Statement on Monetary Policy – August 2006
Foreign Trade and Capital Flows
Commodity prices and the terms of trade
Recent increases in mineral resources prices have brought Australia’s terms of trade to their highest level since the wool boom of the 1950s, although developments in commodity markets suggest that the upswing might not have much further to run (Graph 40). The terms of trade have risen 33 per cent over the past three years, including an estimated increase of around 1 per cent in the September quarter. This upswing has mainly resulted from the sharp increases in prices of Australia’s main resource exports, such as coal, iron ore and base metals. Over the next couple of years, an expansion in the global supply of some resources is expected to put downward pressure on their prices, and together with growth in import prices, this is likely to result in some easing in the terms of trade. Nevertheless, the terms of trade are likely to remain at a very high level in the near term, as there is little sign of much slowing in demand for commodities, and it is likely to take some time for much of the additional global supply to be brought on line.
The RBA’s index of commodity prices (ICP) rose by 0.9 per cent over the three months to October, driven by an increase in base metals prices (Graph 41, Table 10). In contrast, rural commodity prices fell slightly over this period, and have increased much less than minerals prices over the past few years. The recent increase in the base metals component of the ICP was driven in particular by a 25 per cent increase in nickel prices. The price of nickel rose 160 per cent over the year to October, around double the increase in the base metals component overall. This reflects disruptions in nickel supply, which have compounded the effects of buoyant world demand and low global inventory levels that have been supporting most base metals prices for some time.
Prices of other resources have been more stable. As noted in previous Statements, 2006/07 contract prices for iron ore and coking coal were settled effective from the start of April. Data to September indicate that essentially all of the 19 per cent increase in iron ore prices and most of the 18 per cent fall in coking coal prices have now passed through to export prices. However, contract prices for steaming coal are still not finalised, although it is likely that the agreed prices will be little changed or slightly down from last year.
Rural commodity prices have been broadly steady in aggregate for most of 2006. Sugar prices are at high levels, but have fallen substantially over recent months in reaction to expectations that global supply will outstrip demand in the coming year. In contrast, wheat prices have risen lately, as poor weather conditions in many wheat-growing countries have led to downward revisions to global production. The deterioration in growing conditions in Australia has had a noticeable effect on world wheat prices over the past three months.
Export values have increased strongly in recent periods, although growth in volumes has been more contained (Graph 42). Resource export volumes appear to have been broadly flat in the September quarter, although they were up by 6 per cent over the year. Exports of iron ore and LNG increased solidly over the year. Resources export earnings were almost 30 per cent higher over the year, reflecting earlier increases in prices. Volumes are likely to strengthen in coming quarters given that a number of resource projects have recently been completed or are about to be completed. For example, the Enfield oil development, which has a capacity to produce up to 100,000 barrels per day, started production on 24 July, with its first exports being delivered in the quarter. Similarly, the Darwin LNG compression plant, which commenced operations in February, is still ramping up its production.
The volume of manufactured exports is estimated to have increased solidly in the September quarter, and by around 3 per cent over the year. Growth in this category of export earnings has been more subdued in recent years than in the 1990s, due to intense competition from developing nations. Prospects are for continued moderate growth in manufactured exports, given the favourable outlook for world growth and thus demand.
Rural export volumes, which account for around one-sixth of Australia’s exports, are estimated to have risen in the September quarter, taking growth to around 10 per cent over the year. However, the outlook for rural exports has worsened significantly, due to continuing dry seasonal conditions. As discussed in the chapter on the drought, ABARE has lowered its forecasts of the 2006/07 wheat crop from 16.4 million tonnes in September to 9½ million tonnes, which would constitute a 60 per cent decline from the previous year. The fall in exports should be somewhat smaller, given that inventories can be drawn down from their current high level. In contrast, the volume of meat exports is likely to rise, as foreign demand for Australian beef remains strong and slaughter rates are rising in the face of drought in some cattle-raising regions.
The volume of service exports is estimated to have risen by around 4 per cent over the year to the September quarter, supported by solid demand for travel services. This category of exports has been constrained in recent years by the appreciation of the exchange rate and competition from other tourist destinations. The emergence of low-cost airlines in Asia and Europe seems to have encouraged intra-regional travel at the expense of travel elsewhere. This can be seen in the departures data for countries such as Japan, showing that travel to China and Thailand has generally increased more strongly than travel to other destinations, such as Australia. In addition, a few years ago there was a noticeable decline in the average expenditure of visitors to Australia that is yet to be reversed.
Both the value and volume of imports fell in the September quarter, particularly imports of capital goods (Graph 43). Annual growth in total imports has now eased to around 10 per cent for values and 5 per cent for volumes. This is well down from the 10–15 per cent pace recorded in import volumes in recent years, when domestic demand growth was stronger and imports growth was being boosted by the appreciation of the exchange rate in 2002–2003.
In real trade-weighted terms, the Australian dollar is around 16 per cent above its post-float average and has been broadly steady for the past two years (Graph 44). At this level, it is likely that the exchange rate is restricting activity in some trade-exposed sectors. However, for the economy as a whole and especially the non-tradables sector, the boost to income from the increased terms of trade is probably more than offsetting this effect.
In line with the recent marked narrowing in the trade deficit, the current account deficit is expected to have fallen to around 4¼ per cent of GDP in the September quarter. This assumes that the net income deficit (NID) stays close to its June quarter level of around 3.7 per cent of GDP (Graph 45). The NID stands at a high level relative to its history, as both debt and equity payments have increased significantly in recent years. Payments on equity investments in Australia have largely reflected the sharp increase in profitability of resource companies, while interest payments have risen in line with increases in world interest rates and in the stock of Australia’s foreign debt.
National investment continues to exceed saving, in part due to the strong growth in private business investment, and dwelling investment that is still at a high share of GDP compared with its history. This excess has been accompanied by strong foreign demand for claims on Australian entities. As a result, the stock of net foreign liabilities has risen over recent years to more than 56 per cent of GDP. This has been driven by the steady increase in Australia’s net foreign debt; nearly all of the net capital inflow since 2000 has gone into foreign purchases of Australian debt securities (Graph 46). Much of these foreign purchases have been of asset-backed securities and bonds issued by financial companies, which largely fund lending for housing. In contrast, Australia’s net equity liabilities as a share of GDP have fallen over the past year. Foreign equity investment in Australia has been fairly strong, but it has been more than offset by Australian investment overseas. The available evidence for the September quarter suggests that debt inflows have remained solid, particularly borrowing by financial intermediaries (see the chapter on ‘Domestic Financial Markets and Conditions’ for more details).