Statement 2: Economic Outlook (Continued)
The Australian economy is expected to grow solidly over the next two years with real GDP growth forecast to be close to trend at 2¾ per cent in 2013‑14, before increasing to 3 per cent in 2014‑15 (Chart 6).
The economy will undergo a substantial transition over the forecast period. A record surge in resources investment is nearing its peak and growth will increasingly be supported by rising export volumes and a pick‑up in investment outside the resources sector. The level of economic activity is also expected to be supported by continued strong investment in the resources sector and solid growth in household consumption.
Conditions are expected to remain uneven across the economy, with the transition underway occurring alongside ongoing pressure from the sustained high Australian dollar and continued household caution around debt accumulation. The sustained strength of the Australian dollar continues to weigh heavily on a number of sectors, particularly those that are trade‑exposed, and has forced many firms to explore new markets and business practices to meet this competitive pressure. Firms have also responded by focussing on productivity and containing costs, and many have accepted substantially tighter profit margins.
While conditions will remain uneven, economic growth outside the resources sector is expected to pick up over the forecast period, supported by low interest rates and emerging opportunities presented by the shift in global growth towards Asia.
Chart 6: Contributions to real GDP growth
Note: Business investment and public expenditure are adjusted for second‑hand asset sales between the public sector and the private sector.
Source: ABS cat. no. 5206.0 and Treasury.
Household consumption is expected to grow solidly over the forecast period and provide a platform for recovery in some non‑resources parts of the economy. Consumption growth is forecast to rise to 3 per cent in both 2013‑14 and 2014‑15.
Consumer confidence has improved, household incomes are growing moderately, and household net worth has grown. Interest rate cuts over the past 18 months have supported the recent improvement in consumer confidence, and improved global financial market sentiment along with recent growth in equities markets and house prices are supporting growth in household wealth. Recent strong growth in retail trade is also indicative of the recovery underway in household consumption.
Still, while growth in retail trade volumes has been strong, weak growth in retail prices reflects the competitive challenges faced by retailers from lower import prices and changing consumer behaviour (Chart 7). Household spending patterns have shifted, with the continued fall in the discretionary share of household expenditure adding to the challenging conditions faced by retailers over recent years. Households have also reduced their appetite for debt and increased their level of saving since the crisis, even as economic conditions have improved (Box 2). Consequently, while the growth in consumption is forecast to be solid, it is not expected to be as strong as that seen prior to the global financial crisis. The household saving rate is forecast to remain close to current levels, though ease a little as global conditions improve and confidence picks up.
Chart 7: Retail trade turnover
Source: ABS cat. no. 8501.0.
Dwelling investment is forecast to grow by 5 per cent in 2013‑14 and 5½ per cent in 2014‑15, supporting construction and related activity in the non‑resources sectors of the economy. The recovery in dwelling investment is expected to be supported by continued low interest rates and other favourable market fundamentals, such as rising dwelling prices, high rental yields and low vacancy rates.
Favourable demographics are also expected to drive a pick‑up in homebuyer demand. Over the past decade, Australia's population growth has often outpaced the growth in the stock of dwellings. Still, this demand is expected to be tempered by continued household caution towards debt accumulation, as well as ongoing supply constraints associated with the high cost of development, land release restrictions, and complex planning and approval processes (Box 2).
Growth is expected to pick up in both the medium‑to‑high density sector and the detached housing sector over the forecast period. The medium‑to‑high density sector has been the key source of growth in dwelling investment over the past year, as homebuyers increasingly look to make more economical use of land. There are also encouraging signs that growth in the detached housing sector is beginning to recover. Detached housing investment recorded its second consecutive quarter of positive growth in the December quarter 2012, supporting the strongest quarterly rate of growth in dwelling investment in over two years.
Box 2: Dwelling investment response to interest rate cuts
The Reserve Bank of Australia's (RBA) official interest rate cuts since late 2011 have seen the average standard variable mortgage rate drop to around 6.2 per cent. This is a decrease of around 240 basis points since November 2007, saving a household with a $300,000 mortgage more than $5,500 a year.
After four quarters of contraction, there are signs that the dwellings sector has begun to respond to the reduction in interest rates, with positive growth recorded in the first half of 2012‑13. Consistent with near‑term forward indicators and strong economic fundamentals (including favourable demographics, low vacancy rates and high rental yields), the recovery is expected to gain momentum over the next two years. However, growth is not expected to be as strong as that seen during previous interest rate easing cycles (Chart A).
Chart A: Dwelling investment response
to easing cycles
Source: ABS cat. no. 5206.0, RBA and Treasury.
The sector's relatively subdued response to the current cycle reflects a number of factors. First, households have taken a more cautious approach to saving and borrowing since the crisis, even as economic conditions have recovered. During this period consumption growth has moderated, while at the same time disposable income has grown solidly. This has seen the household saving ratio rise sharply and remain elevated relative to recent rates of saving, which included a brief period of dissaving in the early 2000s (Chart B).
