Transcript of Question & Answer Session Remarks at UBS Australasia Conference 2015

If there is excess capacity in the industrial and commodity sector, is it possible the commodity prices could go back to 2000 levels and hurt Australia? So Chris, let me add to that I guess one of the issues that we think about here is trend growth in Australia has typically been sort of three and a quarter, and it was three and a quarter before China arrived we quite comfortably managed that sort of growth rate. If commodity prices go back to those sort of 2000 levels and maybe China has a soft landing, is there still risks there for us, can we regenerate that sort of three and a quarter trend growth over the next decade or so?

Well there’s a lot in there. In terms of commodity prices going back to that sort of level, there’s so many moving parts that would need to come together to do that. You’d need a very substantial further drop in demand, it’s possible one would imagine. But remember one of the reasons why commodity prices now are much higher than they had been in those times, because demand’s expanded over many, many years to pretty high levels, we’ve been exploiting globally higher and higher cost deposits. So you’d need a really big retraction in demand to bring us back to those sort of levels; maybe that’s possible. And then you have to ask what are the high, really high cost producers of things like iron ore doing? And the very high costs ones are in China and they would be even further under the water. So that could be a mitigating factor.

In terms of the adjustment here that we’d be faced with if we had much lower commodity prices than we do now, you’d need a further fall in the exchange rate one would imagine and that would help to rebalance growth towards other sectors, we’re already seeing some of that happening now as we see the exchange rate adjusting. Unemployment is still reasonably high here, so we do need a period of growth above potential to soak some of that up, whether that can be sustained at really high levels will come down to the all important productivity growth. I don’t know that that has much to do with commodities going forward but it’s hard to know where we’re going on that, on productivity growth.

Right, productivity and possibly tax reform are all issues that would contribute to us regaining sort of three to three and a quarter per cent?

Yeah I mean one would imagine you’d need sensible well throughout reforms.

So if we take it a little bit broader Chris if I can ask you obviously China, with China gearing up over the last 15 years and growing so much more rapidly the rest of Asia, particularly east Asia, has sort of been feeding into that China story, how’s the Bank viewing the implication for both east Asia in terms of their outlook as China slows and then bringing that back to Australia in terms of you know last time I looked 75 per cent of our exports went to the broader emerging market sort of complex, a lot of which is in that Asian region. What are the implications of that for Australia?

Well I think what we’ve seen over the course of this year, in addition to the easing in growth in China, we have seen a slowing in growth in East Asia generally. Now that slowing in China’s been associated with a reduction in trade and industrial production growth right across the region. I’m not sure that China’s the soul source of that weakness. Japanese trade has also been weak; Japanese demand has been reasonably soft over the course of this year. The other thing that’s confusing the picture is that some of our Asian partners are commodity producers and much of the reduction in trade across the Asian region reflects lower commodity prices. But clearly East Asia has been affected, their external demand has been weakened, there’s signs that that’s having some impact on their domestic conditions.

Though it’s such a complicated picture because there is quite a bit of variation across the region. Taiwan’s been very heavily affected because with their trade links no doubt with China. Korea, it’s had a little bit of its own sort of snafu with the MERS outbreak earlier in the year, its growth’s picked up in the latest readings. And then as I said, many of the other economies which are a substantial trade partners are still developing economies, they’ve still got very strong growth and that’s likely to continue. So although we’re seeing a slower growth rate across the region, I think one we’ve already seen the effect of that on commodity prices through the course of this year. In fact, maybe commodity prices are providing the earlier signal but then the hard data that was starting to come in from things like GDP and trade and so on were catching up to … and you could see that in base metals prices, base metals prices had sort of come off through the year, they’ve stabilised a bit of late.

I think the point is there’s still a lot of development opportunities right across the region including in China, it’s still got pretty strong growth and we’ve got to remember it’s nearly twice the economy it used to be 10 plus years or so ago and it’s growth rate hasn’t halved, so it’s still making a substantial contribution. The same is true of east Asia it’s still got very strong growth. India’s probably worth a mention. It’s growing as a trade partner and it’s growth has held up and been pretty strong. So we’ve got this near term softness but the longer term prognosis one imagines is quite a good one and it’s fortuitous for us that we’re linked into that region.

One of the questions that’s come through here is, what are types of indicators or business liaison are the RBA staff in Beijing sort of looking at, what do they – what sort of information?

They obviously talk a lot to the various authorities in Beijing, and travel a lot around the country as much as they can. What they’re doing is just helping us get a feeling on the ground from researchers, other financial institutions that are based there, close links to authorities so they facilitate visits from senior staff from Head Office going there. There is no one particular series or set of series. They gather as much information as they can and we’ve also got staff in Sydney who are monitoring these things. And a key benefit is amongst some of those staff is to have key language skills so you can read stuff that’s available on a timely basis and really understand the data that is available.

The first question I wrote down when I was thinking about this panel was systemic risks we’ve talked a lot about China slowing down and even though you know we’ve got numbers with five – high fives on it by 2017 we’re not really – we’re sort of putting that in the framework of a soft landing. I’ll ask all of you and Chris you can defer if you wish, but what are the systemic – why isn’t there a systemic problem, what are the risks in the shadow banking system, in the banking system, in broader – the equity market, why can’t we have a systemic event in China?

Do you want me to try and start?

Yeah.

It’s possible to have a more substantial slowing in China that comes in potentially through the financial system problems that they might experience given they’ve got high levels of debt. That’s something we’ve mentioned in our recent statement, it’s the sort of thing we’ve been mentioning actually in our statements when discussing uncertainties for some time. One of the things we mentioned recently was the fact that the weakness in the industrial sector is affecting some parts of the country more than others, those parts of the countries are often close also to the parts of the country that are experiencing stress in the mining sectors. So one imagines it’s possible that if that weakness continues perhaps a smaller financial institution that has a lot of exposure there might run into trouble.

And then I think the really big question in China, and the other panellists may have different views, but the really big question I think is well what do the authorities do in response to that? Do they see it in a timely manner? And how do they react? And there’s a question between the regional authorities versus the central authorities, and all of the power to do a lot is obviously at the centre. So look they’ve got a lot of options, they’ve still got a lot of fiscal space to respond if needed and I think that’s the big question if some event was drinking financial stress somewhere.