What do the experts see coming in the next financial year, and what will it mean for small and medium businesses?
Financial experts cast their gaze just over the horizon to predict how next year might shape up. They see strong growth in some sectors, a slowdown in others, and most warn small and medium businesses to be cautious with cash flow and expansion.
Economy And Business Confidence
Predictions
John Edwards, chief economist, HSBC
Growth has slowed compared to the average of the last decade as the housing and consumption boom winds down. I expect growth over 2006 to be only a little above three percent. Better than last year, but not as good as the 3.75 percent average of the last decade. Growth depends on exports continuing to pick up, which means we are unusually dependent on the global economy and especially on China, the US and Japan. I think the outlook for all three is pretty good, although I expect some slowing into 2007.
Joseph Capurso, economist, Commonwealth Bank of Australia
The economy is being boosted by high mining prices, and the benefits ripple well beyond the coalface. Transport and construction businesses benefit from miners’ investment binge. Governments benefit from higher tax collections, allowing them to offer tax cuts and lift spending. More workers have been hired, often at a higher wage. Retailers benefit from higher spending. Higher mining prices raise the exchange rate. In turn, import prices fall, freeing up consumer purchasing power to spend on other things. In this way, most businesses benefit from high mining prices.
The economy will continue to reap the benefits of high mining prices in 2006 because Chinese demand will be strong. With incomes and spending to continue growing strongly, businesses have every reason to be confident about the future.
Jonathan Cavenagh, economist, Westpac
We expect the economy to maintain reasonable momentum through 2006. The two-speed nature of the economy—strong business investment but contracting housing activity and moderate consumer spending—that was apparent through 2005 will continue for the first half of 2006. In the second half of the year housing activity will improve, albeit in a fairly modest fashion, and consumer spending is likely to be supported by fresh tax cuts. A key driver of the economy will be the export sector, which will benefit from additional capacity in the resource sector coming on line and strong global demand conditions.
What this means
Neil Wickenden, tax partner, and Jonathan Philpot, manager, HLB Mann Judd, Sydney
The resources sector is continuing with strong export growth, which is helping to prop up our economy. However, the main driver of the economy—consumer spending—has slowed over the last year and the building and consumer discretionary sectors, such as retail and household goods, will suffer further falls in demand.
As a result of this slowing down, smaller businesses should be locking away the profits they have built up, preferably outside the business. For example, they could consider increasing superannuation contributions. In addition, keeping a tighter control on cash flow in light of rising costs (due to the commodity price boom) would be prudent, and any planned expansion with borrowed money needs to be carefully considered.
Tim Harcourt, Austrade
Most forecasters predict the world economy will continue to grow at above its 30 years’ average. So that’s good news for exporters, particularly as emerging economies are providing a major kick, with China and India playing key roles in this surge.
The main constraint is capacity constraints on the supply side, particularly labour shortages. Australia could well become a ‘workers’ paradise’ again if the labour market functions properly. The wage gap between exporters and non-exporters may widen as a result.
Interest Rates
Predictions
John Edwards
I think interest rate increases will be moderate this year, possibly another quarter of a percentage point on home mortgages and bank bills, but not until well into the second half. We may well see another half a percentage point or a little more on five-year rates. But we don’t expect big changes, because inflation remains well controlled, and in Australia growth is not especially fast.
Joseph Capurso
In its latest public statement, the Reserve Bank of Australia (RBA) signalled it will be on the sidelines for some time. That was back in February. Since then, a range of economic indicators have suggested the economy is strengthening. Retail sales are growing strongly. The trade deficit is shrinking rapidly. The world economy remains strong.
The upshot is that the RBA may need to tap on the interest rate brakes to keep inflation contained. But any increase in the official cash rate will be modest at 0.25 percent.
Jonathan Cavenagh
Our central case remains that interest rates will remain on hold through 2006. The recent pick-up in consumer spending and housing market data has heightened expectations of a possible RBA rate hike, but we feel it will take more to tip the central bank’s hand. Importantly, the inflation outlook does not appear threatening and our expectation is for the core measures to maintain close to a 2.5 percent pace over the next 18 months, which is right in the middle of the RBA’s two to three percent target band. The risks around this view are skewed slightly towards the upside though, particularly given an unemployment hovering at generational lows of five percent.
What this means
Neil Wickenden and Jonathan Philpot
Although interest rates appear to be on hold for the time being, it is worthwhile considering that our rates are still higher than the rest of the developed world and that any further rise—even a small one—will only worsen the slowdown in consumer spending.
