Economic overview: September quarter 2021

Matthew Howden

Strong global economic recovery underway

Global economic recovery remains on track. This bodes well for continued strong demand for Australian agricultural products. Global economic growth is assumed by the International Monetary Fund in their July 2021 World economic outlook update to be 6% in 2021 and 4.9% in 2022, after falling by 3.2% in 2020 (Figure 1). Rapid progress in vaccinating eligible populations and very high levels of fiscal and monetary support from governments has meant that the recession of 2020 was short-lived.

COVID-19 continues to be the key risk to economic recovery, with the highly infectious Delta variant challenging global health systems. Vaccine deployment has so far been centred on advanced economies where the economic recovery from the COVID-19 caused recession has been strongest. Limited access to vaccines in emerging and developing economies is delaying their economic recovery and constraining growth in that group.

Global growth assumptions for 2021 remain unchanged from the June edition of the Agricultural Commodities Report. However, underlying these assumptions are offsetting revisions to the growth rates of advanced and emerging and developing economic groups.

In emerging and developing economies, economic growth has been revised down by 0.4% in 2021 to be 6.3%. This downward revision follows renewed outbreaks of COVID-19 in emerging Asia, especially India and Indonesia, and reflects the economic impact of containment measures implemented to control the spread of the virus and relatively lower vaccination rates.

In advanced economies, economic growth assumptions have been revised up compared with those published in the June quarter. Growth in 2021 has been revised upwards by 0.5% to be 5.6%. These revisions reflect better progress with vaccination programs in economies that have reopened sooner than previously assumed, such as those in the eurozone and the United States. Recently announced fiscal stimulus packages, such as the US$550 billion Bipartisan Infrastructure Deal in the United States, will further boost economic growth in that nation and among major trading partners.

COVID-19 continues to disrupt international freight

COVID-19 related disruptions have increased freight costs and transit times in the shipping industry. Higher shipping costs are not assumed to have a strong influence on demand for most Australian agricultural products. This is because other exporters are facing similar price increases. On average, global shipping prices for containers doubled between May 2020 and June 2021 (Figure 2). Over the same period global bulk freight costs for shipping grains and oilseeds increased by 125% while costs for Australian grains exporters increased by 152%. Mismatches in supply chains because of strong demand for manufactured products have meant that shipping prices have declined on some routes, such as from North America to Europe, but costs for most other routes have increased. Prices on major Australian containerised shipping routes have increased, but less so than others. Shipping costs are assumed to remain elevated throughout 2021 and into 2022, which will continue to drive up commodity prices.

Australian farmers export to international markets using bulk carriers, shipping containers and air freight. The effect of higher freight costs on farms will vary according to the commodity and the mode of freight used to transport it to market. A 2019 AgriFutures report on freight costs for Australia’s agricultural industries found that freight costs vary by commodity, and any significant differences between domestic supply chains in Australian and other countries can offset or reinforce differences in international freight costs. Factors such as the relative quality and cost of transport infrastructure, and the cost of fuel, supply chain management and labour can all help or hinder Australian commodities relative to international competitors. Research prepared by ABARES in April 2020 investigating the impacts of COVID-19 on trade found that on average transport costs account for around 7% of the final price of Australia's food and fibre products.

Higher commodity prices have increased inflation

Commodity prices increased during the first half of 2021 (Figure 3) due to the strength of the global recovery and elevated shipping costs. Prices for agricultural products increased. This reflects a rise in demand as COVID-19 related restrictions were lifted, and reduced production due to poor seasonal conditions in the northern hemisphere. Energy prices increased strongly because of amplified demand from eased mobility restrictions and reduced production by the Organization of the Petroleum Exporting Countries group. Higher energy prices are likely to bolster demand for some agricultural products, including biofuels derived from crops, and for natural fibres as the price of substitute synthetic fibres is driven up. Prices of minerals, including iron ore, have been driven higher by strong demand from China and reduced global supply. Demand from China is expected to ease over the second half of 2021 because of lower steel production.

Inflation has climbed in some economies over recent months, notably in the United States (Figure 4). Inflation has been driven higher by increased oil prices and COVID-19 related disruptions to supply chains. Elevated inflation is assumed to be temporary because a large part of the increase is driven by lower prices in 2020 (known as the ‘base effect’). Underlying measures of inflation (which exclude volatile items such as oil and food prices) remain below central bank targets in most major economies. Central banks are assumed to leave interest rates at their current low levels until at least 2023.

