Australias 2015 Economic Situation - Case Study Example

Business Report Student Name Institutional Affiliation Executive Summary Currently, the Australian economy is in a transition phase whereby the focus by investors is shifting away from investments in the resource sector to other sectors. Moreover, the Australian economy continues to post GDP growth rates that are below market expectations. As a result, the Australian government as well as other policy making institutions such as the Reserve Bank of Australia (RBA) have in the recent past engaged in the implementation of various measures aimed at guiding the economy back into its growth trajectory. Among these measures include the federal government’s deficit budget financing as well as RBA’s reduction of the cash rate. The following report presents an analysis of the current economic conditions in Australia. It discusses the effects of such economic conditions on the company’s performance as well as outlines various measures that the company can institute to cushion itself against adverse economic conditions. In addition, there are recommendations on how the company can take advantage of the existing conditions to enhance its performance. Moreover, the report presents a projection of RBA’s cash rate for the remaining period in 2015. The projections are based on a consideration of the existing conditions as well as market expectations coupled with historical behaviour by RBA. The report concludes with a recap of key issues of discussion. Table of Contents Business Report 2 Student Name 2 Executive Summary 3 Introduction 5 Australia’s 2015 Economic Situation 6 Falling commodity prices and increased export volumes 6 Effects on GDP 7 Figure 1: Australia GDP since June 2012 (Data Courtesy of the Australia Bureau of Statistics) 7 Effects on Terms of Trade 8 Figure 2: Australia’s Terms of Trade Since April 2012 (Data Courtesy of ABS) 9 Figure 3: Australia’s Unemployment Rates since 2012 (Data Courtesy of ABS) 11 Effect on Budget Deficits 12 Figure 4: Australia’s Terms of Trade (Data courtesy of RBA). 12 A forecast of RBA’s Cash Rate Movements 13 Figure 5: Australia’s Cash Rate, Past and Projected (Data Courtesy of RBA) 14 Conclusion 14 References 14 Introduction The Australian economy is in a transition phase as investors shift their capital allocations from resources projects such as iron ore to other sectors of the economy such as services and agriculture. According to RBA (2015), the country continues to record economic growth rates that are below trend in the last few years, a factor that has resulted in rising unemployment rates in the country. This is evidenced by fluctuating GDP figures with the ABS reporting a 2.3% GDP in 2014 with a mere 0.5% growth in the economy in the last quarter of 2014 (RBA, 2015). As a result, Tom Allard of the Sydney Morning Herald reports that there seems to be a consensus in the market that Australia’s economy is weak and needs interventions in order to spur it back into a growth trajectory. Australia’s economic growth rate for the year 2015 is projected to reach 2.5 %, while the inflation rate is expected to be around 1.7% (RBA, 2015). The unemployment rate will average 6.4% while the services sector is projected to make the highest contribution to overall output (Common Wealth of Australia, 2014). RBA (2015) further notes that interest rates remain at historically low levels hence financing costs for business investments remain low. As a result, in February 2015, RBA decided to hold interest rates at the previous month’s rate of 2.25% in an effort to foster economic growth. However, in light of the fact that GDP growth rate remains low and may slump further, there is likelihood that RBA may further reduce the cash rate to a new historical low of 2% in an effort to provide the much needed liquidity to jumpstart economic growth. This is further evidenced by Glenn Stevens, RBA’s governor signaled in his March 3rd Monetary Policy statement that the RBA board is considering further reductions in the cash rate as available economic information indicates that Australia’s economic growth rate is below expectations. The following report presents an analysis of the latest economic situation in Australia with advice to company directors on what needs to be done to enhance their profitability. The report further outlines a forecast of the expected cash rate movements in 2015 based on current and expected economic performance. Australia’s 2015 Economic Situation Falling commodity prices and increased export volumes According to RBA (2015), global commodity prices particularly for minerals such as iron ore continue on a downward trend. For instance, iron ore which accounts for 20% of Australia’s export earnings slumped to an all-time low of $70/ ton down from $180/ ton recorded in 2011 (Commonwealth of Australia, 2015). The decline in mineral prices, particularly for iron ore is as a result of declining global demand for steel products coupled with excess supply as a result of recent capacity expansions in Australia. According to Pack (2015), coal and liquefied gas, which are key export earners for Australia, are on a downward trend implying worsening trade deficits and deteriorating terms of trade. The decline in liquefied natural gas prices is expected as a result of projected increases in global supply as many countries including the USA are anticipated to enhance global supply impacting negatively on international prices (Pack 2015). The falling commodity prices and increase in export volumes will have various influences on businesses ranging from effects on domestic inflation, exchange rates, government infrastructure spending and on employment. These outcomes have different impacts on businesses as discussed below. Effects on GDP