Saturday, May 5, 2012
On the eve of next week's federal budget, Treasurer Wayne Swan will nod his head. Two years ago, when he pledged to deliver a budget surplus in 2012-13, Treasury's growth forecasts made it seem easy and appropriate.
But those forecasts proved wrong: too many moving parts didn't move as forecast. Now Swan has to deliver a surplus that will be both difficult and inappropriate.
Reserve Bank governor Glenn Stevens, too, might nod his head. The Reserve also got it wrong during 2010 and 2011 by misreading the speed of the economy's various moving parts. Now the RBA is undoing the interest rate rises it so confidently inflicted on us - and waiting to see how much of the intended stimulus gets past the banks to small businesses and households.
Ted Baillieu and Kim Wells might well nod their heads. In short time, Victoria has gone from economic standout to being close to recession. This week's state budget was sound, but not stimulatory. It assumes that Victoria's economy will trough in 2012, then recover during 2013. But for that, those moving parts will have to click together.
And the moving parts that matter most to us might be on the other side of the world.
Tomorrow, there will be two elections in Europe that could make it switch priorities from deficit reduction to growth. At best, this could revive the global economy; at worst it could unleash a new wave of instability that would jeopardise what the International Monetary Fund calls its ''fragile recovery'', and even send the world into a double-dip recession.
One is the French presidential election. If the polls are right, President Nicolas Sarkozy will be defeated by socialist challenger Francois Hollande. If so, that would mean that since the market rout of September-October 2008, 19 of the 27 European Union leaders then in power have been tossed out, along with their counterparts in Japan, Australia, New Zealand, Israel, etc. In that time, only five EU leaders have won re-election.
Sarkozy has been a disappointment to those who hoped he would reinvigorate France, but Hollande's policies are seriously retro. They include undoing Sarkozy's reforms (Hollande wants to lower the pension age from 62 to 60), lifting France's already high minimum wage, lifting state spending (already 56 per cent of GDP, compared with 36 per cent here), putting a 75 per cent tax on incomes over ?1 million ($A1.28 million) - and demanding a renegotiation of the EU fiscal pact to shift priority from reducing deficits to boosting growth.
In Paris, the markets believe that as president, Hollande would quietly shelve some of those policies to focus on renegotiating the European pact. Sarkozy has been the junior partner of German Chancellor Angela Merkel in steering Europe down the path of austerity. The electoral tide is now swinging Europe the other way. In the short term we will see more crises, more negotiations, more summits, and more instability in global markets.
What could be even more important, however, is the result of tomorrow's Greek election. After years of bitter polemic and two changes of government, the traditional rivals PASOK (left) and New Democracy (right) briefly united last year to negotiate Greece's austerity pact with the EU and the International Monetary Fund. That will require even more tough measures to force the Greek budget back into surplus, at a time when the country is in a deep depression.
Greece's GDP fell by 7.5 per cent over 2011, and by 17 per cent since the crisis began. Unemployment has climbed past 21 per cent; among young Greeks, it is 51 per cent. Not surprisingly, Greeks are rebelling; the polls show that new or previously obscure parties opposing the deal could win most seats in the new Parliament. There is no obvious way out; an unravelling of the Greek agreement risks unleashing a market panic like that of 2008.
This is a year of uncertainty. Australia was well-insulated from the 2008 crisis because its banks had lent wisely, the Rudd government moved boldly to shore up household finances and bank liquidity, and China's demand drove coal and iron ore prices sky-high. We remain relatively well-insulated now.
Despite the Coalition's rhetoric, Australia's government debt is very low. Even gross debt is just 24 per cent of GDP, the third lowest in the affluent world. Foreign investors see Australia as a haven, snapping up a net $110 billion of government bonds in the past two years, and driving bond yields to record lows. Almost 80 per cent of Australian government bonds are now held overseas. Yes, that makes us vulnerable to changes in global sentiment. But look around: whatever we do, Australia is not a country the world is likely to worry about.
Our problems are different from Europe's. The one fact that sums them up is that in 2011, in real dollars, mining investment increased by more than GDP. Mining investment is booming, but the rest of the economy is sluggish. The high dollar has flattened much of it. High interest rates and consumer caution have flattened other parts. And the trickle-down from the mining sector is too much of a trickle to kick-start activity.
The dollar is the biggest problem. It raises the cost of doing anything in Australia rather than in the rest of the world. A KPMG study in March found Australia is now the second most expensive business location in the world, behind only Japan. That happens when your currency rises 50 per cent above its long-term level, as Australia's has since 2005. If you're buying anything overseas - holidays, goods on the internet, machinery - it's a blessing. If you're trying to do anything here that competes with anything done overseas, it's a disaster. And the dollar will remain high as long as the world sees us as a haven.
Even BHP and Rio Tinto are now considering shelving big mining projects here, in part because the high dollar has inflated their cost in global comparison. Mineral processing has boomed, but the output of the rest of Australian manufacturing has slumped 7.5 per cent since the GFC, costing more than 100,000 jobs. Those who tell you manufacturing is doing well are seriously uninformed.
The growth pace of the economy in the second half of 2011 was just 2.5 per cent. There are signs that the slowdown might have bottomed. We are told that next week's budget will forecast growth to accelerate to 3.25 per cent in 2012-13. Indeed, Swan is talking as if the mere forecast is already an achieved fact. Not so - and the risk that it will not be achieved could become his nightmare over the year ahead.
Why? Because the budget usually forecasts growth to be 3.25 per cent or thereabouts. That doesn't mean that's what we get. Two years ago, the budget forecast growth of 3.25 per cent, but we ended up with just 2 per cent.
The budget forecasts were good in the good years, but in the past four years, they have been way out. In 2008-09, 2010-11 and 2011-12 they forecast far more growth than we got, while in 2009-10 they did the reverse. Too many moving parts!
There's a big risk that this forecast will again prove too optimistic. Mining investment could fall well short of the $120 billion forecast. The budget itself will slow activity: even with all the fiddles, you can't take $40 billion out of this economy without it putting a brake on growth, particularly where it is already weak. With the world recovery fragile, state governments also cutting spending, business and consumer confidence subdued, and the banks passing on only about half the Reserve Bank's rate cuts, it's difficult to see where that growth will come from.
If growth falls short, then the budget too will fall short of its target. Swan could be forced to play catch-up, tightening spending again and again in a low-growth economy to ensure that his political target of a budget surplus is met. Those moving parts are unpredictable.