24 November 2015
by Jacob Greber
Stevens tells boomers to curb expectations.
5 things Glenn Stevens just told banking economists
The federal Treasury officially downgraded Australia's potential economic growth rate just as Reserve Bank of Australia governor Glenn Stevens told Baby Boomer shareholders to curb their expectations of ever-rising dividends.
In an acknowledgment that the below-par economic growth of the past three years will persist, the Treasury's top forecaster, Nigel Ray, said next month's budget update would assume long-term growth of 2.75 per cent, down from about 3 per cent.
A sharp slowdown in population growth since export prices peaked in 2011 means the economy won't expand as fast as previously assumed. Lower growth could mean a future of fewer jobs and poorer investment returns. It would hit taxes, making it harder to pay for promised rises in defence, education, old age and welfare services.
"This has immediate and unavoidable consequences for the economy's potential," Mr Ray told the Australian Business Economists annual function in Sydney. "Fewer people means a smaller supply of employees. So for a given capital stock and level of productivity, we can now produce less output overall than we previously estimated."
Speaking at the same event, Mr Stevens warned older shareholders that their appetite for constantly rising dividends were unsustainable unless they accepted the need for companies to take on more risk to generate higher profits.
He predicted that global interest rates would remain "very low" for most of the decade ahead, and that yields for most investors would remain depressed for the foreseeable future.
"In a low interest rate world, the problems of providing retirement incomes will become ever more prominent," Mr Stevens said.
"The very low level of yields on fixed income assets means that it is very expensive today to purchase a secure stream of future income, which is what someone who is retiring is usually seeking. And there are more of such people, living longer."
With most Australians living increasingly into their late 80s, Mr Stevens suggested many retirees dismayed by low fixed-income yields had shifted into more dividend-paying stocks – effectively distorting asset markets by forcing companies to favour capital returns over investment.
"It certainly seems that many Australian-listed corporates feel the pressure from shareholders to deliver that, even some whose earnings are inherently volatile," he said.
"Can the corporate sector realistically promise growing dividends over a long period? Not without being prepared to take the risk on investment in new products, processes and markets.
"How much of that risk an older shareholder base will allow boards and managements of listed entities to take is an important question."
Lower population forecasts
Treasury's economic growth downgrade, weeks from the government's mid-year budget update, is based on lower population forecasts at a time when the demographic wave of Baby Boomers is only just starting to become apparent.
Mr Ray, who heads Treasury's macroeconomic group, said the downgrade would, "everything else equal", make it harder to return the budget to a surplus.
Indicative analysis suggests the growth downgrade will worsen the budget by around $5 billion a year, potentially delaying the return to sustained surpluses indefinitely without extra spending cuts or tax hikes. In May, Treasury forecast a return to surplus early next decade.
Modelling by PwC for The Australian Financial Review published last week showed the nation would lose $288 billion worth of growth over the next decade, if trend growth was 0.25 of a percentage point less than the long-assumed rate of 3.25 per cent.
In the May budget, Mr Ray said potential – or "trend growth" – was estimated to be 3 per cent. "We now think potential GDP will grow by around 2.75 per cent over the next few years," he said on Tuesday.
Critically, the estimate still assumes that productivity growth, a key driver of living standards, will continue at the 30-year annual average of 1.6 per cent in coming years, effectively accelerating from the 1.5 per cent rate of the past five years.
A survey of economists released on Tuesday by the Australian Business Economists shows most expect the headline budget deficit to narrow from $37.9 billion in 2014-15 to $35 billion in 2015-16 and $26 billion in 2016-17.
Mr Ray said Treasury was finalising its estimates for Australia's so-called "output gap", given the lower potential growth assumption.
Mirroring the practice of fiscal bodies such as the US Congressional Budget Office and the UK's Treasury, Treasury in Canberra bases its longer range forecasts on an assumption that growth will accelerate above the potential rate until unemployment falls to a neutral level where it neither adds to nor detracts from inflation.
Long-term growth around 3.25pc
With the jobless rate still significantly above that level, next month's mid-year update will almost certainly include a long-term growth assumption of around 3.25 per cent for several years over the latter part of the coming decade.
In the May budget, Treasury assumed the economy would return to a 3.5 per cent growth pace for five years after 2017-18.
"Because we think potential is a bit lower, the output gap will be a bit smaller," Mr Ray said. "It's likely that on average we won't have to grow quite so fast to get there as we previously thought.
"The economy will still, by definition, have to grow a bit faster than potential [to get the jobless rate down]."
Mr Ray warned that Treasury could be wrong on its latest analysis if productivity growth is considerably lower than it has assumed. "As services become a bigger part of our economy, productivity growth could ease. Equally, breakthrough innovation and the realisation of productivity gains from current technologies could see productivity grow faster than it has in the past."
In a wide-ranging speech, Mr Stevens said while the US Federal Reserve would most likely hike the funds rate next month, or soon after, the European Central Bank and Bank of Japan were still "a long way from even thinking about higher interest rates".
"My guess is that global interest rates are still going to be very low for a good part of the decade ahead."
Mr Stevens' challenge to older investors comes amid a growing realisation that the relatively easy sharemarket gains since the global financial crisis may no longer be sustainable.
"Overall, in a world where a higher proportion of the population wants to be retired and living (even if only in part) off the return on their savings, those returns are likely, all other things equal, to be lower.
"Part and parcel of the same adjustment may be higher real wages for the smaller proportion of the population that is working. These changes, driven by demographics, may require some adjustment to our collective thinking about what is 'normal', not just for rates of return on assets but also for returns to labour."