ATTACHMENT A

2014 State Wage Case - Economic Outlook

1. Overview

Growth in Western Australia's economy has moderated over the past year and is expected to slow further over the coming years , driven by a tapering of business investment from a peak in 2012-13 (which has underpinned strong economic growth in the State over recent years) .

The decline in business investment activity has already had a significant impact on the domestic economy, with State Final Demand (SFD, a measure of Western Australia's domestic economy) contracting by 1.5% in 2013, down sharply from growth of 12.9% in 2012.

This slowdown in the domestic economy can also be attributed to weaker household spending, with limited job prospects and modest wages growth increasing consumer conservatism. On the other hand, dwelling investment has picked-up strongly over the past year, buoyed by strong growth in housing demand over a sustained period.

Taking into account the State's international trade sector, growth as measured by Gross State Product (GSP) moderated to 5.1% in 2012-1 3 (from 7.3% in 2011-12) and is expected to slow further to 3.75% in 2013-14. This moderation reflects an expected transition from business investment-led growth to export-driven growth, as a number of large resource projects move into the operational phase over the coming years.

Furthermore, solid contributions from exports and dwelling investment will not be enough to fully compensate for the loss of the large contribution made from business investment in recent years. As such, growth in GSP is expected to ease further to 2.75% in 2014-15, before steadily improving to 5% by 2017-18, as the contribution of net exports picks-up and business investment declines at more modest rates .

The weakness in the domestic economy has extended through to weaker conditions in the State's labour market over the past year. Notably, employment growth has eased significantly over the year to April 2014, the unemployment rate has drifted upwards, and the participation rate has fallen as people exit the workforce amid limited job opportunities. Consequently, wages growth has also moderated significantly, reflecting greater capacity in the labour market and as businesses focus on restraining cost growth.

Employment growth is expected to remain relatively subdued over the short term, especially as major resource projects transition into the operational phase (which tends to be substantially less labour-intensive than the construction phase). Corresponding to this, the unemployment rate is expected to pick-up to 5.5% by 2014-15, whilst wages growth is forecast to remain below-average. Whilst labour market conditions are expected to improve slightly from 2015-16, conditions are projected to remain soft by historical standards, in line with more moderate economic activity relative to the previous decade.

Following relatively subdued growth in recent years, inflation in Perth strengthened somewhat over the first three quarters of 2013-14, mainly driven by a lower exchange rate, an increase in the tobacco excise rate and seasonal factors. As such, inflation is expected to increase by 3% in 2013-14 (notwithstanding the effect of softer wage growth), before increasing by 2.75% in 2014-15 and 2.5% per annum over the following few years.

Table 1.1: Major Economic Aggregates , Annual Growth (%) (01

2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 Actual Estimated Budget Forward Forward Forward

Actual Estimate Estimate Estimate Estimate

State Final Demand (SFD) 5.0 0.25 0.0 0.75 1.5 2.0 Gross State Product (GSP) 5.1 3.75 2.75 3.0 4.25 5.0 Gross State Income (GSI) -1 .7 6.9 4.6 1.6 4.3 4.8 Employment 3.5 1.5 1.5 1.75 1.75 2.0 Unemployment rate (bJ 4.4 5.0 5.5 5.25 5.0 4.75 Consumer price index (CPI) 2.3 3.0 2.75 2.5 2.5 2.5 Wage price index (WPI) 4.0 3.25 3.25 3.5 3.5 3.75 Poeulation 3.5 2.6 2.1 2.1 2.1 2.1 (a) Annual average growth unless otherwise stated. (b) Average rate over the year. Source: 2014·15 Budget, Budget Paper No.3.

2. Global Outlook

According to the International Monetary Fund (IMF), global economic activity has broadly strengthened and is expected to improve further in 2014 and 2015. While the momentum for growth is stemming from advanced economies, emerging market and developing economies 1

continue to contribute over two-thirds to global growth.

The IMF slightly revised it's projection for world growth to 3.6% in 2014 (from 3.7% previously) in its April 2014 World Economic Outlook. This is based on the expectation that emerg ing and developing economies will grow by 4.9% and that advanced economies will grow by 2.2% in 2014. Growth is subsequently forecast to improve to 3.9% in 2015.

