economist graph of shares dropping

What I’ve been following in Australia . . .

What happened:

The Australian Government announced a $17.6 billion (about 0.9 per cent of GDP) economic response to the coronavirus designed to support the economy by ‘maintaining confidence, supporting investment and keeping people in jobs’. The measures are in addition to a $2.4 billion national health plan.

The government’s economic response is focused around four key areas:

Delivering support for business investment.

  1. An increase in the existing instant asset write-off threshold from $30,000 to $150,000 and an expansion of access to include businesses with aggregated annual turnover of less than $500 million (up from $50 million). The measure will run until 30 June 2020. Estimated net cost over forward estimates to 2023-24: $0.7 billion.
  2. Accelerated depreciation deductions. This will allow businesses with a turnover of less than $500 million to deduct 50 per cent of the cost of eligible assets on installation. The measure will run until 30 June 2021. Estimated net cost over forward estimates: $3.2 billion.

The two measures will apply to more than 3.5 million businesses employing more than 9.7 million people.

Cash flow assistance for small and medium-sized businesses.

  1. Cash flow assistance for businesses with a turnover of less than $500 million who employ staff. Eligible businesses that withhold tax to the ATO on employee salary and wages will receive a payment equal to 50 per cent of the amount withheld, up to a maximum payment of $25,000. Eligible businesses that pay salary and wages will receive a minimum payment of $2,000 even if they are not required to withhold tax. Around 690,000 businesses employing around 7.8 million people should be eligible. Estimated cost over forward estimates: $6.7 billion.
  2. Financial support for small businesses to retain apprentices and trainees in the form of a wage subsidy of 50 per cent of the wage paid during the nine months to 30 September 2020. Eligible businesses are those employing fewer than 20 full-time employees who retain an apprentice or trainee, which covers up to 70,000 small businesses, employing around 117,000 apprentices. Estimated cost over forward estimates: $1.3 billion.

Stimulus payments to households to support growth

  1. A one-off payment of $750 to social security, veteran and other income support recipients and eligible concession card holders. The one-off payment will be paid automatically from 31 March 2020 and its estimated that more than 90 per cent of payments will have been made by mid-April this year. About 6.5 million lower income Australians should be eligible. Estimated cost over forward estimates: $4.8 billion (all in 2019-20).

Assistance for severely affected regions

  1. The government has set aside $1 billion to provide support to regions ‘disproportionately’ affected by the coronavirus, including those heavily reliant on industries such as tourism, agriculture, and education. Measures supported include the waiver of the Environmental Management Charge for tourism businesses operating in the Great Barrier Reef Marin Park and the waiver of entry fees for Commonwealth National Parks. Estimated cost over forward estimates: $1.0 billion.

The total package is worth a little more than $17.6 billion over forward estimates and is front-loaded with almost $11 billion of commitments coming in the current (2019-20) financial year and a further $6.6 billion in 2020-21.

Why it matters:

A dramatic fall in financial markets, growing evidence of business disruption, and the hit to business and consumer confidence due to COVID-19 mean that the Australian economy is in clear danger of falling into recession. Most forecasters had already pencilled in a contraction in the first quarter of this year, and before this week’s announcement the growing consensus was that growth in the June quarter would not only be negative, but potentially worse than in Q1. That would meet the definition of a technical recession in the form of two consecutive quarters of negative growth, bringing Australia’s record-breaking, recession-free run to an end.

The government’s fiscal package is targeted at providing cashflow support to the regions and businesses that are most likely to suffer as a result of the virus, as well as payments to support some of the most vulnerable parts of the community. Then there are enhanced incentives to encourage business investment. In addition, the government had already provided $2.4 billion of health spending directly targeted at controlling, understanding and mitigating the virus itself.

Will all this be enough to stave off recession? At this stage, it’s just too early to tell, as we’re only just starting to see the first domestic economic impacts appear in the data and we still don’t know quite how severe the current economic disruption from COVID-19 will be, how long it will last and what additional measures will be taken to protect public health both here and overseas. But there’s some risk that this first stimulus effort will not be large enough to turn things around, in which case further spending measures would need to follow.

