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Heading into deep waters

 

Postcard of sinking of the Titanic
Postcard of sinking of the Titanic

The issue.

Can Australia avoid the malaise of Southern Europe?Investors and thinking Australians are apprehensive – for good reason. And this has nothing to do with the fact that the Government has posted a high level of terrorist alert, which means it believes an attack is likely. It’s the economy that worries people more. Growth is slowing, the Budget deficit is accelerating out of control, exports are slipping, while the terms of trade are deteriorating.The Lucky Country is out of luck. Can the good times return?

Analysis.

While a halving in iron ore price in the past 15-months, and a sharp drop in coal prices has put a huge dent in the mining sector, many of Australia’s endemic problems are self-made.

Australians are half way through a decade of delusion. They have been led there by poor political leadership, a lack of long term vision, an entitlement mentality, espoused by a very old Australian expression – “she’ll be right mate”. Both main parties are culpable.

Nowhere was this more obvious than in the (normally) buoyant state of Queensland where, earlier this month, the centre-right Coalition government squandered a seemingly unassailable majority and were outed by a negative, vacuous campaign led by the economically-illiterate Anastasia Palaszczuk. Like the Greeks, the electorate was tired of hair-shirt but necessary austerity, and dumped premier Campbell Newman out of his seat, as well as his job.

1.     The Coalition government inherited from Labor in late 2013 a growing Budget deficit and a mountain of debt, estimated to rise to $667 billion. The problem was not simply over spending by the Rudd-Gillard government, but future commitments in education and social services, especially the planned National Disability Insurance scheme, a measure the Coalition supported. In its most recent Mid Year Economic and Fiscal Outlook (MYEFO), published in December, the Abbott government’s treasurer, Joe Hockey, said it was on track to cut debt by $170 billion, but reported a continued deterioration in the forecast Budget deficit, suggesting it would be the end of the decade before it could be brought back to surplus. He cited deterioration in Australia’s terms of trade, a 30 per cent fall in iron ore prices, and the refusal of the hung Senate, the upper house, to pass some Budget measures. These together have cost the government $70 billion in tax receipts since it was elected.

2.     International investment into Australia, particularly in the energy sector, has been falling, partly due to the tumbling oil price, but also because of high labor and construction costs, and a powerful environmental lobby, which has hobbled the development of coal seam gas. Two key states have blocked it.

3.     The Australian government is due to publish two white papers in 2015 – one on the tax system, and the other on defence, the third in five years. Both will be controversial. A comprehensive review of the tax system by former Treasury secretary Ken Henry in 2010 is gathering dust on the shelves. A potential increase in the General Sales Tax (GST), currently 10 per cent, is on the agenda, as is its extension to a number of goods and services currently exempt, including basic foods, fares, and financial services. Also in the white paper will be changes in the way GST revenues are distributed from state to state – a perennial argument. Goods bought on line overseas under $1000 are exempt from GST – that will change. On defence, the identification of China as a potential threat (a feature of the Rudd government’s white paper) will be withdrawn or watered down, with much of the focus being on procurement, including replacement of Australia’s inefficient submarines and fighting aircraft.

4.     Australian GDP growth in the past 12 months has been largely due to residential housing and mining construction. Mining construction is now well past its peak. House and apartment price growth in all cities is likely to slow down, or stagnate, as the government forces the banks to maintain higher reserves, and to tighten lending standards.

What will happen

•    Australia will not hold much excitement for international investors or policymakers. True, trade minister Andrew Robb is the stand-out Cabinet minister for his successful conclusion of free trade treaties with China, Japan and South Korea – and India on the way – but the real benefits of these will not flow until 2016 at the earliest. The reductions in tariffs will reduce the costs to Australians in $US terms, but will be more than offset in the decline of the $A, which has also reduced the benefits of falling oil prices. The stock market will under perform the US and South East Asian markets, pushing Aussie investors oversea.

•    The Abbott government will introduce a new, fairer Budget in May, but will not heed those who believe it needs to be more ruthless on public spending. If, as expected, unemployment rises and company performance falls short of expectations, the Budget deficit will rise further. A modest recovery in minerals exports will be insufficient to halt the trend, leaving Abbott heading into a 2016 general election he could lose. One of the most interesting news items to watch for will be Opposition leader Bill Shorten’s strategy to restore the country’s economic health. Don’t hold your breath – our bet is that by the end of 2015 he and his team will still be in denial.

•    We expect both individual stocks and funds to fare worse in 2015 than the international average. Australia can no longer be regarded as a safe haven. The economy will be outperformed by New Zealand and the countries of South East Asia.

Longer-term prospects are brighter. One of the better prime ministers, Paul Keating – responsible for many sensible economic reforms – used to talk of the “recession we had to have” after he described Australia as a “banana republic” in 1986. He was able to take the public with him by a combination of sound policy, good communications and a (largely) cooperative Opposition. Just now Australian politics lacks all three of these virtues. But if one of the two main parties can articulate the urgent need to restore Australia’s competitiveness, promote a vision of expanding economic strengths, such as in agriculture, education and tourism, and couple these with technology and incentives for small business, we can see Australia becoming the “Lucky Country” again.