Retrospect and prospect
In this last bulletin for the year, we look back at 2013 and forward to 2014.
World economic and trade growth is expected to pick up next year from a rather dull performance in 2013. Australian resource export volumes began to expand rapidly this year as new capacity from the investment boom went into production and is likely to ramp up much further over coming years. QE tapering in 2014 is unlikely to cause an emerging market crisis, but could put overextended companies under strain, as well as economies such as Turkey with large external financing needs.
A large medium-term uncertainty for Australia is where commodity prices settle once the supply response to the earlier price boom completes. We are inclined to believe that commodity prices and the real exchange rate have further to fall, which augurs well for the non-resource export outlook.
Disappointing world growth
Forecasters began the year thinking that 2013 would be a year of stronger growth for the world economy than 2012. But disappointing performance in emerging economies forced them to repeatedly mark down their forecasts – to the point where they are now estimating a slowdown in 2013 for the third successive year. The latest IMF forecasts released last month, for instance, foresee the world economy growing by 2.9% in 2013. This is 0.3% points less than its previous forecast in July, and the fourth time this year it has lowered its projections. It is also lower than the 3.2% recorded in 2012 (Chart 1).
Advanced economies at long last began to strengthen this year, thanks to the private sector recovery in the US, Abenomics in Japan, and some recovery in core eurozone economies.
Despite their slower growth, emerging economies continue to outgrow advanced ones, and to contribute more to world growth, but the growth gap has narrowed.
Growth in Australia’s major trading partners in 2013 is likely to be below its decade average of around 4%, according to the Reserve Bank.
Sluggish world trade
Annual growth in world trade over 2008-12 averaged 3% in real terms, just ahead of world GDP growth of 2-3%. This year is likely to be no better, with trade expanding at the same rate as GDP.
Lacklustre trade growth since the financial crisis contrasts with the previous two decades, when world trade grew at almost double the rate of world GDP – 7% vs 3½%. Thanks to this globalisation, exports as a share of world GDP rose from 20% in 1990 to 25% by 2010. But since then, the ratio has treaded water.
QE taper talk hits emerging markets
Taper talk – or musings by Federal Reserve officials about the scaling-back of quantitative easing – caused big sell-offs in various emerging economy bond, share and currency markets starting in May. Where previously emerging economies had expressed concern about developed economies using QE as a tool of ‘currency war’ to induce
‘hot’ money inflows into emerging economies, and thereby appreciate their currencies, suddenly the concern turned to capital outflow and the threat of external finance shortfalls and currency crises. Some Cassandras even worried about ‘Asia vu all over again’.
In fact, the worst didn’t happen, and nor do we think it will in future, because economies have learnt a lesson from the Asian financial crisis and built buffers against capital outflows. Still, the withdrawal of capital did amount to another growth drag, on top of the end of the commodity supercycle and various domestic supply bottlenecks.
Resource exports outpace non-resource exports
In Australia, resource exports have been outpacing non-resource exports ever since the commodity supercycle got underway a decade ago, and 2013 continues this trend (Chart 2: right panel). There is, however, a difference this year. Whereas past growth of resource exports was price-driven and volume-constrained, this year it is price- constrained and volume-driven. Since the commodity supercycle ended, resource exporters are having to absorb price cuts. Yet the large amount of resource investment in recent years has boosted capacity and supported a strong expansion of volumes, particularly of iron ore.
Other exports have performed less well because of the strong Australian dollar (Chart 2).
Because of its strong demand for resources, China continued to grow in relative importance as an export destination (Chart 3).
Modest rebound held back by liquidity trap
With 2013 proving to be disappointing, most forecasters have shunted their hopes for a global economic rebound into 2014. But they have resisted the temptation to forecast a sharp bounceback to full employment and capacity in advanced economies. The IMF, for instance, foresees advanced economies going from 1.2% growth in 2013 to 2% in 2014, and emerging economies from 4½% to just over 5%. This implies the world economy accelerates from 2.9% to 3.8%.
The reason advanced economies can’t recover faster seems to be the ‘liquidity trap’. Since the financial crash, everyone has been intent on deleveraging, which means that a savings glut has arisen in advanced economies and by extension the world. Lower interest rates would help to eliminate this glut and thereby revive growth. The trouble is, interest rates have hit the ‘zero lower bound’.
Growth in Australia’s major trading partners should increase from slightly below the long run average in 2013 to a little above average in 2014, according to the Reserve Bank.
Brisker world trade
Leading indicators suggest that a moderate rebound in world trade is taking hold. A strong correlate of trade is industrial production and leading indicators of it, such as purchasing manager indexes, have moved into healthy territory, suggesting that world industrial production will pick up in late 2013. Another welcome sign is a reported surge of Korean smartphone and automotive exports in October. The IMF is forecasting almost 5% growth in world trade volumes in 2014.
Disinflation – or a falling rate of inflation, which can shade into deflation, or falling prices – is emerging as a threat to the global recovery. According to the OECD, the annual inflation rate in G20 countries, whose members produce 90% of world GDP, slipped to 2.9% in September, from 3.0% in August and 3.2% in July. The trend was most evident in advanced economies, though emerging economies showed it too. Producer prices in China have been falling for 20 months now.
Emerging market risks
Though emerging markets withstood taper talk well this year, they could come under considerably more strain when the talk becomes action in 2014. Though we don’t believe there will be many economy- wide collapses, industries and even certain economies could experience difficulty. Among those to watch are South-east Asian companies catering to the domestic market that have reportedly made large unhedged US dollar borrowings in industries like property development, retail and food.
Australia’s two transitions
With the resource investment boom peaking this year, the Australian economy has been making one transition – from resource investment to resource exports – and needs to make another – from resource activity to non-resource activity.
Resource exports are likely to continue to grow strongly in 2014 and beyond as more and more resource investments reach completion. According to the Bureau of Resources & Energy Economics (BREE), 18 new projects worth $30 billion were completed in the six months to October. The Australian Treasury estimates that the investment boom as a whole will triple the capital stock of the resource sector. LNG will expand particularly rapidly, around 360% by 2017-18, according to BREE.
Though non-resource exports have been struggling, the A$ depreciation since earlier this year, and the likelihood of further currency weakness, will give them some boost next year.
How far will commodity prices fall?
The big uncertainty facing Australian exporters into the medium term is how far commodity prices will fall as supply capacity in Australia and elsewhere in the world expands to meet the increased demand that has emerged from ‘Chindia’ and other urbanising and industrialising emerging economies.
One view is that rapidly expanding resource export volumes and prices that plateau well above their long-run average will be perfectly sufficient to enable Australia to pay its way in the world. The A$ will stay strong, and non-resource exports will stay weak.
At the other extreme is a view advanced by Prof Ross Garnaut in his just published book, Dog Days: Australia After The Boom. He is much more bearish on resource export volumes and prices, and so thinks non- resource exports have to make a bigger contribution to the balance of payments. How? Through ‘a 20-40% fall in the foreign exchange rate without any pass-through into domestic costs and prices’.
Roger Donnelly, Chief Economist
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