Magazine article Business Credit

Hot Spots: Australia

Magazine article Business Credit

Hot Spots: Australia

Article excerpt

Unlike most other countries in the developed world, Australia has been able to avoid a recession for two decades. It has been able to accomplish this feat mainly because it could ride a commodities' boom powered by enormous and seemingly ever-growing demand from People's Republic of China (PRC). Now that the PRC is in the midst of a marked slowdown, however, Australia is forced to undergo an adjustment so difficult that it has almost split the economy in half with each part moving on a different track.

On the one hand, there are the resource-rich states of Western Australia and Queensland, which are now struggling and pleading with Canberra to give them a greater share of revenues from a nationwide goods and services tax. On the other, places such as South Australia and Victoria have depended far less on resources, are finding the needed adaptation a lot easier to digest, and do not believe that the resource states should be granted any extra money, even if their budgets are hurting.

To give an indication of what is involved, Western Australia has done enormously well selling iron ore to China, but global supplies rose to record levels just as China's appetite for the ore began to fade. Prices have plummeted from a peak of about $190 a ton to the neighborhood of $50 a ton. This is a drop of almost 70% and one that has not only forced smaller mining companies to close or lay off thousands of workers, but has also raised havoc with state budgets. Western Australia worries that if iron ore prices stay where they are, or fall still lower, AU$ (Australian dollar) 4 billion or more in projected royalty revenues in fiscal 2015-2016, or a staggering 12% of the state budget will be erased.

Nationwide, the loss will be felt less, but iron ore is Australia's foremost export commodity, which in the peak year 2013-2014 yielded AU$74 billion. The worldwide slump in oil prices, moreover, is depressing quotations for natural gas and coal, of which the country is also a large exporter. Some sectors of the economy will be supported by lower gasoline prices, which are a clear positive for consumers. Overall, though, the negatives predominate, which explains why foreign exchange traders have been pricing in at least two more reductions in interest rates by the Reserve Bank in the next 12 months.

All told, the picture could be worse. While resource-dependent regions are suffering painful setbacks, Australia is not headed for a recession. One factor that will play an important role in the government's efforts to help the economy diversify and develop such key sectors as agriculture and tourism is the newfound weakness of the Australian dollar in the foreign exchange markets. The Australian dollar lost 8.5% of its U.S. dollar value in 2014 and about 4% so far this year. Reserve Bank Governor Glenn Stevens identified $0.75 as his preferred exchange rate in an interview with the Australian Financial Review in December.

To put this into perspective, one needs to recall that at the outset of last year, driven by the mining boom, the Aussie was still pushing toward $0.90. It was over 98 cents at the time and there were more than a few pundits predicting that its hitting parity with the U.S. dollar was only a matter of time. But conditions have changed and the authorities are now eager, indeed, to diversify the economy to make it less resource-dependent. This requires a competitive exchange rate and the Reserve Bank will do its best, with interest rate cuts and other measures, as needed, to see to it that the AUD does not again start climbing in sustained fashion. …

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