Chart B: The cautious consumer
Source: ABS cat. no. 5206.0 and RBA.
However, when the recent increase in the saving rate is compared to a longer time period, the current level of saving appears consistent with more normal household behaviour. The sustained period of decline which began in the 1980s reflected the trend towards the incorporation of businesses and exceptionally strong household credit growth, which was in part driven by financial deregulation and the economy's transition to a low inflation environment. Reflecting a marked reduction in credit growth from the double‑digit rates experienced in the 1990s and early 2000s, the level of household debt as a share of disposable income has stabilised. Households are responding to the reduction in interest rates by increasing their principal mortgage payments and paying down existing debt, and have become less inclined to take out new housing loans. While the lower interest rates are expected to encourage credit growth, it is unlikely to return to the rates seen prior to the crisis.
The change in household behaviour since the crisis has been largely driven by heightened global uncertainty, which has continued to weigh on households' concerns about their ability to service debt. However, consistent with the nascent recovery in dwelling investment, there have been improvements in household confidence, with a turnaround in consumer sentiment at the start of the year (Chart C).
Chart C: Consumer sentiment
(three month moving average)
Source: Westpac— Melbourne Institute.
A second factor contributing to the subdued dwellings recovery is the moderation in dwelling prices over the past two years. Following average annual growth of almost 10 per cent in the 2000s, which coincided with exceptionally strong growth in household credit, dwelling prices fell by an annual average of 2.1 per cent in 2011 and 2012. Slower growth in dwelling prices drove down expectations for capital gains, dampening both owner‑occupier and investor demand.
Supply constraints (particularly land supply restrictions) have also weighed on the dwellings recovery. The trend towards higher density living partly reflects this constraint, as homebuyers increasingly make more economical use of land. Nevertheless, with a number of state government proposals to boost housing supply recently announced, supply constraints could ease over the forecast period.
Dwelling prices have begun to increase and a number of survey measures point to the expectation of further recovery over the next two years. Coupled with an expectation of continued low interest rates and state government efforts to target supply constraints, the improving outlook is likely to encourage further investment over the forecast period.
Over recent years, new business investment has been underpinned by record volumes of investment in the resources sector. Total resources investment surged to over $100 billion in 2011‑12, more than 600 per cent higher than it was a decade ago. Elsewhere in the economy, investment has been modest with an uncertain global outlook, the high Australian dollar and domestic competitive pressures all weighing on activity.
Still, the outlook for business investment remains solid, with new business investment forecast to grow by 4½ per cent in 2013‑14 and 1 per cent in 2014‑15, and peak at a record 19 per cent of GDP in 2013‑14 (Chart 8).
The pipeline of resources investment is substantial with over $260 billion of investment either committed to or under construction, underpinned by strong ongoing demand for Australia's resources from emerging market economies in Asia. Total resources investment, including exploration and development, is expected to peak at a record 8 per cent of GDP in 2013‑14, before easing over the rest of the forecast period. Historically high levels of resources investment are expected through to at least the middle of the decade.
Non‑resources related investment is expected to strengthen over the forecast period, stimulated by low interest rates and a broadening of economic growth. Consistent with this, business credit growth should pick up from current below‑average rates. In recent years, business credit has failed to keep pace with resources dominated investment growth as resource companies have relied primarily on internal funding to support their investment.
Chart 8: New business investment as a share of GDP
Note: Adjusted for second‑hand asset sales between the public sector and the private sector.
Source: ABS cat. no. 5206.0 and Treasury.
New engineering construction is expected to remain robust in the near term. After surging by 51 per cent in 2011‑12, new engineering construction is forecast to grow by 24 per cent in 2012‑13 and 6 per cent in 2013‑14. As spending on a number of major projects passes its peak, new engineering construction is expected to ease, falling by 4½ per cent in 2014‑15, but remaining near historical highs (Box 3).
Investment in new machinery and equipment is expected to grow modestly in 2013‑14 before strengthening in 2014‑15, reflecting the subdued but strengthening outlook for the non‑resources sector. Business confidence and conditions continue to be affected by global uncertainty, with survey measures indicating some weakness in capital expenditure intentions for the non‑resources sector in the near term. However, low interest rates and improving conditions in the non‑resources sectors are expected to support a modest rebuilding of capital stocks. New machinery and equipment is forecast to grow by 2½ per cent in 2013‑14 and 5 per cent in 2014‑15.
Continued uneven conditions in the non‑resources‑related sectors of the economy are expected to weigh upon investment in the commercial property sector over the next two years, with underlying demand in the sector likely to remain subdued. Investment in new non‑residential buildings is expected to grow by 1½ per cent in 2013‑14 and 3½ per cent in 2014‑15.
