Monday, March 27, 2006

Editorial: Tipping point for sentiment

There is nothing like a negative figure to turn economic warnings into reality. The discovery that gross domestic product fell 0.1 per cent in the last quarter of 2005 spells the end to more than five years of continual growth.

The figure for the December quarter is worse than private economists' median expectation of 0.2 per cent growth over that period, and much worse than the Reserve Bank's forecast of 0.4 per cent growth.

If the contraction has continued over the current quarter, which finishes on Friday, we are officially in the recession the Reserve Bank has been trying to avoid. But at least it means the bank will need to revise its view of inflation and interest rates and business can probably look forward to a relaxation of rates this year rather than next.

Perhaps more important, for exporting industries, the dollar's recent sharp fall in foreign exchange is likely to continue, improving their returns and making imported products more expensive to ordinary consumers. The rest of this year is likely to see the thrust of economic activity shift from household consumption, which has been driving our prosperity for the past several years, to farming, fishing, forestry, tourism, horticulture, winemaking and all the productive sectors we can develop.

That assumes that the December GDP result is not a mere glitch that will be followed by resumed growth. Ordinary experience makes it very hard to tell.

The domestic economy still looks and feels quite lively. Construction projects abound, shops are busy, households and individuals are still consuming happily, riding the confidence of wage and salary increases and rising real estate values.

Despite the contraction overall, household consumption continued to grow in the December quarter, up 0.3 per cent. Household spending over the whole of 2005 rose 4.6 per cent. Clothing and footwear sales were particularly strong, gaining 2.9 per cent over the final quarter.

But this spending is probably the last spree of the growth phase rather than an indication of things to come. The dollar's fall in March has been steep and steady and, although it seems to have survived a big maturity of uridashi bonds without falling through the floor, there is another $14 billion of bonds due next year.

That very prospect, against the background of a deep external deficit and, now, negative growth, means the dollar is likely to fall faster and further than we might hope.

The problems of a high dollar - diminishing export returns and a current account deficit that plunged to 9 per cent last week, the worst in 30 years - are academic to most people. The effects of a low dollar are not. It means more expensive petrol and other imported goods, lower household consumption, less employment, all the pain of a slump - unless the economy quickly improves productivity, especially in exportable goods and services, and wealth quickly spreads through the rest of the economy.

The challenge for the Government is obvious. This is the first serious sign of recession it has faced and markets will watch closely for a reading of its nerve. A wintry turn in the economy should favour the Prime Minister's declared priority for her third term, the long quest to diversify and add value to our tradeable products.

The message needs to be clear that a low dollar does not point the way to a better economy. It merely gives a cyclical boost to our commodity exports. The aim remains to develop finished goods and services that might raise our incomes to Australian levels at least, and pay for the lifestyle we have been enjoying so far on credit.


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