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Australia Country Risk Report Q1 2016

Australia Country Risk Report Q1 2016

Core Views

Real GDP growth is highly likely to slow over the coming years owing to a number of factors: slowing growth in the working age population, a high share of government spending relative to GDP, a reversal in the country's terms of trade and the growing risk of deflation. These impediments will result in real GDP growth averaging 2.3% over the next decade, down from 2.9% over the past decade.

The Australian Labour Party remains in prime position ahead of the general election (to be held by January 14 2017). Malcolm Turnbull's appointment as Australia's 29th Prime Minister in October will do little to improve the Liberal-National's coalition sliding popularity.

We remain bearish on the Australian dollar despite the large fall we have already seen in the currency. While valuations are no longer a headwind to the currency, the trend remains very bearish. Weak economic growth owing to falling investment and correction in the property market amid elevated indebtedness does not bode well for the AUD.

Australia's fiscal accounts are unlikely to return to a surplus any time soon, given downside risks to revenue collection and a lack of expenditure cutbacks. Total revenue collection will remain poor as the economy continues to weaken, which will weigh heavily on tax receipts. Meanwhile, objections to spending cuts from the public, opposition and crossbench senators as well as other state governments indicate that the Australian government will struggle to keep its expenses and borrowing on a sustainable trajectory. While there is currently no danger of a fiscal crisis, our core view is that this growing burden of the government will undermine the productivity of the private sector and take its toll on economic growth over the medium term.

Australia's current account picture is gradually improving in spite of deteriorating terms of trade, thanks to higher export volumes and lower income outflows. Going forward, we maintain that a current account surplus is likely as the Australian dollar depreciates, but this will increasingly be driven by lower imports, to the detriment of the domestic economy.

We expect the Reserve Bank of Australia (RBA) to cut its cash rate by 50 basis points (bps) to 1.50% by H116 as overall economic growth deteriorates owing to a slowdown in residential construction activity, declining investment in the resources sector amid depressed iron ore and coal prices, intensifying drought fears, and tightening financial conditions.

Major Forecast Changes

We lowered our cash rate forecast for 2016 to 1.50% (versus 2.00% previously) as worsening economic activity amid subdued inflation will prompt the RBA to reduce its key policy rate by 50bps by 1H16.

We lowered our end-2015 and end-2016 AUD forecasts to USD0.6600/ AUD and USD0.6000/AUD, respectively (from USD0.7000/AUD and USD0.6600/AUD previously) given that fundamentals remain poor and that the Aussie remains on a downtrend.

We revised our 2015 and 2016 current account deficit as a share of GDP forecasts to 3.5% and 3.0%, respectively (versus 2.3% and 1.7% previously), given the greater than expected widening of the goods and services trade deficit.


Executive Summary
Core Views
Major Forecast Changes
Key Risks
Chapter 1: Political Outlook
SWOT Analysis
BMI Political Risk Index
Domestic Politics
Turnbull's PM Appointment No Fix-All For Coalition's Woes
Malcolm Turnbull's appointment as Australia's 29th prime minister after ousting incumbent Tony Abbott in a snap leadership ballot
conducted on September 14 is unlikely to improve the Liberal-National coalition's sliding popularity. Political uncertainty in the party is
likely to continue for a considerable amount of time, as the margin of victory was narrow. Meanwhile, Labour remains in prime position
to win the upcoming federal election (to be held by January 14 2017), which poses a key risk to the government's fiscal consolidation
efforts.
TABLE: POLITICAL OVERVIEW
Long-Term Political Outlook
Three Key Challenges: Population, Climate Change, China
The Australian political scene is expected to remain stable over the coming decade, although it will still face a number of key challenges.
The most salient are managing population growth, climate change and relations with China.
Chapter 2: Economic Outlook
SWOT Analysis
BMI Economic Risk Index
Economic Growth Outlook
Worst Not Over For Investment Cycle
We expect the Australian dollar to face continued fundamental downside pressure as the country's recurring current account deficit
leaves it exposed to further capital outflows amid a slowing economy. Australia's Q215 real GDP growth figures showed that the
economy remains on a slowing trend, and we maintain our below consensus growth forecast of 2.3% for 2015 and 2016 as the poor
investment outlook will continue to be a major headwind to growth.
GDP By Expenditure Outlook
TABLE: ECONOMIC ACTIVITY
External Trade And Investment Outlook
Wide Current Account Deficit To Keep AUD Under Pressure
We expect the Australian dollar to continue to face fundamental downside pressure, and this will allow the decline in imports needed
to improve the country's external indebtedness over the coming years. Meanwhile, we doubt the sustainability of increased financial
inflows in light of a slowing economy and potential weakness in the housing market.
Outlook On External Position
Fiscal Policy And Public Debt Outlook
Fiscal Deficit Improvements To Remain Slow
Due to insufficient expenditure cutbacks and poor revenue collection, Australia's fiscal deficit is unlikely to narrow significantly. We
forecast the fiscal deficit as a share of GDP to come in at 2.3% in FY2015/16 (July-June) from 2.5% in FY2014/15, which is less
optimistic than the Treasury's forecast of 2.0%.
TABLE: MAIN EXPORT AND IMPORT PARTNERS
TABLE: MAIN EXPORTS AND IMPORTS
TABLE: CURRENT ACCOUNT
Structural Fiscal Position
TABLE: MAIN REVENUE AND EXPENDITURE CATEGORIES
TABLE: FISCAL POLICY
Monetary Policy
Looming RBA Easing Positive For Bonds
We expect Australian bond yields to remain on a downtrend amid heightened deflationary forces and weakening growth. The RBA will cut its cash rate by a total of 50bps to 1.50% by H116 as overall economic growth worsens. This will be caused by a slowdown in residential construction activity, falling investment in the mining sector amid weak iron ore and coal prices, intensifying drought fears and tightening financial conditions.
Monetary Policy Framework
TABLE: MONETARY POLICY
Chapter 3: 10-Year Forecast
The Australian Economy To 2024
Four Major Headwinds To Growth
We forecast Australia's real GDP growth to average 2.3% per annum over the next decade, down from 2.9% over the past decade as the combined headwinds of slowing population growth, greater government spending, declining terms of trade and heightened deflations risks all weigh on economic activity.
TABLE: LONG-TERM MACROECONOMIC FORECASTS
Chapter 4: Operational Risk
SWOT Analysis
Operational Risk Index
Operational Risk
TABLE: DEVELOPED STATES - LABOUR MARKET RISK
TABLE: DEVELOPED STATES - LOGISTICS RISK
TABLE: DEVELOPED STATES - CRIME AND SECURITY RISK
TABLE: DEVELOPED STATES - TRADE AND INVESTMENT RISK
Chapter 5: BMI Global Macro Outlook
Global Outlook
Exit The Dragon
TABLE: GLOBAL ASSUMPTIONS
TABLE: DEVELOPED STATES, REAL GDP GROWTH, %
TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %
TABLE: EMERGING MARKETS, REAL GDP GROWTH, %

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