Box 3: Resources investment and exports
Over the past decade, the rapid development of economies in the Asian region has had a transformative impact on the Australian economy, driving the largest resources boom in Australia's history. Strong demand for resources propelled commodity prices to record levels, supporting rapid expansion of global energy and minerals supply. While this investment phase is nearing its peak, the record expansion of production and exports will continue to support growth well into the decade.
The initial surge in resources investment was driven by coal and iron ore projects, largely to meet demand for steel in China. In recent times, the majority of resources investment has been in LNG projects to support rising global demand for energy (Chart A).
Chart A: Mining capital expenditure
Note: Estimates adjusted using five year average realisation ratios for the mining sector.
Source: ABS cat. no. 5625.0 and Treasury.
The ramp‑up in mining capital expenditure is driving investment in the resources sector towards new highs. In 2012, resources companies invested over $100 billion on buildings and structures, equipment and exploration.
As these facilities move towards their production phase, the rate of construction will slow significantly. Resources investment is expected to peak sometime in 2013‑14, at an all‑time high of 8 per cent of GDP, up from only 2 per cent of GDP a decade before (Chart B).
Chart B: Mining investment,
share of nominal GDP
Source: ABS cat. no. 5204.0 and Treasury.
The exact timing of the peak in investment is uncertain, owing to a combination of factors including the rate of progress on existing projects, the extent and nature of any cost overruns and the outcome of final investment decisions on projects under consideration.
The export phase of the boom has been underway since the late 2000s. Coal and iron ore exports started to pick up considerably in late 2009, driving growth in non‑rural commodity exports of 9 per cent in 2009‑10. Although strong export growth was interrupted by the severe flooding in 2010‑11, non‑rural commodity export volumes have since recovered. In 2011‑12, iron ore exports rose 16 per cent while coal exports rose 4 per cent (Chart C).
Chart C: Iron ore and coal volumes (orig.)
Source: Based on ABS data.
Iron ore exports are forecast to increase by more than 40 per cent over the next three years, with total volumes reaching double their 2008‑09 level in 2014‑15. Coal export volumes are also expected to increase significantly, growing by almost 35 per cent over the same period to reach volumes around 60 per cent higher than in 2008‑09.
While new LNG facilities will start to enter into production from around 2014‑15, the majority of the increase in LNG export capacity falls outside of the forecast period. The Bureau of Resources and Energy Economics (BREE) is forecasting LNG exports to grow by 117 per cent between 2014‑15 and 2016‑17 (Chart D) with Australia expected to become the world's largest LNG exporter by the end of the decade.
Chart D: LNG exports
As the peak of the investment phase passes, the resources sector will transition towards a record expansion in production and exports. Other resource rich countries have also seen a response to strong demand for commodities in their resources sectors. Together with increased export capacity from Australia, these increases in global supply are expected to result in a gradual overall decline in commodity prices over the medium‑term. However, the impact of lower export prices on Australia's trade balance will be offset by the combination of higher export volumes and less demand for imported capital to build resources projects.
Public final demand is expected to remain flat in 2013‑14, before growing by a subdued ½ of a per cent in 2014‑15, consistent with continuing fiscal consolidation across all levels of government.
Over the next two years, record levels of resources investment will generate considerable new production and export capacity in the resources sector. As this capacity comes on line, non‑rural commodity exports are forecast to increase strongly. Between 2011‑12 and 2014‑15, non‑rural commodity exports are expected to grow by over 30 per cent. This will underpin strong growth in total exports, which are forecast to increase by 6½ per cent in 2013‑14 and 7 per cent in 2014‑15.
Iron ore export volumes are expected to grow strongly, with iron ore mining projects in the Pilbara region increasingly adding to production as expansions come online. Iron ore exports are expected to grow by 13 per cent in 2013‑14 and 12 per cent in 2014‑15. Coal exports are also expected to grow strongly, by 12 per cent in 2013‑14 and 10 per cent in 2014‑15. Towards the end of the forecast period, LNG exports are forecast to start growing rapidly as the first of the large export projects in Queensland and Western Australia enter production. Exports of LNG are forecast to grow by 31 per cent in 2014‑15. Overall, non‑rural commodity exports are forecast to grow by 9 per cent in 2013‑14 and 9½ per cent in 2014‑15.
Rural exports are forecast to be little changed in 2012‑13. Drawdowns on inventories accumulated in 2011‑12 are expected to support rural export volumes despite slightly weaker production owing to less favourable conditions for the recent winter crop. Exports are expected to remain around their 2012‑13 levels in the following two years, with a return to average seasonal conditions in 2013‑14 allowing stronger production volumes but reducing stock drawdowns.
Notwithstanding the high Australian dollar, non‑commodity goods exports are expected to grow modestly over the next two years, reflecting robust economic growth in Australia's major trading partners. Non‑commodity goods exports are expected to grow by 4½ per cent in 2013‑14 and 4 per cent in 2014‑15.
