The value of Australias chief commodity and resource exports has never been higher. So, why does Australia have a trade deficit despite the commodities boom? Hans Weemaes explains.
Australias terms of trade, or the ratio of export to import prices, are more favourable today than at any time since the 1970s. The main reason for this is Chinas insatiable hunger for resources and strong economic growth among Australias key trading partners.
With such conditions, observers might expect Australias trade balance to be in surplus. Yet in July 2006, Australia recorded its 52nd consecutive monthly trade deficit. Why? The answer lies in how companies have responded to the commodities boom.
Higher prices for Australias key resources have helped boost the value of exports since the June quarter 2005, but growth in export volumes has continued to be sluggish. One reason for this slow pace is that Australias resource sector has been caught flat-footed the unprecedented commodities boom comes after a period of weak global demand. Capital had abandoned commodities in the 1990s in favour of the 'new economy'. When worldwide demand for commodities picked up in late 2002, resource exports were hamstrung not only by long lead times associated with new capital-intensive projects, but also by supply-side constraints and increased vulnerability to external shocks such as adverse weather and mining mishaps.
The other explanation for Australias persistent trade deficit lies on the import side. The commodities boom has pushed capital and intermediate good imports upwards since 2004. As mining operations have expanded, so too has the demand for imported trucks, tyres, boats and so on. And then theres oil: a commodity that Australia is increasingly importing.
The trade deficit can therefore be thought of as a snapshot of how the prices of tradeable goods (including commodity prices) are working their way through the Australian economy. At present, the trade deficit, among other things, reflects the balance between high resource-export earnings on the one hand, and high capital and intermediate imports on the other. Both sides are being influenced by the commodities boom, but in -different ways.
Perhaps most importantly, the trade deficit tells us that Australia is responding to high commodity prices in the form of business investment a key driver of economic growth.
Australias tardy response to the commodities boom
The sustained rise in commodity prices has sharpened incentives for resource companies to expand output. Accordingly, there has been a surge in mineral exploration and capital expenditure in recent years.
But, while there are now a record number of Australian projects under development or recently completed, growth in export volumes remains sluggish. Mineral fuel and petroleum export volumes have been declining; coal export volumes have lifted marginally; and iron-ore and gas export volumes have only risen since 2004-05. So how did these supply lags arise?
Until 2002, Australias largest resource producers were reluctant to expand projects, fearing markets would relapse to the weak demand for commodities of the late 1990s.
However, as the number of projects grew in response to rising commodity prices, so too did the demand for capital inputs. With hundreds of mineral-and energy-development projects in the pipeline in Australia and around the globe, the demand for skilled labour and industrial equipment rose acutely. This led to capital shortages, higher input costs and project delays.
Supply chain pressures, which manifested themselves in infrastructure bottlenecks, also played an important role in limiting export volumes. With -capacity utilisation rising sharply in response to strong world demand, key links in the supply chain such as ports and rail lines were overwhelmed in some sectors, especially during 2003 and 2004. Moreover, the diversity of ownership of the various linkages between mines and ports made coordination of improvements to transport and port facilities problematic. As a result, long ship queues of the coast off Queensland and New South Wales made international headlines, threatening Australias reputation as a reliable supplier.
These pressures have only been partially eased through improved scheduling and the introduction of capacity-rationing systems. But more capital-intensive solutions such as upgraded rail infrastructure and expanded port capacity will ultimately be needed to lift productivity in the sector.
Recent external shocks have exacerbated the tardiness of the supply response and resulted in sharp see-sawing of Australias resource exports in the first half of the year. A series of cyclones off the coast of Western Australia in the March quarter interrupted shipping schedules, temporarily closed ports, reduced mine production and disrupted rail operations. This affected some of Australias largest resource exports. Oil export volumes were hit hard, while adverse weather also reduced the volume of gas, nickel and iron-ore exports in the Pilbara region. The aggregate impact of these disruptions can be seen in the chart on page 57, which shows a sharp increase in resource volatility over recent months in seasonally adjusted terms.
While the cyclone season is now behind us, the volatility caused by adverse weather demonstrates how vulnerable Australias resource exports remain in an environment where capacity is tight.
The lumpiness of resource exports over recent quarters underscores the challenges of increasing export volumes in a situation of high capacity -utilisation and infrastructure constraints. Export volatility in the resource sector should dissipate as the year progresses. The combination of high commodity prices and increased mine output is likely to support further increases in the value of resource exports, albeit gradually.
High commodity prices: a blessing and a curse?
The supply response by Australia-based mining firms to high world commodity prices has also affected the debit side of the trade balance: many specialised capital inputs needed for mine expansion have come from overseas. Indeed, capital good imports, including trucks, boats, platforms and other industrial machinery and parts rose by more than 20 per cent in the March quarter year on year.
Some of this rise reflects higher volumes. That is, with a record number of mining projects under construction, growth in the volume of capital good imports is to be expected.
But strong commodity demand has also driven prices higher for capital inputs. These imports can act as a large source of monthly trade volatility, since many of these capital goods are valued into the tens of millions of dollars. With a record amount of mining developments still under way, it is quite plausible that imports will jump around, corresponding with every new large piece of capital equipment that crosses Australias borders.
Record nominal oil prices and higher import volumes have also lifted the value of Australias intermediate goods imports in recent quarters. The value of intermediate goods imports rose by more than 12 per cent in July, year on year, with fuel imports up by more than 20 per cent.
This pressure on the debit side of the trade balance is unlikely to ease substantially over the short term.
Notwithstanding the recent moderation in world oil prices and new investment in domestic oil exploration, Australia is a growing net importer of oil, reflecting the maturing of the countrys domestic oil fields. In fact, Australias oil imports now account for about 14 per cent of total monthly imports, compared with about 7 per cent in 2003.
Neither good nor bad
With resource export volumes improving slowly and capital goods imports adding to the countrys future productive capacity, is the trade deficit actually a bad thing? Not really.
In fact, Australia is quite familiar with trade deficits. It began its colonial history running consecutive trade deficits and has recorded annual trade deficits for most of the past ---quarter-century. Yet, Australians enjoy low unemployment, high wealth and one of the highest standards of living in the world.
That Australia has recorded 52 consecutive trade deficits, and counting, is in itself not very meaningful. What -really matters is that Australia continues to enhance the productivity of its export sector.
