AFG Venture Group Dispatches

Corporate advisory and consultancy in Australia, South East Asia and India.

Business and Economic Outlook – Australia 2012 – Andrew Bald, Associate Director, Agribusiness, AFG Venture Group

1.         Precis 

Australia is experiencing what has been referred to as a mining boom. This boom is reshaping our economy via structural changes, both between sectors and within each sector. The implications are not all positive and many of the negative impacts are being felt non-mining sectors including manufacturing, retail and services.

Whilst the mining sector is experiencing a once in a century boom, this sector is one of the smallest employment sectors, the others are all suffering, reflected in lower sales, revenues and employment. The issues are: how long will these forces stay in place and how long will it take for the respective sectors to adjust to the new market place dynamics.

My view is that the Australian economy is in a recession and is facing a depression, the negatives resulting from higher exchange rates are far more wide reaching than the benefits accruing to those associated with the mining sector and will take longer than expected to flow through to the rest of the economy, representing the largest number of households.

Structural change is upon us but structural change is not new: advances in technologies and changes in world demand for different commodities including raw materials such as wool, iron ore, coal and foods such as wheat, barley, hops etc have been affecting the Australian economy since colonization. Whilst impacting large swathes of our economy, the pace of the current structural change resulting from the iron and coal commodity booms are creating once in a generation opportunities for those who can identify them and are willing to grasp them.

2.        The lucky country – for some

Australia has long been portrayed as a lucky country, indeed we celebrated 20 years of growth this year and our economy is riding high on the back of the continued mining boom, reflected in an historically high Australian Dollar driven by an insatiable demand for our resources.

But is it as good as we think it is or is it a “Boom with the Gloom”[1]?

What is certain is that we have a “2 speed economy”, not only between corporate sectors, but geographically.  Our mining services companies and banks all reported strong, if not record, half year profits in March this year[2] as did our largest miners.

Manufacturing, industrial sectors, retail and media however are their poor cousins and appear to be languishing in the dog-house, reflecting a clear lack of consumer confidence and structural changes to purchasing and consumption process.

Our economy is being twisted and pulled in multiple directions by numerous, often juxtapositioned forces.  Some of these factors include our mining boom, our terms of trade (that are at historic highs), record exchange rates, world financial markets and European sovereign debt issues and changes in World and Australian demographics.

3.         The Mining Boom

This really is a misnomer.  The “Mining Boom” per se is really an Investment Boom in mining infrastructure, that is, most of the “Boom” is in the form of capital investment in mining projects such as Liquified Natural Gas (LNG) and coal.

For example, mining companies are forecast to spend a record $120bn in the financial year ending 30 June 2013.[3], a 30% increase in mining investment over the expected $95bn for 2011-2012.

Whilst total capital expenditure for 2012-2013 will rise to $173bn (a new high) mining will account for circa 70% and the RBA expects double digit growth in each of the next couple of years.  Investment in currently approved LNG plants alone will exceed $180bn over the coming few years.

Figure 1: Business Investment as % of GDP

4.           2-Speed Economy

The impacts of this Investment Boom however are not being felt equally throughout our economy.  Investment in non-mining sector is suffering, employment rates across the country are skewed towards the mining states, retail sales are down and commercial property rents are depressed.


Manufacturing investment is expected to fall to $10.6bn in 2012/13, down 8% and the sector shed 43,800 jobs in the 6 months to November 2011.

Furthermore, non-mining investment has fallen over recent years as a % of GDP due to the impact of the high currency on export oriented industries.

Figure 2: Investment by sector as % of GDP


Employment and unemployment are skewed across sectors and, due to the fact that the largest mining projects are in WA and QLD, across the country.  For example, the table below illustrates the disparities in unemployment rates across the country[4].

Figure 3: Unemployment across Australia

Note importantly that the largest workforces are located, NSW and Victoria.  This is significant as the RBA holds the view that workers will migrate to fill the employment opportunities but could WA take an additional 400,000 workers (current NSW & Vic unemployed combined = 185,300 + 216,300 = 401,600) when the mining sector in Australia employs less than 300,000 people (estimated 245,000)?


In the retail sector (the second largest employer in Australia accounting for approximately 11% of the workforce) January new retail sales figures showed growth of only 0.3% with food spending stagnant following a weak December, and supermarket and grocery store sales also flat for the second month in a row.