Table 2.1 IMF global growth forecasts Annual growth (%)

IMF Projections 2012 2013 2014 2015

World Output 3.2 3.0 3.6 3.9 Advanced Economies 1.4 1.3 2.2 2.3

- United States 2.8 1.9 2.8 3.0 - Euro Area -0.7 -0.5 1.2 1.5 - United Kingdom 0.3 1.8 2.9 2.5 - Japan 1.4 1.5 1.4 1.0

Developing Economies 5.0 4.7 4.9 5.3 - China 7.7 7.7 7.5 7.3

Source: IMF World Economic Outlook, April 2014

1 Broadly, an emerging market can be distinguished from a developing economy as a country experiencing rapid growth and industrialisation.

2

Growth in China, Westem Australia's largest export market (accounting for 53.7% of merchandise exports over the year to February 2014) is expected to remain robust. Despite this, growth is likely to be more modest than recent years, reflecting intentions to transition the economy away from an investment-led to a consumption-driven growth path (which is seen as more balanced and sustainable). Growth in Japan and Korea , the State's next largest export markets, is projected to be more modest at 1.4% and 3.7% respectively in 2014.

Notwithstanding these forecasts , the IMF acknowledges that downside risks continue to dominate the outlook for global growth. Specifically these risks include low levels of inflation in a number of advanced economies (such as the euro area); ramifications from the tapering of quantitative easing measures in the US (especially its impact on global financial market volatility); credit growth and local government borrowings in China; and geopolitical risks from recent developments in the Ukraine.

Global commodity markets

Commodity prices, as measured by the Western Australian Commodity Price Index (which captures trends across a number of commodities), have remained high compared to historical levels (see graph below).

Nevertheless, prices continue to be highly volatile. For instance, iron ore spot prices declined by about 16% between early December 2013 and mid-April 2014. Conversely, gold prices have rebounded in early-2014 following a downward trend in the latter half of 2013; whilst oil prices have also picked-up after a trough in November 2013.

Going forward , prices for the State's key commodities are forecast to soften, largely driven by a projected decline in the price for iron ore, oil and LNG, which in turn reflects an increase in global supply of these commodities.

Index (2008-09 = 1 00)

120 -

COMMODITY PRICE INDEX Western Australia

100 1 - $A - $US

80

60

40

20

0 Mar-96 Mar-99 Mar-02 Mar-05 Mar-08 Mar-11 Mar-14

Source: Departmentof Treasury

3. National Economic Outlook

Growth in the Australian economy has slowed as business investment wanes and activity outside of the resource sector remains subdued. While Australia's Gross Domestic Product increased by a solid 0.8% in the December quarter 2013, annual growth has slipped well below trend at 2.4% over 2013 (compared to decade average growth of 2.9%).

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The Commonwealth Treasury 2013-14 Mid-year Economic and Fiscal Outlook projects the Australian economy to grow below trend in 2013-14 and 2014-15, at 2.5% per annum'. This is based on the expectation of a fall in resources investment, accompanied by only moderate increases in activity in non-resource sectors of the economy (with strength in the established housing market a notable exception). Despite these challenges for the national economy, low interest rates and further falls in the exchange rate should support a broad recovery across the economy.

Table 3.1: Major Economic Aggregates, Australia Annual Growth (%) ia)

Real GDP Employment Unemployment rate ia)

Consumer price index (a) Average rate for the June quarter.

Actual 2012-13

2.7 1.3 5.6 2.4

Forecasts 2013-14

2.5 0.75

6.0 2.75

Source: 2013-14 Mid-year Economic and Fiscal Outlook, Commonwealth Treasury

2014-15 2.5 1.5

6.25 2.0

Projections 2015-16 2016-17

3.0 3.0 1.5 1.5

6.25 6.25 2.5 2.5

Consistent with a moderation in economic growth, labour market conditions have remained soft over the past year. Employment grew by only 0.9% in annual average terms in the year to April 2014 (below the decade average rate of 2% per annum), the unemployment rate has picked up (hovering just below 6%), and the participation rate has fallen. Weakness in the Australian economic outlook is expected to flow through to the labour market, with the unemployment rate projected to rise to 6.25% by the end of 2014-15, and employment and wage growth are expected to remain below historical averages.

The Reserve Bank of Australia (RBA) reduced the cash rate on one occasion over the past year to a record low of 2.5% in August 2013, where it has since remained . This reduction in the cash rate was passed on in full to the standard variable home loan rate, which is at its lowest rate since September 2009 (see chart below).

The highly accommodative stance of monetary policy reflects ongoing fragility in the national economy, notwithstanding signs of a tentative pick-up over recent months. In this context, the RBA has hinted that there is likely to be a period of stability in interest rates over the foreseeable future , with current low rates appearing to support a tentative recovery of economic conditions.

