HSBC Global Research at: http://www.research.hsbc.com
Issuer of report: HSBC Bank Australia Limited
Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
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Mining GDP flat, but other sectors are lifting Australia’s rebalancing act is underway, although the transition from mining to non-mining led growth has not been perfectly smooth. This has left GDP growth below its 2000s average (3.0%) for the past three years (Chart 1). This year has delivered more downside surprises. Back in January we were forecasting near-trend GDP growth of 2.8% for 2015, but we now expect growth of 2.4%.
The pace of rebalancing has been hindered by further falls in commodity prices, an unhelpfully high AUD and the federal and state government’s fiscal consolidation efforts. Falling commodity prices have seen Australia’s terms of trade (the ratio of export prices to import prices) decline by 28% since its peak in mid-2011, largely driven by falling iron ore and coal prices (Chart 2). The fall in commodity price has been greater than had been expected (see Global Commodity prices: Finding the new normal, 14 April).
Australia’s rebalancing act continues � As mining investment continues to fall, growth has been rebalancing
towards housing activity, and now, the services sectors � Although the rebalancing act has been slow – as it has been
hindered by further falls in commodity prices, a high AUD and mistimed fiscal tightening – it is underway
� Household demand is strong and jobs growth is picking up, although non-mining business investment is yet to lift
1. Growth has been below average for three years 2. Falling commodity prices have weighed on incomes
Source: ABS, HSBC estimates Source: ABS, HSBC estimates
40
60
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100
1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014
Australia's Terms of Trade F/CIndex
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Although export volumes have been rising strongly, the fall in commodity prices has weighed on national incomes, as Australia has received fewer earnings for its exports (Chart 3). Falling incomes have weighed on economic growth by decreasing tax revenues, corporate profits and household incomes. Real Gross Domestic Income (or GDI) has fallen over the past year (Chart 4).
However, lowered interest rates and rising asset prices have somewhat offset the impact of falling incomes on the economy, leaving real GDP still growing, albeit at a below average pace. Although household incomes and corporate profits have grown more slowly, lower interest rates have reduced debt servicing burdens. Rising asset prices have meant there has been more wealth to draw on to support spending. Because the mining industry is around 80% foreign-owned, a large part of the reduction in profits has also fallen on foreign firms, rather than the domestic economy.
Despite the process being slow, growth has been rebalancing. Part of this transition has been in the mining sector itself. Although mining investment has been falling, resource exports have been rising, which has left mining GDP broadly flat (Chart 5). This process has further to run, in our view, as the major LNG plants under construction are completed and LNG exports ramp up in the coming years.
As a result, real GDP growth is expected to be supported by strong growth in exports, which should offset the impact on mining GDP of falling investment (Chart 6). Again, this process has been slower than had
3. Export volumes growth is strong, while values have fallen 4. Income has been falling, although GDP is still rising
Source: ABS Source: ABS
5. Mining investment falls are being offset by rising exports 6. As mining GDP goes flat, non-mining GDP is slowly lifting
Source: ABS, HSBC estimates Source: ABS, HSBC estimates
-40
-20
0
20
40
60
-20
-10
0
10
20
30
2000 2003 2006 2009 2012 2015
Resources Exports Growth (y-o-y)% %
Volumes (LHS)
Values (RHS)
4
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been expected earlier, as projects have taken longer than originally thought to come online. With mining GDP flat, growth has been driven by the non-mining sectors of the economy, which have been lifting. So far, this process has mainly been supported by rising household demand.
Household demand is rising solidly The pick-up in non-mining GDP has been driven by rising household demand, which has been supported by low interest rates. Housing prices have risen by 27% in the past three years (Chart 7). Rising housing prices, low interest rates, solid population growth and a cumulative undersupply of housing (as not many houses were built when mining investment was booming) have seen a strong lift in housing construction in recent years. Building approvals are at their highest level ever, with over 200,000 dwellings approved in the past year (Chart 8).
The pick-up in housing prices and construction has also motivated increased spending on household goods, such as furniture and white goods (Chart 9). Broader household consumption has picked up and is growing at around its five-year average, as households are choosing to reduce their saving rather than cut back on spending in the face of slower growth in their incomes. The household saving ratio has fallen by 1.3ppt over the past year and has declined by 3.4ppt since its recent peak in mid-2012 (Chart 10).
