Resilience key amid grim forecasts

Allan Trench bristles when asked to assess the likelihood of a recession in Western Australia.

A mineral economist, ASX director and professor at University of Western Australia’s business school, he believes trying to predict when a downturn will come is a mug’s game.

And it prompts him to reach for an oft-quoted maxim generally attributed to celebrated economist Paul Samuelson: ‘Wall Street indexes predicted nine out of the last five recessions’.

It’s an amusing quote to consider amid dire warnings from central banks and industry bodies about surging energy prices, inflation and interest rates.

After all, energy supply issues have not yet cruelled WA’s economy as they have the rest of Australia, inflation is not crushing real wages and purchasing power the same way it is in other advanced economies, and the Reserve Bank of Australia’s official cash rate target, while now at its highest rate in almost a decade, is still lower than those of the US, UK and New Zealand.

“We’re in a nice little bubble here, but clearly we’re not isolated from the rest of the planet,” Professor Trench told Business News.

For months, economic indicators have pointed to trouble for Australia’s economy.

Nationally, growth slowed for the September quarter to just 0.6 per cent in seasonally adjusted terms, while household savings as a ratio of income were cut to pre-pandemic levels.

State final demand growth now sits at just 0.6 per cent in WA, largely due to reduced investment by the mining industry, and labour and material shortages in the construction sector.

Labour shortages remain acute across sectors, according to research from KPMG.

Its annual survey of business leaders regarding the issues they face in the year ahead found talent acquisition as the main challenge for a second year.

Meanwhile, CommSec analysis published earlier this month anticipates that, despite inflation having peaked in December, at least one more cash rate rise is expected from the RBA in February, with a cut unlikely until the end of this year at the earliest.

Survey data captured by the Chamber of Commerce and Industry of WA in early December hinted at what this year’s downturn may look like, as consumers indicated they were likely to rein-in spending on holidays, restaurants and home renovations, let alone essentials like groceries, transport and healthcare, in the face of higher inflation and surging interest rates.

Still, despite dire forecasts and indicators, finding someone willing to put their money on a recession is hard, and certainly CCI chief economist Aaron Morey is not one to wager.

Speaking to Business News last month, he assessed the risk of recession as very low.

Mr Morey did, however, place a caveat on that statement with a distinction between a technical recession (in which WA’s economy would shrink over two consecutive quarters) and the sort of downturn associated with the GFC or the Great Depression, which he sees as unlikely to happen.

“We often think a recession is when [there are] long unemployment queues and people are struggling for work and income,” he said.

“The chances of that are extremely remote for WA.”

Reassuring as Mr Morey’s confidence may be, what’s beyond doubt is that the numbers are tracking in the wrong direction.

Latest state accounts data shows WA’s year-on-year growth contracted slightly, to 3.1 per cent from 3.3 per cent, below the national rate of 3.6 per cent and ahead of only the ACT and NSW.

Public expenditure on infrastructure works helped prop up the final figure, while a decline in iron ore mining and falling overseas demand narrowed the sector’s share of overall growth.

Still, when put in the context of two years during which unemployment fell sharply and some of the state’s biggest mining companies reaped windfall profits, Mr Morey cautions it is unrealistic to expect the good times to last.

“You’ve got to look at these things in context,” he said.

“We’ve recorded extraordinary growth rates in the past 18 to 24 months, whether it be the overall size of the economy or in retail spend … or investment in the resources sector.

“A slowdown is inevitable. You just can’t continue to grow at these sorts of rates, and obviously, with the cash rate rising really quickly and the cost of doing business increasing, it’s no surprise that the rate of growth is slowing and the economy at the moment is looking like it’s leveling off.”

Committee for the Economic Development of Australia senior economist Cassandra Winzar similarly noted that, while a recession was unlikely, lower growth was unavoidable.

She did caution, though, that while WA’s low unemployment, improved government budgeting and confident private sector would undergird the economy, the state would not be immune to further weakening of global conditions.

“I don’t think anything has changed that in the last couple of months, but when you’re at that low growth end of the scale it doesn’t take much to push you into recession, and so there is certainly still a risk there,” Ms Winzar said.

“I don’t think it’s the most likely outcome, but it’s a possibility.”

The state government appears to be preparing itself for that prospect.

Latest state treasury data shows a recession is unlikely this financial year, with growth of 3 per cent pencilled in for the year to June.

That’s set to recede over the outyears, though, as growth crashes to a miserly 1 per cent in FY24 before slowly climbing to 1.75 per cent the next year and 2.25 per cent the year after that.

Presenting his government’s mid-year budget review late last month, Premier Mark McGowan talked up readying the state for “whatever the world might throw” at WA in the months ahead, while conspicuously neglecting to mention a $200 million improvement in the budget’s bottom line.

Other states, such as NSW and Victoria, were in a far worse position, he argued, in part because they incurred significant debt in recent years to prop-up ailing demand.

Ongoing restraint, particularly as it relates to the state’s burgeoning public sector wages bill, would be a necessity, especially as salary expenses have already added about $1 billion in recurring operating costs.

Some, including opposition treasury spokesperson Steve Thomas, are reluctant to give the premier too much credit for keeping the books in order.

