2014-03-28 12:02:30 - New Country Reports research report from Business Monitor International is now available from Fast Market Research
The Australian economy continues to struggle to stay above water, as domestic demand continues to show signs of weakening. We maintain our downbeat outlook for the economy and the currency, projecting GDP growth to come in at 2.0% for 2014 and the currency to weaken to US$0.82/AUD by the end of the year. For one, the manufacturing sector continues to battle high costs and stiff competition from cheap imports. Secondly, the mining sector could face even greater stress as firms seek to re-evaluate their projects in light of a slowing Chinese economy and weak commodity prices.
We believe that the housing market remains precarious, as affordability of homes continue to edge to new lows. Given our poor outlook for the Australian
job market in 2014, in which we forecast unemployment to reach 6.5% by the end of the year, we believe that demand for housing will decline. The overextended household balance sheets further augur the growth in housing-related credit growth. In our opinion, the Australian banking sector is the sector most leveraged on the housing market and we expect that declines in house prices will adversely impact the industry.
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The Liberal-National coalition's popularity has been on the decline since winning the elections in September 2013. Its government remains hampered by a fragmented Senate, which threatens any reform push by the government. The government has also decided to push back the target date on its fiscal surplus, which is in line with our view. Given the federal government's restrained policy-making ability, we believe the state government is likely to step up to the plate and push through reforms at the state level.
We maintain our forecast for the Reserve Bank of Australia (RBA) to hand out another 50 basis points worth of cuts in H214, bringing the cash rate to 2.00% by end-2014, even though the near-term economic outlook has improved. Indeed, we expect that a weak currency will only provide some reprieve against the mining sector slowdown while slow the hollowing of Australia's manufacturing. Thus, we believe that central bank will continue to attempt to stave off a decline in credit growth by easy monetary conditions when price pressures ease.
Major Forecast Changes
We have dialled back our outlook for a fiscal surplus, expecting the government to only achieve a primary balance surplus in FY2020/21, versus our previous projections for a fiscal balance surplus. The Abbott government's Direct Action plan - which will incentivise carbon abatement rather than penalise excess carbon emissions - is likely to cost the government more than the AUD1.55bn that has been set aside. While we believe that the lack of support from minority parties could help prevent the government from implementing new spending policies, we see greater risks from the lack of cutbacks planned. Hence we have revised down our fiscal outlook, expecting rehabilitation of public accounts to occur much further down the road.
We have raised our medium-term outlook for Australia's trade account, on the back of increased liquefied natural gas (LNG) processing capacity currently under construction. Given that gas exports could account for 15-20% of overall exports by 2017, we have revised our forecast to expect a sharper widening of the trade balance from 2015, and subsequently, a surplus in the current account by 2017. However, in the near term, we expect these projects to place pressure on import growth, hence resulting in a slower narrowing of the trade deficit over the 2014-2016 compared to our previous forecast.
Key Risks To Outlook
Policies implemented by major economies like Japan, China and the US will likely have a significant impact on Australia. For example, Japan's policy direction on its use of nuclear power could have a drastic impact should it decide to turn its reactors back on. Should Japan, the US and/or China enact more stimulus as their economies lose traction in 2014, the rebalancing in Australia could be delayed as the Australian dollar could face appreciatory pressures while demand for Australia's mineral exports remain supported.
Australian banks continue to be highly exposed to the domestic housing market. Given its reliance on external markets for funding, the banks could face a liquidity crisis should external counterparts withhold funding due to the deterioration of its balance sheet as the housing market sours. In order to prevent financial panic, government intervention could be needed in this scenario, which could force the budget deficit into double-digit territory.
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