Nothing to fear but fear itself?

By Paula Wallace
Analyst and economic forecaster BIS Shrapnel said late last year that in regard to the global financial crisis there was nothing to fear except fear itself and there would be a downturn but no recession for Australia.
According to BIS Shrapnel’s Economic Outlook bulletin, the measures taken by the Reserve Bank of Australia and the Federal Government would reboot the flailing economy. It believes the Australian economy will be boosted in the short-term by the strength of investment as “the current round of projects are finished, the drought eases and exports strengthen as extra capacity from the minerals boom comes on-stream.”
BIS Shrapnel said the real concern is in the medium-term. The stalling of the next round of projects will start to affect work done on building and minerals investment two to three years from now.
“The issue is the magnitude and duration of the downturn in minerals investment, and the impact on the sectors and regions which service it,” said economist and bulletin author, Rachael Logie, “However, this can be offset as non-residential building recovers and infrastructure spending remains strong, provided that State and Federal Governments hold their nerve.”
Access Economics has predicted that Australia will go into a recession this year as the economic boom unwinds. A blow-out in the account deficit and a loss of 300,000 jobs is likely to be a result of the downturn, its report said. The economic consulting agency said the drop in commodity prices will slash tax revenue and force businesses to shelve investment in infrastructure.
In the drop in commodity prices, base metals have been hit particularly hard, with nickel prices dropping to less than $US12,000/t, from highs of $US33,000/t last March.
When BHP Billiton announced, in January, that it would progressively shut down its nickel operations at Ravensthorpe, one analyst firm said it was an indication that the mining giant does not believe nickel will be turning around for another two or three years.
This time frame mirrored comments from Rio Tinto chief executive, Tom Albanese, who was reported as saying that it will take up to two years for the global economy to regain the strength needed to support new mining projects. Following the publication of Rio's fourth-quarter production report, Albanese reportedly said it was too early to say whether there was any change in economic conditions following a mild uptake in iron ore demand form China in December.
Despite the onset of the global financial crisis, the Deloitte WA Index released on January 7th showed the market capitalisation of Western Australia’s listed companies stabilised during December, with resource stocks staging a small recovery.
On a broader scale, the Australian All Ordinaries index has fallen 40 per cent in twelve months and is back to 2005 levels. Other world markets have fallen more. A larger percentage fall (49 per cent) occurred in 1987 in less than five months, while the following slow market conditions lasted nearly three years. In each downturn, the minerals industry undergoes some restructuring but emerges ready for the next “bull” market period, according to industry association AusIMM. On average, “bull” markets last for 5.4 years while “bear” markets last for 1.3 years (IRESS data).
With mining stocks losing 80 per cent, or more, of their value, company executives across the board are questioning the long-term sustainability of their operating models. According to professional services organisation Deloitte, uncertain of next steps, several companies are suspending their exploration programs, putting expansion projects on hold, announcing shutdowns and trimming workforces.
It said the answer to “what next?” lies in your perception of recent market events. Organisations facing difficulty raising capital and financing their costs have shown themselves willing to take a wait-and-see approach. On the flip side, organisations looking farther out, point to factors that support the long-term strength of the mining industry. Anticipated growth rates in countries such as China and India are expected to push up global demand to such an extent that they may offset commodity price volatility, said the Deloitte report.
However, this is a moot point. Some do not believe that growth rates will stay at high enough rates to sustain a healthy resources sector here. The expectation is for China’s economy to slow significantly, as confirmed by figures released in late January. They showed that Chinese economic growth fell to just 6.8 per cent over the December quarter, below Government targets and many analysts’ forecasts.
The recent quarter figures bring China’s overall annual growth rate to 9 per cent, down from 13 per cent in 2007 and the country’s lowest in seven years.
ABN Amro has bee reported as saying that growth is likely to fall to 5 per cent over 2009 and that the slowdown would likely temper iron ore and thermal coal prices. The export prices from both commodities have been widely tipped to halve by April.
The Chamber of Commerce and Industry (CCI) Western Australia has also revised its estimates for WA’s economic growth down from 5.5 per cent to 3.5 per cent for the 2008-09 financial year.
However, the CCI maintains WA’s economy will continue to grow faster than other States, due mainly to population growth and the mining industry. The 2010 financial year growth forecast was revised down from 6.25 per cent to 3.25 per cent.
CCI chief economist John Nicolaou admitted the Chamber had not expected China to feel the effects of the crisis to the extent that it had.
“We don’t forecast commodity prices, but we have factored in large falls in some of our key commodities that we produce, and what that has meant [is] that our exports for this financial year and next financial year are significantly less than what we had first thought,” he said.
Jon Stanford, partner and resources expert at Deloitte, insists the longer term outlook is strong, “The commodities boom had to end sometime but the market reaction to it has been overdone. While commodity prices have fallen from their historic highs, world growth will resume before too long and once again Australian resources will be in increasing demand.”
In its analysis of BHP’s Ravensthorpe announcement, Macquarie looked to the latest steel data from World Steel Association. What it reported is that steel producers outside of China are accelerating cuts in output with non-Chinese steel production falling by 35.4 per cent year-on-year (or 24.3 per cent including Chinese steelmakers).
In China, steel production actually picked up around 10 per cent in December on a month-on-month basis, with the decline in production the greatest in the United States and Europe.
Despite Chinese production figures, Macquarie said it believed steel production will decline sharply in 2009 - bad news for steel materials, including nickel, iron ore and metallurgical coal, all used in steelmaking.
Following a recent steel conference, Macquarie Research analysts noted, “There was a feeling among many that a recovery in global economic growth would occur in 2010 at the earliest, with 2011 being more likely.”

EFIC keen to lend during GFC
Australia’s export credit agency, the Export Finance and Insurance Corporation, is looking to maintain lending operations during the global financial crisis as it makes economic warnings about the year ahead.
EFIC chief economist Roger Donnelly echoed various commentators around the world as he said the world economy was now in a synchronised downturn that could be one of the most severe in the post-war period.
“Typically trade growth has outstripped GDP growth,” he said.
“Now, a significant risk is that world trade growth could fall below GDP growth.
“Certainly, it will be the role of credit agencies around the world, like EFIC, to continue the assistance they provide to help meet the gap that exists in the financial market and ensure exporters are appropriately financed.”
Of the various central bank action and government bailout packages around the world over the last few months, Donnelly said some of the intervention was justified, but would only work if the actions revived the willingness of the private sector to lend.
In what could appear to be a veiled attack on China, Donnelly said global trade imbalances had proven unsustainable and were now being unwound.
“The unwinding and rebalancing will proceed more smoothly if governments in all economies, but especially surplus ones, support domestic demand, and surplus economies allow their currencies to appreciate,” he said.
On a more positive note, the economist noted resource nationalism is in decline and governments will be content to retain investment in the current economic climate.
“In the resource boom, countries had tried to gain a greater share of resource revenues by renegotiating tax and royalty rates and equity shares,” Donnelly said.
“But now, with commodity prices and associated windfall revenues both down, that risk is ebbing.”
The Export Finance and Insurance Corporation is a statutory authority that is wholly owned by the Australian government and operates under the EFIC Act.