A recession in the US and Europe would quickly flow through to Australia and undermine both federal and state government budgets according to Deutsche Bank research.
An article in The Australian explains that Deutsche Bank research shows that unlike 2008-09, Australia would be unlikely to resist slumping into recession, while growth in China would be slashed.
“We would expect the commitment by the federal government to return to surplus in 2012-13 would be swiftly and appropriately abandoned,” the research note by the bank’s economists, Adam Boyton and Phil O’Donaghoe, says.
“We also suspect the government would want to implement another discretionary easing of policy; however, scope here may be limited relative to 2008-09.”
The analysis is based on an assessment of how a recession in Europe and the US would flow around the world.
It is not their core view but, in the wake of the last two weeks, is becoming increasingly plausible. It considers both a mild recession, with zero growth, and a deep recession with a 3 per cent contraction in GDP.
Deutsche says the biggest impact of a deep recession in the North Atlantic economies on Australia would be a fall in the terms of trade (export prices relative to import prices) of 15 per cent in a year.
The most damaging effect would not be the fall in exports and investment, but rather the economy-wide hit to incomes, profits and employment. “Weaker incomes then feed back into weaker household consumption, business investment and ultimately real GDP.”
Deutsche Bank estimates that this would take the budget from the deficit of around 1.5 per cent of GDP, which was forecast in the budget, to 4.5 per cent, before considering any stimulus spending.
The government’s stimulus policies were largely responsible for Australia’s positive economic growth in 2009 and were cited by Euromoney magazine in naming Wayne Swan as its treasurer of the year last week.
Swan has been clear that the government would return to the stimulus well again if faced with a new global downturn.
“I would make the point that the International Monetary Fund, when they had a good look at our economy and published the results about a month ago, pointed to the fact that there was plenty of room in Australia for fiscal and monetary policy to be deployed should it be required,” he told the ABC’s 7.30 Report last week.
However, Deutsche says that attempting the same level of stimulus spending as effected in 2008-09 would lift the deficit to 7.5 per cent of GDP, or close to $100 billion.
“How a small, open economy like Australia funds a federal fiscal deficit of that size — especially if the world were dominated by sovereign risk concerns — is an open question.”
State governments are also closer to the threshold for ratings downgrades than they were at the beginning of the 2008-09 crisis and are likely to run tighter budget policies than was the case then.
“The scope for fiscal policy to underpin the economy in a second deep global recession is much reduced relative to 2008-09.
“That in turn implies that the domestic economy would be more heavily impacted by a second deep global recession than it was in 2009.”
With less scope for stimulus, Deutsche Bank concludes “a deep recession in the US and EU would be likely to deliver a genuine recession in Australia”.
The Reserve Bank would cut interest rates aggressively, bringing the cash rate down from 4.75 per cent to somewhere between 3.25 and 3.75 per cent. As Australia headed into recession, it could take rates down even lower.
What is different this time round is that our local banks are in a better state than they were in the lead-up to the global financial crisis, when they were obtaining half their funding from wholesale markets, which abruptly froze.
It seems like the banks have been expecting difficult times and have shored up their balance sheets so that if interbank lending stops for a while, like it did in 2008, the banks won’t need not go to the overseas wholesale markets to obtain funds.
At the same time, many Australian businesses have been holding back on new spending, so they are in good shape as is the average Australian household. We’re now saving 10-15% of our earnings. We’re paying off our mortgages faster than ever before as well as paying down our credit card debts.
We’re in for some interesting times ahead – so expect the best but prepare for the worst. This too shall pass. The Deutsche scenario assumes that by 2012-13, the world will move back into recovery.
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