An economic overview by Michael Blythe, Chief Economist of Commonwealth Bank. Presented at the Resources & Energy Symposium 2012

1. CEO Conference
A Macro Look at Resources
Resources & Energy Symposium
Michael Blythe
Chief Economist
(612) 9118 1101
michael.blythe@cba.com.au
May 2012

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2

3. The Big Picture
Outperforming & underachieving!
REAL GDP REAL GDP
Index ( p
(Sep'08= 100)
) Index % (annual % change) %
110 110 6 6
Lehman Australia
collapse
105 105
Trend
4 4
US
100 100
NZ
UK
2 2
95 95
Europe
Japan
90 90 0 0
Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Sep-98 Sep-01 Sep-04 Sep-07 Sep-10
The Australian economy continues to outperform other advanced economies.
But domestic growth is running below trend (3¼% per annum).
annum)
3

4. Resources & The Big Picture
Bigger than Ben Hur
USD COMMODITY PRICES USD MINING INVESTMENT
% %
index (log scale, 1860=100)
scale index (% of GDP)
5000 5000 10 10
Source: The Economist Source: RBA/CBA
"China" 8 CBA 8
(f)
OPEC
II 6 6
500 American
A i 500
Civil War Korean Previous
War 4 booms 4
OPEC
WWI I
2 2
WWII
50 50 0 0
1860 1880 1900 1920 1940 1960 1980 2000 1861 1881 1901 1921 1941 1961 1981 2001
The emergence of China and the commodity boom is the key defining feature of
p
the economic landscape.
4

5. Resources & The Economy
The good – income
The commodity story is an income
COMMODITY INCOME BOOST* story.
% (% of GDP) %
4 4 The numbers:
– the income injection fro higher
commodity prices has been worth
2 2 1-2%
1 2% of GDP pa over the past
eight years;
– incomes are $7,100 per person
0 0 per annum higher than otherwise;
2011/12
to – a ship load of iron ore “bought”
*Source: CBA calculations 2012/13
2,200
2 200 flat screen TV’s in 2005 –
TV s
-2 -2
1994/95 1998/99 2002/03 2006/07 2010/11
now buys 22,000!.
Source: RBA Governor Glenn Stevens Nov’10
5

6. Resources & The Economy
The bad – a “patchwork” economy
ECONOMIC ACTIVITY
Consensus has trend GDP growth
Index (2010/11 = 100) Index over next few years and resources
145 145
Source: RBA , CBA accounting for ½-⅔ of that growth.
Implications:
Mining – mining-related economy to expand at
130 GDP 130
≈9-16%pa over next two years;
– non-mining economy to grow at just
1½-2%pa if overall economy to be
115 Non-mining 115 kept within the “speed limits”.
p p
GDP
GDP
100 100
2010/11 2011/12 2012/13
6

7. Resources & The Economy
The ugly – a high AUD
AUD EXPECTATIONS ESTABLISH FOREIGN OPERATIONS?
(average for the next 10 years) (% of respondents)
95
US
cents Source: CBA AUD Barometer Total
90 Financials
Average of
past ten years
Other
85
Consumer
80
Industrials
75 Materials
M t i l
Resources
70 *Source: CBA AUD Barometer
Importer Exporter Both imp. &
export 0 15 % 30 45
Most businesses now believe the Aussie will be permanently higher
High
Hi h AUD i h i an i
is having impact on capex and labour hiring plans.
t dl b hi i l
7

8. Maximise The Benefits
Minimising domestic constraints - exports
CAPEX & PROJECT STATUS COAL EXPORT CAPACITY
% of Index Mtpa Mtpa
24
GDP 400
Under
consideration* Committed
450 capacity 450
(adv 2-years, rhs)
20 300
Business 350 350
capex
16 200
(lhs) Capacity
Exports
12 100 250 250
*Source: ACCESS Economics Source: RBA/BREE
8 0 150 150
Mar-02 Mar-05 Mar-08 Mar-11 2005 2007 2009 2011 2013 2015
The peak impact of the mining construction boom is still some way off.
A new growth d i
th driver will be needed eventually – resource exports need to rise.
ill b d d t ll t dt i
8