“At a superficial level, the premier’s been able to tell people a story about good financial management,” Mr Thomas told Business News.

“The reality is that there is as much financial luck in it as there is financial management.”

There’s some truth in that remark, with larger-than-expected royalty revenue undoubtedly aiding the budget’s bottom line and helping to service the state’s net debt of $29.6 billion.

Regardless, Mr McGowan’s approach received critical backing late last year.

That came courtesy of a decision by Moody’s Investors Services to revise WA’s outlook from ‘stable’ to ‘positive’, specifically citing wage and salary controls, alongside strong revenue and federal grant dollars, as reasons for the upgrade.

“We consider WA to be an outlier compared with its domestic and international peers,” Moody’s vice-president and senior credit officer John Manning said.

“The state recorded excellent revenue growth and improving revenue diversity through the successful management of the pandemic combined with sustained spending discipline.

“If this continues, in particular through further revenue diversification, WA’s credit profile will be stronger.”

The Moody’s decision came with a few provisos, however.

Federal conditions were cited by Mr Manning as a downside risk to the state’s upgraded outlook, with the Commonwealth’s own spending profile tied strongly to any changes given WA’s reliance on federal grant money for recurring operational expenses.

Ditto any evidence that may suggest the past two years were a blip powered by windfall gains amid a commodities boom.

The jury’s out on whether that has been the case. On the day Moody’s issued the outlook upgrade, iron ore was trading at just under $US100 per tonne, well below the year’s peak of about $US160/t in April but markedly better than state treasury’s generally conservative long-run assumption of $US66/t.

Prices have since improved to just under $US120/t in what could be a sign of a newfound resilience for the state’s economy but could just as easily prove ephemeral if the state’s major trading partner, namely China, wind back demand.

Jon Greenaway is an analyst with Control Risks. Photo: David Henry

“More than half of national goods exports originate from WA and nearly 60 per cent of goods sent to China come from here,” Control Risks analyst Jon Greenaway said.

“Of the commodities we dig and ship, it’s still iron ore first, second and third.

“It’s no surprise then that exposure to a China slowdown is the biggest risk.”

Accurately predicting a downturn in China’s economy has proved especially difficult in recent months.

Projections from the International Monetary Fund are for that country’s growth to slow to 4.4 per cent in 2023, the slowest annual rate since 1990 barring the start of the COVID-19 pandemic.

That’s despite China’s latest growth figures being marginally better than expected, with President Xi Jinping declaring earlier this month that China’s economy grew by about 4.4 per cent last year, which, while below the nation’s target, was well above the World Bank’s expectation of about 2.7 per cent.

The pandemic remains a problem for China, however, with the government only recently unwinding restrictions and confronting commensurate issues with increased absenteeism and a stressed healthcare system.

Mr Greenaway put a question mark over China’s willingness to tolerate that pain in the short term.

“There is no guarantee that [China’s] government won’t return to COVID zero as quickly as [it] shelved it,” he said.

“This will weigh on economic growth.”

But Mr Greenaway still sees plenty of upside amid the tumult.

Investment, of which the US is the greatest source for Australia, looks likely to increase on the back of the Biden administration’s ironically titled Inflation Reduction Act, which will actually funnel billions of dollars into firming up clean energy supply chains in a bid to sideline countries like China.

Conversely, steadily improving diplomatic relations with China may aid WA’s agricultural exporters, with dialogue on trade and economic issues to restart following Foreign Minister Penny Wong’s meeting with that country’s counterpart in December.

“Where there is risk, there is opportunity,” Mr Greenaway said.

Mr Morey similarly noted decarbonisation efforts, alongside continuing strength among WA’s gas and iron ore exporters, as reason for optimism.

“We’ve got so much going for us,” he said.

“Sure, there might be some challenges in the year ahead with some of the slowdown around the world, but I think WA is really well positioned to attract people and to attract capital.”

National headwinds are also likely to have limited bearing in the year ahead, particularly in relation to the federal government’s caps on wholesale gas and coal prices.

That policy, implemented to stave off a projected 56 per cent price rise over the next two years, was widely panned by Australian Petroleum Production and Exploration Association chief executive Samantha McCulloch, who has since suggested the intervention would risk future investment in Australian gas projects.

Supply will certainly become a problem for WA in the coming years, with the national market operator’s latest statement of opportunities for the state implying a significant shortfall beyond 2029 without new investment.

Until then, producers selling into the local market should have few qualms about a $12 per gigajoule price cap, given WA’s gas spot price was $5.66/GJ for the September quarter.

Further cash rate rises may yet bite, particularly with RBA governor Philip Lowe warning last month that, with inflation at 6.9 per cent in the year to October, further interest rate increases should be expected.

That would hardly be assuring news for a state like WA, where latest census data shows 40 per cent of homeowners are repaying mortgages, above the national rate of 35 per cent.

Still, considering the ongoing resilience of iron ore exports, the relative affordability of gas in the state, and lower inflation and interest rates than most comparable economies, any challenges for WA will likely pale in comparison to those facing the rest of the world.

“While it’s not ideal … it certainly looks a lot better than other parts of the world, and indeed the country,” Mr Morey said.