Rudd's WIN: Some Views On The Economy

The Australian stockmarket's 2% rise yesterday was due more to the ill-informed rumour from China about the Chinese Government's wealth fund eyeing Rio than any applause for the election result.

But investors are not really worried: they had a chance to show their views over er the past 11 months as opinion polls moved heavily in favour of Mr Rudd and his party. The markets have ignored politics and concentrated on China, the credit crunch and other factors.

In fact it's been business as usual for investors and that's not going to change.

Here's three views on the new government and the economy:

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This is from Macquarie Equities yesterday morning:

Managing an economic boom is certainly a good problem for a government to have, but is not necessarily any easier than reducing unemployment or eliminating inflation.

So far, the approach of the political parties has been to simply maintain a budget surplus of 1% of GDP and return any additional revenue back to consumers in the form of tax cuts and one-off payments.

While this has been great for retailers, more and more analysts are questioning whether this approach remains appropriate given the current strength of inflationary pressures. We believe the new government will have to be more creative in using its strong balance sheet to ensure that it doesn't add to cost pressures and highlight some viable alternatives such as funding an increase in superannuation or reducing business taxes and charges.

The key challenge facing the new government will be to ensure that strong economic activity doesn't spill over into higher wage growth and inflation.

Given the acceleration of momentum in the economy and the breadth of cost pressures, we think that further interest rate increases are almost inevitable, regardless of which specific policies are enacted. Given this, we think it would be shrewd for the government to ask the Reserve Bank Governor to conduct a press conference whenever monetary policy is adjusted. This would have a number of advantages.

First, it would be an ongoing reminder that interest rates are set by an independent Reserve Bank with a clear focus on inflation, and hence may boost the potency of monetary policy. Second, it would distance the government from the rise in interest rates, which would obviously be desirable from a political viewpoint.

Similarly, if the US credit market crisis does eventually undermine global and Australian growth and the RBA had to cut rates, again it would be beneficial if an independent central banker had to explain why growth was weakening, rather than have the Treasurer appearing to shift blame to external factors.

Another issue for the next government will be the appropriate stance of fiscal policy.

The simple notion that maintaining a budget surplus of 1% of GDP at all times is the 'cutting edge' of fiscal policy management needs to be revisited.

HSBC chief economist John Edwards told AAP yesterday that said inflation was the biggest issue confronting the new government, and it could make spending cuts.

"Well, unquestionably, the major economic challenge, the major immediate challenge, is that core inflation is above the target band," Dr Edwards said.

"In the year to December, it was above 3%.

"This is a very considerable challenge.

"It means that everything the government decides in the context of the May Budget has to be decided with a view to rising inflation."

Dr Edwards said incoming Treasurer Wayne Swan would be likely to cut back on spending on government advertising and consultants.

"But they're relatively small," he said.

"Where the big ones (spending cuts) come from, I'm not sure."

Dr Edwards said slowing US economy was a risk, but it would be unlikely to dent Australia's economic performance.

"There's no doubt the US will slow. It's likely to have quite a slow first and second quarter next year," he said.

"My own view is it will avoid recession as a consequence of the slowdown."

Dr Edwards said global growth - which the International Monetary Fund tipped would slow to 4.8 per cent in 2008 from 5.1 per cent this year - would still be above the long-term average.

"As far as we're concerned, we're fine," he said.

"Fortunately, if there was a major economic slowdown - we can't rule out that possibility - we do have the capacity to lower interest rates and spend a little more freely."

Dr Edwards noted that Australia's major Asian trading partners such as China Japan, South Korea and Taiwan are still growing strongly.

Dr Edwards also said Labor's plan to wind back Work Choices legislation was unlikely to fuel inflationary pressures.

"I would expect it to have zero impact," he said.

"The only thing that the new government plans to do with respect to Work Choices is to, over time; repeal the provisions that provided individual contracts.

"The government intends to introduce flexibility clauses for AWAs permitting ... common law contracts.

"I think and predict there will not be a great deal of difference except the most ruthless employers will be discouraged from using the (existing Work Choices) legislation to eliminate conditions without compensation."

