Satyajit Das: After the Ashes, Australia finds itself on a sticky economic wicket

Economics View: Despite recent falls, the ability to devalue the Australian dollar remains limited

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The Independent Online

Australia’s cricketing stocks are at a low after losses to India (4-0) and England (3-0). And Australia’s new conservative Liberal National Party government also faces a country with diminished prospects, as its stellar economic run seems to have come to an end.

First, Australia’s enviably consistent economic growth, low unemployment and rising living standards were driven by strong growth in emerging nations, especially China and India, and demand for commodities. But China and India are slowing: even if growth levels remain above those in developed markets, the changing composition of growth (a rebalancing from investment to consumption) means that resource use intensity will decrease, reducing demand for commodities. Increased capacity, as a result of aggressive recent investment, will also come on-stream progressively, coinciding with lower demand putting pressure on prices and volumes.

Second, the commodity boom, Australia’s role as an investment proxy for China, AAA-rated safe haven status and relatively higher interest rates have all increased the value of the Australian dollar, reducing the country’s competitiveness in manufacturing, retail, tourism and exports.

Third, since 2001, Australia’s trade account has been weak despite the mining boom and record terms of trade. Australia’s current account deficit of around 3 to 4 per cent of GDP is likely to widen, increasing reliance on international financing.

Fourth, public finances, both national and state, are deteriorating as strong growth in the commodity sector no longer offsets weak domestic conditions. Significant budget deficits are likely.

Fifth, the Australian banking system, while well capitalised, has a very high level of exposure to the domestic economy and the housing market, which is over-valued by most measures. A fall in prices, increases in unemployment and decreases in income could expose financial system vulnerabilities.

Sixth, Australia’s cost structure is high, exacerbated by the high currency. Australian minimum wages are around A$16 (£9.40) per hour, compared to around A$7-8 per hour in the US and A$1-2 per hour in China. The cost of Australian engineers is around A$170 per hour, compared to A$132 in the US. Cash costs in the mining sector have increased by more than 250 per cent in the last 10 years. Improvements in productivity have been lacklustre.

Seventh, policy attempts to rebalance the economy have had limited success. Australia’s central bank, the Reserve Bank of Australia has lowered interest rates to 2.50 per cent per annum, seeking to boost housing and consumption activity as well as reducing the value of the Australian dollar. Lower rates to date have had limited impact on housing, credit growth, consumption, non-commodity investment, employment and confidence.

Despite recent falls, the ability to devalue the Australian dollar remains limited, with major economies implementing quantitative easing programmes. Given the country is an importer of manufactured products, a lower currency will also increase prices, lowering purchasing power.

Eighth, Australia’s attempt to rebalance toward Asia is flawed. As the commodity and mining boom slows, Australia wants to sell food, education, healthcare and financial services to Asia, as well as attract Asian tourists. But Asia faces its own challenges. Australia’s Asian strategy also suffers from inherent contradictions between its political and defence partnership with the US and its economic dependence on Asia. Deep-seated cultural barriers, such as the “White Australia” policy which ended only in the 1960s, are ignored.

The mining boom helped maintain income and buying power, as Australia extracted large rewards for its mineral resources, covering up the lack of international competitiveness in many sectors, which was driven by high costs, poor productivity performance, declining educational achievements and a narrow industrial base. Australia may have substantially wasted the proceeds of its mineral boom.

The author Donald Horne called Australia the “lucky country”. In a fragile and challenging international environment, Australia’s new government will need to make difficult choices and to have more than the usual quotient of luck.

Australia’s cricketers have the opportunity to make a start on the long road to recovery when England tour later this year. The economic recovery is likely to take much longer.

Satyajit Das is a former banker and author of “Extreme Money” and “Traders, Guns & Money”