Brace for a Recession

Its time to batten down the hatches for the worst external shock since the 1974 oil crisis.

This shock from Asia, coupled with an overly ripe domestic business cycle will -- judging by the data -- knock the economy into a recession during the next 12 months.  Victoria, with its large manufacturing base, will probably be hit hardest.

The simple fact is that the main impetus of growth -- exports to Asia -- is collapsing.

Japan -- our major export market -- is going into recession.  The only questions are -- how deep and for how long?  The New Zealand economy shrank by 0.9% during the March quarter and, even by the reckoning of the NZ Treasury, is expected to decline further during the June quarter -- which technically means a recession.

As we know, Thailand, Indonesia, Korea and Malaysia are already deep in recession.

Although the US and European economies appear to be doing fine and China has so far weathered the storm -- though there are clear signs that all is not well in China -- given the dominance of Asian countries, our trading partners in aggregate are headed for recession.

Manufacturing will be hit hardest by the external shock.  The manufacturing exports are already at their lowest level for the decade and, according to the latest surveys, manufacturers expect their exports to decline by a further 25% this year.  Manufactures will also face immense pressure from Asian imports.  As a result of import competition, intense domestic pressures and higher input prices from the appreciation of the US dollar, manufacturing margins have already declined to their lowest level since the last recession and are expected to continue to decline.

The expectation has been that the domestic economy would somehow withstand the tide.  The latest information, however, indicates that this is a forlorn hope.

Domestic demand slowed markedly during March Quarter to around 2 % on an annualised basis.  Moreover, this growth was entirely due to a massive accumulation -- the largest since 1976 -- in stocks.  Without the stock build-up, domestic demand would have been negative.  The stock build-up is a particularly bad omen given the prevalence today of "just-in-time" stock management.

Private non-residential investment is also slowing -- albeit from a very high level.  Many major investment projects, such as the Sydney Olympic, telecommunication-cable role-out and resource processing, are slowing or coming to an end.  Moreover, the recession in Asia is resulting in many new projects being postponed.

Again, manufacturing investment is being hit particularly hard.  Equipment investment intentions in March fell to their lowest level since the 1982 recession.

The housing sector is also slowing with house construction finance down 35% since December 1997 -- though the level of building approval remains high.  Importantly, finance for investor properties has plummeted since January.

Not surprisingly, business confidence is very low and currently stands at the same level as at the beginning of the last recession in 1990.  Indeed the lack of confidence -- specially in the small business sector -- shows through starkly in all available surveys.

The good news is that the economy is in far better shape to weather the storm than at any time in the last 25 years.  Indeed without the reforms of the past decade we would really be a part of the much deeper malaise being experienced by so many Asian economies.

Nonetheless small trading nations with large current accounts cannot avoid being swept along by the tide.

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