GDP growth needs to be higher

Australian output growth halved in the latest June 2014 quarter. Some of the media commentary established that the result was ‘good’, given that the annual rate of real GDP growth of 3.1% is still above the recent average. Implicit in this line of thinking is that growth at above average is good enough and implies that the economy is performing well. Annual GDP growth of over 3% certainly seems like a good number, but is this current rate of growth high enough? The short answer is ‘no’ – and the reason why is because we have experienced slowing and declining real income growth and the pool of unemployed and under-employed persons in Australia has been growing for several years now. These are both important indicators that growth is not high enough. Structural and cyclical factors will continue to weigh on the performance of the economy. Without a clear strategy to address these issues, at best, we will remain in this new world of lower growth.

GDP Performance

The latest quarter of real GDP growth came in at +0.5%, well under half that of the previous quarter, March 2014 at +1.1%. This resulted in the annual rate of growth slowing from 3.3% to 3.1%.

Over the last several decades, the average annual growth in real GDP has continued to slow. Since the start of 2010, the average rate of real GDP growth has slowed further to 2.8% – the current annual rate of growth is sitting above this average.

Source: ABS

The major difference in contribution to GDP growth between the last two (2) quarters was the turnaround in the contribution of net exports from positive to negative and the change in inventories from negative to positive. The growth result this quarter relied heavily on the growth in inventories.

All other elements of GDP expenditure remained fairly stable:-

Source: ABS

Some points on the general outlook:-

  • Net exports should play a greater role in contributing to GDP growth (it hasn’t this quarter) as major resources projects come on line. There is some uncertainty around expected iron ore demand and slower growth figures coming out of China in the short-term. According to the Bureau of Resources and Energy Economics (BREE) June 2014 Quarterly Report, the value of Australia’s iron ore exports is forecast to increase by 3.1%, supported by higher volumes (+13%) which are expected to offset forecast lower iron ore prices in 2014–15. These figures are based on an average spot price of Iron Ore in 2014 of US$105/t – we are currently sitting at that average YTD (source: Indexmundi). In other words, don’t panic yet.
  • Public sector spending is likely to detract from GDP growth given the fiscal tightening agenda, with the bigger part of those spending reductions to hit during the 2014/15 financial year. If the government can get its infrastructure investment agenda off the ground (and assuming it will be well targeted spending), then this would be a welcome addition to growth and likely help support longer term productivity growth.
  • Private investment is likely to detract from GDP growth in the coming quarters due to the slow-down in Mining capex (as the boom shifts into the production and export phase). Indicators so far suggest that non-mining investment is not likely to fill the entire void, but there are some signs of increased spending in Dwelling Construction. It seems much hope rests on igniting the ‘animal spirits’ of our non-resources business sector to step up and start investing.
  • Household consumption is likely to continue at its current pace given the level of unemployment, under-employment, lower wages growth and increased savings rate. There is some potential for upside, considering the role of credit growth in supporting greater household consumption – if lending remains accommodative then any improvements in labour markets could see an increased appetite for credit. Alternatively, we could see a reduction in the savings rate (which might happen regardless).

From an industry perspective, the slow-down in growth was evident across most major industries, with the surprise exception of Manufacturing. In the June quarter, Manufacturing was the single largest contributor to GDP growth. Given the steady decline of Manufacturing-based industries in Australia (share of income, employment etc.), it’s not likely that this will be a driver of output growth into the future.

Of most concern was the pull back in growth in Construction (although remained positive) and the significant turnaround in the contribution of Mining to growth, especially given its importance to the economy at the moment.

Source: ABS

The broader question is whether growing at trend, or just slightly above, is a “good” result. That’s really the purpose of this post. I follow the labour market data closely and have been witnessing the growth in total unemployed persons for several years now as well as the well below average growth in total employed persons and the declining participation rate. These have been red flags that all is not well.

National Income

A more important view of total output and change in economic well-being (i.e. how much we can spend) is the income that output generates. One of the best measures is real net National disposable income per capita (RNDI) as it adjusts GDP for shifts in the Terms of Trade (ToT), which is currently down over 20% from its peak in Sept 2011, nets out depreciation and takes into account net income flows to foreigners.

On a per capita basis, real net National disposable income growth has been slowing or declining since March 2011. In the latest quarter, real net National disposable income per capita fell by -0.5%.

Source: ABS

The decline in RNDI per capita has implications for our standard of living in that sustained declines, and even slow growth, in income reduces our ability to grow our consumption of goods and services. Growth in income has slowed considerably from the prior two decades, making it that much harder for business to generate growth (without rapid credit expansion and/or draw down in savings). The issue of low growth is not one limited to Australia.

There is a stark contrast between income growth during the 90’s and 2000’s and during this post-GFC period. During the 90’s/00’s, RNDI per capita grew by over 2% on average. Other features of this ‘consumption boom’ included record low savings rates and higher credit growth. During the 2000’s, household consumption expenditure (excluding the period of the GFC) contributed, on average, 2.2% points to annual real GDP growth, which is fairly significant.

In this post-GFC period (area circled in the chart above), average growth in RNDI per capita has slowed to +0.7% and the savings rate is now over 9%. Credit growth, especially for mortgages, is strong on aggregate, but led by several key markets only. Personal credit growth has slowed. As a result, the contribution of household consumption expenditure to annual GDP growth has slowed to 1.4% points. It’s still a positive contribution to growth, but it has slowed considerably.

