We have flaws but we’re tough

Published 01 September 2011 05:01

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The combination of European and US debt problems, softer economic data and sharemarket falls are all feeding on themselves, resulting in a significantly increased risk of recession in the US and Europe, particularly the latter.

During the global financial crisis, as a result of the impact on confidence, loss of sharemarket wealth, disruptions to lending markets and reduced demand for our exports, Australia wasn’t left unscathed.

However, thanks to a combination of rapid monetary and fiscal stimulus, a strong financial system, resilient Chinese export demand and a bit of good luck, Australia got by with only a slowdown in growth. It was the only advanced country to avoid recession. But would we be so lucky this time around?

Australia is not immune to any renewed global economic slump. Business and consumer confidence have already been hit hard (see chart), the fall in sharemarkets has resulted in a renewed loss of wealth, another global credit crunch will adversely affect lending and exports will be crunched if economic weakness in the US and Europe drags down our key trading partners in Asia.

What’s more, the renewed threat to global growth is occurring at a time when household demand in Australia is weak and the global turmoil may only reinforce this. Announced job lay-offs are rising and are likely to increase further as companies revise down the demand expectations that underpinned last year’s employment surge. Unemployment is likely to rise to 5.5 per cent by year’s end.

High house prices relative to income levels and the associated high level of household debt is an added source of vulnerability should an economic downturn threaten the ability of people to service their mortgages.

However, despite these risk points, Australia is reasonably well placed to withstand a possible return to recession in the US and Europe. As in 2008, interest rates have a long way to fall if need be. While it may take a month or so for the Reserve Bank of Australia to change its thinking from rate rises to cuts, we expect the combination of increased global risks and rising unemployment to convince the RBA to start cutting interest rates by year’s end, possibly as early as October. With 85 per cent of mortgages being floating-rate loans, as we saw in 2009, slashing them has a powerful impact on demand.

While the scope for fiscal stimulus is less than it was in 2008 as the budget is now in deficit, the trivial level of net public debt (that is, 8 per cent of gross domestic product compared with 72 per cent in the US) suggests there is room for targeted, timely and temporary fiscal stimulus if needed. Gearing and financial leverage is low compared with the situation before the GFC.

In fact, the corporate sector as a whole is cashed-up, having gone from a borrowing sector in 2007 to a net lender now. In the event of a sharp fall in commodity prices, the Australian dollar would likely fall sharply – providing a big boost to competitiveness and thus acting as a buffer.

Banks are less dependent on global markets for funding than in 2007, with 50 per cent of funding coming from deposits compared with less than 40 per cent at the time of the GFC, and are far less dependent on short-term funding.

While households are cautious, they have built up a large savings buffer that they are likely to eat into if jobless numbers rise and interest rates fall.

While the mining sector is not immune to lower commodity prices, the huge pipeline of work in mining projects provides a degree of resilience that wasn’t there in 2008.

Finally, our key export markets in Asia are more secure than those in Europe and the US and may prove more resilient this time. As a result of these factors and provided the RBA acts swiftly, the risk of recession is low, at less than 20 per cent.

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