Sustained high inflation is a risk to the outlook in a continued low wage growth environment. If the temporary factors that are contributing to high inflation do not weaken, inflation could slow the global economic recovery. Elevated prices, combined with continued low wage growth, would mean that households must dedicate a larger share of their budgets to maintain their usual food consumption or substitute to cheaper alternatives. This could lead to falling demand for Australian agricultural exports.

Prolonged higher inflation would also encourage central banks to start raising interest rates sooner to slow inflation. Raising interest rates would slow economic activity as the cost of borrowing and servicing debt increases. This would also lead to falling consumption and investment.

Activity in the services sector, which includes hospitality and tourism industries, has begun to recover in economies with high vaccination rates, such as those in the eurozone, the United Kingdom and the United States. This has further strengthened the recovery of those economies, through increased employment, business investment and consumer confidence. It is assumed that as other economies reach high levels of vaccination, activity in the services sector will rebound strongly, and this will stimulate demand for agricultural products.

Outlook for 2022 will depend on vaccine access

In 2022 growth in advanced economies is assumed to remain strong at 4.4% (above the 5-year average to 2019 of 2.1%).

Sufficiently high vaccination rates are assumed to be reached during late 2021 that will allow most COVID-19 related health restrictions to be removed. Growth in these economies, which includes Canada, Japan, the eurozone, United Kingdom and the United States, will be driven by increasing business and consumer optimism as COVID-19 related health restrictions are removed. Consumers and businesses in these economies increased their precautionary savings or delayed investment during lockdowns. It is assumed that as health measures are lifted, private spending and investment will increase at the same time as government support packages are reduced.

Growth in emerging and developing economies is assumed to be 5.2% in 2022 (above the 5-year average to 2019 of 4.4%). Growth is expected to be driven by a surge in activity as vaccination programs become more widespread and economic activity resumes. It is assumed that vaccination rates will increase over 2022 as vaccines are redirected away from advanced economies towards emerging and developing economies. Emerging Asia, which includes some of Australia’s main agricultural markets, has been especially vulnerable to outbreaks of the Delta COVID-19 variant due to underdeveloped health systems, poor vaccination rates and limited capacity to provide fiscal or monetary support. Economic activity in tourism-dependent economies in the region, such as Indonesia, the Philippines, Thailand and Vietnam, will remain subdued until high vaccination rates allow for the resumption of international travel.

Risks to the outlook

Risks to global economic recovery continue to depend on the pace of vaccine rollout. On the upside, earlier access to and delivery of vaccines than currently assumed will lead to a stronger recovery as restrictions are lifted and economic activity resumes. This would especially benefit economies dependent on hospitality and tourism sectors, such as those in emerging Asia.

Downside risks stem from slower vaccine rollouts, especially in emerging and developing economies. Continued outbreaks risk the emergence of further COVID-19 variants that could be more resistant to current vaccines. Delayed vaccine delivery would further impede reopening. This would weaken economic activity and likely reduce demand for Australia’s agricultural exports.

Outbreaks challenge Australia’s economic recovery

The Australian economy is assumed to grow by 4.5% in 2021–22 after increasing by 1.4% in 2020–21. In 2019–20, COVID-19 related disruptions caused the economy to contract by 0.2%.

Recent outbreaks of the Delta COVID-19 variant have resulted in lockdowns in most Australian states. It is assumed, noting a significant degree of uncertainty, that current lockdown measures in most states will be lifted in the December quarter of 2021. Business and consumer confidence is assumed to improve as vaccination rates increase and outbreaks become less frequent, which will drive economic activity in the second half of 2021–22.

COVID-19 outbreaks weigh on Australian exchange rate

In 2021–22 the Australian exchange rate is assumed to average US75 cents. This is a downward revision of US3 cents from the assumptions in June. In 2020–21 the dollar averaged US75 cents.

The value of the Australian dollar has depreciated in recent months – from averaging US75 cents in June 2021 to an average of US73 cents in August. This has been driven by COVID-19 outbreaks in Australia and an improved outlook for the US economy. Further downward pressure on the Australian dollar has come from falling prices for Australia’s largest export, iron ore. The exchange rate is assumed to appreciate modestly over the second half of 2021–22 because of strengthening economic activity as COVID-19 restrictions are removed.

Risks to the exchange rate assumptions are tilted to the downside. Further widespread lockdowns are likely to cause the Australian economy to contract in the September and December quarters of 2021. Subdued economic activity and weaker market sentiment would cause the exchange rate to depreciate further. Falling prices for iron ore are also a risk to the exchange rate assumptions. The price of iron is assumed to fall over the second half of 2021 because of falling demand from China and a recovery in global supply. Stronger than currently assumed falls in the prices of some exports, particularly iron ore, are likely to cause the dollar to fall further.

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