“The other thing that is in my mind when I think about the consumer is: I do not think we can expect to go back to the consumer leading aggregate demand in the way that they did in the period up to 2006.” Glenn Stevens, Governor of the RBA, Statement to the Standing Committee on Economics, 20 August 2014

This fall in National income per capita is likely driven by the decline in the ToT and it’s expected that prices of our major resources exports will continue to fall as projects come online and supply expands. The question remains as to whether the decline in prices will be offset by the increase in volumes.

The latest 2014/15 Government budget papers clearly outlines the drivers of income growth, both past and future.

“The main sources of income growth nationally are growth in productivity, changes in the terms of trade, changes in output from increased labour utilisation, and growth in net foreign income.”

Future income growth in Australia will be impacted by two key factors – the ageing population and falls in the ToT. The chart below from the Budget Papers 2014/15 highlights the likely decline in per capita income between 2013 and 2025:-

“For annual incomes to grow at their historical average of 2.3 per cent over the period to 2025, annual labour productivity growth would need to increase to around 3 per cent per year to counteract the effects of population ageing and a falling terms of trade. This is well in excess of what has been achieved in the past 50 years, and more than double what was achieved in the past decade.” Source: Budget 2014/15

Drivers of Growth in Income – The hatched area represents the additional labour productivity growth required to achieve long run average growth in real gross national income per capita.


Source: ABS 5204.0 and Treasury.

“Productivity has consistently been the most significant source of income growth. However, over the past decade or so, it has been the dramatic rise in the terms of trade which has maintained growth in gross national income as productivity growth has waned. Over the next decade, the decline in the terms of trade is expected to detract from growth in incomes. This negative impact will be compounded by a declining contribution from labour utilisation as the population ages.” Source: Budget 2014/15

This also highlights the more structural issues facing the economy in the near term with regards to the ageing population.

There are alternative ways to view this same data. Nominal GDP provides a similar view of National output, but at dollar value. This measure overcomes potential issues where ToT declines are outweighed by growth in export volumes. The results are similar and on any measure, Nominal GDP growth is also tracking well below average. On a per capita basis and deflated by the CPI, nominal GDP growth resumed its annual decline in the latest quarter, declining by -1.2%:-

Source: ABS, The Macroeconomic Project

Growing Unemployment

At the same time that GDP has been growing ‘above trend’, the pool of total unemployed persons has been growing and this has been a most telling feature of the state of the economy over the last few years.

The circled areas in the chart below highlight the growth in total unemployed persons during the recession of the 90’s and that of the current period.

Source: ABS

In terms of duration, this current period of unemployment growth is similar to the recession of the early 90’s, which counted thirty-eight (38) consecutive months where the annual change in unemployed persons grew (using trend data). We are currently up to thirty-six (36) months where the annual rate of total unemployed persons has grown (and counting). Over this current period, total unemployed persons has grown by +180k persons – in the early 90’s recession, unemployment grew by over 400k persons.

The current rate of unemployment is higher now than during the GFC – yet output growth remains ‘above average’.

There are other indicators of labour market weakness as well. Firstly, growth in part-time (PT) employment has been the key driver of overall employment growth and proportion of total PT employed persons is now at its highest point, +30.5% of all employed persons. Overall growth in employed persons is currently 50% below its ten year average. This lower demand for labour is showing up in slower wages growth – the slowest rate of growth since the wage price index was first introduced. Finally, the participation rate has been declining since the end of 2010, and is only starting to stabilize this year. Not all of the people dropping out of the labour force are ‘discouraged’ workers, but the decline in participation understates the rate of unemployment in the economy.

Rising Labour Productivity

One of the interesting features of the National accounts recently is that labour productivity growth has been reasonably strong. Labour productivity is measured as GDP per hour worked. This is one part of overall productivity mentioned in the income section.

There has been a sustained increase in labour productivity since quarter March 2011, which, when sustained over time, should be a key driver of National income growth. That National income has been stagnant or falling over the same time suggests that ToT movements are so far having a greater impact on income growth.

Source: ABS

What is driving growth in labour productivity during this time is not clear, but while labour productivity has been improving, unemployment has been growing. The importance of this is that improvement in labour productivity essentially means that less labour is required to generate a given level of output. Going forward, this may mean an higher level of growth is required to start to reduce this pool of unemployed persons.

Defining a ‘good’ rate of growth

At this stage in our business cycle, a “good” rate of growth could be defined as a level of growth that is high enough to reduce unemployment without adding pressure to prices (inflation). A very broad rule of thumb that can provide an indication as to the level of growth that is required, is to add the current level of labour productivity growth with the current level of labour force growth to provide an indication as to the rate of real GDP growth required such that unemployment would no longer rise.

Growth in labour productivity means that less workers are required to produce a given level of output and on the other side, growth in the labour force adds workers to the economy.

The current annual growth in the labour force (at August 2014) is +2%, which equals the ten year average. The current annual growth in labour productivity is +2.8%, which is well above its ten year average of +1.3%. Therefore, real GDP needs to grow somewhere between 3.3% and 4.8% to ensure that unemployment would no longer rise. This is only a rough rule of thumb intended to highlight the level of acceleration that would be required in growth to start to reduce the pool of total unemployed persons.

Forecast Growth

Various forecasts of real GDP growth provide little evidence to suggest that such growth is likely or expected over the next few years (all other things being equal).

