The phrase, “It’s the economy, stupid,” coined by James Carville, a strategist of former US President Bill Clinton, is widely credited with helping America’s 42nd president pull off an unlikely election victory in 1992.
The quip was intended to focus voters’ attention on the fact that the campaign was being held in the middle of a recession, which the Clinton team used successfully to unseat Bush the elder, despite the fact that 90 percent of the country approved of the job that the incumbent President was doing just a year before the election.
Since then the phrase has been considered as much of a truism as you can have in politics.
As NZ counts down to its own election in less than six weeks there has been minimal focus on the state of our own economy, with the country in a recession – albeit a technical one for now.
Record low unemployment and a tight labour market have led to what might be considered a high level of complacency amongst voters, but scratch below the surface and there are plenty of red flags that should be concerning voters regarding our economic outlook.
The release of the International Monetary Fund’s latest report on the state of the NZ economy was therefore timely, but also made for some uncomfortable reading.
The international forecasting agency said the economy likely faces a year or more of tepid growth but warned that things could quickly deteriorate and develop into a deeper recession for longer if inflation is not brought under control or government spending blows out.
“Given the pressing capacity constraints and high and persistent inflation, the monetary and fiscal policy mix must strike a restrictive bias to rebalance the economy – internally and externally,” the report said.
Translated – government spending needs to tighten and interest rates will have to remain elevated.
It warned there were serious risks to the economy if government spending was too high or the Reserve Bank was forced to raise interest rates even higher to tackle stubborn inflation. Ominously, it described the country’s economic outlook as “highly uncertain”.
“The environment of tighter domestic financial conditions and higher rates will increase the risk of disorderly conditions in the housing market, which would have significant consequences for household consumption and overall growth and could result in a prolonged or deeper recession.”
It estimated growth over 2023/24 would be a minuscule 1 percent, while also forecasting inflation would not return to the Reserve Bank’s 1-3 percent target band until 2025 at the earliest. Adding to its ‘worry list’, the IMF continued to warn about our high current account deficit which it said added to the country’s vulnerabilities to global shocks.
While acknowledging that risks such as the slowing housing market appeared to be contained for now, it reaffirmed that housing affordability was a continuing problem – which falling house prices had not improved – and needed to be addressed by increasing the supply of new homes.
For the longer term, the IMF said targeted government spending would be needed to tackle the growing challenges of climate change, education, and freeing up the labour market.
And as it has said in previous reports, it reiterated the need for an overhaul of the tax system, including implementing a capital gains and land taxes, as well as a lower company tax rate, policies both major political parties continue to rule out.
Earnings season ends with a whimper
There was little for investors to get excited about from the final batch of results to wrap up earnings season, with the possible exception of Tourism Holdings.
Its shares end the week up 10 percent after reporting a better than expected net profit of $49.9m following the successful merger with Australian campervan provider Apollo in November last year.
On the flip side, Restaurant Brands result highlighted the problem facing many businesses: margins being severely squeezed due to cost increases.
The fast-food operator reported an 85 percent plunge in net profit of just $2.2 million on revenues of $640 million blaming the poor result on global inflationary pressures and rising ingredient and wage costs.
Chairman José Parés said that while revenues were up 9.4 percent on the same time last year, supported by a strong US dollar and the opening of 10 new stores, higher input costs and increased funding costs on the back of higher interest rates significantly impacted the company’s first half performance.
“Additionally, labour market pressures have caused adverse staff shortages, requiring many stores across our network to reduce operating hours and/or operate with reduced capacity.
“While the business has implemented a strategic programme of price increases and cost control measures to relieve margin pressures, we were not able to raise prices to fully offset the cost increases during the period without significantly impacting transaction volumes.”
The NZX50 recorded its first weekly gain of more than 50 points since early July lifting 0.5 percent to 11,529, though year-to-date it remains down 0.2 percent.
Five companies in particular highlight the degree of uncertainty facing investors currently as well as being symptomatic of the wider NZ economy.
