Despite gloom surrounding external demand, Australia's exports push Q1 GDP growth to a three-year high

Despite all indicators pointing to weak external demand, the Australian economy has returned an unexpectedly robust growth figure, based primarily on a sharp rise in export volumes. According to data from the Australian Bureau of Statistics (ABS), the country last recorded real GDP growth in excess of 3% year on year (y/y) in 2012 when the economy was recovering from the 2011 floods that devastated the eastern coast. Tempering the positive data was the news that real net disposable income growth – GDP adjusted for terms of trade, real net incomes from abroad, and consumption of fixed capital – contracted by a seasonally-adjusted 1.3% y/y against the more robust headline real GDP growth figure. This does not mark a novel development, but is nonetheless a factor worth noting owing to the potential ramifications for future domestic demand.

Australia's net export position and current account benefit from the transition from mining investment to export boom

The 1.2 percentage point contribution to growth from the net export position was the largest since the September quarter of 2015, when exports were recovering from abnormally poor weather conditions (see Australia: 3 December 2016: Strong rebound in Australian economic growth unlikely to be repeated after Q3). Although the ABS does not release a break-down of export volumes by type in its national-accounts data publication, such details are provided in the equivalent balance-of-payments (BOP) release. The BOP data suggest that in chain volume (real) terms, export growth was led by increased exports of metal ores and minerals (predominantly iron ore, 5.8% quarter on quarter: q/q), coal products (4.9% q/q), and other mineral fuels (predominantly liquefied natural gas (LNG, 10.6% q/q). Considering the purported weakness in Chinese demand for commodities, the robust performance by even coal exports was unexpected. An additional unforeseen positive was a 7.7% q/q rise in the volume of travel-services exports, which followed a 6.8% rise during the December 2015 quarter.

Falling imports lent additional support to growth during the quarter. Goods imports fell 1.7% q/q in volume terms, led by a sharp 7.0% q/q fall in capital-goods imports from a correction in civil aircraft and confidentialised items, and automatic data processing (ADP) equipment. Meanwhile, consumption imports were flat in volume terms and intermediate goods fell by a modest 0.5% q/q, further hinting at limited domestic demand. Services imports rose a sharper 2.6% q/q in real terms due to increased foreign-travel-services consumption – possibly a result of low oil prices – but this was not sufficient to offset the fall in goods imports.

Although volumes performed well, the country's terms of trade fell 1.9% q/q, declining to 11.5% y/y as weakness in export prices exerts greater downward pressure on the terms of trade; this weakness creates the greatest negative effect on the previously-cited net disposable income figure. Fortunately, the strength in goods and services export volumes – when coupled with weak import volumes – mitigated the negative impact of the terms of trade, allowing for an 8.1% q/q narrowing of the country's current-account deficit during the March quarter. Improvements in the services- and merchandise-trade accounts offset an 8.8% q/q widening of the country's large primary-income-account deficit, which stemmed from a sharper fall in inflows from foreign direct investment abroad.

Domestic demand picture remains mixed

Household consumption growth in real terms roughly aligned with IHS's expectations, based on retail sales data and an expected small correction from robust growth during the previous quarter. The only two major expenditure components in which household consumption expenditures fell in real terms during the quarter were tobacco products (due to the government's stringent tobacco tariffs), and motor vehicles, which follows several years of robust growth in vehicle purchases. The expenditure component recording the strongest growth was transport services (up 2.5% q/q), possibly related to increased services imports and domestic tourism as oil prices fell. Besides these two components, household spending growth remained relatively modest for the majority of spending categories. Government consumption spending was more of a surprise considering the government's ongoing difficulties with reining in budget deficits (see Australia: 4 May 2016: Budget 2016: Limited action on revenue-generation reforms weighs on Australia's return to fiscal surplus). During the March quarter, the national government boosted spending on defence by 3.8% q/q and non-defence spending by 1.2% q/q; state and local government spending growth was limited during the quarter.

Fixed investment remains the unambiguous weak point in the Australian economy. Dwelling construction was the sole major fixed-investment category to make a positive contribution to growth – adding 0.1 percentage point to growth – but in q/q terms, real growth slowed to 1.4% in the March quarter from 2.8% during the previous quarter. Government-sector fixed investment – including investments from public corporations – made no significant contribution to growth. The most significant negative factor was the 0.5 percentage point deduction to growth from non-dwelling construction activity, which is largely related to the unwinding mining-investment boom. The new engineering construction component of the non-dwelling construction sector has now fallen for 10 consecutive quarters, as the design work for many mining projects has been completed or is nearly completed. New building construction was also down sharply (6.9% q/q) during the March quarter, which is also possibly related to near-completion of mining investments. Fixed investment into machinery and equipment also made a minor deduction from growth, which follows from the data on capital-goods imports. This is a key spending category to monitor for a potential uptick in non-mining business investment; however, current indications remain unfavourable.

Outlook and implications

IHS expects to upgrade Australia's real GDP forecast based on the March-quarter result, which numerically places the economy on surer footing. We had expected growth of 2.2% owing to concerns over a weakness in external demand potentially limiting improvements in the net export position, as well as continued weakness in domestic demand. However, ultimately the export volumes arising from the mining boom remain sufficiently low-priced to displace higher-cost producers, particularly for iron ore. Nonetheless, the June quarter could conceivably witness a reversal in this situation, based on the sharp correction in iron ore prices seen since mid-April as Chinese steel production has faltered once again due to over-supply. Meanwhile, new volumes of LNG coming online – as major investment projects move to production and increase output – will support export growth, since this new production is largely carried out under long-term export contracts.

The greatest concern remains with domestic demand. With real net disposable-income growth undergoing contraction, the continued weakness fixed investment in unsurprising. Most of the associated impact naturally falls on the mining sector due to the terms of trade, but potential knock-on effects upon other businesses and the impact on confidence cannot be completely discounted. Based on the recently released fiscal year 2016/17 budget, there will be only limited fiscal stimulus arising from small and medium-sized enterprises, which will benefit from a reduction in their corporate tax rate. On a positive note, Australia's tourism sector appears to be performing well, which will support growth in the country's services sectors that employ a greater percentage of the workforce. Household spending remains mired in a trap of slow income growth and high debt burden; however, the May interest-rate cut and an improving trend in the unemployment rate may provide some extra confidence to modestly boost spending in the coming months.