The OECD develops forecasts of the output gap (GDP growth less GDP potential). The most recent measurements from the OECD highlights that the current rate of growth is not reaching potential (roughly based on growth in productivity and labour force). The forecast for 2015 is for a further deterioration in that output gap:-


The forecasts contained in the Federal Government Budget 2014/15 also show that real GDP growth is expected to remain outside of this required range over the next several years at least.

Source: ABS, Aus Dept of Treasury

Its worthwhile noting that real GDP growth in the financial year ended June 2014 came in slightly higher than forecast, but it still wasn’t high enough to keep unemployment from growing.

Under these growth forecasts over the next several years, it’s likely that unemployment and under-employment will continue to grow. National income growth per capita will remain low in the face of further ToT declines and this will add further pressure to growth and government revenues.

The ability of the economy to grow at an accelerated rate will depend on:

  1. Both monetary and fiscal policy working in the same direction to temporarily fill the gap left by the private sector (investment & household spending). Fiscal policy is currently focused on tightening and is likely to remain that way until such time that there is an economic emergency or external shock necessitating a change. For the moment, it doesn’t seem likely that all budget cut measures will pass the Senate either, adding further pressure to the budget, but also reducing the contractionary effect.
  2. Whether current monetary policy can stimulate non-resources business investment and expansion. This is one of the more important drivers. Lower interest rates are helping to fuel higher mortgage growth (mainly investors/speculators) rather than productive growth in economy. Outside of Dwelling Construction and Mining, business investment has been lacklustre in the face of subdued local and global growth. It’s unclear that any further cuts to the official cash rate by the RBA would in fact stimulate business investment.
  3. Demand coming out of China – for the moment it appears that growth is slowing. It’s hard to know what to expect from China and forecasts span a very wide range of growth possibilities. It’s an enormous economy with huge potential for growth.
  4. Depreciation in the exchange rate – this would no doubt help local producers and exporters. But there is a downside in that a lower exchange rate could place greater upward pressure on interest rates – not great news for such an indebted economy, with higher interest payments adding further pressure to disposable incomes.
  5. Whether the government can implement its infrastructure investment plan (and various other structural reforms like taxation). Whilst the infrastructure investment would enhance output and likely employment outside of Housing and Mining in the short term, it would also have long term benefits for business development and future productivity growth. The success of such a program depends heavily on whether the investment is strategic and directed to building the infrastructure that will support sustainable business development, innovation and expansion. Going back to the budget chart on income drivers, future productivity growth will be crucial to offset declines in the ToT and the effects of the ageing population. I don’t hold my breath on this one, but I am hopeful.


The credit impulse strengthens in March 2014

Credit data released by the RBA shows growth in Total Private Credit accelerating, as at March 2014.

This should be a positive sign for the economy – changes in spending in the economy depend on changes in income and changes in net new lending (source: The components of this acceleration are also important indicators of where the economy may be headed and this is what I want to focus on in this post.

The main contributor to the acceleration in new credit continues to be investment housing credit. No surprise and no change. But the real news in this data is the ongoing turnaround in business credit. Whilst the size of the business credit impulse is still very small relative to the other credit components, it is now in positive territory. I’m far more enthusiastic about the improvement in the business credit impulse than the ongoing acceleration in housing credit growth. Schumpeter argues that there is a link between accelerating debt and accelerating incomes – if that debt has been used to fund entrepreneurial activity. In theory, that’s an investment in building the productive capacity of the economy, which is positive for growth in income and in employment. Certainly a part of the RBA’s intention with lowering interest rates has been to ‘rebalance’ investment towards the non-mining sectors. But business investment has been slow to respond and new credit for investment hasn’t grown on a large enough scale yet.

On the other hand, the change in monetary policy seemed to impact the speculative aspect of housing finance almost immediately. The majority of outstanding debt in Australia is related to housing and continued increases in house prices relies on accelerating housing lending/debt. Unfortunately, a large share of growth in new credit, and growth in household debt, continues to goes towards the transfer of ownership of houses in Australia.

Why is the credit impulse important?

The data released by the RBA is the stock of all outstanding credit which takes into account existing debt, new debt and debt paid down. More important than the growth in credit is the growth in new credit that is issued. Starting with a basic premise that borrowing equals spending, its new credit issued in an economy that partly drives new spending in the economy. The other source of new spending in the economy is growth in income – not covered in this post. Consider a simple example – if you borrow $10 each month for six months, total credit grows by $10 each month, but after month one, growth in new credit equals $0 or, in other words, there is constant growth in credit and therefore you only spend $10 each month. But if you borrow $10, then $15, then $25, then $40 and finally $60, then there is growth in credit and growth in new credit of $5, $10, $15 and $20. As a result, spending grows each month. So the importance of tracking the credit impulse is that it is one of two important sources of spending that will impact output and/or asset prices.

I first came across the credit impulse through the work of Professor Steve Keen in his quest is to build a more robust and accurate representation of the role of debt and money creation by financial intermediaries in the economy. In working through the impact of growth in new credit on aggregate demand, Professor Keen’s latest work suggests the impact of the credit impulse is also influenced by the velocity of money. His latest thinking:-

“[This formula corrects] a rule of thumb proposition that I have previously asserted, that aggregate demand is the sum of income plus the change in debt (Keen 2014; see also Krugman 2013b). The correct proposition is that, in a world in which the banking sector endogenously creates new money by creating new loans, aggregate demand in a given period is the sum of aggregate demand at the beginning of that period, plus the change in debt over the period multiplied by the velocity of money.”


