Where is Australia heading in terms of the economy, interest rates, the share market, and currency? Not even experts have a crystal ball with absolute answers, but their expertise can offer an educated guess.
We ask a panel of experts to give us their predictions on Australia’s future, as well as advice on what these predictions mean for small business.
ECONOMY
Predictions: Thanks to inflationary pressures building in areas such as shortage of skilled labour, most predict a slowing of the economy for the rest of the year and 2006. The domestic demand component of GDP is on the rise despite an excess of imports over exports.
Steve Ryan, chief economist, St George:
There is a decent chance of the overall economy slowing over 2005, and perhaps 2006. An important driver will be interest rates. The Reserve Bank has signalled they believe that the economy is up against capacity constraints; hence, they have begun nudging up the overnight cash rate. These capacity constraints are not only evident in the export sector, but anecdotal reports also suggest that many businesses are finding it hard to obtain appropriately skilled staff. Combined with the very sharp rise we have seen in commodity prices in the last three years, the risk of inflation emerging is now greater than it’s been in at least five years.
Alan Langford, chief economist, HBOS Australia—Bank West:
Despite a range of risks to the durability of the national economy, they are just that; risks that may crystallise but which should not divert excessive attention from an economy that is still generating solid employment growth despite sluggish ‘headline’ (that is GDP growth). The domestic demand component of GDP continues to grow at a solid rate, albeit slower than that posted in 2003. However, that year was too good to be true. If domestic demand had not slowed last year, we would be now looking at a cash rate closer to 6 percent per annum, rather than 5 percent per annum.
Bernie Fraser, former RBA governor:
We’ve had about 14 years of pretty sustained economic growth, with low inflation, and these sort of long periods of good performance tend to come to an end when there’s a shock of some kind—whether external or internal—or it just runs out of steam because it runs out of skilled labour or capacity and there are some signs of that happening.
What this means
Neil Wickenden and Jonathan Philpot of accountants and business and financial advisers HLB Mann Judd, Sydney:
Slowing consumer spending is not good for small business. With households tightening their spending, businesses will also need to look at their spending and any expansion plans should be carefully considered. Rising interest rates mean spending on home building decreases, so businesses in this sector should plan for a decrease in demand. Near full employment means labour costs are starting to rise, particularly with skilled labour. At times like this, employees often take the opportunity to move jobs. Higher labour costs and greater employee mobility will have a direct impact on SMEs. Wage rises will also lead to more inflationary pressures and push interest rates even higher further reducing household spending.
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Tim Harcourt, chief economist, Austrade:
In the past, a weakening domestic economy would mean more companies would look to export to get rid of excess stock. However, nowadays, as a result of economic reform more Australians see exporting as part of the ‘core business’ and will push on regardless of the level of economic activity at home.
INTEREST RATES
Predictions: While small business debt levels are relatively low, households carry higher debt levels than ever. Any rise in rates (which is generally predicted) will have an impact on the economy. The housing market is still vulnerable to cash rate hikes.
Steve Ryan: It is widely recognised that households now carry higher debt levels than they did a decade ago. Now, the Reserve Bank only has to lift rates by a small amount to get an impact on the economy. It is also true that debt levels for small business (as opposed to households) are relatively low. This leaves an economics catch-22 situation; it puts small business in an excellent position to take advantage of the low interest rate environment, but if household demand continues to slow, small business will then be cautious about expanding and taking on new debt.
Alan Langford: No one is suggesting, and nor should they, that inflation is on the verge of rising to a degree or at a pace that necessitates aggressive tightening of monetary policy. But looking ahead into 2006—which is just what the Reserve Bank was doing when it re-activated monetary policy in March after a 14-month hiatus—rising cost pressures, both materials and labour, should be high on all businesses’ watch lists. Even without the still ever present risk of sharp increases in the oil price, a range of inflation pressure points are emerging.
Bernie Fraser: There are inflationary pressures building up and even if the economy slows down, if over the next six to nine months there is more pressure, then banks will try to head this off.
What this means:
Neil Wickenden and Jonathan Philpot: As households have a high debt level, any interest rate rise has a significant impact on how Australians are able to spend their income. However, the last 12 months have shown even the threat of interest rate rises (the rise in March was the first since December 2003) has slowed spending.
