In this bulletin, we do a ‘mid-year stocktake’, looking back at the past six months and ahead to the next six.
Australia accelerates as the world slows
‘Australia’s glass is at least half full’ said Reserve Bank governor Glenn Stevens last month. Real GDP rose by over 4% over the past year ... Unemployment is about 5%. Core inflation is a bit above 2%. The financial system is sound. Our government is one among only a small number rated AAA, with manageable debt. We have received a truly enormous boost in national income courtesy of the high terms of trade. This, in turn, has engendered one of the biggest resource investment upswings in our history, which will see business capital spending rise by another 2 percentage points of GDP over 2012/13, to reach a 50-year high. And yet ... the ‘global environment’ is one of ‘major uncertainty, largely because of the problems of the eurozone’. This glass half-full, half-empty contrast is the most striking feature of the past six months from the standpoint of Australian exporters.
Hopes dashed, fears fulfilled
Another feature is disappointment.
In our February bulletin, we noted that the hitherto grim world outlook had improved somewhat, thanks to a range of things, but above all to so-called LTROs, or long term refinancing operations, by the European Central Bank. ‘The growing confidence that the ECB is both willing and able to prevent contagion taking hold ... has encouraged the Bank of Canada governor Mark Carney to pronounce “There is not going to be a Lehman-style event in Europe”.’ Famous last words, perhaps.
By April, we were noting that ‘downside surprises replace upside ones’. ‘Bullish sentiment about the world economy since the start of the year has begun to ebb over the past month ... The news has
been disappointing out of the US, the eurozone and China alike.’ We warned of ‘a growing danger that Spain may be forced to seek a bailout’.
In May, we focused on the backlash against euro area austerity. Austerity at the Periphery was neither promoting economic recovery, nor restoring capital market access for governments and banks, nor restoring fiscal solvency. Therefore it couldn’t go on. Either it would be replaced by a better crisis resolution plan, or the euro area would succumb to contagion and disintegration.
Finally, last month, we gave you yet another dose of euro pessimism with stories about Greek political uncertainty, Spain’s banking bailout and the prospect of Cyprus having to seek a bailout. (Sure enough, it did seek one shortly afterwards.)
It wasn’t just about the euro area
The spread of the euro area crisis was our chief focus, but we did examine other risks as well.
In March, our headline was ‘Oil fears supplant eurozone worries’. Oil prices had risen from $110 a barrel at end-2011 to nearly $130 in early March. This was partly due to escalating sanctions on Iranian oil exports. There was also growing fear of military conflict with Iran. ‘If conflict were to occur, oil prices could spike sharply higher and exert a powerful drag on economic growth, probably sending the world economy back into recession.’
In April, we returned to our traditional emerging markets focus, with stories on China, PNG, Egypt, Argentina, Indonesia, Vietnam and Burma. ‘Bumpy political transitions’ was one theme – in China, Egypt and PNG. The Bo Xilai affair was challenging the conventional view that China’s establishment could always manage transitions – political and economic alike – smoothly. In Egypt, a disagreement between the IMF and the Muslim Brotherhood was jeopardising emergency financing and threatening a balance of payments crisis. In PNG, a quarrel between the current prime minister, Peter O’Neill, and the former leader, Sir Michael Somare, was causing uncertainty and instability, including for the $16 billion PNG LNG project.
Weak world growth
‘Slowing and below-trend world growth. Extreme risk aversion. Marked downside risks – from euro area, Chindia and US.’ That is how we sum up the world economy in our most recent chartpack.
- World growth. Not only are the euro area and UK looking prone to double-dip recessions; emerging economies are also undergoing slowdowns. According to Prof Eswar Prasad of Cornell University, ‘this stop-and-go global recovery has stalled once again’.
- Downside risks. The euro area is the No 1 risk, but China and America also need to be watched.
- Euro area. Fingers were crossed before a European summit on June 28-29 – the 19th so far on the crisis – that leaders would finally do a policy reboot. After the summit, markets rallied on news that member states would take action to mutualise their debt problems through greater fiscal and banking union and undertake ‘faster and more flexible’ intervention in stressed markets. Then they read the fine print. Such steps would depend upon prior changes to national laws and constitutions and European treaties – the work of years. Markets quickly retreated (Chart 3). In these circumstances, it would be unwise to rule out the need for a full sovereign bailout in Spain. Or in the (slightly?) longer run, the spread of the crisis to Italy. Or ultimately, the partial or full breakup of the monetary union.