9. Maximise The Benefits
Minimising domestic constraints - costs
Heavy construction focus raises cost
y
$/wk CONSTRUCTION WAGES $/wk
risks in an environment of skill
1300 1300
QIV - 2011
shortages and pressures on
materials.
1200 1200
1100 1100 A theme in recent RBA commentary
is the need to contain nominal labour
1000 1000
cost growth and boost productivity
growth.
900 900
Real wages
800 800
6 7 8 9 10
Share of labour market
9

10. Maximise The Benefits
Getting policy right – Pt I
The non-mining economy and the
HOUSEHOLD SPENDING
% (% of GDP) %
household component of it are bearing
66 66 the brunt of structural adjustment.
Policy
P li makers have a role to play:
k h l t l
63 63 – lower interest rates will help;
– targeting low-middle i
t ti l iddl incomes and small
d ll
6%
of GDP
business for support will help;
60 60 – need to get tax p
g policy right – scrapping
y g pp g
company tax cut and 50% discount on
interest earnings is disappointing;
57 57
– changing superannuation rules (again)
Sep-59 Sep-68 Sep-77 Sep-86 Sep-95 Sep-04 is disappointing;
10

11. Maximise The Benefits
Getting policy right – Pt II
RANKING OF COUNTRIES FOR MINING INVESTMENT BY KEY DECISION CRITERIA: 2011
(highest ranking for each category is 10 so maximum score is 70) Source: Behre Dolbear Mining Survey
RANK COUNTRY ECONOMIC POLITICAL SOCIAL PERMITTING CORRUPTION CURRENCY TAX TOTAL
SYSTEM SYSTEM ISSUES DELAYS STABILITY REGIME POINTS
1
Table on9
Australia
A t li 8 8 8 10 9 5 57
2 location 9drivers
Canada 9 4 4 10 9 7 52
3 Chile 9 9 7 6 8 8 4 51
4 Brazil 7 8 5 5 5 9 6 45
5 Mexico 8 8 2 7 6 6 7 44
6 USA 8 9 3 1 10 7 3 41
7 Colombia 6 7 6 6 5 5 4 39
8 Tie Botswana 6 5 5 5 5 5 6 37
8 Tie Peru 6 6 4 4 5 7 5 37
↕
25 Russia 1 1 3 3 1 2 5 16
Global investment decisions depend on more than tax regimes.
Even if Australia dropped to “1” for tax regime would still rank No. 2 globally
1 regime, No globally.
11

12. Maximise The Benefits
Selling the story – the unhappy consumer
Households are unhappy.
PERSONAL CIRCUMSTANCES
% (net % of respondents) %
40 40 General feeling that the “benefits” of
the resources boom are not being
shared around while the “costs” are:
h d d hil th “ t ”
20 20
Better in six – no tax cuts - carbon tax and flood
months time
levy instead;
y ;
Better
0
than six
0 – high Aussie dollar hurting some
months key sectors;
ago
-20 -20 – household budgets under pressure
(utilities, health etc);
Source: CBA Viewpoint – retirement savings struggling;
-40 -40
Apr 09 Jan 10 Oct 10 Jul 11 Apr 12
– job security fears.
12

13. Maximise The Benefits
Selling the story – sharing the spoils
SHARING THE COMMODITY BOOM SALARIES: WHERE SPENT
(
(cents per $ of revenue)
p ) (% of total earned in region)
%
Leakage offshore 100
Payment to
domestic
shareholders 75
Payment of royalties
& taxes Stays in
y
50-60c of 50 region
every $ of
Buying domestic income Leaves
services & imports remains in region
into resources sector Australia 25
Paying domestic
labour
0
0 15 30 45 Northern WA Central Qld
Source: RBA Source: CBA Viewpoint
RBA calculations are that 50-60¢ of each $ of resources revenue remains in Aust.
The benefits of the boom do spread through the broader economy.
economy
13