12

10

B

e

4

2

% INTEREST RATES

Australia

0~1----~~----~----~----~----~ M~04 May-De May·OB May-10 May-12 May-14

--Standard variable home loan rate --RBA target cash rate Source: RBA

, The latest forecasts available at the time of writing. The 2014-15 Commonwealth Budget, which is due for release on 13 May 2014, may include updated forecasts.

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4. Western Australia's Economic Outlook

The latest annual estimates released by the Australian Bureau of Statistics (ABS) in November 2013 show that Westem Australia 's economy (as measured by GSP3) grew by 5.1 % in 2012-1 3, moderating from 7.3% growth in 2011-12 . Growth is expected to ease further out to 2014-15, driven by sizeable declines in business investment activity, before strengthening over the following years underpinned by strong export growth.

%

8

7

6

5

4

3

~ In 0 1990-91

GROSS STATE PRODUCT Westem Australia, Chain Volume Measures

Decade average

1 t_····· ... ············t .·= .. ···· .. -1·················

1995-96 2000-01 2005-06 2010-11

Forecast

2015-16

Source: ABS Cat. 5220.0& Department ofTreasury

Latest quarterly data for the December quarter 2013 shows that growth in the State's domestic economy (as measured by SFD) has eased sharply, from 12.9% in 2012 to -1.5% in 2013. This was driven by a marked slowdown in business investment growth (from 32.5% in 2012 to -9.8% in 2013) . With the level of business investment likely to continue to decline, albeit by progressively smaller amounts each year, SFD growth is forecast to remain negligible out to 2017-18.

COMPONENTS OF ECONOMIC GROWTH -SEASONALLY ADJUSTED DATA ANNUAL AVERAGE GROWTH TO DECEMBER 2013

Western Australia ('!o ) Australia ('!o)

Household consumption expenditure Business investment Dwelling investment General government consumption expenditure Public investment State I Domestic Final Demand International exports of goods· International imports of goods·

• Figures for Australia are for trade in both merchandise and services.

1.8 2.0 -9.8 0.5 10.6 2.0 2.3 1.1 9.5 -12.6

-1.5 0.9 7.8 6.8

-5.6 -2.8

A more detailed analysis of the individual components of GSP is contained in the rest of this section .

3 Gross State Product is a more complete measure of Western Australia's economic activity, as it includes domestic activity and net external demand for Western Australia's goods.

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4.1 Household sector

Consumer Spending

Household consumption growth in Western Australia has eased to the slowest annual pace since 2009, led by a marked moderation in discretionary-related spending (non-essential items).

Weaker growth in discretionary spending is consistent with softness in consumer confidence and weaker labour market conditions in the State. Furthermore, households are saving a greater portion of their income and opting to take advantage of low interest rates to pay down their debts more quickly. Such trends would place downward pressure on household spending growth.

Reflecting softer growth to date, household consumption is expected to grow by 3% in 2013-14, below the decade average of 4.9%. Consumption growth is expected to strengthen somewhat over the following years, picking up to 3.75% by 2016-17, underpinned by improving labour market conditions and wage growth.

Housing Market

Strong growth in housing demand has begun to translate into higher levels of new dwelling investment activity, with growth in dwelling investment' strengthening in the first half of 2013-14 (after contracting over the previous two financial years).

Supporting this, the number of houses under construction is now at its highest level in over six years, building approvals reached a record level in February 2014, and both housing finance commitments for construction and newly erected dwellings, and first home owner grant applications for new dwellings, were up strongly over the year.

As such, dwelling investment is projected to grow by 14% in 2013-14, well above the decade average of 2.7% per annum. Growth is expected to remain strong in 2014-15, before softening over the following few years to below-trend rates by 2017-18, reflecting slowing population growth, a softening rental market and higher house prices (which reduces housing affordability).

4.2 Business Investment

While record growth in business investment in recent years has been driven by the construction of major LNG and iron ore projects, spending on these projects has passed its peak and is forecast to decline as projects move into their operational phase.

As such, business investment is forecast to decline significantly in 2013-14 and 2014-15, as the quantum of new projects is insufficient to maintain the record levels of investment. The outlook for new major project investment is more subdued than in recent years, reflecting a shift in focus from expansion to efficiency and cost cutting in the iron ore sector. Furthermore, spending on the State's largest ever resource project, Gorgon LNG (worth $55 billion), has passed its peak, and construction on the Wheatstone LNG project (worth $29 billion) is around 30% complete.

