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How vulnerable is the Australian Economy?

Australia has an AAA credit rating from all the world’s major rating agencies, which speaks volumes for the way the international investment community views Australia. Australia is set to have, on average, a 3% growth rate over the next five years, and it appears to be a safe haven with good, although moderate, return on investment in the current economic climate.

Having said that, it must be noted, that there are certain factors that could influence the country’s vulnerability during a not altogether unexpected, sluggish world economy. Certain sceptics are maintaining that we will be lucky to see a 2% growth rate globally in the next year to 18 months. This growth in large part would have to be fuelled by the various investment regions’ willingness to invest in infrastructure. This would spark an increase in the demand for commodities, which would be critical for Australia’s chances of weathering the next few years.

The Influence of China

Although the biggest contributor at 68% of GDP is a very varied and robust services sector, chief contributors to export earnings are commodities, both mining and agriculture. It was China’s phenomenal growth, and therefore, its demand for commodities, that drove the last boom in Australia. This peaked in 2011 when the Australian dollar was 1.10 to the US dollar.

This was good for export revenue but didn’t do much for the Australian manufacturing sector, which was already struggling. It also created increased consumer spending-power, which resulted in the property bubble and subsequent overvaluation of the property market. With the slump in the Chinese economy came the crash in commodity demand and prices.

The outlook regarding China is not all doom and gloom. The Chinese government has pledged $728 billion on infrastructure spending over the next three years. This would certainly go a long way towards boosting Australia’s export earning and would help to offset sluggish demand from other regions which might not be experiencing such an aggressive infrastructure spend as China.

Chinese domestic economic crises would have a profound effect on the Australian economy. Just such a crisis might be looming on the horizon in the Chinese banking sector. China has recently experienced a growth in lending, which has, in turn, fuelled a growth in consumer spend and development.

Unfortunately, this lending growth has not been as a result in an increase in deposits, but rather a reliance on “wealth creation products,” which should not in any measure be viewed as safe debt. These factors could precipitate a financial crisis in China, similar to what happened globally in 2008. An entire shake-up of the Chinese economy and internal banking practices, leading to a shrinking of commodity demand, could have far-reaching effects for the Australian economy.

Is an Interest Hike Possible?

Because of Australia’s household debt loads and soft wage increases, domestic consumer spending and investment cannot be relied upon to fuel any kind of spurt in the growth rate, or come to the rescue during a 2008 type crisis. Coupled with this is the fact that Australia’s property market is considered to be 40% overvalued. It was precisely the falsely overinflated property market in the US that sparked the last global financial crises. An adjustment has to be on the horizon. With Australian homeowners amongst the most indebted in the world, owing $771 trillion in mortgages, an interest rate hike in the near future could have a severe impact on the property market, and the economy in general. Investment sources would be more scarce and more expensive.

Earlier this week the Reserve Bank governor Philip Lowe issued a dire warning with respect to interest only loans.

“Over the past year, close to 40 per cent of the housing loans made in Australia have not required the scheduled repayment of even one dollar of principal at least in the first years of the life of the loan,” he said.

Are investors and first home buyers factoring in a reversal in property prices when taking on interest only home loans? A correction in property prices in the major cities especially Sydney and Melbourne could really turn up the heat on borrowers and test their abilities to stay afloat.

That rise in interest rate could be very easily sparked by President Donald Trump’s expansionist economic policy leanings. Trump has promised the American people a massive growth in capital-intensive, infrastructure spend.  This would no doubt fuel inflation. The American Reserve Bank would raise interest rates to counter this probable rise in inflation, and banks would follow suit to remain competitive. This would have a ripple effect globally.

$50 Billion Infrastructure Spending Promised

The other factor that could bode well for the Australian economy in the event of a sluggish growth rate, or horrors, another 2008 style global financial crisis is the promised $50 billion outlay on infrastructure, as announced by the finance minister in the 2014 budget, over the next five years.

This spending on infrastructure would help to bolster the economy by increasing demand for locally produced commodities, such as steel. This would be coupled, hopefully, by an increase in employment, or at the very least, a stabilisation of unemployment figures. Prices for commodities would be depressed, but at least it would keep the mines working and people employed by building railways and roads. Critics of the current administration, however, point to the government’s complacency, not fulfilling its promises, and underspending on the promised infrastructure.

Australia has a strong, creditworthy economy, which appears to be in reasonably good shape to withstand the vicissitudes of the global economy. This can only be enhanced by Australia continuing to remain as a stable haven for investment, and by continuing investment in its own infrastructure and people.