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Dark economic clouds on the horizon

31-08-2010
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Dark economic clouds on the horizon

The peaking of the Australian resource investment boom and the slowdown of China are likely to be prominent concerns over the next six months and into 2014, a leading economist has warned.

The warning comes in the latest issue of World Risk Developments, produced by

Export Finance and Insurance Corporation (EFIC), Australia’s export credit agency.

EFIC chief economist Roger Donnelly says these risks coupled with the risk of financial volatility in the US may have a significant impact on the Australian economy.

World Risk Developments is a monthly update of worldwide economic and political events produced by the economics team at Australia’s export credit agency, EFIC.

 Mr Donnelly says significant “rebalancing” is likely to take place within the Australian economy as resource investment starts to fall.

“Markets have grown somewhat anxious that there won't be a smooth ‘baton pass’ from resource investment to other forms of domestic spending and resource exports, leaving the economy exposed to a sharp downturn, he says.

“They are pricing in a further 25 basis points of cash rate cuts by the Reserve Bank before the end of the year to cushion the downturn, and the Bank itself, at its June monetary policy meeting, said that there might be some scope for further easing.”

Further depreciation of the Australian dollar may also be in store, the newsletter notes.

Both the Reserve Bank and the Treasury foresee further falls in the terms of trade, as the international supply of iron ore and coal increases and prices come down.

Mr Donnelly says depreciation of the Australian dollar should help to offset some of the financial impact of lower commodity prices on miners. It could also boost the prospects of non-resource exporters.

According to the newsletter, the transition from the investment boom to the subsequent export boom should start to become evident.

Iron ore exports are forecast in the 2013-14 Federal Budget to increase by more than 40 percent over the next three years, with total volumes reaching double their 2008-09 level in 2014-15.

Coal export volumes are also expected to rise strongly: 35 percent over the next three years.

Australia is also expected to become the world’s largest LNG exporter by the end of the decade.

The newsletter notes China’s economy appears to be settling into a slower 7-8 percent growth groove.

This is mainly due to structural factors like a decline in the working age population, slowing rural-urban migration and declining investment.

“It is also vulnerable to a sharper cyclical slowdown because of a credit boom it has undergone since 2009,” the newsletter notes.

This has created a legacy of poorly performing investments financed by loans from local government finance companies and shadow banks that could turn sour once credit growth slows.

A credit squeeze currently being implemented by the central bank to rein in such excessive lending creates precisely this ‘hard landing’ risk.

“There is also a risk of financial volatility from tapering of the US Federal Reserve’s quantitative easing,” says Donnelly.

“The Fed indicated in mid June that it could begin such a taper or scaling back of its asset purchases by year-end if unemployment falls in line with its forecasts. When the tapering starts, there is likely to be a significant decline in asset prices worldwide, and in emerging market assets in particular. Indeed, the anticipation of taper has already begun to induce such volatility,” says Donnelly.

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