The Economic OutlookOctober 2010

Presenter : Richard BlandyAustral Asia*Economics Pty LtdSchool of Management, University of South Australia&

20 October 2010

Disclaimer

This presentation has been prepared by Richard Blandy for general information only.  Though every effort has been made to ensure its accuracy, it is not intended to be a complete description of the matters described.  The presentation does take into account any personal objectives, financial situation or needs.  It does not contain and is not to be taken as containing any securities advice or recommendation.  It is not to be relied on by recipients for the purpose of making investment decisions and does not replace the requirement for individual research or professional tax advice.  Richard Blandy does not give any warranty to the accuracy, reliability or completeness of information contained in this presentation. 

Except insofar as liability under any statute cannot be excluded, Richard Blandy does not accept any liability for any error or omission in this presentation or for any resulting loss or damage suffered by the recipient or any other person.  Unless otherwise noted, Richard Blandy is the source of all charts.  This document was accompanied by an oral presentation, and is not a complete record of the discussion held.

No part of this presentation should be used elsewhere without prior consent from the author. 

Should you wish to obtain personal advice regarding anything in this presentation please contact Anthony Prior on 8561 2400.

The present value of a financial asset depends on:

1. the flow of income people expect to get from it,

2. the ‘riskless’ rate of interest, and

3. the riskiness of the asset in terms of possible variability in its expected flow of income and likelihood of the asset becoming insolvent.

Valuation of financial assets

Therefore, assets in general increase in value when;

1. production and incomes grow faster,

2. riskless interest rates fall; and

3. perceived risk and uncertainty about the economic future becomes less

And vice-versa!

Valuation of financial assets (continued)

All ordinaries index

Why did the All Ords fall 10 per cent in May?• Perceived risk and uncertainty about the global (and

therefore, Australian) economic future suddenly became greater, because fears about sovereign debt in Europe grew sharply (remember the P, I, I, G, S - Portugal, Italy, Ireland, Greece, Spain?)

Why has the All Ords tracked sideways with high (but diminishing) volatility ever since?

• Perceived risk and uncertainty about the global (and therefore Australian) economic future has oscillated as contradictory data about the American and European economies have emerged from week to week.

• Every sign of slowdown and every sign of expansion has been magnified in market price movements up and down.

• Fears of a “double-dip” recession have been openly canvassed but have steadily become less plausible, as other data have persistently contradicted the prospect

• Slow economic growth in America and Europe has become a more accepted scenario for the future rather than renewed sharp contraction in the advanced economies.

Leading Index of Australian economic activity July 1988 - July 2010

Source: Westpac-Melbourne Institute leading index of Australian economic activity

OECD %

Neth BEPA

RBA%

Econ. / IU %

IMF%

ABARE%

United States 3.2 3.0 2.7 3.3 3.0Japan 3.0 3.0 1.5 2.4 1.8Europe 1.2+ 1.0+ 1.5+ 1.0+ 0.5 *Asia 9.0 8.4

China 11.1 9.9 9.6 9.9India 8.3 8.0 9.4 7.8

South America 5.2 4.8 4.0Africa & ME 4.5 4.8

OECD 2.72.3^

2.5 2.6^ 2.0

WORLD 4.5 4.5 4.5 4.6 3.9Australia 3.2 3.3 3.1 3.0 3.0

Sources: OECD, Netherlands Bureau of Economic Policy Analysis, RBA, Economist Magazine and Economist Intelligence Unit, IMF, Australian Bureau of Agricultural & Resource Economics.

+ Euro area * Western Europe^ Advanced / developed economies (IMF)

World GDP growth outlook in 2010 recovery bounce

OECD %

NethBEPA

RBA%

Econ./IU%

IMF%

ABARE%

United States 3.2 2.8 2.4 2.4 2.3Japan 2.0 1.5 1.4 2.2 2.2Europe 1.8+ 1.5+ 1.3+ 1.6+ 1.7 *Asia 8.0 7.8

China 9.7 8.4 9.7 9.0India 8.5 8.2 7.8 7.7

South America 3.7 3.8 3.8Africa & ME 4.5 5.7 4.8

OECD 2.8 2.0^ 1.6 2.4^ 2.3WORLD 4.0 4.0 3.6 4.3 4.1

Australia 3.6 3.8 3.4 3.0 3.5

Sources: OECD, Netherlands Bureau of Economic Policy Analysis, RBA, Economist Magazine and Economist Intelligence Unit, IMF, Australian Bureau of Agricultural & Resource Economics.

