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Big challenges ahead for new government, Coface warns

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The new Turnbull government faces some major challenges ahead as it struggles to maintain its AAA credit rating.

In its latest briefing, Coface, a global leader in credit insurance and risk management, warns Australia’s economy faces several risks in the short and medium turn, despite its past good economic performance.

In the past two decades, Australia benefited both from China’s entry into the WTO in 2001 and the commodity boom from the early 2000s, Coface notes.

“Average GDP growth rate stood at 3.7% from 1991 to 2007 and 2.5% since then. Australia is now the 12 richest country worldwide (with only 25 million inhabitants). And both unemployment (5.7% in May 2016) and public debt (39% of GDP) are low.”

But Coface cites the following risks which could impact on the Australian economy in the months ahead:

China’s economic slowdown

China is Australia’s main trading partner as it accounts for one third of Australian exports of goods (iron ore (56 %), coal (9 %) and gold (8 %).

China’s economic slowdown has therefore a direct and indirect impact on Australia’s trade sector, viz:

- Decrease in exports to China

- Negative spill-overs on East Asia’s economies (trade with this area decreased by 10% between 2014 and 2015).

Along with China’s slowdown, commodity prices decreased sharply (iron ore prices, Australia’s largest export, dropped by 60% in two years).

As a result, exports (in value) of minerals products decreased by 18% from 2014 to 2015 and fuels by 12%. Since 2011, terms of trade have fallen by 30%.

Nonetheless, Australia’s economy started to change its economic model to face the end of the commodity boom by increasing exports of services (+10% in the last two years), especially education and tourism (respectively fourth and fifth largest exports).

House-price boom

Real estate prices rose by 8.3% year-on-year (YoY) at end-June, driven by Sydney and to a lesser extent Melbourne. A sharp reversal could damage the economy in a context of high household indebtedness (160% of GDP).

However, lending standards are generally high and the Australian banking sector is solid, notes Coface.

Widened public deficit

After the 2008/09 crisis, the former government decided to lower taxes and increased spending to support the economy.

“The end of the commodity boom and successive government’s unwillingness to reduce the deficit could become problematic in the long-term, even though the comparatively low public debt level is good news in the short-term,” says Coface.

“(Prime Minister) Turnbull’s program is a pro-corporate one, which implies a further cut to business taxes.”

The new government plans to cut the corporate tax rate by 1 percentage point and to invest $1.1 billion (0.1% of GDP) in incentive innovation and entrepreneurship. Also, the coalition intends to increase Defence funding by $29.9bn over the next 10 years and to extend export trade deals with other economies.

These policies could result in an extended public deficit, Coface warns.

Political instability

There have been five Prime Ministers since 2010 in Australia and none of them reached the end of its three- year mandate. As the election has left the Coalition with only a slender majority, there is still a risk of a hung Parliament.

This could hamper structural economic reforms to boost productivity, growth and bring the budget under control.

Accordingly, US based financial services company Standard & Poor’s lowered the outlook on Australia’s AAA credit rating to “negative” from “stable.”

A new election cannot be ruled out, Coface warns, if the PM hopes to get a wider majority in the coming months or if there is another leadership coup.

However, despite these risks Coface has not changed its country risk assessment for Australia – A2, (low risk), which was downgraded in September 2012.

GDP is forecast to grow by 2.4%.

“Beyond the above risks, Australia has already started to adapt its economic model to the end of the commodity boom and to China’s economic slowdown,” says Coface.

“Therefore, the longest economic boom period among the advanced economies (99 consecutive quarters without a technical recession – i.e. since 1991) is not expected to end soon.” 

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