Over the following years, the decline in major project spending is expected to be partially offset by growth in investment from the non-resources sectors of the economy. Despite further declines in business investment out to 2017-18 (albeit at a reduced pace), investment is expected to remain at historically high levels (see chart below).

4 Dwelling investment consists of the construction of new dwellings (long term average of around 60% of overall dwelling investment) and residential alterations and additions (the remaining 40%).

6

$ Billion

80

70

60

50

40

30

20

10

BUSINESS INVESTMENT Western Australia. Chain Volume Measures

o II In n,II,II,II' 1,11,1 1,11 ,1 I,! III,' I,ll,' 1,1" 1,11,1 I,! I,ll,' I,! 1989-90 1994-95 1999-00 2004-05 2009-10 2014-15

Source: ABS Cat. 5206 .0 & DepartmentofTreasury

4.3 International Trade

Exports

Exports are expected to increase strongly over the coming years, as major resource projects enter their operational phase. Exports will initially be driven by large increases in iron ore production, and subsequently by a strong ramp up in LNG and condensate production.

Total merchandise exports are expected to increase by 7% in 2013-14, supported by a significant increase in the volume of iron ore sales. Strong growth in exports is likely to be sustained over subsequent years (notwithstanding a moderation in 2014-15), driven by continued increases in iron ore exports and a substantial lift in LNG and condensate exports as the large projects (Gorgon, Wheatstone and Prelude) commence production. Accordingly, growth is expected to reach 8.5% by 2017-18.

Imports

Merchandise imports are projected to decrease by 5.5% in 2013-14, consistent with a forecast decline in business investment (which reduces the volume of imported capital goods demanded). Imports are expected to continue to decline out to 2015-16 before recovering slightly in the following two years, underpinned by imports of consumption goods (which is expected to offset smaller declines in capital goods imports).

5. The Labour Market

Conditions in Western Australia 's labour market have softened over the past year, corresponding to more modest activity in the State 's resource sector and broader domestic economy.

In particular, employment grew by only 1.4% in annual average terms over the year to April 2014 (moderating from 4.2% growth over the previous year), the unemployment rate has drifted upwards (albeit in a highly volatile manner), and a smaller proportion of people are participating in the State's labour force . Despite this, labour market conditions in Western Australia have continued to outperform the rest of Australia, where the unemployment rate remains elevated and employment growth subdued .

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Key labour force statistics for the Western Australian economy are summarised in the following table .

Table 5.1: Population and Labour Force forecasts Western Australia

2012-13(') 2013-14 2014-15 2015-16 2016-17 2017-18

Annual level Total population ('000) 2,490 2,554 2,608 2,663 2,719 2,775 Working age population 1,701 1,739 1,767 1,795 1,824 1,853 (15-64) ('000) Employment ('000) 1,321 1,339 1,360 1,384 1,409 1,437 Unemployment ('000) 61 71 79 77 74 72 Underemployment ('000) 79 n.a. n.a. n.a. n.a.

Unemployment rate (%) 4.4 5.0 5.5 5.25 5.0 4.75 Youth unemployment rate 13.0 n.a. n.a. n.a. n.a. (15-19, %) Participation rate,b) (%) 69.0 68.3 68.2 67.9 67.6 67.4

Annual growth ('!o)

Total population 3.5 2.6 2.1 2.1 2.1 2.1 Working age population

3.2 2.3 1.6 1.6 1.6 1.6 (15-64) Employment 3.5 1.5 1.5 1.75 1.75 2.0

(a) Actuals (b) Based on the population aged 15 years and over.

More detail on the labour market is outlined as follows .

5.1 Employment

Employment growth has eased significantly in Western Australia over the past year, led by a pronounced slowdown in full-time hiring (see chart below). Conversely, part-time employment has picked-up strongly over the same period, which has lent some support to total employment growth. Reflecting these trends, annual average employment growth was only 1.4% in April 2014, down from 4.2% a year earlier, and well below the decade average growth of 3.3%.

EMPLOYMENT

('000) Western Australia, Annual Average Growth

10

B

6

4~

2

--Full-time--Part-time -- Total

o I'" -f "0-1 ~, - 'C -2

-4 Apr-DB Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14

Source: ASS Cal. 6202.0

8

Consistent with trends at the aggregate level, industry data shows that employment growth has been modest or detracted in most of the State's largest employing industries. Most notably, mining employment fell over the year to February 2014 (the former driver of strong growth), along with a number of other large industries (including retail trade, and health care and social assistance).