+ Euro area * Western Europe^ Advanced economies (IMF)

World GDP growth outlook in 2011 trend (except USA)

RBA%

IMF%

ABARE%

TREAS%

Econ. IU%

United States 2.4 2.4 1.8Japan 2.0 1.7 0.8Europe 1.9+ 2.1 * 1.3+Asia 8.5 7.7

China 9.7 8.6 8.5 Non-OECDIndia 7.9 7.9 5.8 6.3

South America 4.1 4.5Africa & ME 5.1 4.9

OECD 2.5^ 2.5 1.8^ 2.2 WORLD 4.5 4.2 3.5 4.1

Australia 3.8 3.2 4.0 3.4

Sources: RBA, IMF, Australian Bureau of Agricultural & Resource Economics, Australian Treasury Department, Economist Intelligence Unit Global Forecasting Service.

+ Euro area * Western Europe^ Advanced economies (IMF)

World GDP growth outlook for 2012-2014 trend (except USA)

2008/09

2009/10

2010/112011/1

22012/1

32013/14

South AustraliaGSP 1.0 2.0 2.8 3.5 2.8 2.8Employment 0.8 0.9 1.3 2.0 1.5 1.0

AustraliaGDP 1.0 2.3 3.0 3.8 3.0 3.0

Source: South Australian Department of Treasury and Finance, 2010-11 Budget Overview: Budget Paper 1, p.17

Medium term growth outlook - South Australia Australia & South Australia (%pa)

Shares of World Economy

GDP per head*

2000%

2014%

2000$(000)

2014$(000)

United States 23.5 18.3 35.3 54.0Japan 7.7 5.5 25.3 39.9European Union 25.2 19.4 - -Euro Area 18.5 13.3 25.6 38.4Advanced economies 62.9 48.8 - -Developing Asia 15.2 26.5 2.0 6.8

China 7.2 15.4 2.4 11.0India 3.6 5.7 1.5 5.7

South America 8.8 8.5 7.4 13.0Africa 2.7 3.3 1.6 3.1Middle East 3.5 4.3 6.3 12.5Australia 1.2 1.1 26.8 44.2

Source: International Monetary Fund, World Economic Outlook Data Base, October 2009

* Figures provided in real dollar terms - purchasing power parity

Shares of World economy & GDP per head 2000 & 2014

Source: ABARE, Australian Commodities, March Qu 2007, p12

World Product 2050 = 5 x World Product 2006

World GDP growth scenario to 2050

• Faster real growth means greater real earnings & less risk

• Positive environment for Australian / Asian shares

• Not so positive for US / European shares not plugged into Asia

• Inflation may become a problem in the USA, but not in Australia

• Riskless interest rates may rise significantly around world & dampen upward movement in share & property prices

• AUD likely to continue to rise against USD, £, EURO, YEN - making foreign earnings of Australian companies (& foreign shares) less valuable in AUD

Medium term growth outlook implications investments & share markets

• Good time to save for the future, including retirement

• Government bonds look a bit risky in a rising interest rate environment, because earnings are fixed

• Cash (term deposits) looks good

• Property probably OK despite high prices relative to household incomes

• Blue chip Australian/Asian shares/unit trusts probably best

• Probably wise to hold extra reserves of cash while volatility remains high

Medium term growth outlook implications investments & share markets (continued)

• Tax reform, including mining resource rent tax • Carbon price• Population growth and regional policy• Infrastructure investment• Skills requirements and availability

Some major policy issues in the next few years:

Tax summit scheduled to take place in 2011. Options which could be included are;

• Raising personal income tax threshold from $6000 to $25,000 (Henry)

• Applying a marginal income tax rate of 35% from $25,000-$180,000 and 45% above $180,000 (Henry)

