The Effects of the Global Economic Crisis on the Western Australian Business Environment

Art der Uni-Arbeit: Bachelorarbeit

Fachrichtung: BWL

Autor/-in: Tobias Paul

Abstract

This research project aims on answering the question to what extend Western Australian businesses, especially in the mining sector, have been effected by the global economic crisis. The main trigger of the global economic downturn was the sub-prime crisis in the United States in mid 2007 which still affects the world economy and global financial markets.

To understand the complex interrelated nature between financial markets and economic growth, the study is based on theories of growth and decline of economies and the role of financial markets. In this context, main drivers of economic growth in the era of Globalization theory will be subject to analysis. The emergence of global institutions, a global marketplace and foreign direct investment are of major importance to ensure stability and the development of a global economy.

Then, the focus is on Australia as a major supplier of natural resources such as iron ore, gold, gas and oil. These commodities play a significant role in economic growth for Australia and represent the major share of Australia’s export earnings.

Historically, Western Australia has been and still is the mining state and plays a crucial role in this context. Its contribution to total Australian exports is substantial and is a driver of the Australian economy. The development of the Chinese economy is of major importance to the stability of Australia’s export-based mining sector and is one of the crucial drivers of growth.

An analysis of the development and course of events of the sub prime and world economic crisis provides the basis for explaining the effects to Australia's economy. This includes a consideration of how and to what extend the Australian Government enforced appropriate measures to avert a recession.

In contrast to most other developed economies, Australia has not fallen into recession due to the implementation of various economic stimulus packages worth over $ 70 billion. However, the current situation implies that there are still significant downside risks for the Australian economy.

The project also examines how this crisis may influence the long-term competitiveness of Australia.

Rio Tinto, a major Australian mining company, is used as a case study to reveal direct connections, if any, between the world economic crisis and mining in Australia. The company is a heavy-weight in the Australian Stock Exchange and has suffered more than 75 % in terms of loss of share value from the global economic downturn despite superior operational performance and strategic investments.

Conclusion

The scrutiny of the effects of the global economic crisis on Australia, and particularly Western Australia show that the domestic economy has not been immune to the shockwave of global financial and economic turmoil which was triggered off by the US sub prime crisis in mid 2007.

The major findings can be categorized in five parts.

Australia and the Recession

The analysis of the Australian economy reveals that the global economic downturn has significant effect on the economy of Australia and Western Australia as GDP growth deteriorated and demand for commodities decreased. However the extend of decline in economic growth is not as severe as it is in other developed nations. The intervention of the Australian Government and Australia’s dependence on exports to Asian countries, mainly China prevented a recession so far. Economies of developing nations suffered from the global crisis to a lower degree.

Seemingly, a recession, two consecutive quarters of negative GDP growth, has been avoided in Australia despite the uncertain global economic environment. In December 2008, the Australian economy contracted for the first time in eight years but has shown growth of 0.4 % in the first quarter of 2009, being the only advanced economy which has avoided recession besides South Korea.

Australia’s banking system has prevented the Australian economy from a severe collapse as mortgage securitization and large investments in sub prime related assets have been undertaken to a far lower degree than banks in other developed countries. By implementing adequate fiscal and monetary policies, the Reserve Bank of Australia contributed to a stable business environment which was enhanced by the Government’s various stimulus packages. These stimulus packages proved to be beneficial for the economy as negative economic growth could be avoided. This development however, will have negative long-term effects on Australia’s national budget deficit which increased significantly and will take years to be paid off. In terms of economic downturns and decreasing GDP growth, these measures undertaken by the Australian government seem to effectively support businesses and prevent unemployment rates from surging. Evidently, these efforts counteracted igniting a vicious circle of less employment, lower tax revenues and reduced governmental monetary resources to stabilize the economy.

Unemployment in Australia surged to 5.7 % in April 2009, but declined to 5.4 % in May, implying that the economy has profited from the stimulus packages. Although many companies, especially in the mining sector, used the global crisis as pretence to retrench workers due to increasingly automated production.

Decreasing inflation brings down consumer prices, thus supporting domestic demand which is likely to help stabilize the economy and restore confidence among business- es and consumers.

A recently published Servcorp International Business Confidence Survey which was conducted in April 2009 ranks Australia number one in regards to which country will survive the global economic crisis best (Servcorp, 2009). These finding highlight that despite the turmoil and uncertainty globally, the Australian business environment stayed comparatively sound and stable.

Mining Sector in Australia

The conducted research shows that the mining sector is of major importance to WA, but also Australia’s economy as a whole. WA’s economy has outperformed the Australian economy in terms of economic growth constantly since 2001, highlighting the growing importance of the state (cf Appendix Figure 32).

WA’s mining sector generated over $ 40 billion to the Gross State Product therefore being the main contributor, followed by property and business services accounting for just over $ 15 billion (cf Appendix Figure 33). Mining exports account for almost 40% of total Australian exports, thus making the mining sector a crucial part of ensuring sustainable economic growth for Australia. Commodity export volumes showed different development during the crisis; some increased while others, such as iron ore, decreased.

Despite significantly lower demand and world prices on key commodities, WA’s economy retained profits during 2008 as earnings of mineral resource increased by 45%. Especially petroleum production and exports such as oil, gas and liquefied natural gas increased due to field performance and extended capacity. The positive impact on earnings of some major commodities was mainly due to the sharp depreciation of the Australian Dollar.