14. Global Issues
Demand matters
CHINA: GDP & POLICY CHINA: CONSTRUCTION & POLICY CHINA: STEEL & POLICY
%pa (annual % change) %pts %pa (change) (change)
%pts %pa %pts
6.0 -3.5 40 -3.5 60 -3.5
Ch in reserves Crude steel
GDP requirement ratio production
(ch in annual (6 mnth change
change, (ann ch in g
( growth, lhs)
, )
3.0 growth rate, lhs) -1.4 20 adv 12 months, rhs) -1.4 30 -1.4
0.0
00 0.8
08 0 0.8
08 0 0.8
08
Ch in reserves
requirement ratio
-3.0 (6 mnth change, 2.9 -20 2.9 -30 2.9
adv 14 months, rhs)
d th h ) QI Ch iin reserves
Floor space requirement ratio
under construction
(6 mnth change,
(ann ch in growth, lhs)
adv 8 months, rhs)
-6.0 5.0 -40 5.0 -60 5.0
Jan-02 Jan-05 Jan-08 Jan-11 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12
Even if domestic settings are right, our ability to maximise the benefits will depend
on offshore events beyond our control.
14

15. Global Issues
So does the composition of growth
TRADE & PRODUCTION CHINA & EXPORTS
(
(Jan'08=100)
)
Index
I150
d Index
150 (% of a country's exports that remain in China)
country s
90
%
Emerging Asia Source: HKMA
industrial
production
130 130
60
110 Advanced 110
economy
imports
30
90 90
Source: BEPA
0
70 70
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Phil. Thai. Mal. Sing. Kor. Jap. NZ Indo. Aus.
Asian growth is increasingly domestically driven.
Australia is more exposed to the Asian domestic story
story.
15

16. The Long Run
Middle income consumers
CONSUMPTION SHARE & INCOME
The Chinese consumer is set to
Consumption
100
(% of GDP) become an important economic
driver.
Incomes at the point where the
75
consumption share typically lifts.
USA
Expanding global middle class to
Japan
underwrite consumer demand for:
50
South – larger and better quality housing;
Korea
– more and better quality food;
China Source: IMF – more consumer durables;
25
0 20 40 60
– more education services;
GDP/capita (PPP)
– more holidays.
16

17. A Look into the Abyss
More volatility?
GENERAL GOVERNMENT DEBT IMF defines stabilisation as achieved
Title (advanced economies) when advanced economy gross debt at
120 of
% % 120
of
GDP GDP 60% of GDP (pre-crisis median).
Adjustment is a lengthy process – IMF
scenarios stretch out to 2030
80 80
You
Extended timeframe indicates financial
are market volatility will be an enduring
here
feature.
40 40
“Asia” determines Australian growth
and incomes. “North Atlantic”
Source: IMF
economies drive sentiment and
0 0
financial markets.
2007 2012 2017 2022 2027
17

18. CBA Economic Forecasts
2009/10 2010/11 2011/12 2012/13
Economy (a) (a) (f) (f)
GDP (% ch) 2.3 2.0 2.8 3.3
Of which: Consumer spending (% ch) 2.5 3.1 3.3 2.9
Business Investment (% ch) -5.2 6.4 20.1 12.3
Unemployment (%) 5.5 5.1 5.3 5.5
CPI (% ch) 2.3 3.1 2.3 2.6
Wage Price Index (% ch) 3.1 3.8 3.7 3.9
Terms-of-Trade
T fT d -4.1
41 20.8
20 8 4.5
4 1.5
1
Current account balance (% of GDP) -4.3 -2.4 -2.4 -2.8
Underlying Budget balance (% of GDP) -4.2
42 -3.7
37 -2.8
28 0.2
02
18

19. CBA Market Forecasts
Markets Jun’12 Sep’12 Dec’12 Mar’13
Australia Official cash 3¾ 3½ 3½ 3½
90-day bills 3.8 3.6 3.6 3.6
3-year bonds 2.7 2.7 2.8 2.9
10-year bonds 3.5 3.6 3.8 3.9
3-year swap 3.4 3.4 3.4 3.5
10-year swap 4.3 4.4 4.6 4.6
USA Fed funds 0-¼ 0-¼ 0-¼ 0-¼
2-year bonds 0.2 0.3 0.4 0.4
10-year b d
10 bonds 2.0
20 2.2
22 2.5
2 2.7
2
Spreads AUS-US 10 yr 150 140 130 120
AUS 3-10 yr 80 90 100 100
FX AUD 0.98 1.01 1.03 1.04
TWI 73.9
73 9 75.8
75 8 76.8
76 8 77.1
77 1
19

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