Conversely, construction employment has increased over the year to February 2014, driven by stronger activity in the State's housing market. However, strength in construction (as well as solid gains in other industries) has failed to fully offset the sharp slowdown in mining and other industries, causing total employment growth to soften.

ANNUAL CHANGE IN EMPLOYMENT (,000), February 2014

Construction Transport, Postal and Warehousing

Public Ad ministration and Safety Accommodationand Food Services

Financial and Insurance Services Oth er Services

Rental , Hiring and Real Estate Services Electricity, Gas, WaterandWasteServices

Ed ucation and T raini n9 WholesaeTrade

Health Care and Social Assistance Arts and Recreation Services

Information Media and Telecommunications IProfessional , Scientific an d Technical Services

Retail Trade Man ufacturi nQ _!

AgricultLre, Forestry and Fishing rJ~~~§~L---,----,-----, Administration and support sy:;t~ms Mining ~

-10 -5 o 5 10 15 Source: ASS Cat. 6291.0

The slowdown in employment growth is consistent with sustained weakness in leading indicators of labour demand (including job advertisements and business confidence), and a decline in business investment from its peak in 2012-13. It is also in line with anecdotal evidence, which suggests that hiring has been restrained by employers' efforts to cut costs and improve productivity.

Outlook

In light of the above, employment is projected to increase by 1.5% in 2013-14 and 2014-15, moderating significantly from 3.5% growth in 2012-13.

Beyond this, employment growth is expected to improve modestly to reach 2% by 2017-18, supported by a modest recovery in domestic economic activity. However overall, growth is expected to remain moderate over the forecast period, consistent with softer economic growth relative to the past decade, and the transition of major resource projects into the operational phase (which tends to be substantially less labour-intensive than the construction phase).

5.2 Unemployment and participation

Western Australia's unemployment rate has trended upwards over recent months (despite doing so in a highly volati le manner), averaging 4.8% over the first 10 months of 2013-14, up from 4.4% over 2012-13. This is consistent with a slowdown in employment growth and a rise in the number of jobseekers, which has not been met with a commensurate increase in labour demand. Despite this rise , the State's unemployment rate has remained below the national rate , which averaged 5.8% over the first 10 months of 2013-14.

9

%

12

10

8

6

4

UNEMPLOYMENT RATE Trend

--Western Australia

--Australia

2+1------~----~------~----~------~----~ Apr-78 Apr-84 Apr-90 Apr-96 Apr-02 Apr-08 Apr-14

Source: ASS Cat. 6202.0

The State's participation rate has broadly stabilised over recent months, after falling steeply from a recent peak of 69.8% in October 2012, consistent with weaker labour market conditions. Notwithstanding this, Western Australia's participation rate (currently 67.9% in April 2014) remains the highest of all States and is comfortably above the national rate of 64.7%.

Outlook

% 70

68

66

64

62

60

PARTICIPATION RATE Monthly Trend

--Western Australia

--Australia

58+1------~----~------~----~------~----_, Apr-78 Apr-84 Apr-gO Apr-96 Apr-02 Apr-08 Apr-14

Source: ASS Cat. 6202.0

Western Australia 's unemployment rate is forecast to increase further over the short-term, as a moderation in domestic economic activity is expected to limit the pace of job creation. As such, the State's unemployment rate is expected to rise to 5% in 2013-14 and 5.5% in 2014-15. Beyond this , the unemployment rate is forecast to gradually ease to 4.75% by 2017-18, in line with a modest strengthening of economic conditions and a pick-up in labour demand.

The recent moderation in the participation rate is likely to continue over coming years as employment growth remains subdued and the population ages (with a larger proportion of people reaching retirement age). Accordingly, the participation rate is expected to average 68.3% over 2013-14 (down from 69% in 2012-13), before gradually softening to 67.4% by 2017-18.

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6. Wages

6.1 Wage Price Index

Wage growth has eased in Western Australia over recent quarters, corresponding to softer conditions in the State's labour rnarket.

Of the various wage price indicators published by the Australian Bureau of Statistics (ABS), the Wage Price Index (WPI) is generally viewed as the preferred measure of underlying wages growth. This is because the WPI is designed to measure wage changes for a fixed quantity and quality of labour, and so abstracts from changes in average hours worked and other compositional changes in the labour market.

The State's WPI increased by only 0.5% in the December quarter 2013, the lowest quarterly growth in almost 10 years, following a 0.9% rise in the September quarter (both below the 1.1% decade average). As a result, annual growth moderated to 3.3% in 2013 from a recent high of 4.5% in 2012.