Services exports are expected to return to growth this year after an extended period of weakness following the global financial crisis. Recent strength in overseas arrivals suggests a more positive outlook for inbound tourism. Short‑term visitor arrivals returned to growth in 2012 and are now at record levels, with over six million visitors entering Australia over the past year. The international student sector has also shown signs of a recovery following a significant contraction over the past three years. Services exports are forecast to grow by 1½ per cent in 2013‑14 and 2½ per cent in 2014‑15.
Imports are forecast to remain at elevated levels over the next two years, consistent with the expected continued strength in import‑intensive investment in the resources sector. The resources investment boom is expected to continue driving significant demand for imports in 2013‑14, particularly around LNG construction. Away from the resources sector, imports of consumption goods are expected to grow solidly, as higher consumer confidence takes hold and the high Australian dollar continues to hold down the price of imported goods. Total import volumes are forecast to grow by 6 per cent in 2013‑14 and 3 per cent in 2014‑15.
The terms of trade have fallen 17 per cent from their peak in September 2011. While the continued expansion in global supply is expected to lead to further falls in iron ore prices, these are expected to be more gradual than previously anticipated, with the average grade of iron ore exported from Australia declining less rapidly than previously forecast. Treasury forecasts of the prices of key commodity exports are outlined in Box 4. The terms of trade are expected to decline ¾ of a per cent in 2013‑14 and 1¾ per cent in 2014‑15 (Chart 9).
Chart 9: Terms of trade
Source: ABS cat. no. 5206.0 and Treasury.
Box 4: Bulk commodity prices
Treasury forecasts commodity prices by drawing on consensus forecasts, BREE forecasts, commodity price futures, Treasury liaison and analysis. Treasury's forecasts of iron ore, metallurgical coal and thermal coal export prices are consistent with private sector forecasts (Chart A).1
Prices for Australia's key non‑rural commodity exports continue to be highly volatile, with falls in 2012 weighing heavily on the terms of trade, nominal GDP and tax receipts. The volatility has continued into 2013 with recent declines in the price of some commodities, including gold and copper. If these falls are sustained, they will place further downward pressure on the terms of trade.
Iron ore is a key input to steel production and its price reflects global demand for steel. Seasonally high Chinese steel demand and ore stocking by Chinese steel mills are expected to continue to support iron ore prices during the first half of 2013. Nevertheless, the substantial increase in iron ore supply (particularly from Australia) and high global steel inventories are expected to lead to a decline in prices in the second half of 2013. Further increases in supply are expected to place downward pressure on prices over the forecast period.
The price of metallurgical coal has diverged from the iron ore price in recent quarters, despite it also being a key input to steel production. Prices of both metallurgical coal and thermal coal (which is used in electricity generation) appear to more widely reflect marginal producer costs, and are expected to remain around their current levels, with increasing production costs expected to lead to only a modest increase in prices over the forecast period.
Chart A: Bulk non‑rural commodity prices
(average unit export price)
Source: Based on ABS data and Treasury. Export prices differ from the more‑widely quoted spot prices. Export prices reflect the actual price foreigners pay for our exports and reflect the quality of the resource being provided (such as the iron ore content), long‑term contracts, and exchange rate movements.
The current account deficit is expected to widen slightly from 3½ per cent of GDP in 2012‑13 to 3¾ per cent of GDP in 2013‑14, before narrowing to 3¼ per cent of GDP in 2014‑15 (Chart 10)(Box 5). This profile mirrors the trade deficit, which is expected to widen from 1 per cent of GDP in 2012‑13 to 1¼ per cent of GDP in 2013‑14, before narrowing to ¾ of a per cent of GDP in 2014‑15. The narrower trade deficit reflects the outlook for sustained strong export growth and weaker import growth. The net income deficit is forecast to remain at 2½ per cent of GDP over the forecast period. Data for the past year suggest that the net income deficit has been widening more slowly than had been expected, and this has been reflected in an adjustment to the forecast.
Chart 10: Current account balance
Source: ABS cat. no. 5302.0 and Treasury.
Box 5: Australia's increasingly robust external funding position
Australia has been a net importer of foreign capital for more than 200 years. Foreign capital has financed expansions in the productive base of the economy that have enabled us to sustain higher rates of economic growth and faster improvements in living standards. That Australia has been able to sustain this gradual accumulation of net foreign liabilities reflects both our attractiveness as an investment destination and the confidence foreign investors place in our ability to meet our external obligations.
Nevertheless, dependence on foreign sources of capital does entail some risk. The global financial crisis has shown that severe dislocations in external funding markets can, even if only for a short period, impede the ability of even the most creditworthy of borrowers to obtain funding. This box surveys the drivers of recent and likely future developments in our current account, and the robustness of our external funding position. The conclusion is that, as the private sector's call on international funding has fallen, so too has the risk profile of our foreign liabilities.
The current account balance (CAB) is typically expressed as the sum of the balance on our trade in goods and services (the trade balance) and the net income balance, which is the net flow of payments (primarily interest and profits) on our stock of net foreign liabilities. Australia has historically run a deficit on both the trade and net income balance, although there have been periods when the trade balance has been positive.
