Recession a Growing Danger for Australia





Australia faces a gathering threat to its 21-year run of recession-free growth that will probably require the central bank to cut interest rates to record lows and keep them there for some time, if the winning streak is to stretch to 22.

The slowdown in China has deflated prices for Australia’s main resource exports while forcing miners to scale back on their most ambitious expansion plans. When the country reported its widest trade deficit in three years for August, it seemed just a taste of what was to come.



“It’s like we’re watching a slow motion train wreck,” said Su-Lin Ong, a senior economist at RBC Capital Markets. “The decline in export earnings will take toll on wealth, incomes and consumption right across the economy. And it’s happening when fiscal policy is being tightened and the Australian dollar is restrictively high.”

As a result, she expected the economy’s strength would decline into 2013, leaving it dangerously exposed should a seven-year-old boom in mining investment also top out that year.

The government and the central bank still forecast growth of about 3 percent for the next couple of years.

But when the mining splurge turns, as it must, there will probably be significant quarterly declines in investment even as the level of spending stays high.

And since investment is set to reach a heady 9 percent of Australia’s 1.5 trillion Australian dollar, or $1.53 trillion, in annual gross domestic product, such declines could easily cause a couple of quarters of contraction, the textbook definition of recession.

The danger was hinted at by the central bank, the Reserve Bank of Australia, last week when it surprised most economists by cutting interest rates a quarter point, to 3.25 percent.

That was the lowest in three years and only a whisker from the nadir of 3 percent touched during the global financial crisis.

“The peak in resource investment is likely to occur next year, and may be at a lower level than earlier expected,” the bank’s governor, Glenn Stevens, wrote in explaining the latest easing. Previously, the bank had thought spending would crest as late as 2014.

“As this peak approaches it will be important that the forecast strengthening in some other components of demand starts to occur,” Mr. Stevens said.

The central bank has been hoping that as the investment stage of the mining boom topped out, other sectors like home building, retailing and tourism would take up the slack.

So far, however, the transition has been glacial. Growth in mortgage credit, for instance, was the slowest on record in August, while sales of new homes hit a 15-year low.

Consumer borrowing has been going backwards, with Australians preferring to stash cash away in banks rather than risk investing in homes or stocks. Since 2008, bank deposits have climbed 260 billion dollars, or almost 60 percent.

Household debt also remains high, at about 149 percent of disposable income.

Any foot-dragging by the rest of the economy could have serious implications for unemployment, as mining has been a big hirer in the past couple of years, helping to keep the jobless rate near 5 percent.

But although a lot of workers are needed to construct mines or liquefied natural gas projects, it takes far fewer to actually run them. This was a point highlighted recently by the head of the central bank’s economics department, Christopher Kent. He estimated that for iron ore mines, four times more people were employed in the construction than were needed to dig the steel-making mineral. For L.N.G. projects, the difference was more like 15 or 20 to one.

“So while employment and wage growth in the resource sector is presently robust, it is possible that this may start to reverse in the next couple of years,” Mr. Kent said last month.

When cutting rates this week, it was notable that the central bank was already sounding more downbeat on the jobs front by saying the labor market had generally softened.

Policy makers have long assumed the Australian dollar would ease the transition by falling sharply, making life easier for sectors like manufacturing and tourism.

But for investors to dump the local dollar they have to buy some other currency, and attractive alternatives are few and far between these days.

Central banks in the Britain, Japan, Switzerland and the United States are all adding to the supply of their currencies either through quantitative easing or outright intervention.

The European Central Bank has not gone quite as far as yet, but grinding recession and endless political risk are not exactly a recommendation for holding euros.

Australia’s AAA-rated debt also remains a big draw for sovereign funds and long-term investors wary of the risk of downgrades elsewhere.

Thus, although the Aussie dollar has eased in recent weeks, it remains high historically. Weighted against a basket of major currencies, its current level of 75.8 is not that far from 27-year peaks and a world away from the low of 51 touched in the aftermath of the global financial crisis.

