Mining investment reached a record 7% of nominal GDP in 2012 and has fallen 16% from its peak, taking 1.1pp off GDP. With no new mega-projects on the horizon, we expect mining investment to make a major subtraction from growth over the next few years as it returns to a more normal level.
That said, so far the long-awaited unwinding of the capex boom is proceeding more smoothly than we expected, with three key offsets to the impact of falling investment on growth, namely: 1) falling mining imports; 2) a recovery in the rest of the economy in response to record low interest rates; and 3) rising export volumes.
Mining investment is heavily import-intensive, particularly the major gas projects, where processing modules have been imported from Asia. Although it is difficult to split mining out from total imports, our rough measure of resource imports has dropped sharply recently, adding 1pp to growth since mining capex peaked in 2012.
Activity outside of mining is also helping to cushion the blow from falling mining capex, with private demand, excluding mining, up about 3% over the past year. This recovery has been led by a very strong housing market as the modest pickup in consumer spending recently lost momentum. However, to us the most encouraging development has been the first rise in non-mining business investment in over a year. Admittedly investment is volatile, but there has also been one of the largest upgrades to the surveyed investment outlook in recent years, driven by the service sector.
In the short term, though, the lift in mining exports has been the most important offset to declining mining investment. Export volumes of bulk commodities are up 19% over the past year, adding 1.6pp to growth since mining capex peaked in 2012. This strength has been driven by iron ore exports to Chinese steelmakers, although we expect natural gas sales to Japanese utilities to take the lead soon, as the major gas projects start to come online later this year.
For the current account deficit, these trends have helped narrow the shortfall, with declining mining capex helping from a saving-investment perspective and stronger mining exports driving the trade balance into surplus. With the current account deficit shrinking to 1.4% of GDP, this has sparked a fresh debate over whether Australia might finally run a current account surplus driven by a further improvement in export volumes.
Our view is that this is this is unlikely to be achieved, given that the cost of servicing Australia’s significant foreign liabilities should rise, while export prices have much further to fall. Foreign liabilities are 54% of GDP, and the implied interest rate on servicing these liabilities is currently at a multi-decade low of 4.4%. As such, we expect the servicing cost to rise as global interest rates pick up in line with stronger world growth.
We also expect a further sharp fall in export prices as Asia’s demand for bulk commodities has moderated in the face of the ongoing rapid increase in supply. This is most clear in the case of iron ore, where export volumes are up about 30% over the past year with export prices yet to fully reflect a 20% drop in spot prices over the same period.