The vast mineral resources, mainly iron ore, gold and petroleum are key strategic as- sets which will contribute to further expansion of Australia’s economy in the long term. WA was amongst the biggest beneficiaries of the commodities boom and extensive growth in China and other developing countries. Symmetry would suggest that WA is therefore likely to be hit hardest within Australia by the deterioration in commodity prices and lower economic growth in China. Scrutiny of WA’s economic situation however reveals that the state’s economy is in rather stable due to large mining projects and governmental investments in infrastructure which are implemented in order to maintain momentum. These strategic investments like the Gorgon project or the lifting of uranium production ban are contributing to bypass slowing economic activity. Due to previous times of high earnings and cash flows caused by high demand and high commodity prices, larger companies in WA have still healthy balance sheets and can survive the global crisis.

Government investments in infrastructure helped to overcome economic underperformance particularly in the end of 2008, aiming on short-term relief for businesses. China’s economic growth will play a crucial part for WA in the long-term. According to the above mentioned Servcorp survey, China ranks number two on a global scale of countries surviving the global crisis best. This implies that one of WA’s main ex-

port destinations is likely to continue to grow rapidly and thus drive future demand for commodities.

The fact that the Australian economy has not fallen into recession can give especially WA companies the incentive to start investing. The current development of cutbacks in total global exploration in mining is likely to limit capacity and reduce production in the medium-term. As global demand for commodities is likely to revive in line with in the global economy in 2010, a supply deficit can lead to high commodity prices, what in turn restores high profitability for the mining sector. Due to increased government incentives and large investments in WA’s mining sector, Australia will have the capacity to supply growing demand and thus be one of the main beneficiaries from the global crisis.

Despite slowing projected growth in WA’s mining sector, growth rates are expected to range between 5 % and 6 %, thus maintaining supremacy in the development of the states’ economy (Figure 34).

The negative global development also bears opportunities for companies operating in WA. Companies operating in WA which have been plagued by labor shortages will profit from cheaper labor and freer labor markets, lower construction costs and a depreciated Australia Dollar.

Knowledge in mining operations and services are superior in Australia and create a sustainable competitive advantage over global competitors. Continuous innovation in mining IT and exploration provided main impetus for economic growth which will most likely continue in the upcoming decades.

“Value” in the Global Financial Marketplace

The S&P ASX XMM collapsed between mid September and end November 2008, as a result of deteriorated perception of value of the collective mining sector as commodity prices and global demand plunged.

The S&P ASX 300 recorded extreme losses during that time too, but the S&P ASX XMM lost disproportional in value. Growing fears of a long-term global recession characterized by decreases in industrial production and construction hit the mining sector substantially. The general uncertain and intransparent financial and economic environment created a situation where stock markets did not reflect actual asset values of listed companies. The short-term drive for yield and profits in various sectors of the economy caused a willingness to take high risk and neglect strategic considerations which distorted financial markets around the globe. In this context value and risk perception of market participants developed into extreme forms bringing the global financial system to the verge of a collapse.

Traditionally the value of a share reflects “the extent to which management is efficiently operating the corporation and maximizing shareholder wealth” (OECD 2009b). The objective focus faded during the global crisis as uncertainty and speculations determined the direction of share price development.

The spill over effects, from what started as a crisis in the US financial market, to the real global economy indicate that there is a strong relatedness between the two. However, the complex nature of the interdependence between both components is difficult to discover and even more difficult to predict. The findings indicate that in this particular global crisis the real economy of Australia was adjusting downwards to a more moderate degree than the financial market, which crashed within a short time. The perception of value is reflected in financial markets immediately as shares are traded in real time and chain reactions can lead to radical price movements. The real economy is affected by this development in a delayed time horizon due to the fact that companies cannot align their policies and investments at short notice. Decision made will then in turn influence share development due to market participants’ perception of appropriateness of the reaction.

In this context, the research points out that the media plays an important role as intermediary and information provider for all market participants. Decisions are often based on media publications which state a positive or negative image about a certain incident. Objectivity, reliability and accuracy of provided information are critical elements which determine to what degree shareholders’ perception of value is influenced.

Rio Tinto’s Performance Versus Value of Shares

The Rio Tinto case study reveals that market participants’ perception of value is the main driver of share price development.

Prior to the crisis, share value developed in line with operational profits as shares and earnings increased constantly. During the crisis however, superior operational performance indicated by record profit, cash flow and earnings and adequate long-term strategic decisions could not offset negative value perception in the market, resulting in a sharp loss of share value.

Seemingly, short-term profitability is subject to value appraisal of shares in the global marketplace rather than sustainable growth.

The case study furthermore depicts how a specific mining company was affected by the global economic crisis. Rio Tinto’s rising indebtedness in particular led to significant reduction in share value as access to financing became increasingly difficult during the peak of the crisis. Despite adequate measurements, value deterioration could not be stopped for over six months. The external environment dictated what pattern Rio Tinto share followed when the market crashed.

The case study highlights Australian growing ties with China, which is deemed to be Rio Tinto’s core market despite the dismantled investment of Chinese mining company Chinalco. The Chinalco case underlines the shareholders’ power in publicly listed corporations. Shareholders’ opposition to the Board of Directors recommendation to support the deal led to withdrawal from negotiations.

The negative trend of Rio Tinto’s share development, which started in June 2008, indicates that mining companies have suffered significantly from the global economic crisis. Mining companies are the first tier of global supply chains and are directly impacted by deteriorating economic growth of industrialized and industrializing countries.