I have not gone into the velocity of money detail for this post. Whilst I have quite simply represented the growth in new credit, it’s a useful view of credit nonetheless.

To what degree does the growth in new credit drive growth in output versus growth in net change in the value of assets? I think this is a fairly fundamental question that faces our economy and it comes down to the source of the growth in new credit.

Total Private Credit

The usual way to present the credit impulse is as a % of GDP so that we can relate the size of the growth in new credit to the size of the economy. But given that March quarter GDP will not be released for another month, I’m opting to present this data instead in its dollar amount in order to understand the general direction of the growth in new credit. All the credit components – housing, business and personal are all expressed in dollars in this post, which will serve as the basis for comparison.

My proxy for the credit impulse – the growth in new credit – bottomed back in the June quarter 2013. Despite being in negative territory, the slope of the curve has been positive, meaning that the decline is getting smaller. Even a negative credit impulse with a positive sloping curve will have a positive impact.

The dollar growth in new credit for total private credit is approaching its two previous post-GFC highs, but is still well down on growth in the years leading up to the GFC:-

Source: RBA, The Macroeconomic Project

This gives you a sense of the relative size of the current growth and its potential impact on the economy. But for the impulse to become a larger proportion of GDP, it needs to grow faster than GDP (we’ll know this when GDP data is released). The current size of the growth in new credit at Mar 2014 is $26.6b, up from $17.7b in Feb 2014.

The question now becomes which of the main areas of total private credit have been driving growth in new credit?

The four components that make up total private credit (each with their share of total outstanding credit) are – owner occupier housing (40%), investor housing (20%), other personal (6%) and business (33%). Below is the growth in new credit across these four (4) components and total private credit over the last twelve months:-

Source: RBA, The Macroeconomic Project

There have been some large shifts in momentum over the last twelve months and a more positive shift in direction in the first quarter of 2014. The obvious one is the improvement in business credit – this has clearly had the greatest impact on the growth in new total private credit. But the actual dollar size of growth in new credit for business is still small relative to the other components (at Mar ’14). Growth in new investor mortgage credit is the largest of all components, which has also accelerated in the first quarter. Growth in new credit for owner occupier mortgage and personal credit are on par, but are, respectively, flat and decelerating.

Housing Credit – owner occupier and investor housing currently 60% of total private credit

Investor housing credit currently makes up the largest proportion of the growth in new credit. In March 2014, growth in new credit was $12b, up from $10.3b in Feb 2014, despite only currently representing 20% of outstanding total private credit. So approximately half of the current growth in new credit in the economy is for investor housing finance.

The growth in new credit for investor housing is close to reaching its second highest point of the last ten years.

Source: RBA, The Macroeconomic Project

This is only one part of mortgage credit. More broadly, the growth in new mortgage credit was $18.5b in March 2014, up from $16.9b in Feb 2014. This includes the change in new owner occupier housing credit of $6.6b in mar 2014, which was unchanged from $6.6b growth in Feb 2014. This signals a slowing in growth momentum for owner-occupier activity.

The slope of the curves look quite different between owner occupiers and investors – steep for investors and less steep for owner occupiers. The steeper curve suggests faster/larger growth in new credit for investor housing and this is consistent with what we have seen in other housing finance data.

Growth in new credit for owner occupiers has been somewhat more subdued and at March 2014, is about half that of growth in new credit for investor housing finance. Although the slope of the curve started to steepen in late 2013, the latest data suggests that the momentum is starting to slow.

Source: RBA, The Macroeconomic Project

The overall growth in total new mortgage credit remains strong and is obviously driven by investor activity.

So what can we expect as a result? Intuitively, you would expect accelerating housing credit growth to show up in asset values. As long as we have accelerating debt, it’s likely that we will continue to see house prices grow. Below is the mortgage credit impulse plotted with the annual growth in the residential property price index until Dec 2013. There is a reasonably strong correlation between the two (0.68).

Source: ABS, RBA, The Macroeconomic Project

Some of the accelerating growth in housing credit will show up in GDP, but to a smaller degree, in Private Fixed Capital Formation. This part of GDP captures the value of the creation of new assets only – new dwellings and new alterations and/or additions will add to GDP in that quarter. This currently accounts for just under 5% of GDP at Dec ’13. According to the latest housing finance data, purchase and construction of new dwellings has accounted for only 12% of total housing finance over the last year (ex-refinancing). Many of the current First Home Owners grants have focused on the purchase of new dwellings as it’s the creation of new assets that is likely to stimulate the economy more because jobs and income are created through new projects, rather than through transferring ownership of existing dwellings.

The transfer of ownership costs (legal etc.) are recorded as a part of GDP under Private GFCF- ownership transfer costs, but includes all ownership transfer costs, not just those on dwellings. This accounts for approx. 1.4% of GDP at Dec ’13.

Overall, the majority of total private debt relates to housing – debt which continues to accumulate, for what is essentially an unproductive asset. The downside to this is that this debt for the most part does not contribute to growing the future earning capacity of the economy, employing people, innovating or generating productivity gains.

Business Credit – 33% of Total Private Credit

The growth in new credit for business was the bright spot in this report. For the first time since the RBA lowered interest rates in late 2011, the growth in new credit for business has reached positive territory. Business investment is the single area most likely to generate income growth, employment, innovation and productivity gains for an economy.