Interest rates may be low on a historical basis but they are on a slow upward climb, which raises the cost for businesses with borrowings. It might be worthwhile considering a switch from variable to fixed loans over the next 12 months.
Also, small and medium-sized businesses should be cautious over the next 12 months if considering further expansion.
Tim Harcourt
With low inflation worldwide, there is less pressure on central banks. This not only involves the Fed and the Reserve here, but the World Bank has noted less pressure on Asian central banks to raise interest rates. The World Bank is also less concerned about the impact of oil shocks on the region—as the pressure on oil is demand related not a supply-side shock as occurred during the OPEC-led hikes in the 1970s.
Share market
Predictions
John Edwards
I look for further but smaller gains in the Australian market, of the order of five to seven percent in the ASX 200 over 2006. This will be driven by continuing increases in profits and a more widespread expectation that the economic outlook will be favourable for some years to come. I doubt super choice has had any impact on the level of the market or its sectoral composition.
Joseph Capurso
Since January this year, the ASX 200 has lifted by around 10 percent, putting the benchmark index on track for full-year gains of almost 40 percent. And while growth of that magnitude has occurred in the past—the last time being 1993—the gains have not proved to be sustainable. The share market is overdue for a correction.
Although it is a lot harder to find real value in the share market, valuations are not excessive at present. CommSec be
lieves the ASX 200 will reach 5,350 by end of year.
What this means
Neil Wickenden and Jonathan Philpot
With the strong returns from the Australian share market over the past three years, owners of small and medium-sized businesses should ensure their investment wealth is well diversified across all the asset sectors, so any downturn in the Australian market will limit the losses in the portfolio. This is particularly true of their superannuation investments. ‘Super splitting’ will be an important change for business owners this year, where one family member may have built up a significant superannuation balance while the spouse has a very small balance. From January 1, 2006, 85 percent of annual taxed contributions can be transferred into the spouse’s superannuation to enable them to build their superannuation benefits. This could lead to a significant tax saving as at retirement individuals are utilising two ‘reasonable benefit limits’ (RBL), two tax-free thresholds, and two lower personal tax rates, rather than largely just one of each.
Currency
Predictions
John Edwards
Exporters will be the winners this year because the Australian dollar will depreciate. We expect USD0.68 by the end of the year. Driving change will be higher interest rates in Europe, the US and Japan, versus the likelihood of a quite modest increase here.
Joseph Capurso
We expect the currency to strengthen further to USD0.77 cents by the end of 2006.
For businesses importing from overseas, this will mean the cost of imports could eventually decline. For manufacturers who compete with imports, life could get tougher as a stronger local currency intensifies foreign competition. Exporters will find it a little more difficult to sell into overseas markets.
Overall, a higher currency raises purchasing power and so the benefits of a higher currency outweigh the costs.
Jonathan Cavenagh
Our forecast is for the currency to depreciate over the course of 2006 and into 2007. Two factors are driving this outlook. In the near term, we expect US interest rates to rise at least to five percent, with the risk that rates could go higher. Interest rates are also expected to rise in the Euro area and Japan through 2006. This will reduce the attractiveness of investing in Australian dollar denominated assets. Longer term, we expect commodity prices to moderate as additional supply comes on line in world markets and as global demand slows. As resources represent around 60 percent of Australia’s exports, this will exert considerable downward pressure on the AUD.
What this means
Neil Wickenden and Jonathan Philpot
Currency fluctuations have been volatile over the March 2006 quarter, and the USD has ranged from USD0.759 to USD0.701, which is a 7.64 percent movement within a quarter. A falling Australian dollar is good for exporters but will lead to higher costs for importers. Therefore, depending on which side of the fence a business sits, it may wish to consider some form of hedging to eliminate adverse currency movements.
This may be difficult for small and medium-sized businesses, but as the volatility indicates, import and export prices are likely to be significantly affected by currency movements, so it’s worthwhile exploring this option.
Tim Harcourt
Australian exporters have been used to ‘Living in the 70s’ for some time, though in early 2006 experienced a rare depreciation of the currency. This will provide some relief for manufacturers, although for miners and farmers commodity prices will be a more important factor. Tourist operators may find some international visitors ‘switching’ to higher levels of expenditure (staying in fancier hotels, splurging on that barrier reef tour) but even a weak dollar won’t keep Aussies at home for long.
