Reserve Bank of Australia
Topic: Global Economy
The Response by Central Banks in Emerging Market Economies to COVID-19
The COVID-19 health and economic crisis has severely affected emerging market economies (EMEs). As a result, emerging market central banks have employed a wide range of tools to support their economies and financial systems, many of which have been used for the first time. These measures have helped to support the functioning of domestic financial markets, lower domestic interest rates and facilitate the flow of credit to households and businesses. The scale of monetary easing by EME central banks was larger, and the pace faster, than in some past crisis periods. This was influenced by the sudden and synchronised nature of the COVID-19-induced economic shock and the large scale policy response in advanced economies that occurred alongside the EME response. It also reflects the significant improvements emerging market central banks have made to their institutional frameworks over recent decades and the development of EME financial markets over the same period.
Determinants of the Australian Dollar over Recent Years
The exchange rate is influenced by a number of domestic and international factors. Two key fundamental determinants of the exchange rate are the terms of trade and differences between interest rates in Australia and those in major advanced economies. Since the end of the mining boom, the decline in the terms of trade and easing in domestic monetary policy, including the recent introduction of quantitative easing measures, have contributed to the depreciation of the Australian dollar. On a shorter-term basis the Australian dollar has also moved closely with prices in other international financial markets in response to changes in global risk sentiment.
Economic Developments in India
Over recent decades, India’s rapid economic growth has led to a substantial increase in its demand for Australian exports. However, India is currently facing the most significant setback to its economic development in decades as a result of COVID-19. Like in many other economies, the pandemic has severely affected near-term economic activity and exacerbated existing vulnerabilities in the Indian economy. While it will take some time for the Indian economy to recover, underlying fundamentals should support growth in the long term. This in turn should increase demand for some key Australian exports such as coking coal and education services, and so India will likely remain an important trading partner for Australia. The outlook for other resource exports such as iron ore and thermal coal is less positive because India is expected to be self-sufficient in these commodities.
The Response by Central Banks in Advanced Economies to COVID-19
Central banks in advanced economies have employed a wide range of tools to support their economies and financial systems during the COVID-19 pandemic. Some measures have involved scaling up standard central bank tools or reactivating facilities introduced during the global financial crisis. Other measures are new innovations. The speed at which these tools were deployed and scale of their usage has been unprecedented. These measures have helped to restore functioning of financial markets, lower interest rates, and support the flow of credit to borrowers.
Different Approaches to Implementing a Countercyclical Capital Buffer
The countercyclical capital buffer (CCyB) was one of the measures designed to improve the resilience of the global banking system following the global financial crisis (GFC). It is a bank capital buffer that can be raised or lowered by jurisdictions depending on the level of risk in the financial system. This article describes different approaches to implementing the CCyB. Most jurisdictions set the ‘default’ CCyB rate at zero until risks are elevated; however, recently, several have adopted frameworks where the CCyB is positive through most of the financial cycle. The Australian Prudential Regulation Authority (APRA) has recently announced that it is also considering moving to a non-zero (positive) default CCyB (APRA 2019). This article discusses the possible benefits of a positive default CCyB.
The Global Financial Safety Net and Australia
The Global Financial Safety Net (GFSN) allows for financial assistance to be provided to economies in the event of an economic or financial crisis. Together with the substantial monetary and fiscal policy response globally, the GFSN has played a key role in helping economies respond to the COVID-19 pandemic. The GFSN has a number of elements, including the assistance provided by the International Monetary Fund, regional financing arrangements and some bilateral swap lines established by central banks. This article provides an overview of the GFSN, how it has evolved and been used over recent months, and the role the Reserve Bank of Australia plays in it. Use of the GFSN could increase materially over the period ahead if economic and financial market conditions around the world deteriorate.
Private Sector Financial Conditions in China
Historically it has been challenging to assess financial conditions for private firms in China. This article assembles a range of indicators that shows private firms find it more difficult and expensive to access financing than state-owned firms. Based on these indicators, the private sector had experienced a tightening in financial conditions over the past few years, although more recently conditions have generally eased as a result of new measures that direct more credit to private firms.
China's Residential Property Sector
The property sector is a significant driver of economic growth in China and a key source of demand for Australian commodity exports. Authorities have become increasingly wary of financial risks in the sector, and moved to reduce the importance of policies directed at real estate for managing short-run fluctuations in aggregate demand. The effect of COVID-19 on property sales and developer balance sheets necessitated a moderate easing of policy to support the real estate sector, but it only appears to have delayed rather than halted efforts to de-risk the sector.
Economic Effects of the Spanish Flu
The Spanish flu reached Australia in 1919 and remains the country’s most severe pandemic in terms of health outcomes. At the peak of the pandemic, sickness due to influenza temporarily incapacitated 2 per cent of the labour force. However, despite the social distancing measures used by governments to contain the virus, few job losses in this period were due to a lack of available work. The labour market also recovered quickly, but it is not clear how relevant this experience is for the modern economy.
