This article reviews how major international and domestic developments impacted on the Australian economy in 1998-99, and compares the 1998-99 Budget and 1998-99 Mid-Year Economic and Fiscal Outlook (MYEFO) forecasts with actual outcomes.
Following a sustained period of very strong economic growth over recent years, including Gross Domestic Product (GDP) growth of 4.8 per cent in 1997-98, some moderation in growth was forecast in 1998-99. This was expected to result from a deceleration in the rapid growth of household consumption and business investment, combined with a large detraction from net exports resulting from the Asian financial crisis. The outcomes in 1998-99 of low inflation (1.2 per cent) and strong GDP growth (4.5 per cent) exceeded even the most optimistic private sector expectations. To borrow the words of the IMF Deputy Managing Director Stanley Fischer, Australia has done remarkably well.
Australias higher than expected economic growth in 1998-99 reflected continuing strong household consumption growth and a lower detraction from net exports than earlier expected. Sustained economic growth helped to improve labour market outcomes, with stronger employment growth and a larger reduction in the unemployment rate than forecast. Ongoing productivity growth contributed towards keeping inflation low.
Australias strong economic performance continued to reflect the results of a well-developed economic policy framework. Statement 3 of Budget Strategy and Outlook 1999-2000, Budget Paper No. 1 discussed at length Australias policy reforms and its contribution to Australias recent economic performance.
Against the backdrop of the Asian financial crisis and heightened financial market instability, the Australian economy recorded its longest period of strong (continuous) economic growth since the early 1970s. This outcome was even more remarkable as it was achieved when many of Australias Asian trading partners were experiencing a recession: Australias strong growth and low inflation performance continued to compare very favourably with the US and other OECD countries.
Strong international investor confidence in Australia allowed the spread between Australian and US long-term interest rates to remain at historical lows. Confidence in Australias structural and regulatory reforms, and its sound policy environment was explicitly recognised in Standard and Poors (S&P) decision to upgrade Australias long-term foreign currency debt credit rating from AA to AA+. Indeed, Australia was increasingly viewed over the course of 1998-99 as a model for other economies to follow.
World GDP growth slowed from 3.3 per cent in 1997 to 1.8 per cent in 1998 (measured on a market exchange rate basis). The main source of this slowdown was the deepening of the recession in Japan, the sharper than expected declines in output in many Asian countries, and the turbulence in Russia and Latin America. Continued strong growth in the United States economy, and sustained growth in Europe provided the main support for world activity in 1998. World growth increased in the first half of 1999, as growth resumed in Asia, including Japan, with strong growth continuing in the US. Chart 1 provides an illustration of GDP growth profiles in 1998-99 for our major trading partners.
Chart 1: Economic growth in Major Trading Partners (MTP) (quarterly, through the year)
(a) Korea, Singapore, Taiwan, Hong Kong, China, Indonesia, Malaysia, Thailand and the Philippines weighted by merchandise exports.
(b) Germany, France, United Kingdom, Italy, Canada and New Zealand weighted by merchandise exports.
GDP growth of around 4 per cent was recorded in the United States in 1998, and much of that momentum was carried into the first half of 1999. While growth slowed to 1.6 per cent in annualised terms in the second quarter, this overstated the reduction in the economys momentum. In through-the-year terms, growth was 3.9 per cent in the twelve months to end June 1999.
Strong consumption and investment have been the cornerstone of the sustained and higher than expected growth through 1998 and 1999. Some of the strength in consumption was due to the wealth effects created by the rise in the stockmarket and net sales of shares by the household sector. A sharp increase in mortgage refinancing (to take advantage of low interest rates) also supported consumption growth.
The low cost of capital (both debt and equity) underpinned robust plant and equipment investment and the housing sector also remained strong.
The sustained period of solid employment growth kept the unemployment rate very low, at 4.25 per cent. Strong productivity growth helped contain prices, with increases in the core CPI declining over the later half of 1998 and the first half of 1999.
The other significant impact of the stronger than expected domestic demand over 1998 and 1999 has been the increase in the US trade deficit, which widened steadily since the start of the Asian crisis in mid-1997. Imports have increased sharply, especially in consumer goods, automotive products and computers. At the same time, the weakness in economic growth in the rest of the world and the strong US dollar contributed to export volumes falling (although this has begun to reverse more recently).
On the policy front, one third of the 75 basis point easing in official interest rates late in 1998 to address financial markets stresses was reversed (by the end of June 1999), as these pressures receded and in the face of growing concerns about the outlook for inflation going forward. The US fiscal position remained strong with the Budget moving into surplus in 1998, in large part reflecting the strength of economic activity.
The Japanese economy returned to growth in the first half of 1999, with activity expanding at an annualised growth rate of 3.3 per cent. Despite this stronger than expected result, Japan still recorded a year-average contraction of 1.3 per cent in 199899.
The pick-up in private domestic demand in 1999 (particularly in private consumption and housing) can, in large part, be attributed to the Japanese Governments expansionary fiscal policy and supportive monetary policy. In November 1998, the Government announced its 3rd Supplementary Budget for the year, involving a fiscal stimulus package totaling 23.9 trillion (or 5 per cent of GDP).