The current account deficit (CAD) also represents the extent to which Australia draws on foreign saving to fund that portion of national investment that is not funded by domestic national saving. It is important to recognise that our CAD is not a reflection of low national saving. Indeed, Australia's national saving rate has risen steadily since the early 2000s and is high relative to the major advanced economies (Chart A). Rather, it reflects even higher levels of investment which have been directed at expanding the economy's productive capacity, most recently in the resources sector.
Chart A: Gross saving and investment
Source: ABS cat. no. 5206.0 and IMF.
The payoff from recent investments in the resources sector has underpinned a substantial improvement in the trade balance over recent years. This improvement in the trade balance has seen the CAD narrow to around 3 per cent of GDP, after averaging around 6 per cent of GDP in the years leading up to the global financial crisis. This improvement is expected to be sustained over the forecast period.
As our demand for foreign capital has fallen, there has also been a material shift in both the form and sectoral composition of those capital inflows. Prior to the global financial crisis, the dominant form of net capital inflow was portfolio debt — mostly debt accumulated by the household and non‑financial corporate sectors, intermediated via the banking system.
However, an extended period of balance sheet consolidation has seen the household sector go from being a significant net borrower in the years before the crisis to a significant net lender. While still a net borrower in aggregate, the non‑financial corporate sector has also increased its use of internally‑generated funding (retained earnings), particularly in the resources sector. Since a large proportion of the resources sector is foreign owned, much of this internally‑generated funding enters as an inflow on the financial account of the balance of payments. This form of financing, and direct equity investment more generally, is typically regarded as a more stable funding source than portfolio investment.
As a consequence of this reduced demand for intermediated finance, our banks have generally been net repayers of their total offshore liabilities since mid‑2010. Indeed, whereas the evolution of our accumulated CADs has historically mirrored that of banks' offshore liabilities, recent years have seen a marked divergence (Chart B).
Chart B: Bank intermediation of CAD
Note: Offshore funding liabilities are total offshore liabilities less offshore derivatives liabilities.
Source: ABS cat. no. 5232.0 and 5302.0.
Since the crisis, Australian banks have also reduced their exposure to roll‑over risk by lengthening the average term of their wholesale debt liabilities, which has seen a substantial lengthening in the maturity profile of our overall foreign debt (Chart C).
Chart C: Foreign debt liabilities
Residual maturity basis
Source: ABS cat. no. 5302.0.
Total employment has grown by around 165,000 people over the past year, and around 950,000 people since the end of 2007. As a result of this strong jobs creation, Australia's unemployment rate of 5.5 per cent is significantly below that of the United States and less than half that of the euro area, and remains one of the lowest in the developed world.
Australia's strong employment growth over the past five years has been supported by the resources‑related sectors and some services sectors such as health care and education (Chart 11), although demand for labour in the mining sector has eased from its 2012 peak. In contrast, subdued global conditions, the sustained high Australian dollar and cautious behaviour by consumers have weighed on hiring decisions in other parts of the economy such as manufacturing and retail trade. Firms have also reacted to uneven economic conditions by reducing the average number of hours employees work each week, which has helped alleviate the impact of uneven demand on employment.
Chart 11: Change in employment share — November 2007 to February 2013
Note: This chart shows the four industry categories with the largest increase in employment share since November 2007, and the four categories with the largest decrease over the same period.
Source: ABS cat. no. 6291.0.55.003 and Treasury.
Employment growth is expected to remain moderate, at 1¼ per cent through the year to the June quarter 2014, with the persistently high dollar producing challenging conditions in some labour intensive sectors of the economy, such as manufacturing and tourism. Employment growth is then expected to strengthen to 1½ per cent through the year to the June quarter 2015 as investment and growth pick up in the non‑resources sectors of the economy. Over 350,000 jobs are expected to be created over the forecast period.
The participation rate has declined since November 2010, falling around ¾ of a percentage point. This is a reversal of the upward trend seen over much of the 2000s (Box 6), and largely reflects demographic drag as a greater number of baby boomers reach retirement. Despite these falls, the aggregate participation rate continues to be high in historical terms, and is expected to remain at around 65 per cent over the next two years.
With the resources sector transitioning to the less labour intensive production phase and the high dollar still weighing on many sectors, the unemployment rate is expected to drift up slightly to 5¾ per cent by the June quarter 2014, and stabilise there through 2014‑15. Despite this slight increase, Australia's unemployment rate is expected to remain one of the lowest in the developed world.
Box 6: The participation rate
The participation rate (or proportion of people aged 15 years and over who are either working or willing and available to work) rose over much of the 2000s. However, since its peak of 65.9 per cent in late 2010, it has gradually declined (Chart A), reflecting a range of demographic factors, social trends and the impact of the economic cycle.
Chart A: The participation rate
Source: ABS cat. no. 6202.0.