% 2.5

2.0

1.5

1.0

0.5

0.0 Dec-01

WAGE PRICE INDEX Growth, Westem Australia %

7

_ Quarterl y Growth (LHS) --Annual Average Gro wth (RHS) 6

5

Dec-03 Dec-05 Dec-07 Dec-09 Dec-11

4

3

2

o Dec-13

So urce: ABS Cat. 6345.0

Weakness in wages growth was driven by a significant slowdown in private sector wage growth over the past year, from 4.6% in 2012 to 3.1% in 2013. Public sector wage growth has also moderated, although by a small amount, over the same period (from 4.3% in 2012 to 4% in 2013).

National comparison

Notwithstanding the above, annual average growth in Western Australia 's WPI continues to exceed the national equivalent, which stood at 2.9% in 2013, the equal lowest on record.

Historically, Western Australia's WPI has been more variable than its national equivalent. Annual growth in the State's WPI has also consistently exceeded national growth since 2005, partly due to strong economic activity in Western Australia between 2003 and 2008. As shown in the below chart, this divergence narrowed in 2010 following the global financial crisis but subsequently re-emerged, consistent with stronger economic conditions in the State relative to nationally over recent years.

However this gap has narrowed over the past year as economic conditions in the State converge towards the rest of Australia.

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Outlook

WAGE PRICE INDEX % Annual Average Growth

6 -j --Western Australia

--Australia

5

4

3

2~1----~----~--~----~----~--~ Dec-01 Dec-03 Dec-05 Dec-O? Dec-09 Dec-11 Dec-13

Source: ASS Cat. 6345 .0

Subdued wage growth is expected to continue over coming quarters, as capacity in the labour market continues to build and businesses focus on restraining cost growth. Consequently, the State's WPI is forecast to grow by 3.25% in 2013-14 and 2014-15, below the decade average of 4.3% per annum. WPI growth is expected to strengthen to 3.75% by 2017-18, consistent with a steady improvement in the labour market and domestic economic outlook.

7. Inflation

Inflation in Perth (as measured by growth in the Consumer Price Index) has picked-up somewhat over the past year, consistent with trends at the national level. Notwithstanding this, annual inflation in Perth remains below its decade average rate (of 3.1 %), reflecting modest growth across most of the CPI components over the year.

Perth's CPI rose by 0.7% in both the March quarter 2014 and December quarter 2013, slightly below the decade average rate of 0.8%. Prior to this, the CPI increased by a strong 1.2% in the September quarter 2013, largely driven by price rises in housing and transport (mainly automotive fuel, due to a lower exchange rate).

The magnitude of recent movements in Perth's CPI has been similar to other capital cities. Specifically, all major States experienced strong inflationary growth in September, followed by moderate growth in the following two quarters. Price growth in the March quarter 2014 was similar, ranging from 0.5% growth in Melbourne, Hobart and Canberra, to 0.8% in Darwin. National inflation (measured by the eight capital city weighted CPI) was up by 0.6%.

Furthermore, the main drivers of recent price movements have been broadly similar at the State and national level. Over the yea r, prices growth in Perth was mainly attributable to rises in the housing and alcohol and tobacco components, which grew by 5.3% and 5.2% respectively. Strong growth in the latter of these reflects the Commonwealth's decision to increase the tobacco excise rate by 12.5% on 1 December 2013. These relatively large price increases were partially offset by modest growth in other components, such as food , and furniture, household equipment and services (up by 0.4% and 0.8% respectively). These trends were broadly similar at the national leve l.

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In light of this, annual inflation in Perth has remained closely aligned with nationally. Inflation in the March quarter, in year-ended terms, was 3.1 % in Perth and 2.9% nationally, whilst growth in annual average terms was 2.8% in Perth and 2.6% nationallyS

%

2.5

1.5

0.5

-0 .5 Mar-04

CONSUMER PRICE INDEX Perth %

_ Quarterly Growth (LHS) --Annual Average Growth (RHS) 5

Mar-06 Mar-08 Mar-l0 Mar-12

3

-1 Mar-14

Source: ASS Cat. 6401 .0

Underlying measures of national inflation have increased at a similar annual pace relative to headline indicators. Excluding volatile items (mainly food and automotive fuel), the national CPI grew by 0.5% in the March quarter 2014, and by 2.6% in annual average terms (equal to the headline rate). The RBA's 'trimmed mean' (which excludes the 15% of items with both the smallest and largest price changes), also increased by 0.5% in the March quarter, and by 2.5% in annual average terms.

