Investment Slowdown Weighs on Australian Growth in Q4

Growth Slows, But Things Could Have Been Worse

The Australian economy expanded by 0.4% in seasonally adjusted terms during the December quarter, down from the previous reading of 0.8% quarter-on-quarter (q/q). Market expectations had been for the economy to expand 0.8% q/q. In annual terms, the economy expanded just 2.3% year-on-year (y/y) in the December quarter, down from 2.5% y/y the previous quarter. For 2011 as a whole, the economy recorded real GDP growth of 2.0%, with the large-scale flooding in eastern Australia in early 2011 washing out key exports. Despite the natural disasters, growth in 2011 was driven by stronger-than-expected consumer spending and strong growth in fixed investment.

Private Sector Taps on the Investment Brakes

A slowdown in fixed capital formation by the private sector drove the weakness in total fixed investment as it fell 1.5% q/q in real (inflation-adjusted) terms led by a 3.9% q/q fall in dwellings investment. Weakness was spread across the other investment categories as well with the volume of non-dwelling construction falling 0.5% q/q and machinery and equipment expenditures falling 2.0% q/q. The weakness in private investment spending at the end of 2011 could be categorised as either the result of businesses easing back on investment after several quarters of significant growth or because of concerns about the global growth outlook. Considering that non-dwelling construction grew 26.6% during the September quarter, it is probably the former rather than the latter. The weakness in dwellings construction, however, is a concern as it implies that the supply of new housing is not improving, which could put upward pressure on the country's already high-priced homes in the near-to-medium term. Although private sector investment was weak, public sector real fixed capital formation rose 0.6% q/q, as the national, state and local governments increased investment. It appears that much of the investment spending was in New South Wales and Victoria, with at least a portion of that probably related to infrastructure repair after the floods of early 2011.

A restocking of inventories helped to mitigate some of the negative effects of the slowdown in investment as they rose by 1.57 billion Australian dollars (USD1.67 billion). The only major sector to substantially run-down inventories during the quarter was the farming sector, after a large build-up the previous quarter. The build-up in inventories was strongest in the wholesale and retail trade sectors, possibly on the hopes that the Reserve Bank of Australia's two 25-basis-point interest rate cuts in November and December would boost demand more than actually occurred.

Net Exports Provide a Surprise for the Quarter

Australia's net export position—real exports (goods and services) less real imports—typically is a significant drag on the economy. However, for the first time since the March quarter of 2009, the net export position made a positive contribution to growth as export growth outstripped import growth. This was in part the result of growth in key commodities exports volumes, but also weaker import demand. The increase in real exports of goods and services during the December quarter was led by improved export volumes of metal ores and minerals (up 6.1% q/q), coal products (up 5.3% q/q) and cereals (up 21.1% q/q). The only negative news on the goods export side was that coal export volumes still remain below their pre-flood highs, but should return to those levels in the coming months barring fresh flooding.

Export volumes for services also remained a weak spot for the economy as they fell for a second consecutive quarter. On the import side, declines in imports of consumer and intermediate goods (down 0.4% and 1.1% q/q respectively) mitigated the impact of a 5% q/q increase in capital goods imports. Further pushing down the overall import figure was a decline in services, most notably transportation services. Although the net export position made its first positive contribution to growth since 2009, the country's terms of trade recorded its first decline since the September quarter of 2009, falling 4.7% q/q as export prices fell with the softening global economic outlook and demand, and import prices rose.

Consumption Activity Weaker, Remained Healthy

Household consumption slowed significantly between the September and December quarters, but modest growth was still recorded, and consumption still contributed to the overall growth figure for the quarter. Household consumption activity in real terms was driven by increased spending on food, new vehicles, rent and dwelling services, and insurance and financial services. It does appear, however, that household spending on discretionary items such as dining out, leisure activities and holidays was pulled back somewhat during the quarter after being major growth drivers in recent quarters. The softer spending by households is not entirely surprising as it corresponds with the plunge in confidence during December and the weaker employment situation, which probably encouraged households to use their disposable incomes for paying down debt (see Australia: 15 December 2011: Australian Consumer Confidence Slumps Despite Interest Rate Cuts and Australia: 9 December 2011: Job Cuts Push Australia's Unemployment Rate Up to 5.3% in November). Real government final consumption expenditure, such as government investment spending, rose strongly during the quarter, with spending driven at the national government level, rising for defence and non-defence categories.

Outlook and Implications

The overall result was disappointing, but the economic situation for Australia is not dire. The fact that export volumes improved over the quarter despite the atmosphere of increasing uncertainty and waning commodity demand is promising. Furthermore, household spending did not collapse during the quarter despite consumer confidence faltering as the interest rate cuts by the central bank took some pressure off disposable incomes.

The major problem that the economy is facing is the two-speed economy. The economy is increasingly reliant on developments in the mining sector, either through export revenues or through the ongoing boom in mining investment, as was demonstrated in the December quarter. The other sectors of the economy meanwhile are continuing to struggle owing to the continued strength of the local currency and weak domestic demand. Over the coming year, these issues will continue to play out, especially as the Australian dollar is set to remain relatively strong owing to continued loose monetary policy settings in other advanced economies. Furthermore the massive pipeline of mining investment is unlikely to be halted unless the global economy completely crumbles, which is not currently a probable scenario. That said, the investment will probably progress in fits and starts resulting in uneven growth.

Even with the weaker-than-expected end to 2011, IHS Global Insight still expects the Australian economy to grow in the low 3% range in 2012. Growth will be driven by the continued recovery from the 2011 floods and ongoing investment in the mining sector.