For example, one potentially useful – although highly imperfect – comparison is with Australia’s fiscal response to the global financial crisis (GFC). A significant share of that response came in the form of two big stimulus packages, starting with the October 2008 Economic Security Strategy package of $10.4 billion (then about 0.9 per cent of GDP), comprising $8.7 billion of cash bonuses, $1.5 billion to support housing construction, and $0.2 billion for new training places. As the global downturn worsened, Canberra announced a second stimulus package in February 2009, the $42 billion Nation Building and Jobs Plan (about 3.5 per cent of GDP) which included another $12.7 billion of cash injections for households, $23 billion of major capital works programs, and other programs including subsidies for renewable energy technologies as well as the subsequently controversial program for the installation of roof insulation.

So as a share of GDP, the current fiscal package is actually very similar in scale to the first of the two GFC-era stimulus packages, albeit with relatively less emphasis on delivering cash payments to households as part of the overall policy mix ($4.8 billion in the current package vs $8.7 billion in the first GFC package and $12.7 billion in the second). Note, however, that the total second GFC stimulus effort was much larger than the initial response, once the severity of the global downturn became apparent to policymakers. Hence one lesson from the GFC experience is that if economic conditions do continue to deteriorate despite this initial stimulus, then a second and potentially larger fiscal effort will have to follow.

Of course, there are a great many differences between the current situation and the one prevailing back then, not least the nature of the unfolding crisis. Focusing only on the policy response itself, however, one significant complicating factor for the contemporary position is the very different scope available for supportive monetary policy action. Before the RBA delivered its first rate cut in response to the GFC in September 2008, the cash rate was at 7.25 per cent. By the time the RBA finished cutting, in April 2009, the cash rate was 425bp lower, at three per cent. In the case of the response to Covid-19, the RBA began with a cash rate of just 0.75 per cent, has delivered one 25bp cut already, and with an effective lower bound of 0.25 per cent, has a meagre 25bp of conventional ammunition left to fire. At the time of writing, markets were pricing in that final rate cut to arrive as early as next month. That makes for a very different starting point than in 2008-09 and also explains why many observers think that the RBA will be forced to adopt unconventional monetary policy measures in response to the current situation (see this week’s readings, below). It also implies that this time around, fiscal policy will have to do a relatively greater share of the lifting than was the case during the GFC.

Finally, given the weak performance of business investment in recent years, the focus on stimulating additional capital expenditure has the potential to be a quite useful initiative, although it may prove to be difficult for the policy to gain traction given the strong headwinds of high uncertainty and weak growth expectations now blowing.

What happened:

The Westpac-Melbourne Institute (WMI) Index of Consumer Sentiment fell (pdf) 3.8 per cent to 91.9 in March, down from 95.5 in February.

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Across the five sub-indices that make up the overall index, the biggest fall was in expectations for the economy over the next 12 months, which plunged 12.8 per cent.  Longer-term expectations were much more stable, however, with expectations for the economy over the next five years down only 1.3 per cent.  

The survey also reported a sharp increase in fears about job loss, with an 8.5 per cent increase in the Unemployment Expectations index, signalling a rise in expected unemployment over the year ahead.

The big fall in the monthly WMI index is consistent with similar declines in the weekly ANZ-Roy Morgan Australian Consumer Confidence measure, which fell 4.2 per cent last week in what was a third consecutive weekly drop.

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Why it matters:

Covid-19 and the associated financial market carnage are already having aadverse impact on consumer sentiment, driving the monthly consumer sentiment index down to a five-year low and the second lowest level of the index since the global financial crisis (although it is still far above the level of 79 that it hit back then).   The ANZ-Roy Morgan weekly series is telling a similar story, with that index falling to its lowest level since May 2014 and ANZ pointing out that the ‘current economic conditions’ subcomponent of the index has fallen to its lowest level since the global financial crisis.

