Australia’s economy has plunged into its first recession in nearly thirty years, as it suffers the economic fallout from the coronavirus: Financial Economics Assignment, SU, Malaysia


Sunway University (SU)

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Financial Economics

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Extract 1

Australia’s economy has plunged into its first recession in nearly thirty years, as it suffers the economic fallout from the coronavirus. Gross domestic product shrank by 7% in the second quarter of 2020 after contracting 0.3% in the first.

Australia has had decades of steady economic growth with strong coal, iron ore, and natural gas exports to a growing China. Tourism has also been a big driver of growth. This year, however, the country was hit hard – twice. When the bushfires ravaged more than 12 million hectares, tourism was bashed and thousands of small businesses lost months of essential revenue. Then the coronavirus became a global pandemic. Australia closed down its borders and imposed strict social distancing rules. Nearly 1 million people lost their jobs as a result.

There is also an increasingly tense relationship with China, Australia’s biggest trading partner. Australia has publicly backed a global inquiry into the origins of the coronavirus which infuriated the Chinese government. In response, China imposed an 80% tariff on Australian barley and suspended some major Australian beef imports. The Australian economy felt the pinch.

The recession will keep pressure on the Reserve Bank of Australia to consider additional measures to keep the economy afloat. The central bank reduced interest rates to an all-time low to help businesses and households weather the downturn. The government has pumped more than A$200 billion.

Extract 2

Deferred loans may push the Australian bad debt pile higher Australian banks, facing a drag from the coronavirus pandemic, may see renewed pressure on their earnings. The main uncertainty facing Australia’s banking sector is the loan deferrals extended to customers during the pandemic lockdown. The four major Australian banks have granted moratoriums on the repayment of home loans and small business loans. Deferrals on home loan repayments range between 10% and 12% of the total outstanding home loans, while the relief to small and medium-sized businesses covers between 14% and 15% of the total outstanding loans for the segment. The deferrals for sectors such as retail trade, tourism, hospitality, and entertainment are significantly higher.

Analysts are concerned that the major banks could see an increase in bad debt once the government’s support measures – including cash payments to households are removed. A rise in consumer loan defaults and bad debts across residential mortgage books will reduce banks’ earnings.

Owing to the lockdown, many Australian households stashed away the money they would have otherwise spent on eating out or traveling, driving the savings rate to its highest in several decades. Some of that money saved for a rainy day may help them repay their loans when the deferral window closes. The uncertainty of future income has contributed, at least in part, to the increased savings rate. It is unclear how long the increased savings will be able to support households that significantly or completely lose their income sources

(a) Using the information in Extract 1, comment upon two determinants of net exports and two determinants of household consumption in Australia.

(b) With reference to Extract 2, explain, with the help of numerical demonstration, the process of money creation and discuss why an increase in consumer loan default and bad debts poses a risk to the banking system.

(c) With the aid of diagrams, explain how expansionary monetary policy is
supposed to ‘keep the economy afloat’ (Extract 1).

(d) Drawing upon Extract 1, analyze the impact of

(i) a weak economic prospect,

(ii) trade restrictions imposed by China on Australian products, and

(iii) low domestic interest rates, on the exchange rate of the Australian dollar.

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