The most significant factor weighing on participation is Australia's ageing population, resulting in fewer potential workers as a share of the total population. The 2010 Intergenerational Report projects that the participation rate will fall from its current level of around 65 per cent to less than 61 per cent by 2049‑50. This is the equivalent of around 900,000 people leaving the labour force.
This demographic change is already having an effect, with the changing age distribution accounting for around 80 per cent of the decline in the participation rate since 2010.
In particular, the increase in those aged 65 and over as a share of the working‑age population (aged 15 and over) has accelerated in recent years (Chart B), resulting in a higher proportion of workers reaching retirement age.
Chart B: 65+ share of population
aged 15 or over
Source: ABS cat. no. 6291.0.55.001.
However, a range of longer‑term factors have helped boost participation, offsetting the impact of the ageing population for much of the 2000s.
Factors such as improved health outcomes and a shift away from jobs involving manual labour have allowed people to delay retirement and prolong their working lives. As a result, the participation rate for those aged 55 and over has trended upwards. However, as participation among older people remains well below that of other cohorts, this has only partially offset the impact of population ageing.
Increased education and changing social attitudes have resulted in people having greater opportunities and attachment to the labour market. This continued to boost participation during the 2000s, particularly among women (Chart C).
This longer‑term shift has been facilitated by the increased availability of flexible working arrangements and access to childcare, allowing females with young children to work part time when in previous decades they may not have participated in the workforce.
Chart C: Participation rate —
females aged 25‑54
Source: ABS cat. no. 6291.0.55.001 and Treasury.
The terms of trade boom and strong performance of the Australian economy also attracted potential workers into the labour market over much of the 2000s, with participation rates in the resources states of Western Australia and Queensland increasing significantly.
However, employment growth has been uneven since the global financial crisis as a result of weak global conditions, the sustained high Australian dollar and cautious consumer behaviour.
It is likely that potential workers in some industries have become discouraged and left the labour force, contributing to the decline in the participation rate since 2010. This may have affected younger people, who typically have less attachment to the labour market, are more likely to be engaged in study, and gravitate towards those sectors that have been disproportionately affected by the crisis and weak global conditions. Many young people have likely also taken advantage of increased opportunities to pursue tertiary study.
On the other hand, the crisis may have boosted participation by older workers, as they delayed retirement in order to rebuild wealth and maintain a desired standard of living. This effect could be waning as asset and financial markets improve, with the participation rate of older workers being broadly flat over the past year.
Over the forecast period, there may be some upward pressure on participation as the non‑resources sectors take over as the engine of economic growth and employment, encouraging potential jobseekers to look for work and helping offset downward pressure from demographic change. In the longer‑term, the participation rate will continue to be driven lower by the ageing of the population. However, Government policies in areas such as education, incentives to work, and childcare affordability will help support participation in the workforce.
Wage growth moderated during 2012. Growth in private sector wages was slightly below its 10‑year average during the second half of the year, and public sector wage growth remained weak, consistent with fiscal consolidation at all levels of government (Chart 12). Wage growth is expected to remain contained over the next two years in line with the outlook for moderate employment growth and inflation within the lower half of the Reserve Bank's target band.
The Wage Price Index is forecast to grow 3½ per cent through the year to the June quarters of 2014 and 2015.
Chart 12: Growth in Wage Price Index
Source: ABS cat. no. 6345.0 and Treasury.
Consumer price inflation was subdued in 2012, as the high level of the exchange rate held down prices of imported goods and, together with uneven domestic demand, increased competitive pressures on firms across the economy to pass on low prices. Prices for tradable goods and services have been especially weak, falling by 0.2 per cent over the past year, while prices of non‑tradables grew by 4.2 per cent. The weakness in tradables inflation highlights the significant effect the persistently high Australian dollar is having on prices in the most competitive parts of the economy.
The pressures from the high Australian dollar are expected to continue over the forecast period, with subdued wage growth and continuing productivity growth also expected to contain inflation. Headline and underlying inflation are expected to ease to 2¼ per cent through the year to the June quarters of 2014 and 2015 (Chart 13).
Chart 13: Headline and underlying inflation
Note: The underlying inflation measure is the average of the quarterly growth rates of the trimmed mean and weighted median.
Source: ABS cat. no. 6401.0 and Treasury.
The outlook for nominal GDP growth remains subdued following unusual weakness in 2012‑13. Nominal GDP is forecast to grow by 5 per cent in both 2013‑14 and 2014‑15, below its 20‑year average of 6½ per cent. The outlook reflects the expected decline in the terms of trade and subdued domestic price growth over the forecast period (Chart 14). Nominal GDP is distributed throughout the economy mainly as compensation of employees, gross operating surplus and gross mixed income.
