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Economic Impact of the Queensland Floods

Economic Impact of the Queensland Floods

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Published by Harsha Goonewardana

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Published by: Harsha Goonewardana on Jun 07, 2012
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27/02/12 1:24 PMEconomic impact of the Queensland floodsPage 1 of 3http://www.macquarie.com.au/mgl/au/advisers/keep-up-to-date/oxygen/march-2011/economic-update
Economic impact of the Queenslandfloods
02 March 2011The Queensland floods could cut GDP growth over 2011 by half a percentage point and boost inflationby half a percentage point. In the short term, the negative impact on activity should prevent further monetary policy tightening and as a result we no longer expect that the RBA will raise interest rates inQ1. However, the higher inflation profile will keep a tightening bias very much in place.Certainly monetary policymakers will adopt the view that the greatest contribution they can make is tokeep the overall economy growing at a sustainable pace with moderate inflation, as that will enableState and Federal Governments to enact the recovery plans that are sorely required. Of course, it goeswithout saying that the greatest cost of this disaster is the loss of lives and the pain and suffering whichthe floods have caused.
Estimating the impact of the flooding on GDP growth
In thinking about the flood devastation in Queensland, it is useful to consider the several ways in whicheconomic activity will be affected.First, there is the temporary disruption to activity itself, as production that would have taken place --construction work, mining, shopping -- was interrupted. While this is important, it is easy to overestimatewhat impact it will have on GDP growth. For example, if we make the extreme assumption that noactivity in Queensland took place for 1 week, then this would result in Queensland's GDP falling by 8 per cent in the March quarter and Australia's GDP falling by 1.5 per cent. Over 2011 as a whole, growthwould be trimmed by just 0.4ppts.But that is an extreme assumption. First, Queensland is the most decentralised state in Australia, andBrisbane only accounts for half of Queensland production. Second, many sectors of the economyincluding health, most areas of the public service (including police, ambulance, fire etc),communications, media and education haven't experienced a fall in output. Third, for some sectors thathave been affected -- such as grocery retailing -- the floods are more likely to have affected the timing of spending rather than the overall amount of spending, as people still have to eat. So the directtemporary disruption to activity caused by the flooding will likely only have a modest effect on GDPgrowth -- probably less than a quarter of a percentage point. In our view, however, this is the wrongplace to look for the real effects on the economy.The second way in which the floods could affect activity is by the damage to infrastructure itself. If thesupply of electricity or water was disrupted for an extended period, then factories and shops would haveto close down even if they were fortunate enough to have escaped the flood devastation. Similarly, if rail or port infrastructure was badly damaged, it could force coal production to cease even if the minewas operational. The coal sector could be currently running at just 20 per cent of capacity and it willprobably take 3 months before full coal production -- and shipments -- have resumed. And, of course, if there is further heavy rain -- which is a distinct risk -- then this timetable will be pushed back further.
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 

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