RBA hopes for smooth transition
The Reserve Bank's latest Statement of Monetary Policy is less bearish that some had feared, though anything but bullish. It slashes the bank's growth forecast for this year, while leaving the forecasts for next year untouched and even nudging its forecast for 2015 a little higher.
But all that is qualified by risks and uncertainties, as it tries to gaze into the unknowable future. And the biggest risk is an acceleration of the slide in mining investment.
"While the expectations component of the (March) Capex survey remains strong, this is inconsistent with information from the bank's liaison, few new commitments to mining projects, and a lack of current expenditure on the development and planning work that would typically precede new projects," the Reserve Bank reports.
"This is especially noticeable in the coal industry, where lower prices of late have led to a significant curtailment of this type of expenditure. Given this, the expectation is that mining investment will decline somewhat over the next year or so, before falling away more noticeably thereafter."
The RBA says the main game for the economy is "a transition in the drivers of growth from mining investment to other parts of domestic demand and to exports". And while it is cautiously optimistic the transition will be relatively smooth it adds a strong note of caution.
"There remains considerable uncertainty about how this transition will proceed. The forecast for mining investment remains uncertain.
"Also, there are still several proposed large projects slated for later in the forecast horizon (2014-15), and there is considerable uncertainty about their prospects. With little planning and development for other new policies under way, mining investment could fall away faster than anticipated.
"However, with commodity prices forecast to only decline modestly, lower domestic costs in foreign currency terms (as a result of exchange rate depreciation and reduced demand for labour inputs) could lead to new projects being slated."
The Reserve's baseline case is for the country to muddle through. It has slashed its growth forecast this year from 2.75 to 2.25 per cent, continuing the slow pace of growth in the six months to March. With the population assumed to grow by 1.8 per cent a year, the real bottom line, GDP per head, is expected to grow by roughly 0.5 per cent, or just a third of its long-term average.
But the Reserve has left its forecasts for next year unchanged at between 2.25 and 3.25 per cent, the wide range of possible outcomes reflecting its uncertainty.
By the end of next year its best guess is that GDP growth will be back to its trend rate of 3 per cent, and it thinks could rise to 3.5 per cent by the end of 2015.
The unchanged forecasts for 2014 result from changed assumptions. It assumes an exchange rate of US90¢, against US100¢ in its May forecasts, and a cash rate of 2.5 per cent into the future, reflecting this week's rate cut. These have pushed forecasts up considerably from what they would have been.
Frequently Asked Questions about this Article…
The RBA says mining investment is sliding faster than expected and is the biggest risk to the Australian economy. It notes few new commitments to mining projects, little current expenditure on planning and development, and expects mining investment to decline over the next year or so before falling away more noticeably thereafter.
The Reserve Bank cut its growth forecast for this year from 2.75% to 2.25%. It left next year’s forecast unchanged at a wide 2.25–3.25% range, expects GDP to be back near a 3% trend rate by the end of next year, and projects growth could reach about 3.5% by the end of 2015.
The RBA’s baseline is that Australia will 'muddle through' as growth drivers shift from mining investment to other parts of domestic demand and exports. It is cautiously optimistic the transition will be relatively smooth but stresses there is considerable uncertainty and downside risk.
The biggest risk is an acceleration of the slide in mining investment, driven by cost overruns, weaker global demand and lower commodity prices. The RBA also flags uncertainty about several large projects planned for 2014–15 and warns that mining investment could fall away faster than expected if planning and development do not proceed.
The RBA notes commodity prices are forecast to decline only modestly. If the exchange rate depreciates and domestic input costs fall in foreign currency terms (for example because labour demand eases), that could make new projects more attractive and lead to some projects being slated despite lower commodity prices.
The RBA highlighted the coal industry as especially affected: lower coal prices have led to a significant curtailment of expenditure on planning and development that would normally precede new projects, contributing to the expected decline in mining investment.
Key assumptions include population growth of about 1.8% a year, an exchange rate assumption around US$0.90 (down from US$1.00 used earlier), and a cash rate assumed at about 2.5% into the future (reflecting a recent rate cut). The RBA also expects GDP per head to grow roughly 0.5% this year.
The RBA’s statement signals slower-than-usual growth and greater uncertainty while the economy shifts away from mining-led investment. Everyday investors may want to monitor developments in mining project commitments, commodity prices, the exchange rate and RBA guidance, as these factors could influence sectors linked to resources and the wider economy.
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