What happened:

The NAB monthly business survey showed both business conditions and business confidence fell in February.  Business conditions fell two points to zero index points while business confidence fell three points to minus four index points.

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In addition to business confidence, other leading indicators were also softer in February, with forward orders falling to well below average levels and capacity utilisation rates slipping back to average levels.

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All industries saw conditionsdecline over the month with the exceptions of wholesale and (somewhat surprisingly) retail trade, while business confidence was lower across all industries except mining.  

Why it matters:

February was expected to start to show the impact of the coronavirus on business sentiment, and according to this month’s results, business confidence is now at its weakest level since 2013 while business conditions are down to well below their long run average and at their weakest since 2014.  That said, NAB also reported that the deterioration in conditions over the month was not as large as it had feared, noting that interim results from its quarterly survey showed around 50 per cent of firms still reporting no impact from the coronavirus to date and just over 30 per cent reporting only minor impacts.  Against that, around 20 per cent are reporting moderate to major impacts.  With March having brought significantly greater economic and financial disruption, however, those responses seem likely to shift markedly.

What happened:

The ABS reported that the value of new loan commitments for housing rose 4.6 per cent in January (seasonally adjusted) to be up 23.3 per cent over the year.  Loans to owner occupiers rose by five per cent month on month and 26.9 per cent in annual terms, while loans to investors were up 3.6 per cent and 14.7 per cent, respectively.

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Personal fixed term loans rose two per cent over the month and ten per cent over the year while business loans for construction and for purchase of property were both down sharply.

Why it matters:

Spurred on by the recovery in house prices, lending to households for dwellings has been rising at a rapid clip over the past few months.  Lending to owner-occupiers has led the increase, with the recovery in lending to investors much more muted to date.  The next two months readings will provide a test as to how resilient this story is to the impact of Covid-19, although weekly auction clearance rates haves been holding up to date, suggesting housing market sentiment has shown a degree of resilience so far.

What happened:

Last Fridaythe ABS reported that Australian retail turnover in January fell 0.3 per cent over the month (seasonally adjusted).  In annual terms, growth slipped to just two per cent, the weakest result since October 2017.

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Turnover fell in every state except South Australia in January, while by industry turnover was down in household goods retailing, clothing and footwear, department stores, other retailing, and cafes, restaurants and takeaway food services.  Only food retailing saw an increase over the month. 

Why it matters:

The market consensus was for retail to be flat in January, so the outcome was worse than expected.  The ABS noted that the summer’s bushfires had taken a toll on retail activity over the month, with businesses reporting reduced customer numbers due to factors including interruptions to trading hours and tourism.  Next month’s results should then start to show how Covid-19 is changing the picture, with the impact of household stockpiling to be set against the damage to consumer confidence (see above) more broadly and the hit to tourism spending (estimated at around ten per cent of total retail for total – domestic and international – tourist spend, concentrated mostly in the restaurants and takeaway food services).

. . and what I’ve been following in the global economy

What happened:

On 11 March, with more than 118,00 cases of COVID-19 in 114 countries and more than four thousand fatalities, the World Health Organization (WHO) finally declared that the coronavirus could be characterised as a pandemic.  

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The rapidly evolving public health situation – and the increasingly drastic measures governments around the world are now taking in order to try and contain it – has taken a heavy toll on global financial market sentiment.  

Global stock markets have plummeted:

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Stock market volatility has jumped:

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As has exchange rate market volatility.

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Bond yields have tumbled to new record lows:

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  Financial conditions have tightened:

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And global oil prices have slumped, helped on their way by the outbreak of an oil price war between Russia and Saudi Arabia.

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Why it matters:

It’s likely to take some time before we see the full impact of COVID-19 in the economic data.  Last week, we pointed to early signs of disruption apparent in China and global PMI readings, and over the weekend, data on China’s trade flows showed a steep drop in exports and a fall in imports for the January-February period, providing further evidence of the unfolding damage to international trade, global supply chains and economic growth.  We’ll get a better picture as the economic numbers continue to roll in over the coming weeks.  But financial markets aren’t waiting for the slow drip feed of statistical releases: they have already decided that things are looking very bad.  They are also signalling that the policy measures taken to date are insufficient to stabilise the economic and financial outlook.

