Economic overview: March quarter 2021

Matthew Howden, Robert Curtotti and Harrison Coe

Executive summary

This overview explores the implications of the recovery phase of the COVID-19 pandemic on demand for Australia's agricultural products. Significant uncertainty surrounds the outlook for the global economy, with potential for upside and downside outcomes. Because of this uncertainty, ABARES has prepared 2 alternative macroeconomic scenarios in addition to the macroeconomic assumptions that underpin the commodity forecasts. The scenarios are based on those presented in the International Monetary Fund's January 2021 World Economic Outlook Update. Each scenario has different implications for demand for Australia's agricultural exports.

Following a turbulent 2020, the global economy has entered 2021 with indications of a return to growth. However, the strength of the recovery remains uncertain and uneven. Economies that fared better in containing COVID-19 are assumed to recover more quickly than those still experiencing widespread community transmission.

Consumption of agricultural products has remained strong during the pandemic, but consumption patterns have changed for some categories of food and apparel. This will affect future demand of agricultural products. Food and fibre demand is assumed to grow fastest in emerging and developing economies.

The upside and downside scenarios present alternative pathways for the global economic recovery. The upside scenario assumes a faster economic recovery, resulting in stronger demand for commodities and generally higher prices for agricultural commodities. The downside scenario assumes extended delays in containing COVID-19, which weakens demand for Australia's agricultural exports and results in lower prices for higher-quality exports.

In Australia, economic growth is assumed to be relatively subdued due to the effects of COVID-19 related shutdowns during mid-2020. In 2021–22 growth is assumed to rebound strongly to 4% as the drag from the pandemic is offset by a resurgence in business and consumer confidence and government expenditure. The Australian dollar is assumed to average US75 cents in 2020–21 and 2021–22.

Global economy to exit recession in 2021

The outbreak of COVID-19 in 2020 triggered the largest global recession in over 100 years, with global economic growth contracting by 3.7% in 2020. Global economic growth is assumed to be 5.3% in 2021 and 4.1% in 2022.

The economic recovery will be uneven across economies. Economies that fared better in containing COVID-19 are assumed to recover more quickly, because containment measures can be lifted earlier (in some cases these measures have already been removed). At February 2021 mass vaccination programs were already underway in many economies and it is likely they will continue for much of 2021. Between 2023 and 2026 global growth is assumed to moderate to average 3.4%.

Global economic activity slowed in 2020 because of COVID-19

Despite stronger than expected growth in the second half of 2020, the global economy contracted by 3.5% in annual terms. As a result, significant output gaps – the difference between an economy's actual and estimated potential GDP – have emerged. These will weigh on growth over the outlook period.

In 2020, COVID-19 caused significant disruptions to economic activity as lockdowns, social distancing and other health measures were introduced in an attempt to contain the pandemic. Continued lockdowns have weakened business and consumer confidence, and altered consumption patterns. These disruptions slowed global merchandise trade and industrial production growth during the middle of the year.

Governments and central banks deployed unprecedented levels of fiscal and monetary support during 2020. Despite this, consumption and investment have remained subdued because of rolling lockdowns and prevailing uncertainty about the pandemic. During the second half of 2020, confidence improved as faster progress was made in the development and approval of vaccines. However, rising infection rates and subsequent lockdowns in some European and North American countries weakened confidence in late 2020 and early 2021.

Commodity prices generally fell during mid-2020 as economies went into lockdown. Energy prices fell sharply because international travel restrictions reduced demand for fuel. Mineral prices also fell, as lockdowns interrupted construction projects. Food prices were relatively unchanged during the first half of 2020 because food consumption patterns remained broadly stable.

Commodity prices recovered towards the end of the year, driven by a combination of factors. Mineral prices increased due to increased demand from economies commencing large-scale infrastructure projects designed to stimulate economic recoveries. Energy prices rose, reflecting lower production among OPEC countries and increased demand as travel restrictions were relaxed. Food prices also increased, due to unfavourable seasonal conditions in the United States (which limited exportable supplies) and disruptions to international travel that increased global transportation costs for air freighted food exports.

Consumption of agricultural products has remained strong during the pandemic, but consumption patterns have changed for some categories of food and apparel. Because of prolonged lockdowns, consumption of food at home has increased relative to consumption outside of home. This has led to greater demand for base food products and less demand for luxury food items. Activity in the food services sector – a large market for luxury food products through restaurants, travel and accommodation catering – remains severely reduced in early 2021. The trend towards working from home has also resulted in lower demand for high-end apparel, which has affected international fibre markets. The extent to which these trends will persist over the medium term remains unclear.