Gross operating surplus (the National Accounts measure of profit) is forecast to decline by ¾ of a per cent in 2012‑13 before recovering to grow by 4¾ per cent in 2013‑14 and 5½ per cent in 2014‑15, remaining below its 20‑year average growth rate of around 7 per cent. The recent weakness in profit growth is indicative of the widespread and significant effect of the high Australian dollar (Box 7). The unusual combination of a high Australian dollar and falling commodity prices has led to sharp declines in resources profits. At the same time, the persistently high Australian dollar is having an acute and enduring effect on profits in the non‑resources parts of the economy as firms squeeze margins to remain competitive both in export markets and domestically.
Compensation of employees (primarily wages) is forecast to grow by 5¾ per cent in 2013‑14 and 5 per cent in 2014‑15, reflecting the slightly below‑trend outlook for wage and employment growth over the period.
The forecast decline in commodity prices and competitive pressures from the sustained high dollar are expected to result in a decline in the profit share (and a corresponding rise in the wage share) of income over the forecast period.
Gross mixed income, which includes the wages and profits of farms and other unincorporated enterprises, is forecast to grow by 3¼ per cent in 2013‑14 and 2¾ per cent in 2014‑15.
Chart 14: Components of nominal GDP growth
Note: The small discrepancy between nominal GDP and the sum of its components is due to interactions which cannot be attributed to individual components. Totals may not add due to rounding.
Source: ABS cat. no. 5206.0 and Treasury.
Box 7: The impact of the persistently high Australian dollar
Movements in Australia's exchange rate and terms of trade are typically closely related and it is unusual for the Australian dollar to remain broadly unchanged while the terms of trade fall. However, while the terms of trade have fallen sharply since their peak in late 2011, the Australian dollar has remained high. The persistently high dollar is creating acute and enduring challenges in many sectors and is weighing heavily on profitability and prices across the economy.
The floating Australian dollar promotes macroeconomic stability by encouraging the reallocation of labour and capital to parts of the economy that provide the best return. This has occurred most recently by reducing returns in non‑resources sectors of the economy to meet the record demands in the resources sector. While this has presented challenges for some sectors, without a floating exchange rate, this adjustment would have occurred through higher domestic inflation.
The Australian dollar appreciated strongly in response to the terms of trade boom, rising from less than US$0.50 in 2001 to a peak of over US$1.10 in the middle of 2011, and appreciating around 50 per cent in the past four years alone. Yet, while the terms of trade have fallen sharply in the past two years, with non‑rural bulk commodity prices now around 35 per cent below their peak, the Australian dollar has remained relatively stable and high (Chart A).
More recently, the trade weighted index of the Australian dollar has risen to around 30‑year highs, driven by a 20 per cent appreciation against the Japanese yen over the past six months.
The strength of the Australian dollar reflects the fundamental strength of the Australian economy. With low unemployment, contained inflation and low levels of public debt, Australia is one of only eight countries with a AAA credit rating with a stable outlook from all three ratings agencies. These strong fundamentals and the relative attractiveness of yields on offer have increased the demand for Australian dollar denominated assets.
Chart A: Terms of trade and AUD
Source: ABS cat. no. 5302.0 and 5206.0.
While the high Australian dollar reflects our strong fundamentals, it has also contributed to uneven conditions domestically and weighed heavily on company profits across the economy. Total gross operating surplus has fallen for five consecutive quarters (Chart B) — the first time this has occurred in the history of the quarterly National Accounts.
Chart B: Gross operating surplus (growth)
Source: ABS cat. no. 5206.0.
The record decline in profits partly reflects the decline in commodity prices, with mining sector profit falling 20 per cent in 2012. However, away from the mining sector, profit growth has also been very weak as firms continue to adjust to the high Australian dollar. Non‑mining profit rose 0.9 per cent in 2012, well below the annual average increase of 14.1 per cent in the ten years prior to the global financial crisis (Chart C).
Treasury's business liaison program suggests that subdued profits in the non‑resources sectors reflects competitive pressures from the sustained high Australian dollar, with firms absorbing costs by squeezing profit margins at the same time as they pass on lower import prices to consumers. Business survey data support the information from liaison, with margins particularly weak in manufacturing, wholesale, retail and construction.
Chart C: Non‑mining gross
operating profit (growth)
Source: ABS cat. no. 5676.0.
With profit representing around 40 per cent of nominal GDP, the weakness in profit growth has led to an unprecedented period of relative weakness in nominal GDP. Through‑the‑year nominal GDP growth was below real GDP growth for the third consecutive quarter in December — its longest period of relative weakness on record.
While the dollar remains high, it will continue to place downward pressure on profits. Firms are innovating and adapting to manage this pressure, but the persistent strength in the Australian dollar is making the economic transition to non‑resources drivers of growth more challenging, particularly in the trade‑exposed sectors.
The fiscal aggregates in the Budget are underpinned by a set of forward estimates consisting of short‑term economic forecasts and projections based on medium‑term assumptions (Box 8).
Real GDP is projected to grow at its trend rate of around 3 per cent over the two projection years of the medium term based on analysis of underlying trends in employment and productivity (Chart 15). Trend growth in real GDP is projected to slow early next decade as the participation rate declines in line with Australia's ageing population profile.