% 5

4

3

2

1 Mar-04

MEASURES OF CONSUMER PRICE INFLATION Annual Average Growth, Australia

Mar-06 Mar-08 Mar-10 Mar-12 Mar-14

--All Groups --Excluding volatile items -- Trimmed mean

Source: ASS Cat. 6401.0

5 There are two ways in which annual changes in the Australian CPI are commonly measured, year-ended groVv'th and annual average growth. Year..,nded growth (also referred to as "through the year" growth ) compares the CPI for one quarter with the CPI for the same quarter a year earlier, while annual average growth compares the average of the CPI for four successive quarters with its average in the same four quarters of the previous year.

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Outlook

Perth's CPI is expected to increase by 3% in 2013-14 and 2.75% in 2014-15, as a lower exchange rate and further increases in the tobacco excise rate are anticipated to more than offset the effect of the softer outlook for wage growth. Beyond this, the CPI is forecast to stabilise at 2.5% per annum, in line with the middle of the Reserve Bank of Australia's (RBA's) target band of 2-3%.

Uncertainty surrounds changes to the Commonwealth's carbon price/emissions trading scheme, and as such, the current CPI assumptions do not include any specific adjustments for potential changes to the carbon price.

Nevertheless, these forecasts are broadly consistent with national CPI projections from the RBA, which has projected that headline national inflation will rise by 3% over 2013-14, around 3% in 2014-15 and about 2.5% in 2015-166

. These forecasts partially reflect the effect of the lower exchange rate, and increases in the tobacco excise.

8. Risks to the economic outlook

Notwithstanding the outlook for the Western Australian economy, there are a number of potential risks that may hinder the State's growth prospects over the near-term.

Globally, these risks mainly revolve around the growth prospects in China, Western Australia's largest trading partner. Key domestic risks relate to the magnitude and timing of expected declines in business investment over the next few years. This has flow-on implications for the timing of exports, and the outlook for labour demand and population growth.

These risks are discussed in more detail below.

8.1 Global risks

Notwithstanding positive signs of global economic activity in late-2013 and into 2014, downside risks are still apparent, with economic conditions remaining fragile and uneven between advanced and emerging economies.

As Westem Australia's largest trading partner, the growth prospects and economic conditions in China remain a key risk to the economic outlook of the State. There are a number of risks to China's outlook. In particular, Chinese authorities are keen to transition the economy away from investment-led growth to a more sustainable private consumption-led growth path. Given the high level of investment as a share of Gross Domestic Product, the transition will require a significant increase in Chinese consumption, and past experience suggests the lift in consumption required may prove difficult to achieve. The transition will also require reforms, including to the financial sector, which authorities have not tackled in earnest in the past. There are also risks associated with the Chinese financial market, including the increased size of China's unregulated shadow banking sector.

However these risks must be balanced against China's continued urbanization, which is expected to support further investment in infrastructure and construction.

Other prominent global risks include the winding up of quantitative easing measures in the US, ongoing fragility in the euro area, and geopolitical risks between the Ukraine and Russia. However, any implications of global risks for Western Australia will largely be determined by growth prospects in China.

6 Reserve Bank of Australia, Statement on Monetary Policy, May 2014. The RBA forecasts national headline infiation to rise (in year-ended terms) by between 2.5% and 3.5% in 2014-15 and between 2% and 3% in 2015-16.

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8.2 Domestic risks

Business Investment

As investment in major iron ore expansions and large LNG projects declines, it is expected that these falls will be partially offset by growth in the non-resources sectors of the economy. It is also assumed that some new major project investment, that has yet to be identified, will proceed over the next few years. However, if this additional investment is not realised, the declines in business investment are likely to be larger than currently forecast.

Exports

The potential for project delays represents a significant risk to the projected ramp up of LNG and condensate production and exports from the large LNG projects currently under construction. This is because complex operations are particularly susceptible to project delays and unplanned shutdowns. Larger than expected delays could result in lower export volumes and lower than forecast growth in GSP. However, it is also possible that exports from these projects will ramp up faster than currently expected.

Labour Demand

Labour market conditions are expected to improve slightly from 2015-16, reflecting a modest pick-up in domestic economic activity. However, consistent with downside risks to the business investment outlook, labour market conditions are likely to be weaker than projected if the decline in resource investment is more pronounced than currently anticipated, and activity in the non-resource sectors of the economy fails to gain momentum.