And the AMP's Dr Shane Oliver updated his note we highlighted yesterday in AIR.

Through the election campaign both the Australian share market and the Australian dollar largely ignored the election with gyrations in the US and global share markets being the key driver. This is likely to remain the case now that the election is out of the way.

Expect more action at the sectoral level

Our broad assessment is that a Labor government won't alter the overall outlook for the share market. However, there is more potential for a sectoral impact. Sectors and shares which might be positively affected by a Labor government could include:

Construction - via increased infrastructure spending;

Building materials – via policies to improve housing affordability, although the impact is likely to be small as most policies are focused on demand, not supply;

Renewable energy stocks – via a more aggressive renewable energy target;

Telcos – via the proposed high speed broadband network;

Child care – via increased child care funding;

Asset managers – if the superannuation guarantee is increased to 12 or 15%;

Retailers – via tax cuts, but this would have occurred under the Coalition as well.

Sectors that may be negatively affected include:

Miners and most sectors – on the back of a windback of Work Choices, however, as noted earlier the impact is likely to be minimal;

Energy utilities, transport stocks and heavy power users – via more aggressive action on climate change via carbon trading.

Broad macroeconomic policy is unlikely to change under the new Australian Labor Government, so the outlook for the economy and Australian investment markets will be little changed. Any near term uncertainty in investment markets associated with the change of Government is likely to be short lived.

However, share market sectors that may benefit include construction, building materials, renewable energy stocks, telcos, child care, asset managers and retailers.

The polls got it right

After eleven years the political pendulum has swung back to the Australian Labor Party (ALP) which ran on a campaign of economic conservatism, a wind back of recent industrial relations reforms, faster action on climate change, a high speed broadband network, action to improve housing affordability, national health and hospitals reform, improving skills and access to computers at schools and a staged withdrawal of Australian combat troops from Iraq.

Minimal macro impact from change in Government

There is little reason to expect that the change in government will significantly alter the outlook for the Australian economy or investment markets.

It has been a phenomenon of developed countries in the last two decades that once in government political parties adopt sensible macro economic policies if they wish to deliver rising living standards to their constituents and therefore hope to be in office beyond one term.

This has been particularly the case in recent decades after the failure of the huge ramp up in welfare spending funded by budget deficits and onerous top marginal tax rates of the 1960s and 1970s and as it has become obvious that allowing a little extra inflation as a way to reducing unemployment simply does not work.

The Labor Party's election campaign policies indicate that macroeconomic policy will be little different to the generally pragmatic and sensible approach of the previous Coalition Government. The Labor Party is committed to an open and competitive economy; to the RBA remaining independent and continuing to target 2-3% inflation; and to maintaining budget surpluses of around 1% of GDP when the economy is recording reasonable growth. Like the Coalition, big income tax cuts were the centrepiece of the ALP's election promises, but its total spending promises since the last Budget were more than $15bn less (over four years) than those of the Coalition.

Given the upwards pressure on inflation and interest rates coming from the strong economy, it's also possible that on advice from Treasury and the RBA the new Government may decide to find extra savings to help reduce the size of the net fiscal stimulus over the next few years in order to minimize the pressure on interest rates.

The only area of significant policy difference with potential to affect the macroeconomic outlook relates to industrial relations where the ALP is committed to rolling back parts of Work Choices and abolishing Australian Workplace Agreements (AWAs – or individual contracts). The fear is that this will contribute to higher wages growth given the tight labour market. However, assuming the changes even pass through the Senate, the economic impact is likely to be less than some fear:

Firstly, it is not clear how important Work Choices has been in ensuring benign wages growth in recent times – the decentralised wage setting system, increased global competition, increased immigration and tax cuts damping pay demands may have been the key drivers.

Secondly, ALP industrial relations policy is seeking to maintain labour market flexibility – it is not proposing a return to the centralised system of the past.

Thirdly, only about 10% of the workforce is on AWAs. Many of these are in the mining industry earning more than $100,000 pa, and are simply likely to switch across to common law contracts.

Finally, there will be a lengthy transition period as existing AWA's will take time (up to 5 years) to expire.

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