Slow and steady wins the GDP race

Continuing on the theme of Australia outperforming other major economies, Australia’s gross domestic product (GDP) grew by 0.4 per cent in the March quarter 2009, avoiding the ‘two quarters in a row of negative GDP growth’ definition of recession. This is very welcome news.

However, the better-than-expected GDP number was driven by a strong net exports contribution that looks unsustainable. In addition, while the consumer/household sector was supported by significant monetary and fiscal policy stimulus, the investment and income sides of the economy were extremely weak.

The danger is, therefore, that over the remainder of 2009, the strength in net exports and consumer activity will wane and the local economy will suffer at the hands of a sharp fall in business investment and declining income growth, likely leading to higher unemployment rates and a return to negative GDP — before a more substantial recovery gets underway in 2010.

The growth in Australia’s economy in the March quarter 2009 was higher than market expectations and marked a solid increase from the revised 0.6 per cent decline of the December quarter 2008. Nevertheless, the annual pace of growth slowed to 0.4 per cent a year from an upwardly revised 0.8 per cent a year at the end of 2008, and well down from 3.4 per cent a year in the March quarter 2008. (See chart for details.)

While the media and, no doubt, some politicians will focus on this achievement, it is also important to focus on the composition of the growth and on the view expressed by the Reserve Bank Governor that the ‘two quarters in a row of negative growth’ definition is “not very useful”. (It is also worth noting that the trend series of GDP has been negative for two quarters in a row, with falls of -0.1 per cent per quarter (-0.1%/qtr) in both the December quarter 2008 and March quarter 2009.)

In the March quarter 2009, the strength in the economy was led by private consumption (clearly linked to the aggressive monetary and fiscal policy easing) and a huge increase in net exports. Household consumption expenditure rose 0.6%/qtr, providing 0.3%/pts to GDP growth. Away from this, however, the remainder of the domestic economy was weak.

Dwelling investment fell by 5.6%/qtr, providing -0.3%/pts contribution to growth, while business investment fell 6.1%/qtr, subtracting 1.1%/pts from growth. A small positive contribution to growth from ownership transfer costs (+0.1%/pts) was offset by a small decline in public investment (-0.1%/pts). With the change in inventories providing no contribution to growth on the quarter, gross national expenditure (GNE) declined by 1.0%/qtr.

This weakness in the domestic side of the economy was, however, more than offset by a 2.2%/pts contribution to growth from net exports, with a 2.7%/qtr increase in exports on the quarter adding 0.6%pts to growth, while a 7.0%/qtr decline in imports added a massive 1.6%pts to growth.

It is also important to focus on what is happening on the income side of the economy. Real gross domestic income adjusts the GDP measure for changes in the Terms of Trade (export prices relative to import prices). For many years, real gross domestic income was rising much faster than GDP, thanks to the boom in Australia’s terms of trade.

This growth in real gross domestic income was the primary driver of strength of many indicators in the Australian economy, including employment, wages growth, company profits and private capital expenditure. It also formed a large part of the boom in government tax revenue that led to the large budget surpluses and a primary driver behind the RBA’s monetary policy tightening phase as inflation pressure built.

Now this development is reversing. Real gross disposable income declined by 1.4%/qtr in the March quarter 2009, with the terms of trade down 7.8%/qtr. The key here is that further sharp falls in real gross disposable income could be expected over the remainder of 2009, as the terms of trade continues to move lower (due largely to falling prices for our key commodity exports, coal and iron ore).

This sharp fall in real gross disposable income is likely to show itself in a continued rapid decline in private capital investment, reduced income growth for companies (ie, lower company profits) and individuals (ie, lower wages) and a rise in the level of unemployment. The concern is, therefore, that the remainder of 2009 could look worse for the Australian economy, as the monetary policy and fiscal stimulus benefit to the consumer and household sector wanes and before the increase in public sector capital investment (ie, the government’s focus on infrastructure spending) really kicks in.

This outcome is something the RBA will be focused on, given it implies reduced inflation pressures, and the financial market would do well to also reflect on this possible outcome.