Source: RBA, The Macroeconomic Project

The growth in new credit for business started to turn positive from mid-2013, but growth accelerated recently. In five months, growth in new credit for business has turned from a large negative to positive growth: Jan ’14 -$11.7B, Feb ’14 -$5.2B and Mar ’14 +$2.6b. Looking at the relative peaks over the last seven years (chart above), there is still a long way to go though.

Where is the growth in new credit for business likely to show up?

The labour market has been improving over the last several months – indicating at least progress on business expansion. There has been a shift from PT to more FT growth in jobs, although it appears that hours worked has not grown at the same rate. But this isn’t directly where growth in new credit is likely to show up.

This is more likely to show up in business investment. Over the last year, business investment has been slowing down and some forward indicators suggest that this will continue. One of the key objectives of the RBA in its easing stance has been to influence business investment and specifically to ‘rebalance’ investment towards non-resource sectors in light of the coming slow-down in mining investment. Recall that the first interest rate cut happened all the way back in Nov 2011.

Business investment and capex are measured in several ways. One way, is via the private new capital expenditure and expected expenditure survey (ABS 5625). This is not the equivalent of, or a complete view of the business investment component from GDP, but provides detail of expected capex expenditure, especially with regard to mining and manufacturing. You can read the full details of the inclusions and exclusions on the ABS website, but ‘all other selected industries’ excludes capital expenditure by all private businesses including units classified to agriculture, forestry and fishing, education, and health and community services industries and capital expenditure on dwellings by households.

The slow-down in mining capex is evident in the actual private capital expenditure data (ABS 5625):

Source: ABS 5625

I’ve opted for quarterly growth in this chart because I think it highlights the change in capex perfectly – “consistently slowing”:-

  • Mining capex growth has slowed since Sept 2011 and started to record quarterly declines from Dec 2012. At Dec 13, growth was -0.6% versus Sept qtr. 2013, a far cry from the high growth recorded in the mid-2000 and during 2010/early 2011. But this not the “mining capex cliff”.
  • Manufacturing capex growth peaked in Jun 2011 at 5.2% quarterly growth and since Mar 2012 has been in decline. Over the last year, the quarterly declines have become smaller, but capex spending continues to shrink – it’s not a drop off a cliff, but it’s a consistently lower value. At Dec 13, capex was -1.7% versus the prior quarter.
  • “All other selected industries” capex has been declining quarter on quarter since Jun 2011. There were two brief quarters of small growth in Jun and Sept 2013, but Dec was back to decline of -0.6% versus the prior quarter. As mentioned though, this is a not a complete representation of all other industries. See note above.

If you really want to know what the coming mining capex cliff will start to look like, then look no further. From the same ABS catalogue (5625):-

Source: ABS 5625

I’m referring to the 2013-2014 labelled graph above. The December ’13 quarter is marked ‘5’, which is half way through the 2013/14 financial year. Estimate 5 is made up of actual capital expenditure for the Sept and Dec ’13 quarters (as at the end of the Dec 13 quarter), plus the short term estimate for the Mar and Jun ’14 quarters. At this time, total capex for 2013/14 financial year is estimated to be $167,066m.

At the end of Dec ’13 quarter the first longer term estimate of capital expenditure is provided (E2) for the next financial year. This is the estimate marked ‘1’ for 2014- 2015 – and this is the estimate that has many spooked. Total capital expenditure is estimated at $124,880m, which is -17.4% lower than for the same period of 2013/14. The main reason for this lower estimate was a decrease in mining capex of -25.2%.

As mentioned, these estimates won’t add up to the investment data shown in the National Accounts – it’s a smaller view of what you would see in the GDP figures, but more detailed with regard to an ‘expectations’ view. The full explanation can be found on the ABS website.

So, looking at the more complete view of business investment from the latest GDP figures at Dec 2013 – this is what the quarterly growth in Private Gross Fixed Capital Formation (PGFC) for total private business investment looks like in the National accounts (ABS 5206.002):-

Source: ABS 5206.002

This includes all private business investments in non-dwelling construction, new machinery & equipment, cultivated biological resources and intellectual property. This represents approx. 17.1% of GDP at Dec ’13. I have excluded private fixed capital formation for new dwellings, new alterations to dwellings and ownership transfer costs – as this relates to mortgage activity.

Growth in total private business investment has been slowing since June 2011 and turned negative in the Sept 2013 quarter and the quarterly decline accelerated in Dec ’13. Given this consistent decline, it’s difficult to see that, based on the small size of the growth in new credit for business, that there will be a large turnaround in business investment at this stage.

Other data sources, such as the 2014 quarter one NAB Business Conditions report highlights a pickup in capex intentions in the coming twelve months, but at the same time points to ‘patchy’ investment intentions across the non-resources sectors.

Source: NAB

The latest NAB Business Conditions report for May 2014 (further out than the credit data I have presented here), suggests further gains in capex spending, but not enough to counter the falls in mining investment:-

Source: NAB

Given the size of the growth in new credit for business, I wouldn’t expect to see large improvements in business investment, but would at least expect a slowing of the decline for the March 2014 quarter GDP. There doesn’t yet appear to be high enough non-resources investment growth to counter the end of the mining investment phase.

Personal Credit – 6% of Total Private Credit

Over the first quarter of 2014, growth in new credit for total personal credit has been decelerating. Growth in new credit for personal lending reached a high of $11.6b in Oct 2013 and that growth has virtually halved since then to $5.4b at Mar 2014.

