The March quarter GDP data show that Australia started the year quite well. However, this does not change our view that Australia’s long-term growth prospects will be challenged by an accumulation of domestic and external headwinds. Based on Bank for International Settlements data, credit growth to non-financial sectors has been slowing down from its recent peak of 7.7% (year-on-year) in Q1 2016 to 4.2% in December 2017. It has already had a very negative effect on credit impulse which is the second derivative of credit growth and a key driver behind economic activity.
As a result, credit impulse reached a post-financial crisis low at minus 3% of GDP at the end of 2017.
In 2009, the magnitude of the contraction in credit was much larger and yet Australia held up well. The impact on the unemployment rate (see chart below) and on aggregate demand are clearly perceptible but the country has escaped the global recession.
The real reason for that was that the debt engine restarted quite quickly in Australia in the aftermath of the crisis. The Australian miracle is mostly based on a rapid accumulation of public and household debt from 2008, as shown in the graph below. Over the past 10 years, household debt jumped from 108% to over 121% of GDP. At the same time, the country benefited from its sales of coal and iron ore, especially to China which launched a massive stimulus program in 2009. The last factor that helped to mitigate the crisis was that credit contraction was smaller in Australia than in the US and it followed a period of stronger credit boost with credit impulse reaching a high of 6.8% of GDP before the crisis against a peak at 3.3% of GDP in the US.
Nowadays, unlike 10 years ago, Australia is less able to cope with headwinds occurring at the same time as negative credit impulse. The Reserve Bank of Australia is on hold until the end of this year and even beyond, but the problem is that global monetary conditions are deteriorating, cost of capital is rising, and liquidity stress can be observed in USD money markets.
At the domestic level, the country faces a number of challenges that negatively impact household consumption: a low savings rate, timid wage growth, and negative wealth effect linked to weakness in home prices while mortgage repayments in the country’s main cities are above the risk zone (30% of average earnings). Sydney and Melbourne are particularly worrying spots for real estate observers. In addition, the Royal Commission that will run through the rest of this year (a final report is due in February 2019) raises many doubts about future lending conditions that might be more restrictive.
Although the ongoing slowdown in China is also a short-term headwind for Australia, only China may be able to save Australia. China's credit impulse leads Australian nominal GDP by one year (chart below). China credit impulse is still in contraction, at minus 1.9% of GDP, but it is slowly rising and might be back above zero sooner than we think. In the last Chinese State Council’s executive meeting held on June 20, a slight change of wording was mentioned regarding monetary policy indicating that the People's Bank of China will adopt a more accommodative stance (as indicated by the recent RRR cut).
On the back of weaker economic momentum and increasing trade tensions, China is doing what it knows best: stepping in in order to push credit impulse back into positive territory, lending at the same time a welcome element of support to the Australian economy.