7. Low interest rates are driving rising housing prices 8. Housing construction is in a strong upswing
Source: RP-Data Core-Logic Source: ABS
9. Household spending on durable goods has been lifting 10. Household saving is falling as asset prices rise
Source: ABS Source: ABS
-5
0
5
10
15
-5
0
5
10
15
1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012
Household Saving Ratio*Per cent of disposable income
%
* Net of depreciation
%
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The rebalancing of growth away from mining and towards the non-mining sectors has also favoured the regions that have the least exposure to the mining industry. New South Wales and Victoria are seeing the strongest conditions, while Western Australia and Queensland are being weighed down by the slowdown in the mining sectors. Partly as a result of this, housing prices are rising most strongly in Sydney and Melbourne, and have been rising more slowly elsewhere (Chart 11). Housing prices have risen by 43% in Sydney and 26% in Melbourne over the past three years, but are only 11% higher in the rest of the country. Likewise, retail spending has been strongest in the non-mining states (Chart 12).
Improving conditions are driving a pick-up in hiring The pick-up in household demand has seen a modest improvement in business conditions and confidence (Chart 13). Business confidence has also received a recent boost from the recent Federal budget, which reversed the May 2014 budget’s attempts to cut back on spending and included proposals for additional spending on childcare and tax cuts for small businesses and was generally more upbeat on Australia’s growth prospects than last year’s budget. Improving business conditions and stronger household demand are supporting a pick-up in employment growth. Over the past year, 224,000 jobs have been created and jobs growth has lifted to 1.9% y-o-y, up from 0.5% y-o-y eighteen months ago (Chart 14).
11. Non-mining states are leading the housing price gains 12. Retail sales are strongest in the non-mining states
Source: RP-Data Core-Logic Source: ABS
13. Business conditions and confidence are rising modestly 14. Employment growth has been picking up pace
Source: Thomson Reuters Datastream Source: ABS
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-65
-50
-35
-20
-5
10
25
-40
-20
0
20
40
60
80
100
2001 2003 2005 2007 2009 2011 2013 2015
NAB Business Survey
Confidence
Conditions
-3
-2
-1
0
1
2
3
4
-3
-2
-1
0
1
2
3
4
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Hours Worked and EmploymentYear-ended change, trend
% %
Aggregate hours worked
Employment
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Jobs growth has also been concentrated in the non-mining states, with job vacancies rising strongly in New South Wales and Victoria, holding steady in Queensland and South Australia, and falling sharply in Western Australia, where the pullback in mining is having its most severe effect (Chart 15). Employment growth is being driven by a pick-up in the services sectors, led by household and business services, while mining, manufacturing and public service jobs weigh on overall jobs growth.
Business investment outlook is still uncertain Despite some improvement in business conditions and confidence and a pick-up in hiring, the key measure of business investment intentions, the ABS capital expenditure survey, is weak. Unsurprisingly, the survey shows that mining investment is expected to have fallen sharply in 2014/15 and to fall in the 2015/16 financial year (Chart 17).
More surprisingly, the survey suggests that non-mining businesses appear to be planning to cut back investment spending in 2015/16. This is surprising because many of the pre-conditions are in place to support a pick-up in non-mining business investment. Interest rates are low, population growth is solid, the AUD has fallen (boosting competitiveness), and there has been little new investment in recent years.
Part of the challenge here may be measurement. For a start, the ABS capital expenditure survey only covers around half of all non-mining business investment (Chart 18). The sectors that are not covered are also those that are showing the strongest pick-up in employment growth, including healthcare and education.
Nonetheless, there remains significant uncertainty about the outlook for investment in Australia and it this area of growth that presents the biggest challenges. Beyond measurement issues, there are a number of other possible explanations for Australia’s weak non-mining businesses investment intentions.
Part of the story may be the shift towards services sector-led growth itself. This is because the services sectors are generally more labour- and less capital-intensive. For example, tourism services require more workers and less heavy equipment than mining. New disruptive technologies, such as storage of information in the ‘cloud’ and greater usage of mobile devices, may also mean that the economy can effectively do more with less capital. For example, in years gone by, the ramp-up in investment may have involved personal computers and office space, but new technologies favour mobile workers with smartphones.
15. Labour market is improving in the non-mining states 16. Services sectors are driving the pick-up in jobs growth
Source: ABS Source: ABS
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Global factors may be at work, with many other countries also suffering from a lack of business investment. As HSBC’s Stephen King points out recently, amongst other things, this could reflect the impact of the ageing population on the global economy as it encourages greater saving and less investment and may also discourage risk taking, which is necessary to motivate investment (see Stephen King’s report, Alas Kapital, 25 June 2015).
In recent work, the Reserve Bank of Australia (RBA) has focused on the idea that firms still have high hurdle rates for making investment decisions, despite the fall in global interest rates (Lane, K. and Rosewall, T. 2015). As a result of this, the central bank suggests that ‘the capital expenditure decisions of many Australian firms are not directly sensitive to changes in interest rates’.
