The Aussie Economy in 2010

He sees this possibly pushing unemployment back below 5% over the year ahead while the long term outlook for the Australian economy is also bright reflecting Australia's exposure to high growth Asia, strong population growth, low public debt and a reasonably healthy financial sector.  

While the worry list for the global outlook is still significant - Chinese tightening, high public debt levels, a shift towards populist policy making in the US, etc - there is plenty of reason for optimism concerning the outlook for Australia.

This is both in terms of the coming cyclical economic recovery and also from a longer term perspective.

From growth slowdown to growth rebound

After its worst slowdown since the early 1990s recession, Australia's economy is set to rebound over the year ahead.

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In 2009 the Australian economy is estimated to have grown by 0.9%.

This seems low but far better than expected a year ago, and significantly better than what occurred in other developed countries where GDP contracted 5% in Japan, 4% in Europe and the UK and 2.5% in the US.

Australia's relative resilience is owed to a range of factors including tougher bank lending standards and a stronger financial system; a shortage of houses; the quick application of significant monetary and fiscal stimulus; the relative resilience of demand from China and a sharp fall at the height of the crisis in the value of the $A which acted as a shock absorber.

Over the year ahead Australia is likely to see a strong recovery in growth reflecting:

A rebound in housing construction activity - finance approvals for the construction of new dwellings and significant growth in building approvals point to a strong increase in housing construction this year.

While housing finance has recently dipped, it fell from a very high level and it is likely to remain strong on the back of the improving jobs market.

Housing starts this year are likely to be around 165,000 dwellings - up from 135,000 in 2009 but still well down from underlying demand which is now around 200,000 dwellings pa.

(both housing finance graph here)

National income is likely to rise strongly supported by a 40% plus increase in prices for iron ore and coal (spot prices for iron ore would even suggest a 90% rise).

A solid turnaround in business investment - on the back of stronger profits which are expected to rise 20% this year, the recovery in business confidence from the 2008-09 slump and a large number of mega-projects particularly in the resources sector with the top ten projects alone having an estimated cost of $240bn.

(confidence graph here)

Solid consumer spending - on the back of high levels of consumer confidence (see the previous chart), an improving labour market (with unemployment now back down to 5.3% and likely to fall below 5% over the next 12 months), more tax cuts from July (worth $5.80 a week for a worker on $80,000 and $13.50 a week for a worker on $120,000), the recovery in wealth over the last year thanks to higher house and share prices and still low interest rates.

While mortgage rates are on the rise, they are still low.

For example, a family with a $300,000 mortgage on the standard variable mortgage rate currently has an annual interest bill of $20,100 pa, but this is down from $28,800 in mid 2008.

Even if expectations for a 1% rise in interest rates by year end come to pass, this will still be relatively low at $23,400.

Our leading indicator for the Australian economy is pointing to growth of around 4% over the year ahead.

(the australian economy on track graph here)

This has a number of implications:

The 2009-10 budget deficit is likely to be $20bn less than the November projection for a $57.7bn deficit, bringing forward the return to surplus to around 2013-14.

The lucky country rides again

At the end of the 1990s Australia was seen as an 'old economy', lacking much exposure to the 'new economy' driven by information technology.

Partly reflecting this, the Australian share market had been a relative underperformer versus global shares for the previous decade or so and the Australian dollar was sinking to new historic lows versus the $US.

By contrast, as we commence a new decade, Australia is looking a lot brighter.

This is reflected in a range of factors:

There are four reasons to remain optimistic about the relative long term economic outlook for Australia.

First, Australia's major export markets - with the dominance of high growth Asian countries - have relatively strong growth prospects compared to the world has a whole which is dragged down by debt constrained advanced countries.

The potential here is highlighted by China, which is now Australia's biggest export market.

China's industrialisation process still has a long way to go - per capita GDP is still just over $US3000, the percentage of the population in urban areas is still just 45% and despite being the world's biggest car market, per capita car ownership is only where the US was in 1917.

The upshot is demand for raw materials is likely to remain strong for several decades as China continues to industrialise.

The same goes for other emerging countries such as India and Brazil.

This suggests the boost to Australia's national income from the resources boom has a lot further to go.

Second, Australia has relatively favourable demographics compared to other developed countries.

While Australia's population is aging, thanks to a higher fertility rate and high levels of immigration it is growing faster than most countries and this is projected to remain the case at least to 2050.

As a result, Australia's labour force (which is a key driver of economic growth) will keep growing solidly, whereas in many developed countries, including Japan and parts of Europe, it is already declining.

Third, Australia is not lumbered with a massive public debt overhang.

The next graph shows budget deficits against public debt, as a percentage of GDP.

The countries most at risk have high budget deficits and high public debt levels, including Greece, Iceland and Japan, i.e. countries in the top right corner of the chart.

By contrast, Australia is in the bottom left corner in the very low risk category.

(public debt blow out graph here)

Fourth, the Australian financial system is relatively strong with low levels of non-performing loans and signs that the bad debt cycle is likely to have peaked.

With the Australian financial regulatory framework performing well through the recent global financial crisis, a significant re-regulation of Australian banks is unlikely, compared to say the US where a tougher approach is being proposed.

So apart from international influences, the supply of credit is unlikely to be as constrained in Australia as in other advanced countries.

All of these considerations point to relatively strong growth in Australia in the decades ahead.

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Concluding comments

None of this is to say Australia does not face problems and risks - household debt and house prices are relatively high, manufacturing and some service industries will be under pressure as a result of the resources boom, the two speed economy is alive and well, productivity growth needs to be boosted (as the Government has noted) and there is always a danger of hubris setting in.

However, unless things go terribly wrong these problems should be manageable and allowing for the normal cyclical ups and downs, the big picture outlook for Australia is pretty positive.

This should augur well for the relative performance of Australian assets - bonds, property, infrastructure, equities and the $A.