Falling commodity prices will have a negative impact on the country’s GDP with far-reaching consequences for businesses. For instance, the Australian government continues to feel the effects of lower GDP figures compared with previous years. Australia’s past GDP growth rates are as presented below. Figure 1: Australia GDP since June 2012 (Data Courtesy of the Australia Bureau of Statistics) The most notable impact has been the federal budget deficits due to dwindling government revenues from taxation. In December 2014, Australia’s budget deficit for the 2014- 2015 financial year was revised upwards to $40.4 billion (Pack 2015). Such budget deficits may hamper infrastructure spending by the government with the effect that businesses may suffer due to poor infrastructure such as in roads and other amenities. This is likely to hamper productivity for businesses which may lead to lower profits. Further still, a widening budget deficit implies that any possibilities of corporate and income tax cuts are not expected, at least in the near future. As a result, the company should brave for tax increases as the government seeks to raise revenues to finance its budget and reduce the budget deficits that have been observed in the recent years. However, the falling prices seem to be diluted by an increase in the overall export volumes being favored by a depreciating exchange rate that has made Australian exports competitive in the global markets. This is further coupled with economic recovery in countries that are Australia’s major trading partners such as China, Japan and the USA. Effects on Terms of Trade Another effect of falling commodity prices is on the country’s terms of trade. The ABS reports Australia’s decline in terms of trade by 1.9% in December relative to November 2014. This is evidenced by a reported trade gap of $ 980m during January 2015. This trade gap was a staggering 95% increase from the deficit recorded in December 2014. The widening trade gap is attributable to lower commodity prices, particularly the export commodities, as well as an increase in capital imports into the country. Moreover, Australia’s terms of trade fell in the last quarter of 2014 relative to the third quarter of the same year from 89.40 to 87.90 Index Points (Commonwealth of Australia, 2015). The figures over the past three years are presented below. Figure 2: Australia’s Terms of Trade Since April 2012 (Data Courtesy of ABS) An improving terms of trade position is indicative of business opportunities for many Australian businesses, particularly those in the export segment. According to Pack (2015), there is a positive relationship between the terms of trade position and the exchange rate. As a result, with deteriorating terms of trade, there is a corresponding depreciation of the exchange rate. Consequently, the Australian dollar continues to weaken against the US dollar in light of Australia’s terms of trade position. On a positive note, a depreciation of Australia’s exchange rate is associated with greater competitiveness of Australian exports in the global market place. This is in line with Kohler, Manalo & Perera (2014) who state that exchange rate movements influence economic activities and overall demand for both exports and imports. A depreciating exchange rate makes locally produced goods cheaper in the global markets increasing their competitiveness and subsequent demand. Conversely, an appreciating exchange rate makes local exports more expensive than foreign gods thus reducing their demand. The same happens for imports with a depreciating exchange rate making imports more expensive while an appreciating exchange rate makes imports cheaper. The current exchange rate position is good for the company’s export business as its goods will be more competitively priced in global markets. This is informed by the fact that different sectors of the economy respond differently to exchange rate fluctuations with some being more or less sensitive than others (Kohler, Manalo & Perera, 2014). However, based on the fact that much of the company’s production inputs are imported, the current exchange rate position will lead to higher costs of inputs. This is likely to offset any gains realized from increased export volumes and eat into the company’s reported profits. As a result, there is a need for the company to increase overall export volumes so as to generate more revenues that will absorb any increases in costs of inputs. This will ensure that there is a real gain as a result of the depreciating exchange rate for the Australian dollar. Additionally, the signing of free trade agreements with a number of key Australian export destination countries such as China, Korea and Japan is expected to expand the export markets and consequently help reverse the worsening terms of trade. Hence, the company needs to take advantage of these trade agreements to expand its exports in these markets. Effects on Employment and Household Expenditure The current economic conditions are also having a toll on the country’s employment levels. Australia’s employment sector continues to record sluggish performance with the ABS reporting a mere decline in unemployment rate of 0.1% between January and February 2015 (ABS, 2015). The unemployment rate for January was 6.4% while that for February was 6.3% (ABS, 2015). The overall unemployment rates for Australia are shown below. Figure 3: Australia’s Unemployment Rates since 2012 (Data Courtesy of ABS) As a result household incomes for unemployed Australians will continue to suffer at least until there is economic recovery capable of supporting greater employment levels. However, due to an improvement in dwellings investments, the equity markets have responded with listed equity prices recording substantial