17. Capex survey suggests weak investment outlook 18. Non-mining capex is weak, but is an incomplete measure
Source: ABS Source: ABS, RBA, HSBC estimates
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Services account for the bulk of the economy The services sectors account for around 73% of Australia’s GDP and over 80% of jobs (Chart 19). So, when considering which sector’s growth is likely to rebalance, following the end of the mining boom, it is natural to consider that services should play a significant role. Although the current upswing is being led by a pick-up in housing prices and construction, an upswing in these cannot continue indefinitely. Indeed, a continuation of the current pace of growth could lead to excessive housing prices and an eventual over-supply of dwellings. We expect the current housing ramp-up to begin to level out in 2016.
Growth is then expected to be driven by the services sectors, supported by both domestic and foreign demand. There are already signs that this is happening, with the services sectors driving recent employment growth. Over the past year, the strongest contributors to overall jobs growth have been healthcare, professional and accommodation and food services (Chart 20).
What’s next? Services� Growth should increasingly be driven by the services sectors,
including tourism, education, healthcare and professional services � Domestic demand for services is expected to continue to rise,
supported by low interest rates and solid population growth � Foreign demand for services is set to be supported by rising Asian
middle class incomes and a lower AUD
19. The bulk of the economy is the services sectors 20. Services sectors are driving recent jobs growth
Source: ABS Source: ABS
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100
Share of GDP Share ofEmployment
Share of GDP Share ofEmployment
GDP and Employment by Sector
Mining Sector Non-Mining Sectors
Business Services
HouseholdServices
ManufacturingConstruction
Retail and wholesale
Others
-0.4 -0.2 0.0 0.2 0.4 0.6 0.8 1.0
Health and social assistanceProfessional services
Accommodation and food servicesArts and recreation services
Transport, postal and warehousingConstruction
Admin and support servicesEducation
Public admin and safetyWholsale Trade
Information media and telecomsUtilities
ManufacturingFinancial Services
Real estate and hiring servicesRetail Trade
Other servicesAgriculture, forestry and fishing
Mining
Contributions to Employment Growth by IndustryYear-ended change (%)
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Domestic demand for services is rising Part of the shift to services-driven growth reflects the changing preferences of domestic consumers. Growth in services consumption has been outpacing goods consumption for many years (Chart 21). The largest contributors to growth in consumption over the past five years have been dwelling rent, healthcare, recreation and cultural, and financial and insurance services (Chart 22).
Services consumption has been a rising share of total consumption, currently accounting for over three-quarters of all household spending (Chart 23). It has also been a rising share of the overall economy, with household services consumption around 44% of GDP. We expect these trends to continue and for domestic demand for services to continue to be supported by low interest rates, rising asset prices, shifting preferences towards services consumption and solid population growth (Chart 24). A key challenge for economic observers is to keep track of the contribution of services consumption to economic growth, as there are limited timely measures of spending on services beyond the numbers that are compiled in the quarterly GDP figures, which arrive with a three-month lag.
21. Household consumption is largely spending on services 22. Healthcare, finance and recreation driving consumption
Source: ABS Source: ABS
23. Services consumption accounts for a rising share of GDP 24. Population growth is driving increased demand
Source: ABS Source: ABS
-2
0
2
4
6
-2
0
2
4
6
2000 2002 2004 2006 2008 2010 2012 2014
Household ConsumptionYear-ended change
%
Services
Goods
%
30
32
34
36
38
40
42
44
46
48
60
62
64
66
68
70
72
74
76
78
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013
Services Consumption ExpenditureQuarterly, current prices
% %
As a share of total consumption (LHS)
As a share of GDP (RHS)
10
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Services exports are picking up and larger than they appear Foreign demand for Australian services is rising and is expected to pick up further, supported by rising Asian middle class incomes and their shifting consumption preferences. Australia’s tourism and education export industries are already getting significant support from rising demand from Asia, particularly China.
Although resources dominate the value of Australia’s exports and will continue to do so (as we discussed above), it is worth keeping in mind that services are a larger share of value-added and are likely to have a larger impact on the domestic economy than the resources sector (Chart 25 and 26). Estimates from the RBA, based on numbers from the World-Input-Output-Database, reveal that although services have only accounted for 22% of the value of Australia’s exports in recent years, they accounted for 41% on a value-added basis, which is little ahead of resources exports (Kelly, G. and La Cava, G. 2014).
Value-added measures take account of the fact that services are used extensively as inputs in the production of manufactures and resources (for example, transport or technical services). Because services tend to be higher value-added than resources they also tend to be more labour-intensive, which helps to explain why the rebalancing of growth away from mining is seeing a lift in employment growth.
Tourism upswing is already underway In 2014, tourism spending contributed around 3% of Australia’s GDP, with around one-third of this driven by international tourists. Australia’s tourism sector is benefitting from rising Asian demand. Asian arrivals account for 45% of short-term visitor arrivals into Australia, so the sector is already highly exposed to the region (Chart 27). This has helped support continued growth in tourism exports, despite several years of subdued growth in developed world demand.