Shares in Port of Tauranga, the country’s largest port operator, closed at their lowest point since March 2020 at the height of the Covid sell-off. Likewise Freightways, SkyCity Entertainment and The Warehouse Group.
Synlait Milk, which saw its shares fall to a new all-time low of $1.29 on Friday, continues to be buffeted by the increasingly uncertain outlook for infant formula demand in China.
While both business and consumer confidence lifted slightly in August, they remain at low levels. The latest ANZ-Roy Morgan Consumer Confidence Index increased just 1 point to 85, driven by the question of whether it is a good time to buy a major household item. This rose slightly from minus 39 percent to minus 31 percent.
Consumer price inflation expectations two years ahead eased from 4.7 percent to 4.6 percent, and a net 13 percent of respondents expect to be better off this time next year, up 2 percent on the previous survey.
ANZ Research said inflation expectations remain stuck at levels inconsistent with the inflation target but are at least pointing in the right direction.
Brent Crude Oil futures experienced their biggest weekly rise since late March gaining 5.7 percent, closing just shy of US$89 per barrel, a nine month high, which will see prices at the pump continue to push higher.
“Supply shortages, partly owing to reasonably healthy global consumption, particularly in the US, and partly because of the Saudi determination to provide a high price floor,” were behind the increase an oil analyst told Reuters.
China’s economic gloom spreads across Asia
Increasing concerns about the floundering state of China’s economy, our largest trading partner and a major source of visitor traffic for the country’s tourism sector, have also received surprisingly little mention in the election campaign to date.
Fonterra has already revised down its expected payout to farmers twice in recent weeks and there is every likelihood the dairy co-op will be forced to make further cuts in the coming months as China’s economic outlook continues to darken.
And now there are growing fears of a contagion effect in Asia, as waning consumer demand and slower manufacturing are hitting neighbouring countries with close ties to the world’s second-largest economy.
A manufacturing slump in South Korea has extended to its longest in nearly half a century while other big exporters in East Asia area also being hit by slowing demand.
As the Financial Times reported on Friday, Asia’s fourth-biggest economy, which is viewed as a bellwether for the region’s technology supply chain, saw its exports fall in July at the steepest pace in more than three years, due in part to smaller shipments of computer chips to China.
Meanwhile, South Korea’s latest Purchasing Managers’ index showed that factory activity fell in August for the 14th consecutive month, the longest drop in the survey’s history.
Concern has intensified in recent weeks after the Chinese economy retreated into deflation, fuelling fears over soft consumption, a weakening currency, a shaky property sector and unsustainable levels of local government debt.
In a sign that slowing global demand is further dragging on the Chinese economy, China’s manufacturing sector contracted for a fifth straight month in August, according to official data.
All eyes this week will be on Country Garden, China’s largest homebuilder, which missed a US$22.5 million coupon payment to bond holders last month and has until this Wednesday to remedy the missed payment or follow hundreds of other developers into default and restructuring. Trading in its bonds, which had all but collapsed to just a few cents on the dollar, was halted on August 14th.
At the rate Country Garden was constructing homes in 2022, at least 144,000 buyers will not receive the new residences they were promised at the start of the year, while even more families are likely to face financial hardship if the company defaults on its debts.
Unlike its rival developer Evergrande which collapsed last year due to over-leverage, Country Garden is facing a crisis of confidence among consumers that has seen China’s property crisis intensify in recent months. Sales among the 100 biggest developers fell by an unprecedented 33 percent in July compared to a year earlier, while Country Garden’s sales plummeted by 60 percent.
As a result, its decline is becoming self-reinforcing instilling a growing sense of fear amongst potential home buyers to stay out of a market as property prices continue to fall, while apartment owners are refusing to pay mortgage instalments and are unable to recoup their deposits.
Property supply chains including engineering and professional services providers, building suppliers and contractors risk not being paid further hampering the outlook for what has been China’s main engine of growth.
With almost US$100 billion of depositor funds at risk if Country Garden does default there is a growing risk of serious social unrest, something China’s government will want to avoid at all costs.