Recession
This Explainer describes the nature of the business cycle, different approaches to identifying a recession and some of the recessions that have occurred in Australia.
How Do Global Financial Conditions Affect Australia?
Australia is closely integrated with global capital markets. This integration has been of benefit to the economy, but also means that Australian financial conditions are influenced by developments abroad. The flexible exchange rate regime partially insulates the economy from global financial conditions. In particular, that flexibility means that monetary policy in Australia does not need to move in lock step with policies of the major central banks. However, to meet its objectives for employment and growth, the Reserve Bank can choose to offset pressure on the exchange rate from shifts in foreign monetary policies. Indeed, for much of the past decade or so, forces underpinning the structural decline in global risk-free rates have placed downward pressure on interest rates offshore and in Australia. International investors’ willingness to take risk also has an important bearing on domestic financial conditions.
Long-term Growth in China
Slowing trend growth in China, and the risks around this trajectory, are relevant to the future economic prospects of its major trading partners, including Australia. This article provides a long-term perspective on growth in China, beginning with a review of historical trends. It then examines the drivers of growth since reforms were introduced in the late 1970s and how these drivers are affecting the growth outlook. The article concludes that a range of structural headwinds will constrain growth in the coming decade, posing challenges for policymakers.
Potential Growth in Advanced Economies
Potential growth is the rate of growth that an economy can sustain over the medium term without generating excess inflation. Potential growth has declined in the advanced economies in recent decades due to lower growth in the labour force, capital stock and productivity. Current projections and long-term growth expectations suggest that the low rates of potential growth in advanced economies will persist for some time.
Conditions in China's Corporate Sector
Revenue and profit growth have slowed in China’s corporate sector in recent years, alongside a broader moderation in China’s economic momentum. The slowdown has been most severe for labour-intensive private companies, particularly export-oriented manufacturing firms. The government has responded by announcing a range of measures aimed at easing financial conditions faced by the private sector. Earlier efforts by the Chinese authorities to reduce risks in China’s financial system appear to have been successful in stabilising leverage in the state-owned sector, but the financial position of private sector firms is more fragile, and risks remain elevated in the real estate industry.
Liberalisation of China's Portfolio Flows and the Renminbi
China’s equity and bond markets have grown rapidly to be among the largest in the world, yet, until recently, participation by foreign investors has been limited. Over recent decades, the Chinese authorities have relaxed investment restrictions to allow greater foreign access to these capital markets. This has enabled greater foreign investment and for global equity and bond index providers to increase the weight of Chinese securities in their indices, which are tracked by a range of global investment funds. These developments have contributed to an increase in gross foreign capital flows into China and they are likely to continue to support inflows in the period ahead. At the same time, an increase in Chinese resident portfolio outflows is also likely as domestic investors seek to diversify by investing abroad. The opening of China’s financial markets entails benefits associated with deeper global financial integration, but may also contribute to greater variability in the renminbi.
The Changing Global Market for Australian Coal
Coal is one of Australia’s largest exports, and has accounted for around one-quarter of Australia’s resource exports by value over the past decade. However, demand in the global market for coal has been evolving in recent years, which is creating some uncertainties for the longer-term outlook for coal exports. Looking forward, demand will be shaped by the speed of the transition towards renewable energy sources, changing steel production technologies, and the pace of global economic growth. Over the next few years, Australian coal production and exports are expected to grow fairly modestly.
Spillovers to Australia from the Chinese Economy
China is Australia's largest trading partner. The strong links between the two economies raises the question of how a sizeable slowdown in Chinese activity would affect Australia. Through our research we have attempted to quantify how such a scenario could play out and its implications. We consider the main transmission channels, notably trade and financial market effects, and describe possible scenarios that could lead to a material slowing in China. We apply a stylised shock encapsulating features of these scenarios to a medium-sized macroeconometric model of the Australian economy and analyse how the shock is transmitted through real and financial channels. The potential for the exchange rate and monetary policy to offset some of those effects is also examined.
China's Local Government Bond Market
China's local government bond market is a key source of financing for local governments, particularly to fund infrastructure investment. The market has grown rapidly in recent years but is still relatively illiquid and has a narrow investor base. It also shows little difference in pricing of credit risk across different bond types and issuers, partly due to the perception that local governments enjoy an implicit guarantee from the central authorities. The Chinese Government has implemented measures to foster the development of these features of the market, bearing in mind risks to financial stability.
The International Trade in Services
Services are becoming increasingly traded globally and technological advances have led to the rise of more modern services such as communications, financial and intellectual property services. While advanced economies continue to account for the bulk of the demand and supply of services traded around the world, the emerging economies' share has been increasing. This article examines the changing global trends and compares them to Australia's experience with services trade, which has been shaped by China's growing demand.