The key driver of growth in tourist arrivals over recent years has been China, which is now the second largest source of visitors to Australia, behind New Zealand. Chinese visitors now make up around 13% of total visitor arrivals, up from 6% in 2009. Arrivals from China over the 12 months to May 2014 were 21% higher than over the previous year. The increase in Chinese arrivals reflects the increased propensity of Chinese people to travel. Chinese visits to Australia have increased to 920,000 over the past year, from 370,000 five years ago.
25. Resources dominate exports by value… 26. …but services are larger in terms of value-added
Source: ABS Source: RBA
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Although these numbers are impressive, it is just a small share of overall Chinese foreign tourism. In 2014, there were 109m outbound visits by Chinese people. Excluding visits to Hong Kong and Macau, the numbers have risen from 14m to 32m (Chart 28). At this rate, Australia has actually seen its share of China’s visitors fall from 3.5% in 2005 to 2.5% in 2013. There remains significant scope to see further growth in Chinese visits to Australia. This is not least because the Chinese passport penetration rate is still low, at around 4% of the population. HSBC expects Chinese outbound travel to double over the next decade (see Fred Neumann’s Chart of the Week: Here come the Chinese, 27 June 2014).
Recent work by the RBA suggested that demand for leisure tourism from China generated AUD1.9bn in export receipts in 2013/14 and has accounted for half of the growth in Australia’s leisure travel exports over the past decade. Tourism Australia forecasts suggest that this could rise to AUD4.4bn by 2022/23 and that China could by then be the largest source of inbound arrivals (Dobson, C. and Hooper, K. 2015). Arrivals from other Asian countries have also been growing quickly, albeit from a lower base; arrivals from Malaysia were up around 20% y-o-y, while Indian arrivals were up 14% y-o-y.
Overall, tourism exports came to about AUD14bn in 2014, up 8% from the previous year. There are several factors that should support continued growth, including rising Asian middle class incomes, Australia’s already-strong ties to the region and the lower AUD.
29. Tourism is a key services export, which is picking up 30. The net flow of tourists may be increased by a lower AUD
Source: ABS Source: ABS, RBA
27. Asian arrivals dominate growth in tourist inflows 28. Lots more Chinese tourists could visit Australia
Source: ABS Source: ABS, CEIC
-300
-100
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-300
-100
100
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700
1990 1995 2000 2005 2010 2015
Short-term Arrivals and DeparturesMonthly, seasonally adjusted
'000 '000
Arrivals
Departures
Net flow
40
45
50
55
60
65
70
75
80
85
90-300
-250
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-150
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-50
0
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1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014Net flow of short term visitors (LHS) Trade-weighted exchange rate (RHS)
'000s
Net Inbound
Net Outbound
Low AUD
High AUD
Tourism and the AUD Index
0
500
1000
1500
2000
0
500
1000
1500
2000
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Country of Origin for Short-term ArrivalsAnnual totals
'000'000
Asia (excl. China)
Europe
New Zealand
Other
ChinaUS
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Australia’s services trade is also expected to get support from the lower AUD in another, less obvious, way. The lower AUD is expected to discourage locals from spending and travelling abroad, as it has become more expensive, and make it more attractive to buy local goods and services (Chart 29 and 30).
Rather than boosting exports, this channel works to support local demand by reducing imports and supporting the competitiveness of industries that directly compete with imports. A mechanism through which this has worked in the past in Australia is discouraging locals from travelling overseas and encouraging them to take local holidays. This also means that there may be more spent in Australia’s retail sector as locals holidaying in Australia could spend on other items while they are vacationing.
Education exports are rising Australia’s education exports rose rapidly during the early 2000s, with the number of international student enrolments in Australia increasing by 130% between 2002 and 2009 (Chart 31). However, student numbers then fell quite sharply in 2010, following government cutbacks of student visas and also reflecting the effect of the high AUD on competitiveness. At the time, the AUD was well above parity against the USD, making it comparatively more attractive for students to study in the US rather than Australia.
Over the past two years though, student numbers have begun to increase strongly again. In 2014, output from Australian onshore education facilities accounted for around 1% of GDP. International student enrolments reached a new record high at the beginning of 2015 with nearly 147,000 students starting course in Q1, ahead of the previous quarterly record of 142,000 in Q1 2009.
This partly reflects new visa arrangements, which have reduced requirements for many prospective students and made it easier for international students to stay and work in Australia after the completion of their studies. The fall in the AUD is also helping to support demand, along with the ongoing rise in Asian middle class incomes, which is making studying in Australia more affordable for a larger group of students.
Education exports – which are measured to include spending by international students on goods and services in Australia, such as housing – reached AUD17bn in 2014, surpassing the previous peak of AUD16.1bn in 2009 (Chart 32). This makes education Australia’s fourth largest individual export by value, behind iron ore (AUD66bn), coal (AUD38bn) and natural gas (AUD18bn).
