27/02/12 1:24 PMEconomic impact of the Queensland floodsPage 2 of 3http://www.macquarie.com.au/mgl/au/advisers/keep-up-to-date/oxygen/march-2011/economic-update
This is potentially more significant than the first effect for two reasons. First, because the disruption toactivity could be sustained over a much longer period (and so the impact on GDP much larger).Second, because the Australian economy is much more dependent on growth from the mining sector.Recall that the Reserve Bank of Australia has been deliberately trying to make room for the miningboom by raising interest rates and dampening household spending. At the same time, governmentfiscal policy has become contractionary. This has meant that the Australian economy is extremelydependent on the mining sector. Coal accounts for about 20 per cent of mining production and so evenwith iron ore production remaining okay, a loss of production in this sector would mean that there is noremaining engine to drive growth in Q1.Third, the floods will have a large impact on rural production. Heavy rains in south-eastern Australia inrecent months had already reduced the quantity and quality of the wheat harvest; however, theQueensland floods will have a greater impact on fruit and vegetable production, cotton growing andhave some impact on the beef sector. Again, this impact will be more enduring than simply the Marchquarter. Last, the flooding could also delay the commencement of investment projects, meaning thatbusiness investment could be much weaker than expected in 2011H1.
The impact on profits and inflation
The floods obviously undermine the profitability of some companies, such as those firms in theinsurance sector which are exposed to Queensland property. And, initially, some spending will bediverted so that while sales at hardware stores may kick higher as people try to repair their homes, salesof televisions and overseas holidays fall. Again, the temptation will be to view this as 'swings androundabouts' with the aggregate impact on profits only moderate. And for large companies with strongbalance sheets that may well be true. That is, while profits in the insurance sector will take a hit, profitsin the retail sector may ultimately rise as people spend their insurance pay outs and people startreplacing their cars etc.While there is an element of truth in this view, we think it understates the potential effect of the floodingparticularly for smaller businesses. First, while the loss of income for a week or two may not sound toosignificant, for many firms in Queensland, which had already been struggling with a softening economy,the loss of cash flow could be crippling. In effect, it could be the straw that breaks the camel's back.Tourism operators, for example, that had been struggling to cope with the impact of the high A$ andhave been affected by flooding, may now think it is a good time to take the insurance payout and leavethe industry rather than try to struggle on.The flooding will also push up prices. Besides higher food costs, transportation costs are likely toincrease as may insurance costs. Governments may introduce 'temporary' levies to help fund the costof repairing damaged infrastructure. And the cost of skilled tradespeople is also likely to surge aseveryone starts trying to find a plumber or a carpenter to repair damaged properties. Again, for thosefirms that are unable to pass on these costs, profits will take a hit.
The rebuilding phase
Of course, while the GDP data don't capture the destruction caused by the flooding, they are boosted byreconstruction. This is one reason why natural disasters can sometimes appear to have a surprisinglysmall impact on growth. To be precise, repairs -- such as patching up a roof -- are not considered bythe Statistician to be 'production' and so do not boost GDP growth. But if a house is completelydestroyed and is replaced, the new dwelling will boost GDP growth. This might seem like an arcanepoint, but it is important in thinking about some of the claims floating around that "$10 billion will need tobe spent on reconstruction". Even if that is true, if half of this reflects repairing damaged property, thenit will not be reflected in stronger GDP growth. Of course, for a building materials firm this distinction isirrelevant as demand for those building products will still rise.That said, it is also important to note that much of the reconstruction will not be an incremental increasein spending, but will displace other spending that would otherwise have occurred. That is, instead of