Short-term recovery will be uneven

In 2021 economic activity is assumed to rebound strongly across all regions. Growth in advanced economies is assumed to be 4.4% in 2021 and 3.0% in 2022. In emerging and developing economies, growth is assumed to be 5.9% in 2021 and 4.8% in 2022.

In 2021 the assumed economic recovery will be contingent on progress in containing community transmission of COVID-19. A resurgence of infections in the eurozone and United States during late 2020 resulted in economic growth slowing during the December quarter. In economies where infection rates have remained low, such as Australia, China and New Zealand, economic activity has recovered sooner, following the safe removal of social distancing measures.

Outbreaks that began in late 2020 will continue to hinder growth in affected economies in early 2021. Growth is assumed to rebound during the second half of 2021, as infection rates fall and mass-vaccination programs progress. Economies that have had to endure prolonged lockdowns are assumed to recover more slowly, due to factors such as higher unemployment and bankruptcies. Economies that have been able to re-open sooner will not feel these effects as strongly.

In 2022 it is assumed that falling community infection rates will mean more economies will be able to safely re-open. This will provide a boost to both business and consumer confidence, leading to increased economic growth. International travel is assumed to be gradually reintroduced, as economies remove border restrictions. This will lead to increased trade and allow a recovery in international tourism, which will provide a boost to growth in tourism-dependant economies – including Australia.

In economies with high infection rates, controlling COVID-19 is assumed to take several years. Mass-vaccination programs will help reduce community transmission, but other health measures are assumed to be required. Implementing these measures will likely take longer in emerging and developing economies because of less-resourced health systems and limited access to vaccines. In some regions, adequate coverage of vaccination programs is unlikely to be achieved until at least late 2022. This will weigh on economic growth in these economies, as the effects of the virus will continue to disrupt economic activity until containment measures can be safely lifted.

Medium-term recovery also uncertain and uneven

Significant uncertainty surrounds the medium-term outlook for the global economy. Global economic growth is assumed to average 3.4% between 2023 and 2026. This is in line with the medium-term assumptions presented in the International Monetary Fund's October 2020 World Economic Outlook. Upside and downside scenarios around this set of assumptions are described in the Alternative macroeconomic scenario box.

Recovery over the medium term is expected to be uneven between regions, with emerging economies projected to grow faster than advanced economies. Emerging Asia is assumed to grow faster than regions such as Latin America and emerging and developing Europe. Through the outlook period, economic activity is assumed to remain below pre-COVID-19 levels across all geographical regions and significantly below pre-COVID-19 levels in advanced economies.

Growth in advanced economies is assumed to slow gradually over the medium term to average 1.8% by 2026. This compares to the average growth of 2.1% achieved by these economies in the 5 years preceding the pandemic. Over the short term, economic activity in these economies is assumed to be lower than before COVID-19 due to failed businesses, higher unemployment and other structural factors. Medium-term growth prospects are also assumed to be constrained by demographic factors, such as ageing populations and slowing population growth.

In emerging and developing economies, growth is assumed to average 4.5% between 2023 and 2026. These economies will face challenges related to structural changes stemming from the pandemic. They will also be more exposed to other factors, including weaker commodity prices (especially relevant for oil producing economies that derive revenue from exports) and softer external demand (for those economies engaged in global manufacturing supply chains). China is the largest economy in this group and its ongoing economic transition away from manufacturing and export-driven growth to consumption-based growth is the main driver of this slowdown over the medium term.

Alternative macroeconomic scenarios

Because of uncertainty regarding the economic recovery, ABARES has prepared 2 alternative macroeconomic scenarios based on those presented in the IMF's January 2021 World Economic Outlook Update. The pace of economic recovery from the COVID-19 pandemic is central to these scenarios and depends on the effective containment and treatment of the virus. Climate factors also play an important role in determining prices for agricultural commodities. Alternative climate scenarios are presented in Seasonal conditions.

The strength and timing of the economic recovery has implications for Australia's agricultural sector. In the upside scenario, a faster global economic recovery is assumed to support demand for both agricultural and non-agricultural commodities (including metallurgical coal and iron ore), leading to higher commodity prices. A slower recovery is assumed for the downside scenario, leading to weaker demand for commodities and lower prices.

These alternative scenarios will influence Australia's agricultural sector through their impact on demand and the competitiveness of Australian products in international markets. A stronger recovery will lead to faster income growth and an assumed increase in demand for Australia's agricultural products, whereas a slower recovery will result in subdued demand.