The unemployment rate is projected to be 5 per cent over the medium term, consistent with Treasury's estimate of the non‑accelerating inflation rate of unemployment. Inflation is projected to be around 2½ per cent, consistent with the Reserve Bank's medium‑term target band.
After 2014‑15, the terms of trade are projected to decline by a total of 20 per cent over a 15‑year period, settling around their 2005‑06 level.
The exchange rate is assumed to remain around its recent average level during the forecast period. Over the projection period, the exchange rate is assumed to move in line with the long‑term historical relationship between the terms of trade and the real effective exchange rate. The terms of trade projections imply a fall in the real exchange rate of 0.9 per cent per annum over the projection period.
The carbon price parameters underpinning the Government's Clean Energy Future Plan have been revised in the 2013‑14 Budget. The revised methodology ensures that the carbon price parameters reflect both short‑term market dynamics and longer‑term fundamentals. Further detail on the methodology used to estimate the carbon price is outlined in Box 9.
Chart 15: Real GDP growth over the forward estimates period
Source: ABS cat. no. 5206.0 and Treasury.
Box 8: The transition in the resources sector and the projection methodology
Treasury prepares detailed forecasts of the economy for the budget year and the subsequent year. Beyond this, there is less information on which to prepare detailed forecasts, so Treasury prepares projections of high level economic aggregates to underpin budget estimates of receipts and payments. The projection methodology is based on medium‑term assumptions of growth consistent with historical experience or longer‑term factors, such as demographic change.
As a result of the current investment boom in the resources sector, private business investment has increased from its historical average share of around 14‑15 per cent of GDP, and is expected to peak at around 19 per cent of GDP in 2013‑14 (Chart A). Normally, the approach for projecting business investment in the projection years would be to assume that this high investment share of GDP is maintained in 2015‑16 and 2016‑17. There is usually little information on the likely path of business investment beyond the forecast period and this assumption would normally provide a plausible path.
However, at present, the scale of investment in resources projects and the lengthy timeframes for their construction mean that some information on business investment and exports beyond the forecast period is available. Based on company reports, analysis of the resources investment pipeline, Treasury's business liaison and historical investment to capital stock ratios, resources investment is expected to fall significantly as a share of GDP in 2015‑16 and 2016‑17.
To account for this expected decline, new business investment is projected to fall to around its historical share of GDP by 2016‑17. Associated imports growth is projected to decline at the same rate as resources investment. Non‑rural commodity exports are projected to grow at a rate sufficient to maintain the standard projection assumption of 3 per cent growth in real GDP. This is consistent with the continuation of the production phase of the resources boom and is comparable to forecasts produced by BREE.
The revised projection methodology has been introduced in this Budget for a similar reason to the step‑down assumption for terms of trade projections, first introduced in the 2005‑06 Budget.
Chart A: New business investment
as a share of nominal GDP
Note: Adjusted for second‑hand asset sales between the public sector and the private sector.
Source: ABS cat. no. 5206.0 and Treasury.
Box 9: Updated carbon price estimates
The Carbon Pricing Mechanism commenced operation on 1 July 2012, with a fixed price period of three years. The fixed price arrangements for emissions liabilities remain unchanged, with the price set at $23.00 in 2012‑13, $24.15 in 2013‑14 and $25.40 in 2014‑15.
The 2013‑14 Budget estimates incorporate a revised carbon price methodology for when the price links to the European Union Emissions Trading Scheme (EU‑ETS) in 2015‑16, and for the advance auction of permits related to the floating price period. The methodology incorporates market information for the advance auctions of permits in 2013‑14 and 2014‑15.
These advance auctions in the Budget forecast years are based upon average EU‑ETS market futures prices for 2013‑14 and 2014‑15. However, carbon prices in the Budget projection years are not forecasts of carbon prices. As outlined in the 2012‑13 Budget, projection year parameters generally rely on longer‑term factors.
Projections for carbon prices for emissions liabilities for 2015‑16 and 2016‑17 incorporate the straightforward approach of a linear transition from market prices in 2014‑15 to the modelled price of $38 in 2019‑20 from the Strong growth, low pollution (SGLP) modelling report. The price is now projected to be $12.10 in 2015‑16 and $18.60 in 2016‑17.
The longer‑term modelled carbon prices from SGLP reflect the price levels required to meet long‑term global environmental goals as well as the international commitment pledges for 2020, and these have not changed.
The near‑term outlook for prices in the EU‑ETS remains unclear given the profound economic weakness in Europe and uncertainty in relation to the timing of any regulatory changes that may be agreed with respect to the scheme.
The revised methodology ensures that the carbon price parameters incorporated in the 2013‑14 Budget reflect both short‑term market dynamics and longer‑term fundamentals.
1 Previously, Treasury could not publish forecasts which relied more directly on information provided by individual firms on an in-confidence basis.
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