31. International student enrolments are rising again 32. Business service exports are expected to rise
Source: Australian Education international Source: ABS
0
100
200
300
400
500
600
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
International student enrolments in AustraliaAnnual, by nationality
China India Vietnam Korea Thailand Other
'000s
0
2
4
6
8
10
12
14
16
18
0
2
4
6
8
10
12
14
16
18
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Australian Services ExportsAnnual, A$bn
Education
Other Business Services
Leisure Travel
Transportation
Business Travel
Financial Services
IT and Telecoms
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Business services present another opportunity Together, financial, information technology and ‘other’ business services exports totalled AUD14bn in 2014 (the ‘other’ category covers professional consultancy and management fees, as well as engineering and other technical services). However, recent growth has been slow and has largely been driven by the rebound in financial services exports following the global financial crisis.
Business services could, though, represent another significant export growth opportunity. Much of this growth will most likely be in transactional services tied to increased trade and financial flows between Australia and Asia.
However, Australia also possesses technical expertise and knowhow that could be exported to emerging Asian economies. Examples include financial markets knowledge, farming and food production techniques that could help Asia meet its growing food demand, expertise in health services, design services and, of course, expertise in natural resource extraction.
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The policymaker’s role in the rebalancing act The rebalancing act has, so far, largely been managed using monetary policy. By lifting interest rates through 2009 to 2011, when the recent mining boom was ramping up, the RBA successfully held back the non-mining sectors and kept inflation contained. This allowed it to then cut the cash rate aggressively when the mining boom peaked, to support growth in the non-mining sectors. Having been held back during the mining boom, the non-mining sectors had scope to see a strong pick-up in activity (Chart 33).
Other arms of policy have, however, played a less helpful role in supporting the rebalancing of growth. Fiscal policy has generally been ‘pro-cyclical’, with too little public saving when the mining boom was strong and consolidation plans being made at, arguably, the wrong time in the past couple years (Chart 34). The latest GDP numbers showed public investment falling over the past year, at a time when an increase would be helpful. The recent shift in tack by the Federal government in its May 2015 budget
Policy challenges� Monetary policy is reaching its useful limits: while a lower AUD
would help to improve local competitiveness, further interest rate cuts risk inflating asset price bubbles
� Recent free trade agreements with China, Japan and Korea should help support Australia’s competitiveness
� To lift productivity, policymakers should focus on tax and regulatory reform, as well as investment in infrastructure
33. Cash rate settings and AUD have managed rebalancing 34. Fiscal policy settings have been less helpful
Source: ABS, RBA Source: ABS, Australian Treasury
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to a more pro-growth strategy is a positive development, but a number of the state governments could afford to also provide more support for growth, particularly through infrastructure development plans.
More broadly, the mining boom and the boost to tax revenues it delivered also discouraged structural reforms, which have contributed to a slowdown in productivity growth. The lack of progress in reform has been one of the ‘curses’ of the resources boom (see Does Australia have a resources curse: The challenges of managing a mining boom, 22 August 2011).
On the positive side, recent free trade agreements with China, Japan and Korea should help to support increased trade and financial integration with these growing regions. Nonetheless, policymakers face many challenges.
Monetary policy may be reaching its useful limits Having cut its cash rate to its lowest level in history, at 2.00%, the RBA has delivered a significant loosening of financial conditions. Monetary policy has worked to lift housing prices and construction, and support a solid pick-up in household spending, including on services. Lower local interest rates have also contributed to a decline in the AUD, which has helped to improve Australia’s competitiveness.
However, with the cash rate already at 2.00%, the extent to which further cuts can usefully support growth looks limited to us. First, persistent low interest rates have already driven a strong rise in Sydney and Melbourne housing prices and, together with low global term rates, have supported growth in commercial property prices well ahead of rents (Chart 35). Further cuts to the cash rate risk over-inflating asset prices. Second, there is limited evidence that further cuts in interest rates would have much impact on firms’ investment planning, which is the next stage of the rebalancing act (as discussed above).
Although current market pricing suggests the RBA could deliver another cut to its cash rate, if it were to cut, it may do little to support sustainable growth in the economy. A key mechanism that could help to support growth would be a further decline in the AUD, which still appears to be over-valued when compared with the level of commodity prices (Chart 36). However, local interest rates appear to be having only a limited impact on the AUD, with international factors, such as the timing of the Federal Reserve’s expected interest rate hike, having a larger effect.
35. Low rates are having some adverse side-effects 36. AUD still needs to fall, but local rates are not the driver
Source: Core Logic RP Data Source: RBA
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Trade policy to help support competitiveness Recent free trade agreements (FTAs) with China (signed this year) and Japan and Korea (signed last year) are positive steps to supporting increased trade and financial linkages with these economies.