Commercial Property

This in turn is having a flow-on effect on commercial property as stores struggle to pay rents.[5]  The result was a fall in average commercial property rents in the December quarter of 0.1%, led by weakness in Brisbane and Sydney’s weak fashion sector where Sydney retail rents fell 14% qtr on qtr, and Brisbane rents fell by 2.9%.

5.         What are the forces at play

Some of the obvious forces include the strong demand for Australian resources, the influence of European sovereign debt crises on Australian consumers’ confidence, resulting changes in Australian household spending and saving patterns and, most importantly in my opinion, changes in world demographics.

World demographic

The world is seeing an unprecedented rapid development and associated urbanization of emerging market economies that is resulting in hundreds of millions of people entering the global economy.  This is resulting in unprecedented demand for natural resources and has pushed commodity prices to new records[6].

The result has been a surge of investment in Australian natural resource projects, particularly iron ore, coal and LNG and record volumes of exports of these resources.  As a result, we are now experiencing the highest exchange rate since the currency was floated (the previous high in the 1970s was under the pegged regime).

Figure 4: Real Exchange Rate since 1970

Put simply, as Asia’s middle classes expand and urbanise, so too does their demand for household goods such as refrigerators, televisions and motor vehicles and energy, particularly electricity.  The result: increased demand for coal, iron ore, LNG.

Australian Spending & Savings Patterns

National Savings (the difference between an nation’s income and what it spends on consumption of goods and services) has started to trend higher over the second half of the 2000s, partly due to compulsory superannuation.  A large contributor also has been a reversal of the availability of debt resulting from a deregulated financial sector in the 1980s that drove an increase in borrowings and ultimately drove up housing prices.  This made households feel richer, the Wealth Effect, that in turn led to increased spending.

Since the GFC however, bank credit for home lending has contracted in line with falls in housing values.

This fall in housing values has had a large negative wealth effect on domestic households (housing accounted for 85% of Australian households’ non-financial assets in 2010) and when combined with the recent volatility in asset prices[7], has most likely resulted in lower expectations of future income and asset prices.  This leads to reduced expectations as to resources available for future consumption and typically results in increased pessimism and increased savings or reduced borrowings.  The effects can be seen in the following graph.

Figure 5: Household savings as % of GDP

Consumer Confidence

Much of the weakness in the real estate sector has been driven to an extent by the recent GFC, triggered in turn by the events in Europe, contributing to the negative wealth effect of falling asset prices both domestically and internationally (financial assets).

For decades, European governments (with a few notable exceptions such as Germany) have been spending more than they have been raising in revenues, funding the deficits by borrowing or issuing bonds.  This has now come to a head and the implications for those countries such as Greece and Spain are startling and ominous.

The resulting sharp economic contractions have made headlines around the world and there is little doubt these are having an impact on household confidence and hence spending and saving habits here in Australia.  What spare cash households have is being used to reduce debt.

6.          Real Estate and Wealth

Australian household borrowing and spending patterns have undergone some dramatic changes since the GFC that in turn are resulting in even greater structural changes in Australian industry demographics.

The most obvious of these has been the Australian property market.  Since the end of World War II (if not before) Australians have been obsessed with owing their own property.  Around 67% of households own their own home, of which 50% own them outright.

Australia in the 2000s went through a property boom driven by a range of factors including negative gearing (where any net loss of rental income less borrowing costs could be deducted against other income sources, most significantly salaries) and increased competitiveness in the bank lending sector.  In the 2000s, around 1 out of every 12, or 8%, of all properties were changing hands each year!   Today, that rate is less than half at circa 4% or 1 in 25 dwellings.

The reasons for this fall are varied but the most commonly quoted reasons include negative sentiment towards future prices and increased uncertainty leading to a tendency to reduce borrowings and increase savings.

The recent changes in the real estate sector have been dramatic and are reflected in a broad range of indicators including: building approvals, 14.6% lower in Feb 2012 than 12 months previous; home loan approvals in January 2012 down 1.2%; value of loans down 7.1%; and the number of new home loans approved down 6%[8].  NSW was particularly hard hit as a result of winding back of stamp duty concessions for first home buyers, resulting in a slump in housing finance of 6.3% but Queensland was the standout with dwelling investment down some 25%[9] below its peak of 2008.

Figure 6: Residential Building Approvals

This slump in residential housing is affecting not only the obvious areas such as employment in the real estate sector and construction, but is having a flow-on effect to others such as the financial sector reflected in job losses in the banking sector (but increased employment in the insolvency practices!)