As a result, as while as the direct demand and supply shocks arising from the impact of COVID-19, the global economy is also facing the prospect of a large demand shock driven by financial marketdislocation, the attendant wealth destruction, the consequent hit to confidence in the real economy, and the tightening in financial conditions.  Moreover, there is also the risk that market volatility triggers a destabilising bout of market stress, including the possibility of a financial crisis.  

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One area of risk, for example, is the large build up in corporate debt that has taken place in recent years as companies took advantage of a long period of low rates to ramp up their borrowing.  Market access conditions are now worsening for weaker corporate borrowers as the coronavirus threatens future cash flows (see last week’s readings for more on this).  As one example of this process in action, the sharp drop in the price of oil has seen nearly US$110 billion of bonds sold by energy companies in the United States fall into distressed territory – that is, with a yield more than ten percentage points above treasuries.

Might the sharp fall in oil prices nevertheless offer a macroeconomic silver lining amidst this market bloodbath?  In the past, the standard assumption has tended to be that falling oil prices are good news for global demand.  That’s because they work to transfer income from net oil producing countries (often viewed as having high savings rates on average) to net oil consuming ones (assumed to generally be higher spending economies), and because lower prices reduce input costs for many businesses.  Some of that story may well play out again this time, and lower oil prices will be welcomed in major consuming markets like China and India.  But the overall impact will be complicated by the bond market impact noted above, the parallel hit to share market valuations, and the blow to producers not just in the usual suspects in OPEC and its chums, but also in the case of the new big oil producer on the block - the United States.

What I’ve been reading

Guy Debelle’s speech on The virus and the Australian economy saw the RBA deputy governor tell his audience that Quantitative Easing (QE) was ‘absolutely’ under consideration.His starting point was the significant disruption to activity in China (captured by indicators including coal consumption and traffic congestion) and beyond, which implied that ‘the global economy will be materially weaker in the first quarter of 2020 and in the period ahead.’  For Australia, the RBA thinks that the direct effects of the virus will be felt in a 10 per cent decline in services exports in the March quarter, leading to a subtraction of 0.5 per cent from quarterly GDP growth, excluding any potential impact from supply chain disruptions to the construction and retail sectors.  Debelle also reported that, to date, the RBA has seen no material disruption to exports of coal and iron ore, where export values have been supported by relative price resilience in both commodities, likely reflecting a combination of disruptions to domestic Chinese production and a consequent switch to imports plus the expectation that Beijing’s policy response will involve resource-intensive infrastructure spending.  In contrast, lower oil prices will flow through to lower LNG prices for Australian exporters.  On the financial front, he stressed that the domestic banking system was in good shape and ‘resilient to a period of market disruption.’  On monetary policy, he noted that of the 100bp of cuts to the cash rate since June 2019, 95bp had been passed on in cuts to mortgage rates (via a combination of an 85bp drop in the standard variable rate plus larger discount deals) and that monetary policy was supporting the economy both through boosting disposable incomesin the household sector and via a lower exchange rate.  What about the longer-term outlook?  Here Debellecautioned that it ‘is just too uncertain to assess the impact of the virus beyond the March quarter’but did argue that, post-COVID-19, ‘the Australian economy will be supported by the low level of interest rates, the lower exchange rate, a pick-up in mining investment, sustained spending on infrastructure and an expected recovery in residential construction.’Finally, in the Q&A session following his speech, Debelleconfirmed that QE was under consideration and when asked what an Australian QE program might look like, indicated that the RBA’s preference was for a price-based rather than quantity-basedapproachto QE, suggesting that the RBA might adopt a form of yield curve control – see next reading below.