Population Growth

Growth in Western Australia's population is projected to slow rapidly in line with forecast declines in the State's share of net overseas migration (NOM)'. Western Australia's share of national NOM declined in the September quarter 2013 in line with softening business activity and labour market conditions. However, if the State's share of NOM does not slow as quickly as forecast, population growth may be stronger than anticipated.

Dwelling Investment

In the short-term, dwelling investment may be stronger for longer than the current outlook suggests if supply constraints (such as limited skilled labour and titled land) reduce the speed at which the demand for new housing translates into actual construction. However, across the forward estimates, growth in dwelling investment may be softer than forecast if housing supply meets demand sooner than expected. This risk will be heightened if forecast declines in business investment have a bigger than anticipated impact on other sectors of the economy.

7 The 2014-15 Budget assumes that Western Australia's share of national NOM will return to long run average rates (around 13.5%) relatively quickly. This contrasts with ABS projections released in December 2013, which assume the State's higher share of NOM in recent years (around 20%) will be sustained.

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Table 1 2014-15 BUDGET

ECONOMIC FORECASTS

Western Australia, Annual Growth ('!o)

2012-13 2013-14 2014-15 2015-16 2016-17 2017-18

Estimated Bu:lget Forward Forward Forward Actual Actual Estimate Estimate Estimate Estimate

Demand and Output (a)

Household Consumption 3.9 3.0 3.25 3.5 3.75 3.75 Dwelling Investment -1.8 14.0 7.0 3.75 2.0 1.5 Business Investment 8.3 -7.5 -8.5 -6.0 -3.75 -1.25 Government Consumption 2.1 3.5 4.0 4.25 4.25 4.25 Government Investment 2.0 3.75 -0.75 0.5 1.5 1.0

State Final Demand (SFD) 5.0 0.25 0.0 0.75 1.5 2.0 Merchandise Exports 9.1 7.0 4.5 5.5 7.25 8.5 Merchandise Imports -2.1 -5.5 -7.75 -2.0 1.0 1.5

Net Exports (bJ 14.0 11.75 8.25 7.5 9.0 10.0 Gross State Product (GS?) (e) 5.1 3.75 2.75 3.0 4.25 5.0

Labour market Population 3.5 2.6 2.1 2.1 2.1 2.1 Working Age Population (15-64) 3.2 2.3 1.6 1.6 1.6 1.6 Employment 3.5 1.5 1.5 1.75 1.75 2.0 Unemployment Rate (d) 4.4 5.0 5.5 5.25 5.0 4.75 Participation Rate (d) 69.0 68.3 68.2 67.9 67.6 67.4

Prices Consumer Price Index (CPI) 2.3 3.0 2.75 2.5 2.5 2.5 Wage Price Index (WPI) 4.0 3.25 3.25 3.5 3.5 3.75 SFD Deflator 2.1 2.2 2.7 2.4 2.3 2.3 GSP Deflator -4.1 3.8 1.4 1.7 1.5 1.3 Median House Price (el 7.1 6.6 2.5 1.4 0.8 1.5

Other key parameters (d)

Exchange Rate $US/$A (cents) 102.7 91.5 90.6 88.3 86.4 84.9 Effective Iron Ore Price ($US!t) (FOB) ~

121.1 114.4 111.3 109.6 107.1 104.7

Crude Oil Price ($US/barrel) 92.2 108.9 104.1 99.7 96.6 94.5

lal Based on 2012-13 State Accounts annual data, released on 28 November 2013, updated with the latest quarterly State Final Demand data (for the December quarter 2013, released on 5 March 2014).

(b) Net exports refer to international trade in both goods and services.

(c) Forecasts for ownership transfer costs, international trade in services, and the statistical discrepancy and balancing item components of the State Accounts are not separately reported.

(d) Data expressed in terms of the annual average during the financial year.

(e) Refers to the median house price of the Real Estate Institute of Western Australia. Previously, house price forecasts were based on the Perth Established House Price Index published by the Australian Bureau of Statistics, Catalogue 6416.0.

(f) The benchmark delivered price minus the cost of freight (adjusted for moisture). In 2014-15, the assumed moisture adjusted freight cost is $US 11.4 per tonne. Therefore, the FOB iron are price of $US111.3 pertonne in 2014-15 equates to a delivered benchmark price of $US122.7 per tonne.

Note: Since the 2013-14 Government Mid-year Financial Projections Statement, Treasury has changed the source of the benchmark series for the iron are price from Steel Home to The Steel Index (TS1) and the benchmark for crude oil price from the West Texas Intennediate (WTI) to Brent Crude.

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