Source: RBA, The Macroeconomic Project

Total personal credit represents activity conducted with a bank on a non-business basis (excluding housing). This includes all manner of personal spending, so there isn’t one good place where you would expect this growth in new credit to impact output. It would likely be a combination of retail sales, new car sales and/or other discretionary spending etc.

Either way, growth in new credit for personal may be pointing to a slow-down in growth of the more discretionary spending categories (this is most likely where you’d find personal credit used).

Has this started showing up in Q1 retail sales? The month on month growth in retail sales has been slowing (sales remain high though), and whilst it does look like there is a correlation between the two measures, the correlation isn’t strong at all (0.23).

There was a stronger relationship between the actual personal credit impulse (as a % GDP) and the annual change in the Household Final Consumption Expenditure (HFCE) component of GDP (0.46) – at Dec ’13. The HFCE component of GDP is the single biggest part of GDP approx. 50%, so clearly spending that shows up here is ‘funded’ by a combination income as well as change in new credit.

Source: ABS, RBA, The Macroeconomic Project

It’s still not an ideal relationship/proxy, but does at least provide a very general view.

One thing to bear in mind is that a slowing in new personal credit growth could also reflect the current improved labour market conditions. It’s possible that income growth via increased labour market activity may counter any slowing in the growth of new personal credit. Using trend numbers for the first four months of this year we’ve seen +50k FT jobs (the first 4mths of 2013 was -11k FT jobs) and +22k PT jobs (the first 4mths of 2013 was +61k PT jobs) added. Unemployment has ‘only’ grown by 6.8K in the first 4mths of this year (versus 26.7k for the same time last year). This may have an impact on consumer discretionary spending, possibly cancelling out any slow-down in growth of new credit in personal spending for now.

Overall, the majority of the growth in new credit is going into housing – via investor activity. But it’s worth noting that growth in new credit for owner occupier housing appears to be slowing. For the moment, this is still likely to result in continued house price appreciation. Whilst business investment and expected capex, so far, looks like it will fall short of countering the drop in mining investment, the growth in new credit for business is an encouraging sign. But this needs to continue to accelerate in order to fuel business investment in new, productive activity in the economy. Business will likely expand investment if there is a strong growth business case. The continued high level of the Australian dollar, any potential impact of a slow-down in China and changes to fiscal policy are going to weigh on these business investment decisions.














Growth Re-balancing & the Credit Impulse in Australia

On the 1/11/11, the RBA Board commenced what has now become a series of eight (8) interest rate cuts, reducing the benchmark rate from 4.5% to 2.5% (as at Oct 2013). These rate cuts came on the back of a relatively strong AUD, weakening commodity prices, falling Terms of Trade, a softening in the domestic labour market, weaker house prices and overall weakening domestic demand as evidenced by lower than expected CPI.

Since the Oct 2012 board meeting, it’s clear the RBA has recognised the approaching peak in resources investment i.e, the “mining capex cliff”. In its own words “it will be important that the forecast strengthening in some other components of demand starts to occur.” Emphasis added by me. Those “other components of demand” include business, personal & housing spending/investment. According to the RBA, the aim of lower interest rates has been to encourage sustainable growth in the economy consistent with achieving the inflation target and to rebalance growth with a combination of depreciating exchange rate and lower interest rates to stimulate non-mining investment. 

So, two years and eight rate cuts later – is there traction in the economy? Is ‘rebalancing’ underway? I want to look at this through the lens of the credit impulse in Australia.

Demand for Credit

Recently, the RBA released its Lending & Credit Aggregates for Sept 2013.

Source: RBA 

Besides the growth in Government borrowing, Investment and Owner Occupier housing finance have been the main drivers of growth in total credit. It’s easy to get caught up in % changes, but these two areas of credit alone contributed 87% of the actual dollar growth (ex Government) in all lending over the last year.

The very big concern is the fact that Business credit growth is low. Business credit represents 34% of total credit at Sept 2013, but only accounted for 9% of the actual dollar growth in credit over the last year. Other Personal credit has similarly underperformed.

Government credit (not included in Total Credit) has seen strong growth.

The Credit Impulse

Growth in credit is the usual way to relate developments in credit with developments in the economy. Possibly a more insightful way to measure this is by growth in new credit issued relative to the size of the economy. From, if someone is borrowing a fixed amount each month, then spending is constant (the assumption is that borrowing=spending). There is growth in credit, but no growth in spending because the amount borrowed is the same each month. The credit impulse would be zero. If that person borrows more each and every month, then new credit is accelerating and result is that spending is also likely to grow. In this case, the impulse is increasing (there is a positive slope to the line). This perspective follows the change in the flow of money and credit, not the stock. The above chart/table “demand for credit” is the % change in stock.

Total Private Credit Impulse

Below is the estimated credit impulse in Australia for total Private credit comprising Business, Personal and Mortgage credit. It’s calculated by taking the change in new credit expressed as a % of GDP for that quarter. Whilst I have credit data up to Sept 2013, I only have GDP up to June 2013.

Source: RBA & The Macroeconomic Project 

The slope of the line is what counts and since July 2012 the slope has become negative, despite eight (8) interest rate cuts.

Total Private credit has been growing (in nominal terms) but at a decreasing rate. Between June 2012 and June 2013 the growth in new credit has been getting smaller as a % of GDP. For example, new credit grew by $91b between June 2012 and June 2011, but new credit only grew by $61.4b between June 2013 and June 2012. Therefore the change in new credit is -$29.7b or -2% of GDP – a negative credit impulse at June 2013. 

To keep funding new growth, new credit needs to grow by an increasing amount.