Around the same time, to offset a sharp contraction in the availability of bank credit, the Government introduced, from 1 October 1998, a substantial programme of loan guarantees and other funding support for small and medium-sized enterprises and selected larger firms. In an attempt to prevent the Japanese economy from falling into a deflationary spiral, and the economy from deteriorating further, the Bank of Japan lowered its targeted overnight cash rate on 12 February 1999 from 0.25 per cent to around 0.15 per cent.
The Euro area was created on 1 January 1999, bringing 11 European countries into a monetary union. The transition to the new exchange rate regime has been smooth. Monetary policy for the region is now set by the European Central Bank System with reference to economic conditions prevailing in the region as a whole.
The pace of economic growth within Eu
rope over 1998 and the first half of 1999 was somewhat mixed with growth remaining strong in some countries while weakening in others. Overall growth in the Euro area increased to 2.9 per cent in 1998, mainly due to stronger growth in Germany (2 per cent), France (3.4 per cent) and the non-core economies. However, activity in Italy remained relatively weak (1.3 per cent). Output slowed over the second half of 1998 and into the first half of 1999 in the core Euro economies (especially in Germany and Italy), which further amplified the divergence of growth rates in the Euro area. GDP growth in 1998-99 was 2.7 per cent in France, 1.1 per cent in Germany and 0.8 per cent in Italy.
The external sector was a substantial drag on growth during the slowdown in the second half of 1998 and the first half of 1999. Exports weakened due to the collapse in demand in Asia and Russia. Germany and Italy were the worst affected, due, in part, to the composition of their exports, which are cyclically sensitive. Production was also negatively affected by a substantial decline in business confidence in Germany and Italy. This decline was an outcome of the turbulence in the global outlook and, in the case of Germany, uncertainty over the direction of government policies.
Consumption was the main factor underpinning growth in Germany and France over 1998 and the first half of 1999. Private consumption growth remained relatively buoyant, benefiting from high consumer confidence, a modest decline in unemployment and low inflation. Accommodative monetary conditions also supported consumer demand. Consumption in Italy, by contrast, was relatively weak over the period due to the continued stagnation of real disposable income and fragile consumer confidence.
Following an extended period of expansion, the United Kingdom economy slowed to 1.6 per cent in 1998-99, compared with 3.2 per cent in 1997-98. Similar to the core euro economies, the slowdown in the United Kingdom was greatest in the external sector and also manufacturing production. Net exports fell as a consequence of weaker international demand and the high sterling exchange rate. On the other hand, sustained employment growth and sound household disposable income supported both consumption and investment and, ultimately, domestic demand.
The economic performance of our Asian major trading partners strengthened as 1998-99 progressed. Many of the Asian economies stabilised before commencing their recovery in the second half of 1998-99. The robust pick-up in activity in some economies was impressive, particularly in Korea.
Key to the recovery of the Korean economy over 1998-99 were supportive macroeconomic policies, particularly the easing in short-term interest rates. Rates peaked at 30 per cent at the end of 1997, and were held above 20 per cent until mid-1998. Short-term interest rates were steadily reduced to below pre-crisis levels following a stabilisation of the won exchange rate in early 1998-99.
Korea has benefited substantially from the pick-up in the world electronics cycle. After contracting sharply during the crisis, industrial production bottomed in July 1998, and has been on a rising trend since then. By the end of 1998-99, industrial production was 33 per cent above the level at the start of 1998-99, with the electronics sector showing even stronger growth. Also contributing to the turnaround in the Korean economy was a recovery in international and domestic investor confidence the Korean equity market tripled over 1998-99. Although the economy only recorded 0.3 per cent growth for 1998-99, growth in the first half of 1999 was 6.7 per cent.
Indonesias economic growth contracted by around 11 per cent in 1998-99. Activity stabilised in the latter half of the financial year, with modest, positive growth of around 2 per cent recorded over-the-year to June 1999. Government spending and a recovery in net exports mainly supported this turnaround. While household consumption spending improved, by June 1999 it was still moderately below the levels of June 1998. Capital expenditure remained in a deep slump, reflecting the continuing difficulties in the financial system. The rupiah recovered significantly, doubling its value in US dollar terms from its record low levels in June 1998, although by June 1999 it was still less than half its June 1997 (pre-crisis) value. Inflation eased substantially over the year, from around 70 per cent to less than 25 per cent by June 1999.
After contracting by 6.8 per cent in 1997-98, Thailands economic growth contracted by 4.1 per cent in 1998-99 as it continued to adjust in the wake of the 1997 financial crisis. Nevertheless, by the March quarter of 1999, Thailands economy was showing signs of emerging from recession as strong growth in manufactured exports underpinned the first quarter of positive growth for two years.
