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RECESSION WATCH: FIVE FACTORS TO WATCH

Economic perspective

At least 14 major economies are in recession or have experienced recessions in 2008. However at least another 14 major countries have so far avoided entering recession.
Whether in recession or not, the global economy seemingly fell off a cliff in the fourth quarter of 2008.
Australia can avoid recession in 2009 supported by five key factors. However the economy will still face significant challenges.

What does it all mean?

In general, an economy is regarded as being in recession when it goes backwards for two consecutive quarters. It is not an uncommon or extraordinary experience with most countries experiencing recessions around once a decade.
Still, what has been uncommon or extraordinary is the fact that Australia has not experienced a recession for over 17 years. Many countries experienced recessions in the technology bust period of 2001 but Australia avoided a serious downturn.
While the global downturn is far bigger than the 2001 slowdown, it is not out of the question that Australia could avoid recession yet again. But whether meeting the technical definition of recession or not, the economy faces significant challenges over 2009.
The five factors that will help Australia through 2009 are housing undersupply; high population growth; the terms of trade; the speed and extent of stimulus; and the strong state of the financial sector.

Housing undersupply

Housing prices are falling in many parts of the globe, reducing consumer confidence and spending power, and leading to slower economic growth.
Despite gloom and doom predictions, housing prices haven’t slumped in Australia. Simply, population has been rising in recent years but supply of housing hasn’t kept pace, leading to an under-supply of housing.
Clear evidence of Australia’s tight housing market is found in the rental market. The rental vacancy rate is close to the lowest levels in 20 years and rents are rising at the fastest rate in 20 years.
Lower interest rates, the first home owners grant and increased interest of investors will lead to greater construction over 2009. Housing finance data points to more construction. But building approvals are still falling with the value of approvals recording the biggest drop in 18 years.

Terms of trade

Over the past five years Australia experienced the biggest terms of trade (ratio of export prices to import prices) or income boost of any major developed economy.
The Reserve Bank Governor said the terms of trade rose 65 per cent over the period – the biggest boost in half a century – although it will ease 20 per cent over the next year.
The income boost from the terms of trade hasn’t been lost, rather the effects can be seen in new construction, profits and government balance sheets.

High population growth

Australia’s population is growing at the fastest pace in 20 years. While much of the gain is produced by record immigration, Australia is also experiencing a ‘baby boom’.
In Australia, population is growing at a 1.7 per cent annual rate, above the 0.9 per cent growth pace in the US, 0.3 per cent increase in the UK and negative population growth rates in Germany and Japan. Higher population growth means greater spending, housing demand, employment and investment.
The Deputy Prime Minister has recently rejected calls to lower Australia’s migration target noting that businesses are still struggling to fill skilled vacancies.
The other important issue associated with high population growth is the nature of demographics. The share of young people in the working age population is the lowest on record, highlighting the need for immigration and underpinning population growth.

Speed and extent of stimulus

Fiscal and monetary policies have been loosened markedly in the past five months, reinforced by the depreciation of the Australian dollar.
No other country has received the same economic boost from all three factors – government spending, lower interest rates and cheaper Aussie dollar.
The Reserve Bank estimated the boost from the easing of fiscal policy in 2009 at 2.5 per cent of GDP – on par or greater than other major developed economies.
Official cash rates have been cut from 7.25 per cent to 3.25 per cent. And as the Reserve Bank Governor noted, the fall in cash rates has been passed through to housing borrowers, boosting loan demand and supporting balance sheets. The "transmission mechanism" or pass through has been far weaker in countries like the US and UK.
Since peaking in mid July 2008, the Aussie has fallen by over 50 per cent against the greenback (from A$1.02 per to A$1.55). The decline is understandable when you consider the similar drop in commodity prices. In fact the CRB futures index has lost 57 per cent over the same period.
But other major currencies haven’t fallen anywhere near as much as the Aussie dollar. The euro has declined 20 per cent against the greenback, the British pound has lost 41 per cent and the Japanese yen has actually strengthened by 15 per cent. (The yen had actually lifted 21 per cent but has lost ground recently.) And the US dollar has lifted 22 per cent against a basket of major currencies.

Strength of financial system

Australia banks have not experienced the same sort of stresses and challenges experienced by banks in the US and Europe. A key reason is the fact that Australian banks have far greater exposure to the domestic market – businesses and individuals – than foreign markets or financial institutions. While the global slowdown has led to higher bad debts (largely a small number of highly-geared corporates), the impaired asset ratio was at a record low ahead of the event.
Australian banks are still recording solid profits at a time when overseas banks are reporting losses. Commonwealth Bank reported a 9 per cent lift in first half profit to $2.57 billion. Bendigo and Adelaide Bank reported a 56 per cent lift in first half profit to $118.8 million. Bank of Queensland has flagged a 25 per cent lift in first half profit to record highs, expecting normalised cash profit of $79.3 million.

Source: Commonwealth Bank Economic Insights, Feb 23rd 2009