Upside scenario

The upside scenario assumes a faster and stronger economic recovery, driven by accelerated progress in vaccination programs as well as effective contact-tracing and isolation programs. These developments will boost business and consumer confidence and contribute to recoveries in consumption and investment. Improved business confidence and strong private demand will encourage firms to invest in both capital and labour, which will in turn lead to higher employment. Globally, stronger demand will stimulate a faster recovery in trade and the removal of travel restrictions will benefit tourism sectors.

In 2021 faster economic growth is assumed in advanced economies and in emerging and developing economies. Advanced economies are assumed to grow the most during 2021. This largely reflects earlier access to vaccines and more comprehensive health infrastructure, allowing COVID-19 related measures to be removed sooner. An assumed delay in deploying vaccines to emerging and developing economies means that growth peaks in 2022. Over the medium term, growth is assumed to moderate for all economies.

Rising global incomes are assumed to drive stronger demand for Australian agricultural commodities in the upside scenario, but the strength of this demand would be partially offset by an appreciation of the Australian dollar in the short term. This appreciation would reduce the competitiveness of some price-sensitive agricultural commodities in international markets. The Australian dollar is assumed to depreciate towards the end of 2022 and into 2023. This is partly because the demand for bulk commodities is assumed to weaken over the medium term, as major projects near completion. Global supply of these commodities is expected to increase over the same period.

Downside scenario

The downside scenario assumes that the pandemic takes longer to contain than in the baseline assumptions. In the downside scenario, efforts to contain the pandemic – including vaccines – are not as effective as hoped or take longer than expected to become effective. This leads to continued outbreaks and prolonged lockdowns, which further weigh on business and consumer confidence. The likely delayed delivery of vaccines will mean that health sectors are strained for longer, elevating the risk of worse health outcomes and further constraining the economic recovery. Drawn-out lockdowns are assumed to contribute to increased bankruptcies, elevating the reliance on fiscal support packages to care for the unemployed.

Despite the slower recovery, fiscal support packages in advanced economies are assumed to be reduced at a relatively early stage because of concerns over mounting public debt. The withdrawal of this support – especially employment subsidies – is assumed to lead to a fall in incomes and consumption, both directly and indirectly via rising unemployment.

The combination of potential unequal access to vaccines (driven by supply shortages) and inequality of income (in part driven by the withdrawal of fiscal support) is assumed to lead to some social unrest in some countries. This further impedes the global recovery.

The drag on economic growth in the downside scenario is assumed to be strongest in 2021. As the pandemic is brought under control during 2022 and 2023, the drag on growth is assumed to weaken. However, growth in this scenario is assumed to remain lower over the entire outlook period.

The outlook for the Australian dollar under the downside scenario assumes a depreciation during 2021–22 and 2022–23, reflecting lower bulk commodity demand and higher levels of uncertainty. From 2023–24 to 2025–26 the dollar is assumed to appreciate modestly, in line with reduced global uncertainty and improved economic conditions.

 

Income still driving demand for agriculture

Income growth, measured by gross domestic product per person, is a useful indicator of demand for agricultural products.

In 2020 global incomes contracted by 5.5%. This contraction was most severe in emerging and developing economies, where incomes contracted by 6.4%. In advanced economies, incomes fell by 6.1%. Despite these declines, incomes in most of Australia's major trading partners remained above the 10-year average to 2020 (in real purchasing power parity terms). This helped maintain demand for Australia's agricultural exports over the year.

In 2021 income growth is assumed to rebound strongly in all regions. Growth is assumed to be especially strong in emerging Asia (which includes some of Australia's major agricultural trading partners), where incomes are assumed to grow at 6.9% in 2021. Over the medium term, income growth in all regions is assumed to decelerate back to trend growth rates.

Favourable prospects for Australia's economic recovery

In 2020–21 Australian economic activity is assumed to be relatively unchanged as the effects of COVID-19 related shutdowns drag on growth. In 2021–22 growth is assumed to rebound strongly to 4% due to the drag from the pandemic being offset by a resurgence in business and consumer confidence and government expenditure.

The Australian economy has performed better than expected since the onset of the pandemic and much better than some other advanced economies. In its February 2021 Statement on Monetary Policy the Reserve Bank of Australia indicated that the Australian economy had begun to recover in the second half of 2020, much earlier than expected. Despite the weaker than expected economic shock caused by the pandemic, the economy is expected to remain below potential growth over the short term, due to the persistence of higher unemployment than seen before COVID-19. This assumes that any further lockdowns required over the short term will be at a local level and that COVID-19 infections remain very low.

