The impact of the Australian bushfires on investors worldwide

The scale and breadth of damage to businesses and industries as a result of the bushfires in Australia should prompt all investors to be aware of whether parts of their portfolio are vulnerable to climate change risks.

GDP and wealth: the short-term impact

• Activity related to farming, manufacturing, transport, tourism and business generally in the affected areas will be disrupted – this will involve around 2-3% of the population and will be concentrated around the March quarter. It will also be partly offset as affected people have to undertake spending that they otherwise wouldn’t have had to. 
• A bigger impact on economic activity is likely to come via a hit to consumer spending as the constant news of the fires and the smoke haze in several capital cities weighs on confidence. Australians were already very hesitant about the economic outlook after the slowdown in growth seen last year and continuing weak wages growth and high underemployment. A range of surveys also show that consumers are uncertain and depressed, and this looks to have intensified since Christmas. The constant terrible news since October about the bushfires along with the smoke in cities is likely weighing further on the national psyche adding to weakness in consumer spending as Australians feel less motivated to spend when their fellow Australians are suffering. The hit to household spending power from higher prices for food and a likely rise in insurance premiums flowing from the fires will only accentuate this.
• Inbound tourism is also likely to be impacted by the heavy coverage of the bushfires globally – with doctored maps showing much of Australia on fire (including where I am right now) – likely to adversely affect perceptions of Australia. This may be short lived (just as the positive boost from the Sydney 2000 Olympics was) but it could still last a year or so.

The collective result…

Taken together we expect a detraction from GDP due to the bushfires of around 0.4% starting in the December quarter but mainly impacting the March quarter before a rebuilding boost kicks in from the June quarter.

Given the uncertainty, the range around this negative impact is -0.25% up to a worse case of – 1% of GDP should the fires continue on a widespread basis through the rest of summer. The rebuilding boost should reverse much of this drag later in the year, but there is considerable uncertainty around this as the impact on tourism and consumer spending may linger longer.

A big proximate contributor to the severity of the bushfires is the severe drought gripping much of Australia. This has already driven a decline in agricultural production, which has been directly detracting around 0.2 percentage points from GDP growth for the last two years. Unfortunately, the Southern Oscillation Index is still in El Nino territory pointing to ongoing relatively dry conditions in eastern and top-end Australia.

This shows us the impacts of climate-related disasters are not contained to the land. They impact business, people, infrastructure and the economy.”

The case for stimulus

The fires have only added to the pressure for more policy stimulus. We remain of the view that the Reserve Bank of Australia (RBA) will continue to cut the cash rate. The bushfires will push up food prices and insurance premiums but the RBA’s focus on underlying inflation will mean that it should look through this. In fact, increases in such prices will act as a tax on consumer spending power and are negative for spending and so could depress underlying inflation.

The pressure for further fiscal stimulus has also intensified. The Federal Government has already committed an additional AUD$2bn for bushfire recovery to be spent this year and next (which is relatively small at 0.05% of GDP per year) and the NSW Government has committed another AUD$1bn. However, the total hit to government budgets from the bushfires is likely to be much greater than this given assistance under existing disaster programs, extra expenses associated with fighting the fires and the impact of slower growth in the short term on revenue flows.

More broadly given the hit to confidence a circuit breaker is arguably needed to help boost economic growth. Monetary policy alone is unlikely to be enough. So there is a need for a broader fiscal stimulus – maybe in the form of a bring forward of the personal tax cuts, an increase in Newstart (an income support payment for the unemployed) and broad based investment allowances. To have an impact it needs to be at least 0.5% of GDP (or around AUD$10bn).

Rightly in the face of the pain caused by the bushfires the Federal Government has relaxed the focus on achieving a budget surplus and it is now questionable as to whether it will be achieved this year and next. That is not a major problem in the relative scheme of things given the relatively good state of Australia’s public finances.

Four long-term challenges

1. Increased pressure to adopt a tougher stance in reducing carbon emissions. While Australia has always had droughts and bushfires we have been warned for more than a decade now that the world and Australia is getting warmer, that increasing global greenhouse gas emissions are likely contributing to this and that in the absence of actions to reduce emissions the world will get significantly warmer with the outcome being rising sea levels and more extreme weather events – including storms, floods and droughts – with more severe bushfires an outcome of the latter.
2. The damage inflicted by the extreme bushfires highlights the need for investors to be aware of industries and businesses that are vulnerable to climate change risk – whether it comes from the physical impact from climate change or via measures to reduce emissions.
3. The severity of the bushfires and the risk that this is the new normal will necessitate better strategies for reducing the risk to property posed by future bushfires.
4. In the absence of policy action the bushfires risk accentuating the decline of some regional communities particularly where key industries have been destroyed by the fires – with some taking their insurance and rebuilding elsewhere. This will only further centralise Australia in its big cities adding to all the costs that entails – notably congestion and expensive housing.

The damage inflicted by the extreme bushfires highlights the need for investors to be aware of industries and businesses that are vulnerable to climate change risk – whether it comes from the physical impact from climate change or via measures to reduce emissions.”

A note to investors, for now

The likelihood of more RBA monetary easing and continuing weak economic growth in the short term will likely keep Australian bond yields down relative to global bond yields, possibly pushing them lower. This will also keep the Australian dollar relatively soft.

At time of writing, the Australian share market appears to be looking through the short-term hit to economic growth focusing more on the rebuilding boost, but the negative impact of the bushfires risks seeing it remain a relative underperformer versus global shares.