Housing Policy and Economic Growth in China
Housing investment has contributed significantly to Chinese GDP growth in recent decades and, due to the steel-intensive nature of that investment, has also been an important driver of Australian exports of iron ore and metallurgical coal. Trends in Chinese residential investment have been strongly influenced by government policies. Since 2016, the Chinese Government has tightened policies, particularly towards ‘speculative’ housing purchases, to moderate property price inflation. It has simultaneously implemented targeted, incremental measures to improve longer-term housing supply. Even so, construction activity has weakened and prices have continued to rise rapidly. Maintaining this policy mix towards the sector is likely to prove challenging as downside risks to broader economic conditions mount.
Developments in Emerging South-East Asia
A number of economies in South-East Asia have been making significant progress in their economic development. This article focuses on the largest middle-income economies in South-East Asia: Indonesia, Malaysia, Thailand, the Philippines and Vietnam. We examine the developments in these economies over recent decades, explore their relationship with Australia and the global economy and consider their potential to reach a significantly higher level of income. These economies have benefited from favourable demographics over recent decades although some will face pressures from ageing populations. However, there are ample opportunities to gain from further improvement in infrastructure, education and labour force participation.
China's Supply-side Structural Reform
Supply side structural reform is a key component of China's economic policy agenda. The motivation for reform is the view that the supply side of China's economy is out of balance with the demand side and requires adjustment. The reform targets the structure of production, to make it more efficient at the macro and firm level. As well as improving efficiency, firms are being pushed to make production more environmentally friendly. Promoting advanced industries and innovation in existing industries are also key features of the policy.
RMB Internationalisation: Where to Next?
China's push to make its own currency – the renminbi (RMB) – available for use by non-residents was a catalyst for important reforms. Since the RMB internationalisation policy began in 2009, not only is the RMB now in greater use internationally, capital flows more freely across China's borders, the exchange rate is more flexible and domestic interest rates are more market determined. In time, the RMB could emerge as a widely used regional currency in Asia.
Trends in China's Capital Account
Chinese policymakers' approach to liberalising capital flows has been gradual and controlled over time, as the authorities have sought to mitigate volatility in the Chinese renminbi (RMB) and private capital flows. Direct investment flows out of China have grown, become more diversified and have increasingly been accounted for by private investors. Banking-related flows have proved more volatile and are correlated with expectations for the RMB.
Developments in Correspondent Banking in the South Pacific
This article examines the withdrawal of global financial institutions from providing correspondent banking services to the South Pacific region and the implications for remittances. Disruptions to the flow of remittances, an important source of income to many low-income island nations, could limit local consumption and adversely affect economic stability. So far, however, remittances to the South Pacific region have continued to increase.
Economic Trends in India
The Indian economy has experienced a notable turnaround in recent years. Growth has rebounded, inflation has moderated, and the budget and trade deficits have narrowed. The Indian Government has also initiated policies and reforms aimed at encouraging investment, strengthening productivity and ensuring fiscal sustainability. Stronger growth in domestic demand has led to a recovery in India's imports, including from Australia. The recent volatility in foreign exchange markets and the recovery in oil prices pose upside risks to inflation and the current account deficit. However, India's strong long-term potential for growth, driven by demographics, urbanisation and productivity-enhancing reforms, suggests there is scope for trade between Australia and India to expand further in coming years.
Indicators of Labour Market Conditions in Advanced Economies
While the unemployment rate is the most widely used indicator of labour market slack, there are many other measures. This article reports on what a broad range of indicators say about conditions in the labour markets of advanced economies. We summarise the various indicators using a standard statistical technique. The summary measures show labour markets in most advanced economies are tight, although in some cases not as tight as implied by the unemployment rate. The Australian labour market has spare capacity remaining, consistent with readings from the unemployment rate. The summary measures provide additional information about wage developments for most advanced economies, above and beyond the unemployment rate, but do not fully account for the weak wages growth of recent years.
Wage Growth in Advanced Economies
Nominal wage growth in advanced economies has been sluggish, despite unemployment in a number of places falling to levels consistent with full employment. This article finds that, in most economies, low wage growth does not reflect a weaker relationship with unemployment. Instead, lower productivity growth, the difficulty of cutting wages following the global financial crisis and a decline in labour's bargaining power help explain some of the wage sluggishness. There also appears to be a common, but yet unidentified, factor that has weighed on wages over the past two years.
Non-bank Financing in China
The rise of shadow banking activities over the past decade has provided a range of benefits to the Chinese economy and financial system. Yet, it has also raised considerable financial stability risks, prompting Chinese authorities to announce many changes to the regulatory and supervisory framework. This Bulletin article examines the nature and complexity of shadow banking and highlights the challenges facing the Chinese authorities.
The graphs in the Bulletin were generated using Mathematica.
ISSN 1837-7211 (Online)