The Reserve Bank of Australia left interest rates on hold yesterday at 4.5%. The RBA also released Australia's current Monetary Aggregates and Commodity Index, which demonstrates why rates were lifted and probably why they should be on hold.

Australia entered the downturn with unemployment only going as high as 5.8%. The RBA's response was to drop interest rates from 7.25% to 3.00%.



The RBA left interest rates at a high of 7.25% until September 2008, way after the rest of the World had progressed toward zero interest rates. In a similiar fashion Australia has moved early to lift interest rates, but has paused as World events have overshadowed its bullish growth predictions for the economy.

Australia's Mortgage market is predominantly a variable rate market, so when interest rates fall by 4%, it goes straight into disposable income. In late 2008 there was about $1 Trillion in Home Loan lending (RBA - Release D02), so about $40 Billion flowed into incomes.

The Government embarked on a stimulus plan, adding fuel to housing demand, by paying a First Home Buyers grant of up to $32,000. Over a 10% deposit comes in handy to fuel a housing boom, with most borrowers benefiting from record low interest rates.

So the record borrowing continued.



Employment grew and Unemployment fell (source abs.gov.au):



Wage growth continued (February 2010 - 5.86%):



All helped along by a resurgent Commodity sector:



Commodity prices dipped in May 2010. The Government focus on Home Lending has provided imbalances in the Economy:



Business lending has been consistently contracting since the GFC started and now has contracted by 7% since April last year. Personal lending (credit cards/personal loans etc.) is now growing.

Also, the stimulus spending has shown up in the Budget (source RBA):



Revenue has flat lined, and expenses keep on increasing. Which in turn has shown up in Government Debt (source: RBA):



Government Securities issued increased by $98 Billion for the year ending March 2010. With GDP tracking $1,269 Billion, the increase in debt represents 8% of GDP, and total Debt is 21% of GDP.

Company Tax revenues are declining:



The Federal Government put out its Budget in May, forecasting receipts over the next 4 years. There is no decline in spending, but the revenue is forecast to grow by 35% by 2014, due to an forecast expanding GDP of the same growth.



source: www.budget.gov.au

So we have Revenue of $294.2 Billion in 2009/10 growing to $407.2 Billion in 2013/14. As Revenue is targeted to around 25% of GDP (24.6%), this necessitates that GDP is $1,655 Billion. This of course is a 30% increase from the current GDP of $1,269 Billion.

So the whole Budget is premised on the economy growing by 30% over the next 4 years. And being a resource based economy, this brings into focus that the forecast is based on a furthering commodity boom, which hopefully will feed back into the commercial sector rather than the Housing market.

This is probably why the Government is focusing on the Resource Sector to further take up the slack from decreasing Corporate tax receipts. The year to date (March 2010), the Government collected $56 Billion in Corporate tax. According to APRA (Australian Prudential Regulation Authority), the banks have contributed about $10 Billion in tax to that total. The mining industry are saying that they pay about $13 Billion in Corporate Tax (plus $7 Billion in state tax). So between the Banks and the Miners, they contribute 41% of tax collected. With a falling Commercial sector (borrowing is tougher), and consumer spending relying on a continued home price increases, what better electoral target is there than the miners to get revenue back to growth to match the budget. The Miners, of course, are putting on a fight to defeat the tax.

This of course has the Government doing a backflip on "guaranteeing" not to spend public money on advertising Government Policy:

see link. The Government intends now to spend $38 Million in delivering it's message on the Mining Tax to the public.

Overall, although Australia may enjoy the benefits of the future growth of a buoyant mining sector, but any deviation from that path will highlight an economy dependent on debt growth and rising home prices. Targeting the mining sector may remove a pillar of support that may have softened the blow. Australia is totally exposed to rising interest rates, as having mentioned before, every rate rise removes disposable income from borrowers on variable rate loans.



What is it called when economies stagnate and inflation rises? The bets are on.