- China. Chinese growth slowed to 7.6% over the year to June 2012, the lowest rate since late 2009 (Chart 4). The slowdown reflects both weaker export growth and policy tightening through 2011. The consensus is that renewed policy stimulus and stabilisation in the euro area will buoy Chinese growth in the second half. The trouble is, the Chinese economy has its own large imbalances that could obstruct any such uplift.
Looking beyond China to other BRICs, India grew at its slowest rate in nearly a decade in the March quarter. Persistently high inflation and a large budget are tying policymakers’ hands. As for Brazil, its economy appears to have stalled.
- US. The American economy slowed through the first half of 2012, and is moving towards a so-called fiscal cliff. This refers to a fiscal tightening of up to 4% of GDP that will occur if a large number of spending programs and tax cuts scheduled to end on December 31 are not extended. If tightening does occur as legislated, GDP growth is likely to slow markedly in 2013 (Chart 5). To make matters worse, Republican House Speaker John Boehner has again raised the prospect of not lifting the federal government debt ceiling – when it is reached some time between September and December – and thus provoking a sovereign debt default.
The worse things get, the more likely policymakers are to mount decisive and effective responses. That is our main consolation. True, it is hard to see a euro area policy reboot. But the US and China could do better than expected.
Rather than driving the economy over the fiscal cliff, US lawmakers could broker a grand bargain that gives the government muchneeded ‘fiscal space’ in the short term – but establishes a prudent budgetary envelope in the long term.
In China, the authorities are already beginning to mount a policy response. In May and June, the People’s Bank surprised markets by cutting interest rates and the government is increasing infrastructure and social spending again.
A US fiscal grand bargain looks less likely than Chinese stimulus. Even so, America will probably do ‘just enough, just in time’ to avoid default and the fiscal cliff, rather than ‘too little, too late’. Even more positively, Beijing seems to have both the will and the wallet to mount a big policy stimulus to counteract any large global shock.
Will Australia’s glass drain?
Would another international downturn set back many projects in Australia’s bulging resource investment pipeline, and thereby transmit the downturn here?
Fortunately, the pipeline is so bulging – at $500 billion – that even if ‘less advanced’ projects without committed financiers and overseas customers go into hibernation or die, ‘advanced’ projects will still propel investment (Chart 6).
All bets would be off, however, if a severe downturn set off another global financial crisis. Such a setback would result in sharp fall in commodity prices and could severely curtail the supply of trade and project finance and syndicated loans, thwarting even the most advanced of projects.
The long shadow of the GFC
Households and businesses in the North Atlantic economies continue to struggle with the unsustainable debts that they accumulated during the credit boom before 2007. In an attempt to pay down these debts, they have stepped up their savings considerably, which is exerting a big drag on growth. They are also defaulting, which is knocking bank solvency.
Governments, meanwhile, have seen their budgets battered by increases in safety net spending and declines in tax revenue. They have also been raising discretionary spending to offset the drag from private sector retrenchment. Finally, they have been obliged to lend and provide equity capital to illiquid and insolvent banks.
Around the periphery of the euro area, the fiscal costs of the crisis have frightened bond markets and prompted sudden funding stops. Thus, a private debt crisis has turned into a fiscal crisis. Stronger Core economies in the euro area have come to the financial rescue of weaker Peripheral economies, but this is giving the latter only a reprieve, not restoring them to growth and solvency. The joint unwillingness of the Core to take losses on the Peripheral debt, and inability of the Periphery to repay all of its debt, could yet provoke Peripheral economies to seek further debt relief and quit the monetary union.
In emerging markets, the picture is less bleak, though because they have their own imbalances and are reliant on the North Atlantic for exports, they too are slowing.
We return to the point that the global recovery is likely to be a fragile one in the next six months. But in our base case at least, commodity prices remain well above-trend and the resource investment boom remains on track.
Roger Donnelly, Chief Economist
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