Households and businesses have been deleveraging. Much like the rest of the developed world, declining asset prices and reduced appetite for borrowing have seen Australia’s credit to GDP ratio fall.
On its own, this would have meant much weaker growth prospects in Australia. But offsetting this drag on the Australian economy has been the run-up in commodity prices which boosted the terms of trade. Rising commodity prices boosted incomes and led to a mining investment boom which supported growth while other parts of the economy, particularly those that are interest rate and exchange rate sensitive, have slowed down.
Now the economy needs to see a switch back from commodity price-driven growth to credit-driven growth. This shift away from the mining industry being the key driver of growth towards other sectors of the economy is what policymakers, including the RBA, are seeking to achieve. The next couple of years are expected to see a great growth rebalancing act.
There are a number of reasons to think they should be successful.
First, the Australian banking system is in good shape and having not suffered a banking crisis, banks are well placed to lend. Banks have reported solid profits this year and non-performing loans are low at 1.5% of total loans.
Second, the parts of the economy the RBA is seeking to support are interest-rate sensitive sectors, including housing, retail and consumer services. Together these sectors constitute a much larger share of the Australian economy than mining. Indeed, mining is less than a tenth of value-added in the Australian economy. The bulk of the economy is services.
Third, the RBA have time on their hands. As we noted above, the mining investment story is still supporting growth until mid-2013 which will then see the exports come on-line and support growth into 2014 and beyond. The RBA have already lowered rates by 175bp, which is starting to show some signs of supporting growth in the sectors one would expect to be supported by lower interest rates.
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