This is particularly important for the next stage of the rebalancing, because services are a highly competitive market and Australia’s comparative advantage is less clear in these industries than it is for resources exports.
The World Trade Organisation’s enabling trade report shows that although Australia ranks reasonably well across a range of metrics, it does poorly in ‘foreign market access’, ranking 134th of 138 WTO members (Table 37). The report lists the top five barriers to exporters as: identifying potential markets and buyers; high costs of international transport; access to imported inputs at competitive prices; tariff barriers abroad; and, burdensome procedures at foreign borders.
As a result of the recent FTAs, tariffs on a range of Australian agricultural exports will be progressively reduced and Australian service providers have been given (at least) equal access to the local markets as other preferred trading partners. In particular, the FTA with China allows Australian suppliers to set up wholly-owned hotels, restaurants, aged-care facilities and (in some provinces) hospitals in China. In exchange, screening thresholds on foreign investment into Australia from these countries have been lifted.
Australian authorities are also in the process of negotiating free trade agreements with India and Indonesia, as well as being part of the Trans-Pacific Partnership (TPP).
Infrastructure and reform needed to lift productivity Reform needs to be a policy focus, in our view, particularly with regards to improving the tax and regulatory systems, and improving Australia’s infrastructure. A limited reform agenda in recent years has left Australia with an inefficient tax system, overly burdensome regulatory environment and congested infrastructure. These factors have been weighing on productivity growth. Total factor productivity growth has slowed to an average annual rate of 0.5% a year over the past decade, which is much slower than the 2.1% averaged over the previous decade (Chart 38).
37. Trade agreements will help improve access to markets 38. Productivity growth has slowed in the past decade
Enabling trade index for Australia in 2014
Indicator/Pillar Australia’s rank*
1) Domestic market access 18 2) Foreign market access 134 3) Efficiency/transparency of border admin 22 4) Availability/quality of transport infrastructure 24 5) Availability/quality of transport services 20 6) Availability/use of ICTs 15 7) Operating environment 19
Source: World Trade Organisation. *Of 138 countries Source: ABS, HSBC estimates
90
105
120
135
150
165
90
105
120
135
150
165
1978 1982 1986 1990 1994 1998 2002 2006 2010 2014
Total Factor ProductivitySeptember 1978 = 100
IndexIndex
0.5%pa
2.1%pa
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Supporting near-term growth through infrastructure investment Improving the quantity and quality of Australia’s infrastructure, particularly in rapidly growing urban centres, would support near-term growth during the construction phase and would also be beneficial for long-term productivity, efficiency and living standards. Australia’s cities are becoming increasingly congested, which is weighing on local productivity growth.
The Federal government’s May 2014 budget featured infrastructure investment quite prominently, mainly in the form of the ‘asset recycling’ programme. This provided incentives to state governments to sell or privatise existing assets and recycle the proceeds into new infrastructure projects.
Most state governments were receptive to the ‘asset recycling’ initiative at the time. However, since then there have been two changes of government at the state level, one in Victoria and one in Queensland. In Queensland, in particular, the opposition Labor party won an election in January 2015 with an aggressive campaign against the planned asset sales. Labor also won in Victoria (in November 2014), opposing the East-West Link road project amid general anti-privatisation sentiment.
In Queensland, the proposed asset sales that had been expected to generate around AUD37bn will not proceed. The funds raised had been intended to go towards a combination of new infrastructure and debt reduction. The new state government has not yet made any major announcements regarding infrastructure funding; however, without the funds from asset sales, available funding is likely to be more constrained.
The new Victoria government has not ruled out some asset sales. For example, the state government intends to proceed with the 50-year lease of the Port of Melbourne, which is expected to raise AUD5-6bn. The government has, however, cancelled the East-West Link, a major AUD6bn road project that was about to begin construction. While there has been some debate about the project’s ultimate net benefits, the cancellation means a greatly diminished pipeline of work in the near term. Similar-sized projects, such as the new government’s proposed metro rail link, are unlikely to reach the construction phase for several years.