By the end of 1998, the Malaysian economy had contracted by 7.4 per cent. Private consumption collapsed and the contraction in investment was particularly severe, with the manufacturing and construction sectors hardest hit. This reflected lower domestic and external demand, lower levels of foreign investment activity and high interest rates. Import compression on the back of the collapse in domestic demand saw the current account move into surplus, although weak regional activity also led to a decline in exports for most of the year despite the significant depreciation of the ringgit (which was fixed in early September 1998). The recovery in activity has been stronger than anticipated with the economy returning to positive growth in the December quarter 1998 - an important contributor to the turnaround has been the cyclical upturn in the international demand for electronics. In 1998-99, Malaysias GDP contracted by around 5 per cent.
Unlike most other countries in the region that moved to float their exchange rates, Hong Kong maintained its pegged exchange rate to the US dollar throughout 1998-99. This required tight monetary policy, which hit the domestic economy hard and had a significant impact on asset prices. As a result, GDP continued to contract (falling 3.8 per cent in 1998-99) and strong deflation emerged. Although fiscal policy was quite expansionary, it had little apparent impact on reviving the economy and it was not until the second quarter of 1999, following six quarters of contraction, that it emerged from recession (the last economy in the region to do so).
China continued to withstand the effects of the Asia crisis, recording economic growth of around 7.5 per cent in 1998-99. Chinas economic performance was assisted by a strong economy going into the crisis, a sound balance of payments position, low external debt and lack of free convertibility on its capital account. The exchange rate was not altered despite widespread market expectations of a possible devaluation. With both private and public sector activity slowing, the fiscal package introduced in the second half of 1998 sustained growth, but this began to diminish in the first half of 1999. Retail sales grew at slower rates as a result of concerns about job security and deflation. Private investment also grew more slowly as a result of low confidence, saturated markets, and high real interest rates. Foreign direct investment also fell, partly as a result of the regional slowdown. Relatively tight monetary policy had a contractionary effect on growth as deflation throughout the four quarters of 1998-99 kept real interest rates high, despite nominal interest rate reductions.
Singapores sound macroeconomic fundamentals and sound corporate and financial sectors, it experienced a mild recession in 1998 as a result of its strong trade and investment links in the region. However, it rebounded strongly, emerging from recession in the fourth quarter of 1998, leading to GDP growth of around 1 per cent in 199899. The rebound was supported by a strong recovery in property and equity markets and in private consumption, with retail sales returning to strong growth. The pick-up in the electronics cycle also had a positive impact, with significant demand from the US and a pick-up in regional conditions returning exports to strong growth. The Government also engaged in a range of expansionary and competitiveness-enhancing measures including tax cuts, wage cuts and a reduction in employer superannuation contributions.
Taiwan continued to withstand the effects of the Asia crisis, avoiding recession and recording strong growth of 4.7 per cent in 1998-99 as the region recovered. Prudent macroeconomic management and lower exposure to foreign borrowing were important factors. Expansionary fiscal policy, through public infrastructure investment, supported growth as private consumption and investment growth slowed. An improvement in competitiveness was provided through exchange rate depreciation and a pick-up in the electronics cycle boosted export growth. Expansionary monetary policy, combined with a return to strong growth in the equity market and a return of confidence, underpinned a recovery in private consumption growth, despite moderate deflation being experienced.
The Philippines economy weathered the Asian crisis relatively well, with output having contracted by 0.5 per cent over calendar 1998. The contraction was predominantly driven by sharp falls in the agricultural sector, which was badly affected by adverse weather conditions, and falls in investment, particularly in construction and construction-related manufacturing. Consumption, in contrast, remained firm and export growth was supported by strong trade ties with the United States. However, imports declined due to weak demand by industry. The Philippines economy, however, resumed growth in the first half of 1999, joining the broader regional recovery, and grew by 0.6 per cent in 1998-99. The rebound in activity was driven by a turnaround in agricultural activity and stronger export growth.
Emerging markets, notably Brazil and Russia, were caught up in severe financial market instability and capital flight over the latter half of 1998 and early 1999. The more pessimistic assessments of some forecasters were, however, proved incorrect, as the contagion effects and severity of the economic slowdowns in these markets were much milder than expected.
The momentum of the New Zealand economic recovery continues after experiencing a short-lived recession in the first half of 1998. Growth returned in the September quarter 1998 and despite a small contraction in the June quarter 1999, GDP increased by 2 per cent through the year to June 1999. This economic pick-up was largely attributed to strong private domestic demand growth on the back of improvements in consumer and business confidence, and supportive monetary conditions.
1 Changes implemented by the Australian Bureau of Statistics to the national accounts and the Consumer Price Index make some comparisons between forecasts and outcomes misleading.
2 The Business Review Weekly's survey of private sector forecasts reported average GDP forecasts of 2.9 per cent in March 1998 (survey high of 3.9 per cent), 2.2 per cent in June 1998 (high of 3.0 per cent), 2.4 per cent in September 1998 (high of 3.0 per cent) and 3.5 per cent in December 1998 (survey high of 3.9 per cent).
3 Subsequent revisions to the US national accounts that were released towards the end of October 1999 have not been taken into account.