Tuesday, May 25, 2010

Garnaut's got the goods on mining taxes

QUESTION 1 is whether the slump in global markets is a crisis or a correction. Are we seeing a second wave of the panic of late 2008, or just seeing investors retreat from positions that now seem too optimistic?

Question 2 is whether the resource rent tax will damage foreign investors' long-term confidence in Australia, and hence our future growth.

The two questions are inter-related. The mining companies and their supporters tell us the plunge in mining share prices is the result of the new tax. And as we all indirectly own shares in the mining companies through our super funds, we're all worse off.

Let's put the facts. When the markets closed on Friday, April 30, the Australian dollar bought US93 and the benchmark S&P/ASX200 index stood at 4807.4.

On the Sunday, the government released the Henry report and announced it would impose the resource rent tax.

The next day, both the dollar and the market index fell, but slightly, by 0.5 per cent. Over the next two weeks both slid by roughly 4 per cent. That's a fall, but no cataclysm.

The real damage came in week three. By last Friday morning, the dollar had plunged 9.7 per cent in four days and a bit, and the sharemarket by 8.7 per cent. That's a market plunge. But then they kept rising.

The important thing is that this was not unique to Australia. Sharemarkets worldwide have fallen by similar amounts over the same period. Mining stocks in the US fell by similar amounts to mining stocks here.

The Aussie dollar fell more than most against the US dollar, but there are other reasons for that.

Commodity exporters such as Australia have manic-depressive currencies: they rise higher and fall lower than the rest when the outlook for global growth changes. Back in 2008, we went from US97.86 in July to US61.22 in October. Now forecasts for global growth have fallen, with Europe facing years of slow growth and China slamming on the brakes to head off inflation.

Second, the crisis in Europe has reversed the market's bets on what the Reserve Bank will do next. A month ago it was forecasting several rate rises ahead. Now it's punting on rates staying on hold until the second half of 2011. And that has halted the carry trade, in which investors borrow in Japan or the US at low interest rates to invest in Australia.

Third, Australia plans to impose a resource rent tax on miners, reducing the profitability of mining projects. All three are factors in our falling dollar and share values. Yet Australian shares have fallen at similar rates to the rest and bank shares have fallen as much as mining shares. To me, that suggests the new tax has been only a marginal influence.

What of the future? Your guess is as good as mine, but most analysts see this as more correction than crisis, at least outside Europe.

Asia's biggest markets are growing at incredible speed: China, Taiwan, Thailand, Malaysia and Singapore all grew by more than 10 per cent in the year to March, with South Korea and Hong Kong not far behind. That momentum would take some stopping. And the Federal Reserve is forecasting US growth of 3.2 to 3.7 per cent this year. Europe alone is in trouble.

What about us? With an election looming, it's no surprise that the mining companies have put projects on hold. I suspect they will stay on hold until the election is over and (if Labor wins) the new tax becomes law, with the support of the Greens, who will hold the balance of power in the new Senate.

In the short to medium term, you'd expect that it will lead to less mining investment than otherwise. Mining Australian deposits will become less profitable, and in some cases those projects will drop down the priority list of the multinational miners. But as I have argued before, that simply defers those projects until they become more profitable. Our mineral despots will not be moved. Coal aside, they will all be mined eventually. And the government is right to demand a better return for them.

But how? A consensus is starting to form around a sensible compromise, well-expressed last Thursday in a thoughtful, fair-minded speech by Professor Ross Garnaut at the University of Melbourne. Decades ago, Garnaut and Anthony Clunies-Ross invented the resource rent tax we now use for the oil and gas industry. Garnaut is also the long-time chairman of Lihir Gold, and has worked closely with both the Rudd government and Rio Tinto. No one knows the issues better.

There is no space to summarise his speech here: for those interested, it's at www.theage.com.au. Garnaut chastised his fellow miners for using emotive arguments and threats rather than logic, and upheld the government's right to impose it on existing as well as new projects.

But he also questioned Treasury's assumptions that mining companies could borrow money at the same rate as the government to finance their initial losses, and that future governments would honour the pledge to pay mining companies 40 per cent of their losses on failed projects.

A better solution, he argued, would be to use the Henry formula to tax mining exploration, and put his own long-established (and less extreme) tax on mining production. It's the logical solution. Pity they won't agree on it any time soon.