Decreased retail sales and consumption expenditure were the main culprits of the stall in the Australian economy over the past year, according to industry analyst and economic forecaster, BIS Shrapnel.
The company’s economic outlook bulletin identifies household spending as the key driver of prospects for the economy. Continued weakness in expenditure will determine the extent of the damage to the economy over the next financial year. Conversely, it will be the timing and strength of the recovery in household spending that drives the next economic upswing.
BIS Shrapnel’s chief economist, Dr Frank Gelber, said since last year’s financial shock the drivers of household spending will fall naturally into three phases.
“Phase one, the precautionary savings phase, drove the initial weakening of the economy in 2008,” explained Gelber.
“Retail sales and private consumption expenditure stalled, initially because of rising interest rates, but then as awareness of the global financial crisis increased.”
The collapse in confidence and resultant rise in precautionary saving initiated a sharp rise in the savings rate, offsetting still strong household disposable income growth. Disposable income was very strong last year as the fall in interest rates reduced mortgage interest costs for households. However, this boost to household disposable income is now largely over.
“The slight pick-up in consumption expenditure this year has largely been due to the household handouts,” continued Gelber.
“This won’t be sustained and we are close to the end of the stimulus associated with cash handouts.”
During the second half of this year we will enter phase two – weak household disposable income. BIS Shrapnel is expecting employment to fall, the unemployment rate to rise and real household disposable income to be flat to negative during 2009-10. Households simply won’t have as much disposable income to spend.
“This means the economy will stay weak through the next financial year which is when we’ll see the full extent of the damage caused by the current downturn,” said Gelber.
BIS Shrapnel is not expecting the economy to begin to recover until mid-to-late 2010. This is phase three, and the timing of the upswing will depend on when confidence recovers and households ease off saving and start to spend again.
It is in phase three that we will start to see household disposable income picking up again and a strengthening of retail sales and private consumption expenditure. It is also expected retail sales will be boosted by strengthening housing construction and property markets. BIS Shrapnel said this is what will underpin the economic recovery, however, the company warns that the retail industry won’t be same again.
Longer term, retailing will be much less lucrative than it has been this decade. Retail sales and private consumption expenditure growth are expected to remain lower, because households won’t go through the same debt build-up that drove retail growth earlier this decade. And, with governments focusing on reducing debt, there won’t be tax cuts to boost household disposable income.
“It will be a long time before we see the ‘golden age’ conditions for retailing that we experienced between 2002 and 2007,” said Gelber.
“Private consumption expenditure will be limited by growth in real household disposable income, which will be limited by more conservative savings ratios and constraints on tax reduction.”
More importantly, from the point of view of retailer profitability, retail margins are unlikely to reach the dizzy heights of the ‘golden age’.
BIS Shrapnel said this decade transformed the retail business. The rise in margins, from under three per cent in the 1990s to over four per cent at the end of last year, was helped by strong retail sales and income growth. However, the primary influence was the rise in the Australian dollar, which was also helped by ‘the China effect’, reducing the cost of manufactured goods. The reduction in the cost of imported goods allowed wholesalers and retailers to contain retail prices, and at the same time increase profits.
“This compares to the 1980s and 1990s when retailing was a difficult business,” said Gelber.
“Back then we were faced with tight margins and high levels of business failures, leading to empty spaces in many retail centres.
“However this decade has seen strong profitability, which has meant relatively low business failures and a queue of people waiting to get into the better regional and sub-regional retail centres.”
BIS Shrapnel said the current shock to retail sales and the lower dollar, provided it sticks, will squeeze retail margins, affecting the profitability of retailers. Certainly, hardest hit will be imported goods and discretionary goods. Nonetheless, the recent rebound in the dollar is undermining the improvement in competitiveness of domestic tradeables, that is, import-competing goods.
“In the next decade, lower growth and, presumably, a lower dollar will constrain retail margins, making retailing a much tougher business,” concluded Gelber.
“For retailing, the next decade will look a lot more like the 1980s and 1990s than this decade.”