Economists at NAB reckon that the RBA will soon undertake unconventional monetary policy in the form of yield curve control (YCC).  YCC is a form of QE that involves the central bank announcing target levels for (government) bond yields and then standing ready to purchase bonds to make sure yields hit the targets.  The idea is to further flatten the yield curve, which in turn should help lower interest rates across the economy, weaken the dollar, and signal the central bank’s commitment to supporting activity.  The Bank of Japan pioneered YCC when it announcedits new policy framework of Quantitative and Qualitative Monetary Easing (QQE) in September 2016, a program which began bytargeting a yield of zero per cent for ten-year Japanese government bonds.  See also this piece from the Economist which looks at the attractions and limitations of YCC as a monetary policy tool.

Treasury Secretary Stephen Kennedy’s opening statement to Senate Estimates from last week.  This includes Treasury’s estimates that the bushfires will subtract around 0.2 percentage points from GDP growth across the December 2019 and March 2020 quarters, with most of the impact felt in the latter, and a preliminary estimate that COVID-19 will subtract at least a half of a percentage point from growth in the March quarter 2020. Again, this estimate includes direct impacts to tourism, international education exports and some exchange rate effects but not any hit to growth from supply chain disruptions or other potential broader impacts.  Kennedy also noted that it was now clear that the ‘economic impact of COVID-19 is likely to be deeper, wider, and longer when compared with SARS. It will create more risk of a prolonged downturn and fiscal support will be needed to accelerate the recovery of the economy, especially once the health and health management effects of COVID-19 begin to fade.’  He added that ‘allowing the fiscal position to temporarily deteriorate as a result of this shock is entirely consistent with a medium-term fiscal framework that supports sustainable patterns of expenditure and taxation over the medium term.

The latest IMF Article IV report on the Australian economyand the accompanying Selected Issues paper are now available from the Fund’s web site.   The Article IV report describes an economy performing at below-potential and faced with downside risks around China, international trade protectionism, the fallout from COVID-19, and fragile households.  The Fund’s policy recommendations include structural reforms to support growth, including ‘an ambitious, national, integrated approach to energy and climate change policies’, reforms to housing supply, tax reform and support for business investment and innovation. The Selected Issues paper examines the slowdown in business investment.  It finds that key drivers are global policy uncertainty related to international trade, domestic policy uncertainty around energy policy, taxation, and R&D treatment, the commodity cycle, the real exchange rate, and financial constraints, especially for smaller and younger firms.  The Fund argues that reducing national policy uncertainty needs to be a priority, and advocates further support for R&D, additional product market reform, efforts to ease financial constraints, and reducing the company tax rate for all firms to 25 per cent.

The IMF has started a series of blogs looking at how policymakers should react to COVID-19.  This post looks at fiscal responses, which the Fund thinks should include: (1) spending on prevention, detection, control, containment and treatment; (2) timely, targeted and temporary cash flow relief to people and firms most affected, including via wage subsidies, transfers to vulnerable groups, and tax relief; (3) business continuity plans to ensure continued service delivery to citizens and tax payers.  Thisone from the Fund’s Chief economist digs into the nature of the economic shocks seen to date and makes the case for targeted policies in response.  And this third post examines monetary and financial stability.

VoxEU has a new ebook on economics in the time of COVID-19.  At more than 100 pages, it’s on my ‘to read’ pile.

Two more from VoxEU.  First, are we facing a supply-demand doom loop?  Second, the risk that falling oil prices will erode macro and social stability in the Middle East and North Africa.

Mohamed El-Erianpraises the UK’s economic response to the coronavirus.

An FT Big Read on how China plans to revive its faltering economy in the face of what’s likely to be the first quarter of zero or negative growth since the Cultural Revolution.  

A Brookings piece on China and the return of great power strategic competition, including the prospect of a bifurcated globalisation.

Paul Krugman reviews Thomas Piketty in the NYT: ‘something of a letdown is his take.

Another one from the ‘to read’ rather than ‘read’ pile: A new report from the Asian Foundation on the future of work across ASEAN in the context of the fourth industrial revolution (4IR). 

A sign of the times: a guide on ‘how to politely decline a handshake’.