In addition, adverse conditions in the retail sector are having flow-on effects in the commercial real estate sector as retail shop owners, particularly fashion, struggle to cover their rents.

7.           Exchange Rate dynamics and the Non-Mining sector

In the non-mining sector, the high Real Exchange Rate is behind significant structural changes affecting sectors such as manufacturing and retail.

Fundamentally, a higher currency values affect the competitiveness of Australian exports and make imports cheaper.  This is having a particularly severe effect on the manufacturing and retail sectors.


Australia’s manufacturing sector has been suffering over the past decade.  Structural change takes time and requires significant investment in new machinery.  The adverse impact on manufacturing seems to be reflected in lower employment resulting from new lows in exports of manufactured goods that are currently below pre-GFC levels.

Figure 7: Employment in Manufacturing

The high exchange rate however decreases the cost of importing new machinery so is there something else happening?  Is it possible that new machines are being imported over time and these new machines are more efficient, resulting in a structural change in employment away from manufacturing?  This analysis is beyond the scope of this paper but I believe that this may be going on but that many manufacturers did not believe the high real exchange rate would be a sustained change.


The mining boom has also been blamed for having an indirect influence on structural change in the retail sector.  Retail sales at department stores and clothing and footwear retailers have declined by about 6% since 2009 vs. steady growth in volume across the remaining retail industries.

In addition to the higher currency resulting in constantly lower prices for newly produced goods, some of the fall in retail sales has been blamed on increased price transparency due to the increase in the number of goods that can be bought on the internet however in the opinion of one of our biggest retail store owners, Gerry Harvey, the biggest driver results from the fact that consumers are jittery, choosing to pay off their credit cards rather than spend.

The chairman of Harvey Norman, one of Australia’s largest retail franchises, noted a 6% dip in sales as a result of intense competition in home entertainment (televisions, stereos etc) and computers compounded by price deflation, squeezing margins.

The Effect of Internet Sales

In addition to the higher currency resulting in constantly lower prices for newly produced goods, some of the fall in retail sales has been blamed on increased price transparency due to the increase in the number of goods that can be bought on the internet however in the opinion of one of our biggest retail store owners, Gerry Harvey, the biggest driver results from the fact that consumers are jittery, choosing to pay off their credit cards rather than spend.

In addition to the higher currency resulting in constantly lower prices for newly produced goods, some of the fall in retail sales has been blamed on increased price transparency due to the increase in the number of goods that can be bought on the internet however in the opinion of one of our biggest retail store owners, Gerry Harvey, the biggest driver results from the fact that consumers are jittery, choosing to pay off their credit cards rather than spend.

8.        But its not all bad – higher real incomes

Even if you are not working in the mining sector, there are some positives, for example, higher real incomes.

Australia’s Real Income (reflecting the amount of goods that can purchased for any given nominal income) is rising.  This is one of the many benefits of the relatively high Australian dollar, imports are cheaper.

It is startlingly obvious that the price of televisions, computers, clothes, shoes etc are all falling and to be blunt, seem ridiculously cheap.  Great if you are a consumer, but terrible if you are a retailer!

Similarly if you are a manufacturer looking to import new equipment, capex costs are falling or if you are mobile and willing to migrate interstate, there are plenty of opportunities in the mining services sector.

9.         Are we seeing structural shifts? – Employment shifts

To date we have not seen unusually large shifts in industry structure of employment.  That is, the relative employment levels of the various sectors, mining services, retail, manufacturing and so on, have remained relatively static.

The reason is that whilst mining service employment has boomed (and this is what all the focus has been on) increasing by more than 70,000 jobs over the last few years or about 40%, the mining sector employs a very low percentage of the workforce, circa 245,000.  The vast bulk of Australians still work in the non-mining service industries.  Australia’s total labour force is circa 12.1M of which 11.4M are employed, implying 11.155M employed in non-mining service industries.

(Note interestingly, the total number of unemployed in NSW and Victoria, 401,600) exceeds the total number of people employed in the mining sector.

10.       Who Will Benefit

Winners will emerge from this process, they include:

◘      Those that can see the opportunity to embrace new technology that reduces inputs will flourish.

◘      Those companies and individuals that are profiting from demand for their services in Australia should profit further if they are able to export their expertise to newer, developing, commodity rich regions such as the Middle East where infrastructure expenditure dwarfs that being undertaken in Australia.