The infrastructure pipeline is strongest in New South Wales. In March 2015, the state government won re-election with a campaign agenda that included asset sales. The state government will now progress with the AUD20bn partial lease of state electricity infrastructure. The government’s fiscal position has also been temporarily boosted by strong stamp duty revenues, thanks to Sydney’s surging housing
39. Major planned infrastructure projects (selected)
Project Type Location Expected construction dates
Estimated cost
Pacific Highway Upgrades Roads NSW 2013-2019 Over AUD5bnBruce Highway Upgrades Roads Queensland 2013-2024 AUD8.5bnPerth Stadium Sporting Perth 2014-2017 AUD1.2bnSydney Metro Northwest Rail Sydney 2014-2019 AUD8bnSydney CBD and South East Light Rail Rail Sydney 2015-2020 AUD2bnNorthConnex Roads Sydney 2015-2019 AUD3bnToowoomba Second Range Crossing Roads Queensland 2015-2018 AUD1.6bnPerth Freight Link Roads Perth 2015-2019 AUD1.6bnForrestfield Airport Link Rail Perth 2015-2020 AUD2bnWestConnex Roads Sydney 2015-2023 AUD15bnVictoria Level Crossing Removal Programme Rail Victoria 2015-2023 AUD5-6bnWestern Sydney Roads to support a new airport Roads Sydney 2015-2024 AUD4bnMelbourne Metro Rail project Rail Melbourne 2018-2026 AUD9-11bnSource: Australian Government, NSW Government, Victorian Government, WA Government, South Australian Government, HSBC
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market. These factors have allowed the acceleration of planning work on many projects. Overall, the state government has a capital spending plan of AUD70bn over the next four years, including several large-scale transport projects (Table 39).
The New South Wales infrastructure pipeline could be further strengthened if plans for a second Sydney airport are pursued. The Federal government is expected to release a final proposal before the end of 2015, with the first stage of the project expected to cost around AUD4bn over eight years.
In Western Australia, the state government’s fiscal position has been adversely affected by reduced mining royalties. The state’s credit rating was downgraded in 2013 and both Standards & Poor’s and Moody’s have placed the current rating on negative outlook over recent months. Under pressure to improve its budget position, the state government’s ability to fund major infrastructure projects has become more constrained. To manage this, the state government has plans to sell surplus land and buildings, as well as the Fremantle Port, although many of the proceeds are expected to be put towards debt reduction rather than new infrastructure spending.
South Australia’s major current infrastructure project is the AUD1.5bn North-South road project, funded jointly by the state and federal governments. The state government’s recent budget allocated AUD165m over four years to other road maintenance, upgrade and construction projects.
The case for tax and regulatory reform Australia’s tax system needs an overhaul, in our view. In particular, reform could focus on shifting the mix of taxes away from corporate and personal incomes taxes, which distort economic behaviour, towards more efficient taxes.
Among OECD economies, Australia’s tax system is one of the most reliant on the taxation of corporate and personal income (Chart 40). In a similar vein, Australia’s tax system has a comparatively low reliance on consumption taxes, which tend to be more efficient. This reflects the fact that Australia’s goods and services tax (GST) only covers a little under half of all goods and services consumed by households and has a rate of only 10%, which is low when compared with an OECD average of 19%.
40. Tax revenue is mostly coming from inefficient taxes 41. Tax revenues are down: ‘bracket creep’ to drive a rise
Source: Australian Treasury, OECD Source: Australian Treasury
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The government’s May 2015 budget projections saw tax revenue climbing over the coming years, as nominal GDP growth is expected to pick up, although much of the expected tax increase reflects that households are expected to move into higher tax brackets (‘bracket creep’) (Chart 41). Importantly, though, this bracket creep also discourages participation in the labour market and investment. Without reform, the tax system is likely to become increasingly inefficient, which would contribute to slower productivity growth and increasingly hinder labour market participation and investment.
Simplifying the regulatory environment could also prove a useful policy focus. Australia performs poorly in international comparisons of the ease of complying with government regulation, ranking 118th among 134 WTO members. By comparison, Canada is 47th and New Zealand is 13th on this metric.
Without reform and investment, expect lower potential growth Reform and investment are needed to lift productivity growth and sustain Australia’s potential growth rate. Results from the standard models of Australia’s potential already show some worrying trends. These models assume that growth in the capital stock, hours worked in the economy and productivity (that is, how efficiently labour and capital are used together) drive the economy’s potential growth rate.
For Australia, growth in the capital stock has already slowed and the ageing population is contributing to slower growth in hours worked (Chart 42). Combined with slower growth in productivity, as shown in Chart 40 above, our estimates suggest that Australia’s potential growth rate may already have slowed to 2.50-2.75%, down from 3.25-3.50% a decade ago (Chart 43).
This is not a new story, with our estimates from early 2014 suggesting that Australia’s potential growth rate could by then have already fallen to ‘around 2.8%’ (see Downunder digest: Australia's lowered potential, 22 January 2014). Since then, productivity growth has nudged a little higher, but population growth has slowed a touch and capital investment has fallen further.
Looking forward, productivity is expected to get a boost from the mining industry, as new capacity comes online and resources exports ramp up with fewer workers needed. However, if growth is shifting to the services sectors, this could be a drag on productivity growth, as many of these industries are more labour-intensive.