Source: RBA, The Macroeconomic Project 

In terms of trend change, real Private credit growth has started to increase again since July 2013 – the red arrow on the chart above. We’ll need to await Sept 2013 qtr GDP figures to understand the size of the impulse.

So with a negative credit impulse, we should have seen a decline in spending in the economy. But the other component to view together with the Private credit impulse is the Government credit impulse.

Source: RBA, The Macroeconomic Project 

Up until June 2013, the Government credit impulse has been strong – as witnessed by the steepness of the curve (chart above). When you compare the change in new credit as a % of GDP (the actual impulse), the positive Government credit impulse of 2% of GDP counteracts the negative -2% print of the Private credit impulse. You could argue that growth in the economy has been held steady by Government spending.

But during July – Sept 2013, real Government credit growth looks to be slowing down again with quite a substantial drop between July & August 2013. Luckily, the growth in Private credit that we saw above may counteract the Government slow-down in this latest Sept 2013 quarter.

Source: RBA, The Macroeconomic Project 

Looking at the Private and Government credit impulse can provide a general view over growth in the economy. One way to look at the effect on the economy is to look at recent trends in GDP growth;

Source: ABS 

Quarterly GDP growth ‘peaked’ around Dec 2011 (trend) and has continued to slow since then. This isn’t the lowest growth environment that we have been in, but the trend in growth in real GDP indicates that the economy is not ‘rebalancing’ after eight (8) interest rate cuts. This is consistent with the low credit impulse in the economy.

But not all pockets in the economy are performing equally. Breaking down the credit data provides some insight as to the areas that have and have not (yet) responded to rate cuts.

Business Credit Impulse

The business credit impulse has been in a down trend since June 2012 qtr and this is the most concerning insight in this study.

Business credit is the second largest area of total credit behind owner occupier housing finance so it has a far reaching impact on the economy. Since Dec 2011, the Business credit impulse has gone from +3.3% to -2.3% of GDP.

Importantly, business investment is the engine of the economy. If business is investing in new technology or additional capacity, then this likely to drive future employment and income growth. This is an important source of the RBA’s sustainable economic growth.

Source: RBA and The Macroeconomic Project 

Growth in real Business lending has been slowing down since June 2012 and started declining (year on year) around March 2013. Make no mistake, the Business credit impulse has been by far the largest contributor to the total Private credit impulse and growth of new credit for Business represents a larger % of GDP than growth in new credit for Mortgages. The performance of the Business credit impulse has shifted dramatically over this time period – as you can see from the chart. Since the RBA started cutting rates at the end of 2011, the Business credit impulse has gone from positive to negative, not the other way around.

Real Business credit growth has been zero or negative since November 2012;

Source: ABS, The Macroeconomic Project 

This means that total outstanding Business debt has been getting smaller – more debt is paid down than new credit is raised.

Source: RBA, The Macroeconomic Project 

As you can see from the chart above, the last 3 months of growth suggest a slightly improving Business credit impulse for Q3 2013. 

Despite eight (8) interest rate cuts, total Business credit has not grown, and in fact has become smaller as a % of GDP – from 62% in 2008 to 47% in June 2013. The impact of this deleveraging is contraction. The only upside is that business will be in a better position to invest should (when) demand conditions pick up.

These next two charts provide some further context about the current business environment – non-mining profits falling as a share of GDP and even mining profits have stopped accelerating as a % of GDP. Business profits have been squeezed and this is showing up (on aggregate) in cost cutting (see recent employment reports) and what appears to be a reduced appetite for debt/investment for future growth.


This is another view of business investment – by industry sector. Share of business investment in most industries, with the notable exception of mining, is declining. This is exactly the situation that the RBA is aiming to ‘rebalance’ given the forecast for mining investment to slow. 


The NAB Monthly Business Conditions report has shown that excess capacity continues to plague the economy across multiple sectors (including mining). There is clearly no reason for business (on the whole) to invest in building capacity;- 

The one thing that immediately jumps out to me on these last two charts is the discrepancy between the growing share of Mining investment and the low and falling capacity utilisation in Mining. 

The other important factor affecting business (exporting ones) is the exchange rate. The aim of the RBA has been to rebalance growth through a combination of a lower $AUD and lower interest rates. Despite the spike down in 2012 (probably more due to speculation of US FED tapering its QE program than interest rate differential), the exchange rate has remained fairly high. The benefit of a lower exchange rate is that exports become more competitive – which should fuel higher investment and employment locally. It also makes imports more expensive, possibly helping locally manufactured goods to compete domestically, but increasing costs of inputs priced in USD eg fuel.


Overall trading conditions continue to be challenging and business has not been investing. In the short-term this does not paint a positive picture for rebalancing economic growth. 

Housing Finance Credit Impulse

This contrasts with the acceleration in mortgage credit growth, especially for Investor housing finance, during this recent rate cut period. There appears to be an increasing disconnect between the relatively weaker underlying business conditions and say, the strength of the housing market.

Since Dec 2011, the mortgage credit impulse in Australia has gone from -2% to -0.09% of GDP at June 2013. The high point was May 2013 at 0.33% of GDP. Clearly a far smaller impact than the Business credit impulse.