Small business is particularly hard hit by a fall in spending, particularly the more discretionary goods and services providers like entertainment, restaurants, and small retailers. Businesses will also need to control their level of borrowings if interest rates rise further. It would also be prudent to review variable loan rates against fixed loan rates. When looking at interest rates over the last 20 years, they remain at the lower end of the cycle and may settle at about 6 percent, which on an historical basis is not a high rate. If interest rates do settle, then borrowing costs will still not represent as much of a cost to businesses as other expenses such as labour, rent, and information technology.
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SHARE MARKET
Predictions: Despite a weakening housing market, business investment remains robust. And while it is hard to see it being as strong as last year, if interest rates rise only slightly and debt levels in business stay low, the market should consolidate.
Steve Ryan: In this environment, it’s hard to see the stock market posting another year as strong as 2004, where the All Ordinaries index rose 23 percent. However, if interest rates only rise slightly, and given debt levels in business are not high, we would expect the stock market to consolidate rather than fall back sharply.
Alan Langford: The housing market is still vulnerable to one too many cash rate hikes by the RBA. The cyclical downturn in dwelling construction is well underway but still has some way to go, at least until well into 2006. In contrast, business investment remains robust and, in the absence of a sharp deterioration in the global economy, should remain so into 2006. So there is no real reason, other than perhaps a debilitating appreciation of the Australian dollar, for business to be pessimistic.
What this means
Neil Wickenden and Jonathan Philpot: Many small business owners only focus on building the value of their business, but they should also be building wealth outside of the business, which is often overlooked.
Self-managed superannuation funds (SMSF) is a structure that can be used to accumulate long-term investment wealth as it is a low tax structure and its purpose is to provide retirement benefits. Such investm
ents need to grow over the longer term, which makes shares an attractive option, and short-term volatility shouldn’t affect this. The volatility or additional risk of share markets has to be accepted in order to produce greater returns over the long term. The negative return from shares a few years back is a reminder to all not to expect positive returns year after year.
Business owners should also be aware of the impact of major share market corrections on the survival of companies, and make sure their own business is not overly reliant on one or two major customers.
CURRENCY
Predictions: It seems clear that a strong currency depends on commodity prices and growth in other countries, as well as positive political conditions. There are estimates that it may finish the year around $US0.70, while others predict exporters will be better off so long as it stays below $US0.80.
Steve Ryan: The Australian dollar depends largely on the direction of commodity prices, but interest rate differentials with other countries will also play an important part in driving the Aussie dollar. Economic growth in China and other Asian economies will have a big bearing on commodities prices. The Chinese authorities are currently trying to slow the economy (because of similar capacity-constraint type arguments as the RBA is worried about) and a slower China will almost certainly mean lower commodity prices. Interest rate differentials may also begin to work against the Australian dollar, with the US Federal Reserve being more likely than the Reserve Bank to raise rates. Our ‘best guess’ on the Aussie is will finish 2005 nearer $US0.70, rather than $US0.78 where it is at present [early April].
Alan Langford: The Australian dollar tried to breach $US0.80 in late 2004 and again in March 2005, but failed each time. As long as it stays safely below 80 cents, the currency remains conducive to an eventual recovery in exports as business investment addresses the export capacity constraints that are letting some of the benefits from China’s booming economy slip through our fingers.
Bernie Fraser: All we can be sure of is, it’s going to move around, and exporters know that and they have to plan on that. The exchange rate can be anywhere from $US0.60 – $US0.80. But it’s been like that for 16 years now and exporters have coped with that. They can take out hedging and whatever to cope with the exchange rate.
Tim Harcourt: The currency does matter to exporters. In the DHL Export Barometer, the exchange rate and political conditions overseas were the two biggest concerns. However, most exporters think that while the exchange rate does affect prices and profits, it doesn’t affect the decision to invest and to expand their business.
What this means
Neil Wickenden and Jonathan Philpot: Predicting currency movements is very difficult and the only way to mitigate currency risk is to hedge. Big business has the resources and the flow of funds to be able to hedge their international transactions. For SMEs it is a more costly exercise at approximately 2 to 3 percent of the monetary value. Given the growth in the South East Asian economies, led by China, more Australian small businesses should be considering doing business with SE Asian countries. Those who do, and those already trading in the region, choosing the currency denomination of their contracts and managing any currency risk will become more critical.
If we assume that the $AU is above its fair value, there is no reason for small businesses with overseas investments to hedge the value of the investment as they would only be reducing any currency gains.