Domestic demand for Australia's agricultural products is expected to remain relatively strong in 2020–21 and over the remaining outlook period. The prevailing low incidence of COVID-19 infections in Australia has allowed businesses to reopen earlier than in other economies. This has supported a recovery in the food services sector. In 2021–22 increased movement of people will drive a recovery in the domestic travel, accommodation and food services sectors, which will support demand for higher-value agricultural products.

Around 30% of Australian agricultural production is consumed domestically and the agricultural sector is working to increase exposure to the domestic economy. A number of initiatives are already underway, including the Great Australian Seafood campaign and the buy Australian beef and lamb, and fruit, vegetable and nut campaigns. Although in their early stages, these campaigns suggest a willingness and agility of the industry to explore new options for increasing consumption.

The main risk to the short-term outlook for the Australian economy is a resurgence of COVID-19, which would necessitate prolonged and widespread lockdowns. This outcome would be in line with the ABARES downside scenario, in which vaccines are less effective in reducing infections either because of new viral strains or a slow vaccine rollout. Extended lockdowns from community outbreaks would dampen the recovery of the services sector. Under this scenario the agricultural sector would be relatively well placed, since it was less affected during 2020 than other areas of the economy.

In the upside scenario, the national vaccine rollout is assumed to effectively and quickly control COVID-19 in the community. Activity in the Australian services sector decreased significantly in 2020 because of measures to combat the spread of COVID-19. As they are rolled back, the services sector is assumed to recover more strongly over the medium term, especially in the domestic and international travel industries. Agricultural performance is also assumed to improve, when the removal of international travel restrictions allows for the resumption of temporary migration programs, including the Pacific labour mobility, seasonal worker and working holiday maker programs. Workers under these programs have historically made up a significant proportion of the casual and contract workforce on Australian farms.

Australian economic growth to stabilise over medium term

From 2022–23 to 2025–26 economic growth is assumed to average about 3%. Economic growth in Australia is assumed to recover because of private consumption growth, increased public and private investment and the continuation of accommodative monetary and fiscal policy. Sustained export demand is also assumed to contribute positively to growth over the outlook period.

The potential influence of the factors underlying the upside and downside scenarios wane over the medium term since most risks identified in the scenarios are assumed to manifest in the short term. In the upside scenario, bulk commodity prices are assumed to gradually decline over the medium term, reflecting falling demand and increased supply. The removal of travel restrictions, following the elimination of the virus within the region, should allow for a resumption in migration, which will support population growth and strengthen domestic economic growth. On the downside, prolonged COVID-19 outbreaks would mean partial travel restrictions remain in place until late in the outlook period. This would weigh on population growth and result in weaker economic growth over the medium term.

Australian dollar to rise in short term before easing over medium term

The Australian dollar is assumed to average US75 cents for 2020–21, a 12% appreciation compared with 2019–20. Rising iron ore prices and a broad-based depreciation of the US dollar are contributing to this appreciation. These factors are assumed to provide support for the dollar in the short term, resulting in the exchange rate remaining at US75 cents in 2021–22.

The exchange rate of the Australian dollar has a large influence on the export returns of agricultural products and on the cost of Australia's agricultural exports to consumers in foreign markets. The negative effect of the higher dollar on farm profitability in 2020–21 has been moderated by a combination of factors. These factors include favourable seasonal conditions, which have boosted production and hence revenue, and lower input costs, particularly for imported inputs such as fuel and fertiliser. The decline in international crude oil prices during 2020–21 is assumed to help bolster farm profitability in 2020–21 and 2021–22.

For the remainder of the outlook period, a slight depreciation of the exchange rate is assumed to occur, averaging US74 cents for 2022–23 to 2025–26. The stable exchange rate over this period is assumed to result from a reduction in global uncertainty as COVID-19 is brought under control and prices for bulk commodities decline.

The upside and downside scenarios have implications for the exchange rate. In the upside scenario, the Australian dollar is assumed to appreciate more strongly as a result of sustained high prices for bulk commodities and a broad-based depreciation of the US dollar, because of optimistic investors turning towards investment in emerging economies. In the downside scenario, increasing global uncertainty drives investors to safe haven assets like the US dollar and subdued demand causes commodity prices to fall. This leads to a depreciation of the Australian dollar, which would make Australian exports more competitive in some markets.

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