That puts the onus on the Australian central bank to do more, particularly as Australia’s Labor government is politically shackled to a painful fiscal tightening aimed at delivering a promised budget surplus years before most other developed nations.

Unlike past downturns, inflation is still low, giving the central bank more room to reduce borrowing costs.

“The end of the commodity price and associated capex boom means more will probably have to be done to stimulate domestic demand,” said Adam Donaldson, head of debt research at Commonwealth Bank of Australia.

He thinks 10-year government bond yields could get down to all-time lows of 2.5 percent in coming months, from a current 2.93 percent, with the central bank’s cash rate not too far behind.

“The strength in the Aussie against this backdrop is inherently disinflationary — so we look for interest rates to remain low for an extended period as the economy navigates this difficult path.”






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The first half of 2012 was quite unsurprising in the aircraft market as the prices continued falling. Although all aircraft cost considerably less than before, as expected, the biggest price drop could be spotted on the price-tags of the older generation aircraft. The cost of the Boeing family “ B737-300 and B737-400 models dropped by 13% in comparison with the 2011 end/ 2012 beginning rates.

Extensive demand

'Boeing 737 aircraft remains to be one of the most popular aircraft types in the world. During the first half of 2012 over 250 B737s were sold, leased or delivered. Moreover, additional aircraft are being re-delivered to the global market, since the recently bankrupted carriers, particularly the larger ones, are returning or selling out their fleets. Such ample offer of aircraft on the market is one of the main (and natural) factors which continue to push the prices down,' commented the Deputy CEO of AviaAM Gediminas Siaudvytis.


At the same time, due to financial difficulties in 2012 alone three large European carriers “ Malev, Spanair and Olt Express Poland “ were forced to file for bankruptcy. Their fleets, consisting mainly of aircraft "classics" like Boeing 737 and Airbus A320, as well as the fleets of other air companies which are also facing tough financial times, will potentially supplement the aircraft market offer by selling out or reshaping their fleets. Moreover, the market is also sensitive to the intensifying production rates of the main aircraft manufacturers. Boeing and Airbus have increased production by 10% (compared to 2011) and are planning to deliver over 1110 new aircraft by the end of this year.

Uncertain prospects

The diminishing price rates reflect the on-going financial uncertainty, particularly in the Western markets. Many carries are on the edge of bankruptcy and almost all of them are experiencing serious financial difficulties. As a result, the demand is shrinking, especially for the larger aircraft types. Moreover, any negative fluctuation in the airline community sends warning signals to other market players, forcing them to be more cautious with regard to any sizeable acquisitions.
Furthermore, the latest traffic growth analyses have shown that the North American market also shrank in the end of 2011and the first signs of its recovery were observed in end of winter only. Compared to other regions, the traffic growth rates in Europe were very modest, too. Naturally, the demand had to suffer and the aircraft prices had to go down.

A chance for regional jets with 50 seats

'Unfortunately, some of the regions continue experiencing the aftermath of the recession, which naturally fetters carriers' expansion plans. However, there are two sides to every coin. Driven to cut costs, some airlines are considering shifting to smaller, regional jets in order to optimize their route maps and lower operational costs,' commented Gediminas Siaudvytis.

The figures clearly indicate that the prices for regional jets with 50 plus seats, such as Embraer ERJ 195 and Bombardier CRJ 700, were in the green. These types of aircraft are becoming more and more popular while their manufacturers maintain stable production rates, which are quite moderate in comparison with those of the two major aircraft manufacturers. Moreover, while Airbus and Boeing are suffering from a high inter-competition (even between the models of the same manufacturer), the regional aircraft market is certainly not as intense. The market picture clearly indicates that the supply of some larger regional aircraft simply fails to keep up with the rising demand thus triggering the price growth even further.

'The fact that more and more airlines prefer to operate the regional airplanes of 50 plus seats rather than long-haul narrow body models shows that carriers continue searching for ways to optimize their operations in the climate of economic uncertainty. This, along with the forecasts of drastically dropping carriers' profits, clearly sends warning signals to the market that the industry, possibly, hasn't recovered from the consecutive crises after all,' commented the Deputy CEO of AviaAM Leasing.



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