gains in the recent past. As a result of rising equity prices, those households who have invested in the ASX have experienced substantial wealth growth, a factor that has boosted household consumption in the wake of falling household incomes. As a result, the outlook for consumer expenditure is forecast to improve further supporting business investment returns due to increased activity among households. However, according to the ABS, Australia’s overall consumer spending reached an all-time high of AUD 216, 940 during the third quarter of 2014 (ABS, 2015). This figure is projected to increase even further painting a rosy picture for mast Australian businesses as well as foreign ones with operations locally. Improved household consumption is expected to result in a decline in household investment and savings ratios. This may be a pointer to an expected increase in the household’s appetite for consumer credit which may further impact positively on business activity. This is expected to support business confidence in committing their finances to investments as enhanced household consumption provides a clear picture of improvements in demand. Moreover, improving household expenditure will enable businesses to enhance their utilization of existing spare capacity resulting in improvement in the overall GDP growth rate. Nevertheless, The RBA projects that consumer demand is likely to remain low in the short term with a weak anticipated growth rate in consumer spending. As a result, businesses should continue to expect unutilized spare capacity Effect on Budget Deficits Australia’s Terms of Trade continue to worsen meaning that there is likely to be enhanced budget deficits. Australia’s budget deficit is as represented below. Figure 4: Australia’s Terms of Trade (Data courtesy of RBA). The consequence of an expanding budget deficit is that the federal and state governments are likely to turn to the domestic financial markets for financing its credit deficits. This will enhance competition between the government and businesses implying that the amount of credit that will be available will be minimal. This will have a negative effect on business investments and hence, lower revenues. Moreover, an increasing budget deficit may spark increased taxation for both businesses and consumers. On the consumers, increased taxation will negatively impact on their overall spending power and confidence. This means that demand for goods and services may be affected leading to reduced revenues for businesses. A forecast of RBA’s Cash Rate Movements Many economic analysts anticipate that the Reserve Bank of Australia will make a further cut in the cash rate. This seems to be the only rational mechanism of jump starting the economy and averting the slump in employment figures that spells doom for both businesses and households. Nevertheless, global oil prices continue to fall although the effects have not been fully felt domestically. However, these effects are expected to infiltrate into the economy in the medium to long term. In light of these harsh economic undercurrents, the government has continuously engaged in instituting various measures aimed and containing any negative impacts on the economy. Such measures have included both fiscal and monetary interventions. For instance, the Reserve Bank of Australia continuous to monitor the cash rate closely with the objective of ensuring that there is adequate liquidity for businesses and households to participate in the economy. The RBA has periodically adjusted the cash rate with the recent trend indicating a downward revision of the cash rate over the last few years. This is as shown in the graph below. Figure 5: Australia’s Cash Rate, Past and Projected (Data Courtesy of RBA) Conclusion The Australian economy is in a transition phase as investors shift their capital allocations from resources projects such as iron ore to other sectors of the economy such as services and agriculture. The country continues to record low economic growth rates that explains the increasing unemployment rates in the recent past. RBA’s decision to hold interest rates at the previous month’s rate of 2.25% seems to have little effect on GDP growth hence the anticipated further reduction in the cash rate to 2.00% in the remaining part of 2015. References Allard, T. (2015, January 17). Why everything you think about the economy in 2015 is probably wrong. Retrieved April 1, 2015, from http://www.smh.com.au/business/the-economy/why-everything-you-think-about-the -economy-in-2015-is-probably-wrong-20150116-12iouc.html Australia Bureau of Statistics. (2015). 5206.0 - Australian National Accounts: National Income, Expenditure and Product, Dec 2014. Retrieved April 1, 2015, from http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/5206.0Dec%202014?OpenD 0cument. Commonwealth of Australia. (2014). Statement 2: Economic outlook. Retrieved April 1, 2015, from http://www.budget.gov.au/2014-15/content/bp1/download/bp1_bs2.pdf. Kohler, M., Manalo, J. & Perera, D. (2014). Exchange rate movements and economic activity. RBA Bulletin, March, 2014. Retrieved April 1, 2015, from http://www.rba.gov.au/publications/bulletin/2014/mar/5.html Pack, C. (2015). The Australian Economy and Financial Markets. Reserve Bank of Australia. Retrieved April 1, 2015, from http://www.rba.gov.au/chart-pack/pdf/chart-pack.pdf. Reserve Bank of Australia. (2014). Economic Outlook: August 2014. Statement on Monetary Policy. Pp. 69-76. Retrieved April 1, 2015, from http://www.rba.gov.au/publications/smp/2014/aug/pdf/eco-outlook.pdf Reserve Bank of Australia. (2015). International economic developments. Statement of Monetary Policy, pp. 5-12. Retrieved April 1, 2015, from http://www.rba.gov.au/publications/smp/2015/feb/pdf/intl-eco-dev.pdf Read More