Making sense of a trade deficit blowout

A decline in net exports, coupled with soft household and government spending, may suggest the economy is taking a turn for the worse. If China's economy sours, our trade balance could deteriorate further.

Net exports, the main driver of growth during the March quarter, have taken a turn for the worse during April and May. Combined with soft household and government spending and an expected fall in business investment, we cannot discount the possibility that the economy contracted during the June quarter.

Australia’s trade deficit blew out to $1.9 billion in May -- the biggest deficit since January 2013 -- to continue a fairly ordinary quarter for trade. The result missed expectations for a modest deficit of $200 million.

Graph for Making sense of a trade deficit blowout

The result follows a strong start to the year, which was enhanced further by unseasonably warm weather. Nevertheless, the recent decline in export values has been sharper than was widely expected and for now appears to be sharper than the recent decline in commodity prices. This suggests that net exports will contract from real GDP growth in the June quarter.

The value of exports fell by 4.6 per cent in May to be 0.6 per cent higher over the year. This follows a decline of 2.2 per cent in April. The recent decline has been driven by exports of goods, with service exports actually increasing modestly in May.

Iron ore, Australia’s biggest commodity export, rose by $319m in May, but this was offset by falls in coal, gas and gold exports.

Export values are likely to come under further pressure in June, with the Reserve Bank of Australia’s commodity price index falling a further 2.8 per cent in Australia dollar terms in the month. This was the fifth consecutive decline in the series, with commodity prices falling by a total of 12.3 per cent over that period.

By comparison, imports declined by 0.6 per cent in May to be 4.4 per cent higher over the year. This follows a rise of 3.2 per cent in April. The decline was driven by fewer capital imports, likely reflecting reduced mining investment, with the other components such as consumption, intermediate goods and services largely unchanged.

Exports to China rose by just 1.4 per cent over the year to May and now accounts for about 35 per cent of all merchandise exports. Chinese exports declined by 5.7 per cent in May, which might simply reflect monthly volatility, but with Chinese authorities looking to ease excess capacity, exports might be a little softer than we have become accustomed to.

Exports to Japan and Korea have declined by 6.7 per cent and 14.4 per cent respectively over the year to May.

Graph for Making sense of a trade deficit blowout

Based on the current outlook for China, trade should rebound over the remainder of 2014. But our reliance on China certainly leaves the Australian economy particularly vulnerable if their economy begins to slow. With increasing speculation regarding China’s housing market and the broader economy, we cannot simply assume that it’ll be business as usual.

Needless to say, if the Chinese economy does sour, our trade balance will deteriorate further and the Australian economy will be left with few thriving sectors, limited monetary stimulus available and a federal government more intent on reducing spending than supporting growth.

Household spending has slowed significantly in recent months and housing construction is simply too small to contribute significantly to growth. These two sectors, in addition to exports, represent the rebalancing of the Australian economy, a process that has not been running smoothly in recent months.

From a growth perspective, I hope that the recent decline in exports simply reflects a drawback following a particularly strong March quarter. Recent comments from the RBA indicate that it believes that this might be the case. Nevertheless, it provides further evidence that the June quarter was particularly weak and there’s a very real possibility that activity contracted during the quarter.

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