◘      Those that have not indulged in borrowing excesses and have avoided the housing bubble should be well positioned to take advantage of falls in real asset prices that will, over the long term, recover due to population growth and the tendency to migrate towards larger demographic centres.

◘      Young workers who are willing to move interstate and if necessary, retrain, will benefit enormously from the relatively high wages that are being paid to attract workers to the mining services sector.

11.       Business Outlook: Summary

Australia, in my opinion, is in a recession and a depression is imminent.  The result will most likely be a prolonged period of stagnant if not falling asset prices, particularly housing prices, and rising unemployment.  Retail is suffering from lower profit margins which follow from lower absolute prices and affecting commercial property returns.  Manufacturing is suffering from competition from cheaper imports and both of these are affecting other service sectors, negative flow-on effects.

Whilst the Investment Boom in the West will have positive flow on effects for the rest of the economy, these effects will take longer than expected to filter through and I fail to see how an increase in nominal and real incomes for even 300,000 mining service workers can flow through with significant benefits to the 11.4 million workers, particularly when much of the capital investment is in equipment manufactured overseas and imported!

Within 3 years, many of the large mining infrastructure projects will be completed and those employed in the Western Australian and Queensland mining sectors will join the queues of those displaced by the downturn in retail, manufacturing, real estate and service sectors.

But why am I so negative?  Why, for example, can’t the manufacturing sector modernize, adopt the newest technology and compete with imports produced by cheaper labour from newly emerging economies?

No reason at all, in fact, as I wrote before, I think that process may be just beginning and I believe that those that do survive will be those that do just that and the stronger exchange rate means it is cheaper to do so.  The problem is in the likely outcomes of adopting new technologies.  Surely these modern, advanced technology capital equipment will be more efficient and that means reduced numbers of employees will be required to produce the same amount of product, i.e. reduced workforces.

To put it another way, the only way our export oriented or import competing industries can compete against cheaper overseas labour is to replace dearer Australian labour with technologically advanced machinery.

The RBA believes it has the right balance of monetary and fiscal policy.  The risk of a reduction in interest rates will be to create excessive demand and possible inflation that will be compounded by an expected fall in the currency (import prices up).

My view is that the RBA is wrong and that the sheer mass of the mining investment boom is benefiting a limited percentage of the population and masking long term structural changes that are going to have negative effects on vastly greater numbers of households and individuals.

If I am right, our economy is suffering from a crisis of confidence.  There is cash available for investment from the compulsory super as well as those that liquidated assets at their peak but there is a reluctance to invest.

The world has seen these before and typically, it will require some form of explicit government intervention to restore confidence and turn the negative sentiment around.


[1] Martin Parkinson, Federal Treasury

[2] Australian Financial Year ends on the 30th June with the exception of some of the banks who have staggered year ends for reporting.

[3] Australian Bureau of Statistics

[4] Australian Bureau of Statistics, Labour Force, Feb 2012

[5] Asia Pacific Prime Retail Report, CBRE

[6] Albeit commodity prices have softened slightly in 2012.

[7] RBA Bulletin, March 2012, Trends in National Saving and Investment

[8] Australian Bureau of Statistics

[9] RBA Bulletin, March 2012, The Recent Performance of the States


About the Author

Andrew Bald has over 25 years experience in merchant banking and corporate finance. He has advised and assisted a number of private and public (i.e. ASX listed) companies with their financing requirements (both debt and equity), over a variety of sectors including natural resources such as coal, gas and gold, IT and food/agribusiness.

Andrew has started a number of companies including the Pisces Group (founder and CEO), which was formed in August 1995 to commercialise marine aquaculture in NSW. The Pisces project, located on the east coast of NSW, north of Pt Stephens, ran for more than 8 years with a project budget in excess of $10M. The company successfully farmed Snapper and Mulloway and developed new markets for aquaculture product in Australia and overseas. Andrew was an inaugural member of the NSW Minister’s Aquaculture Advisory Council.

Andrew is currently an advisor to Sports Drug Testing International, a newly formed but rapidly growing drug testing company with contracts including the ICC (Cricket), IRB (Rugby), Cycling and AFL and works as a consultant to Indigenous Business Australia, a Federal Government body which provides funding assistance to business owned and managed by Indigenous Australians.

Andrew Bald, March 2012