42. Capital stock and workforce growth have slowed 43. Without reform, potential is 2.50-2.75%, down from 3.25%
Source: ABS, HSBC estimates Source: ABS, HSBC estimates
-1
0
1
2
3
4
5
-1
0
1
2
3
4
5
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013
Factor Contribution to Potential GDP GrowthYear-ended change
% %
Total factor productivity
Growth in capital stockGrowth in hours worked
3.3%
2.6%
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Without reform and investment, Australia’s economy may not be able to grow as quickly as in the past. One way to think about this is to look at how much potential output could be lost if Australia’s trend growth rate is lower than in the past. For example, if it turns out that 2.75% is the ‘new normal’ for Australia’s growth, rather than 3.25%, this would mean the economy would be 7.5% smaller by 2030 than it would otherwise be (that is, Australia would have lost a little over two years of growth at the previous trend rate). Without reform and investment, expect lower potential growth.
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References Bloxham, P. (2011) ‘Does Australia have a resources curse: The challenges of managing a mining boom’, 22 August.
Bloxham, P. (2014) ‘Downunder digest: Australia’s lowered potential’, 22 January.
Bloxham, P. et al (2015) ‘Global commodity prices: Finding the new normal’, 14 April.
Dobson, C. and Hooper, K. (2015) ‘Insights from the tourism industry’, March.
Kelly, G. and La Cava, G. (2014) ‘International Trade Costs, Global Supply Chains and Value-added Trade in Australia’, RBA RDP 2014-07.
King, S. et al (2015) ‘Global Economics Quarterly: Alas Kapital’, 25 June.
Lane, K. and Rosewall, T. (2015) ‘Firms’ Investment Decisions and Interest Rates’, RBA Bulletin, June.
Neumann, F. (2014) ‘Chart of the Week: Here come the Chinese’, 27 June.
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HSBC’s forecasts for Australia
_______ Year-average ________ __________________________ Year-ended ___________________________ 2014 2015 2016 Q414 Q115e Q215e Q315e Q415e Q116e Q216e
%* AUSTRALIA GDP 2.7 2.4 3.0 2.3 2.3 2.5 2.7 2.8 3.0 3.1 Consumption 2.5 2.7 3.1 2.6 2.6 2.9 2.8 3.1 3.2 3.1 Public consumption 2.0 1.6 1.6 1.7 1.8 1.1 1.6 1.7 1.6 1.5 Investment -2.7 -3.5 -0.8 -3.7 -4.9 -2.3 -3.0 -1.8 -1.1 -0.4 - Dwelling 7.9 11.1 6.0 9.2 9.9 13.8 11.4 8.0 7.1 5.3 - Business -5.1 -7.3 -3.4 -6.0 -7.7 -7.7 -8.0 -5.5 -4.2 -2.6 - Public -4.3 -6.0 -0.3 -9.9 -11.1 -0.6 -1.4 -0.5 -0.5 0.0 Final domestic demand 1.1 1.0 1.9 0.8 0.5 1.3 1.3 1.7 1.9 2.0 Domestic demand 1.1 1.3 2.0 1.5 0.6 1.3 1.9 2.0 1.9 2.0 Exports 6.8 9.3 8.4 8.1 10.6 9.3 9.1 7.1 8.5 8.7 Imports -1.6 3.7 4.3 3.3 1.4 3.9 6.2 3.8 4.0 4.0 GDP (% quarter) -- -- -- 0.9 0.5 0.6 0.7 1.0 0.7 0.7 CPI** 2.5 1.7 2.5 1.3 1.6 1.8 2.2 2.5 2.5 2.4 Trimmed mean** 2.5 2.4 2.6 2.2 2.2 2.5 2.5 2.6 2.5 2.6 Unemployment rate 6.1 6.2 5.9 6.2 6.2 6.2 6.1 6.0 5.9 5.8 Labour price index 2.5 2.3 2.8 2.3 2.3 2.3 2.3 2.5 2.6 2.9 Current A/C (%GDP) -2.8 -3.1 -2.6 -2.7 -3.2 -3.3 -3.3 -2.8 -2.7 -2.5 Terms of trade -7.4 -8.7 -1.7 -11.4 -9.0 -7.3 -6.7 -3.9 -2.0 -1.0 Budget balance (%GDP) -3.1 -2.5 -1.9 Capital city house prices 9.1 7.1 6.1 6.9 7.0 7.6 7.0 7.0 6.4 5.6 Private sector credit 5.1 6.6 7.1 6.1 6.4 6.8 7.0 7.2 7.3 7.2 USD/AUD (end period) 0.78 0.72 0.70 0.82 0.75 0.74 0.72 0.72 0.71 0.71 Cash rate (end period) 2.50 2.00 2.00 2.25 2.00 2.00 2.00 2.00 2.00 2.00
Source: ABS, RBA, HSBC forecasts *unless otherwise specified. **includes the effect of the carbon tax from Q312 and its removal from Q314
Key economic forecasts
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Notes
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Notes
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Notes
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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Paul Bloxham and Daniel Smith
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