Source: RBA, The Macroeconomic Project 

Whilst there is appears to be a slight pull back in the latest months to June 2013, the growth in new mortgage credit (not as a % of GDP) appears to hit a new high in Sept 2013. This is also reflected in the accelerating rate of growth in total real mortgage lending (chart below) – yes that small blip at the end of the chart;

Source: RBA, The Macroeconomic Project 

At this level, we can start to ponder where the main effect of the Mortgage credit impulse is felt. The effect of rising mortgage debt and a rising mortgage impulse (rising faster than housing supply) could be seen in economic growth, but is likely to show up more directly in a change in house prices.

This doesn’t mean that there aren’t benefits from a GDP perspective. These benefits might include transaction costs based on the exchange of dwellings – stamp duty, solicitor fee’s, realtor fee’s etc. Rising house prices can signal the potential for new supply requirements. Construction of new dwellings would have a far reaching economic growth impact through higher employment, income etc. The final way is through higher asset prices – and the ability to use equity to fund more spending. But few scenarios here relate the growth in debt to growth in the future earning capacity of the Australian economy.

Most of the recent lift in the mortgage credit impulse is due to Investment lending. The steepness of the Investor credit impulse curve shows just how strong Investors have been in this market relative to Owner Occupiers.

Since the Dec 2011 qtr, the credit impulse has moved from -1.3% of GDP to +0.17% of GDP in June 2013. It reached a high of 0.7% of GDP in Jan 2013. Again, this is a far smaller impact relative to the Business credit impulse.

Source: RBA, The Macroeconomic Project 

Investors have been leading the way during this spate of interest rate cuts, and whilst the chart above shows momentum stalling, the growth in new credit between July & Sept 2013 has accelerated again. See below growth in real Investment housing credit;

Source: RBA, The Macroeconomic Project 

There has been far more gradual growth in the Owner Occupier credit impulse (below). Despite a negative credit impulse, the slope is positive and that’s the important point. Since the start of rate cuts in Dec 2011 the impulse has improved from -0.8% to -0.27% of GDP in June 2013. The strength in the Investor-led credit impulse has helped to make up for the weaker, but improving, Owner Occupier credit impulse;

Source: RBA, The Macroeconomic Project 

Growth in real Owner Occupier financing has also grown fairly consistently since Feb 2013 and the latest 3 months of data suggests that the credit impulse is likely to continue its modest improvement into the Sept 2013 qtr.

Source: RBA, The Macroeconomic Project 

What it is also saying is that owner occupiers have been quite late to the party on housing.

Personal Credit Impulse

Personal credit has seen a recent uptick in activity which is a positive sign for consumption spending growth in the economy. Since Dec 2011, the Personal credit impulse has gone from -0.3% to +0.2% of GDP. A smaller effect but it will impact spending growth nonetheless.

Source: RBA, The Macroeconomic Project 

Without a doubt, there has been an improvement in rate of growth. But the improving credit impulse can be related back to a slow-down in the decline of real personal credit growth – note the chart below. Current growth is a far cry from the growth in personal credit pre-2008 of anywhere between 5% and 15% growth.

Source: RBA, The Macroeconomic Project 

In the latest months from July to Sept 2013, real personal credit declined by 1% each month – which is an improvement over the June result of -2%.

The stock of outstanding Personal debt has fallen from a high of 13% of GDP to 9% of GDP in the June 2013 qtr.

Source: RBA, The Macroeconomic Project 

The trend is improving but it’s not exactly a ‘snap-back’ rally in personal credit growth. Its also possible that some of the lending traditionally called ‘Personal’ may now be accounted for in mortgages via redraw and offset facilities.  

But with household mortgage debt is back near its highs (84% of GDP), a weak labour market (PT growth over FT growth) and wage growth slowing, its no wonder Personal credit growth is low. 

Unless one of these constraints is removed/reduced, personal credit growth is likely to remain subdued. 

But counteracting this data is the improving consumer confidence index. Together with the slightly improving personal credit impulse, it could be signalling a shift in consumer attitude back to greater consumption. If we see improvements in the labour market, then spending and confidence are likely to improve further.

There have been two key drivers of the credit impulse in Australia over the last six months; 

  • the negative performance of the Business credit impulse, &
  • the positive performance of the government credit impulse

The impact of an improving Mortgage & Personal credit impulse has not been enough to counteract the negative Business credit impulse. Several points about this:-

  • Its been a lucky co-incidence that Government borrowing has helped to stave off the negative impact of the Business credit impulse. But with the Liberal government committed to bringing the budget back into surplus, Government may not be a source of spending growth in the future.
  • In a later post I’ll highlight that the Mortgage impulse and the resulting impact on house prices, does not reflect a broad-based uplift in housing – which is probably why the mortgage impulse hasn’t had a more influencing effect. This is really a much bigger issue. The effect of an improving mortgage impulse will likely stimulate house prices – but is it big enough to rebalance growth in the economy? As more established houses are sold at higher prices, more debt is created but this debt accumulation isn’t an investment in the future prosperity of the economy.
  • The real issue for our economy is the contraction of business activity ie via investment & cost cutting – in response to slack/capacity in the economy. Why is that? Demand for debt (& therefore spending ability) seems constrained apart from investment housing. The shift in interest rates hasn’t moved the credit impulse in a proportional way. Accumulation of debt, together with income, has been a source of spending growth in the past. So do we now have our fill of debt?

The huge fear is that as a result of lower interest rates, we’ve only managed to see rising house prices, more debt, little/no improvement in business investment and therefore no change or improvement in economic growth prospects. If business isn’t investing in expanding capacity or improving competiveness (beyond reducing costs) then the RBA will be hard-pressed to achieve its rebalancing.