With Australia’s terms of trade at unparalleled levels the question is, how long can this good run continue?
THE growth of the world economy that has occurred over the past year has resulted in a significant lift in the prices of commodities. The prices of the two commodities of most importance to Australia – iron ore and coal – have been especially strong, and have again risen in recent weeks.
As a consequence, Australia’s terms of trade – the ratio of export prices to import prices – have surpassed the 2008 peak, and are pretty much at unparalleled levels. The increase in the terms of trade during the past year has added about $25 billion to the Australian economy.
The question is, how long will this last? At the Reserve Bank, we have for some time been forecasting a gradual decline in the terms of trade over the next couple of years, on the assumption that the supply of commodities will increase and that demand will slow a little, in line with the assumed slowing in the global economy. This continues to be our projection, though recent commodity price outcomes have caused us to revise up our forecasts.
Beyond the next couple of years, it is hard to predict what will happen. Both China and India, however, are going through a phase of their development that is very intensive in the use of steel. In the past, other countries have taken up to 20 years to move through this phase. It is likely that China, and more particularly India, will have strong demand for steel for quite some time yet.
This, of course, would be a very favourable global environment for the Australian economy.
Let me now turn to the Australian economy. Our economy recovered relatively quickly from what was a shallow downturn following the GFC, and over the past year has grown around its trend rate of 3.25 per cent
The financial side of the economy remains subdued. Household credit is growing at a moderate pace while business credit remains soft. That softness is largely in relation to large borrowers; lending to small businesses has increased at an annual rate of about 5 per cent over the first nine months of 2010.
We have spent a fair amount of time at the RBA looking at the question of why business credit is so soft. It is clear that banks had tightened lending standards sharply following the onset of the global financial crisis, which no doubt contributed to the slowdown in business lending. This has been most acute in the area of commercial property, where there has been a sharp cutting back, particularly by foreign-owned banks.
More recently, there are signs that banks are becoming more willing to lend, at least in areas other than commercial property, but demand for loans, in aggregate, is not very strong. It seems that the investment taking place in Australia, particularly in the case of the mining sector, is largely being financed outside the banking sector, either from retained earnings, direct investment from overseas or capital market raisings.
The exchange rate is also clearly having an impact on business conditions. It has risen to post-float highs recently, although the real effective exchange rate remains below the levels recorded in the resources boom of the early 1970s.
A rise in the exchange rate is a natural consequence of a resources boom and, at the aggregate level, is helpful in allowing the economy to adjust. Nonetheless, some sectors of the economy are adversely affected. A notable example at present is the tourism industry, where there has been a sharp increase in the number of Australians travelling abroad rather than taking holidays domestically.
While there are differences between sectors and between regions, the Australian economy overall is doing well. We expect that the economy will continue to grow at a solid pace over the next couple of years.
• This is an extract of a recent address given by Reserve Bank of Australia deputy governor Ric Battellino to the Committee for Economic Development of Australia (WA).