• Reducing company tax from 30% to 25% (Henry)

• Mining Resource Rent Tax (MRRT or something different?) (Henry and others)

• Cutting tax on earnings in super funds from 15% to 7.5% (Henry)

• Employer super contributions taxed at individual’s marginal income tax rate (Henry)

• 1% annual tax on the value of real estate holdings (Henry)

• Estate duties (Henry and Greens)

• GST increase to 15% (Copy New Zealand)

Tax Reform

All Party Parliamentary Committee to consider options in 2011

• Introduce Carbon Tax set at average world carbon price (McKibbin)

• Introduce new CPRS (with reductions tied to average of world reductions?)

• What activities to be included (energy? agriculture? transport?)

• Role of “direct action” schemes and subsidies (RECs, REES, carbon capture and sequestration, R&D subsidies, etc.)

Carbon Price

2006(a)

2007(b) 2026 2056

Observed Series A Series B Series CSeries

ASeries B Series C

Sydney 4,282.0 4,334.0 5,487.2 5,426.3 5,358.2 7,649.0 6,976.8 6,565.2

Balance of NSW 2,534.1 2,554.0 3,189.9 2,968.8 2,780.2 4,140.1 3,233.4 2,646.1

Total New South Wales 6,816.1 6,888.0 8,677.0 8,395.1 8,138.511,789.

110,210.2 9,211.3

Melbourne 3,743.0 3,805.8 5,272.3 5,038.1 4,861.7 7,970.7 6,789.2 6,100.9

Balance of Vic 1,383.5 1,399.1 1,626.1 1,624.1 1,636.3 1,879.6 1,749.1 1,742.9

Total Victoria 5,126.5 5,204.8 6,898.3 6,662.2 6,498.0 9,850.3 8,538.3 7,843.8

Brisbane 1,819.8 1,857.0 2,908.0 2,681.1 2,465.6 4,955.1 3,979.3 3,237.0

Balance of QLD 2,271.1 2,324.5 3,645.4 3,356.9 3,129.7 5,966.3 4,759.6 3,998.2

Total Queensland 4,090.9 4,181.4 6,553.3 6,038.0 5,595.210,921.

38,738.9 7,235.2

Adelaide 1,145.8 1,158.0 1,410.8 1,384.5 1,391.8 1,848.5 1,651.8 1,623.7

Balance of SA 422.1 426.2 531.5 499.8 451.0 691.4 552.7 406.7

Total South Australia 1,567.9 1,584.2 1,942.3 1,884.4 1,842.9 2,539.9 2,204.5 2,030.4

Perth 1,518.7 1,554.1 2,455.2 2,267.6 2,112.1 4,164.4 3,358.4 2,815.5

Balance of WA 540.6 552.0 796.8 732.9 660.5 1,207.6 935.0 702.3

Total Western Australia 2,059.4 2,106.1 3,252.0 3,000.5 2,772.7 5,372.0 4,293.4 3,517.7

Australia (d) 20,697.9 21,015.028,723.

027,236.

725,971.

942,510

.435,470.0 30,906.1

Source: ABS, Population Projections Australia 2006 to 2101, 4 Sept 2008, p. 7.

Population Growth and Regional Policy:Australian & State populations to 2056 000’s of people as at 30 June

• Major shortfall in infrastructure investment in last two decades by States

• Large scale borrowing programs will be needed

• NBN financing will add to fiscal and interest rate pressures

• Private sector participation and overseas borrowing will be essential

• Rational prioritisation using cost-benefit analysis rather than pork barrelling will be essential

Infrastructure Investment

All Party Parliamentary Committee to consider options in 2011• Introduce Carbon Tax set at average world carbon price

(McKibbin)• Introduce new CPRS (with reductions tied to average of world

reductions?) • What activities to be included (energy? agriculture?

transport?) • Role of “direct action” schemes and subsidies (RECs, REES,

carbon capture and sequestration, R&D subsidies, etc.)

Skills Requirements and Availability:• Example of South Australia

Will the present Government be strong enough to meet these policy challenges effectively - or will we be heading back to the polls fairly soon?