Bottom line
The mining boom delivers significant revenue benefits to the resource-rich states both directly and indirectly via the capex boom. Mining capex drives employment (payroll tax) and population growth, state final demand and, hence, house prices (stamp duties). Given current semi-government bond relativities, investors who expect the mining capex boom to continue should view Queensland Treasury Corp (QTC) bonds as offering value versus New South Wales Treasury Corp (NSWTC) and Treasury Corporation of Victoria (TCV).
Risks remain. As encouraging as recent PMI data has been, the fact remains that Australia’s commodity price basket has declined 9% and faces continuing, substantial downside risks. Historical precedent suggests this presents a risk that mining capex will be scaled back. Such an outcome, however, would likely encourage the RBA to ease policy further to foster growth in the interest-rate-sensitive sectors. Once again, we expect QLD’s diversified economy to work towards protecting state revenues, and hence QTC spread relativities.
State revenues ride the mining capex wave
As forecast by our commodity-based GDP model, GDP grew a robust 1.0% q/q in Q3 11. The strong Q3 GDP outcome was primarily driven by very strong private sector capex in the resource-rich states of Queensland (QLD) and Western Australia (WA). As highlighted in Figure 2, the strong performance in the resource-rich states has seen their y/y GSP growth rates move ahead of the non-resource-rich states for the first time since December 2010. In other words, the strength of Q3 activity in the resource-rich states has been able to offset the severe negatively weather-affected March 2011 quarter for QLD and WA.
Figure 1: Q3 Gross state product (GSP) proxy breakdown
Figure 2: State Final Demand (SFD) growth differential
The relative strength of activity in the resource-rich states is even better highlighted by comparing State Final Demand (SFD). As highlighted in Figure 2, the SFD growth differential currently surpasses anything seen over the past 20-plus years. An obvious contributor to the divergence in SFD growth between resource-rich and non-resource-rich states has been the commodity-price-induced surge in mining capex. This in turn has delivered stronger growth in both employment and population despite the recent shift in mining employment practices to “fly-in, fly-out” workers (Figure 3). Nonetheless, population growth across Australia remains well below the 2008 peak due to the federal government’s tougher migrant restrictions. In our opinion, this has been the single largest driver of the relatively poor recent performance in Australian house prices.
Figure 3: Population growth by state (% y/y)
Implications for state revenues and semi-government bonds
The above developments have clear implications for state revenues and, over time, should affect the relative performance of semi-government bonds. The beneficial revenue implications for resource-rich states from the boom in mining capex should accrue via:
§ Payroll tax revenue driven by employment growth; and
§ Stamp duty revenue driven by house prices. Our modeling suggests population growth, along with SFD, drives house prices (see Australia: Population unlocks house prices, 13 July 2011).
The budgetary impact and its ultimate effect on net financial liabilities to revenue, the measure used by rating agencies to assess financial sustainability, is unfortunately difficult to calculate precisely. That said, state budget papers do provide sensitivity analyses to gauge the impact on revenues from the above sources. For example, the Queensland 2011-12 budget papers estimate that in the context of taxation revenue of approximately AUD10.5bn in 2011-12:
§ payroll tax receipts in 2011-12 would be positively affected by approximately AUD33mn by a 1 percentage point increase in wages growth or employment; and
§ stamp duties would be increased to the tune of approximately AUD22mn for each 1 percentage point increase in the average value of property transactions.
Nonetheless, with Queensland employment growth tracking 0.6% y/y versus the 2011-12 Queensland budget assumption of 3% y/y and property demand and house price growth still lacklustre, it is clear that the benefits of mining capex to date have had to offset other influences on the Queensland economy. Looking ahead, however, on the assumption that a significant proportion of 12m-ahead mining capex expectations are realised, the benefits should become more palpable.
Complicating current and future state revenue calculations further is the fact that, despite encouraging global PMI data, Australia’s commodity price basket has declined 9% in USD terms from its August 2011 high. Moreover, our spot commodity price tracker suggests further substantial declines are possible. This presents significant revenue implications via:
§ Mining royalties being adversely affected. For example, the Queensland budget papers suggest a 1% decline in AUD coal prices would reduce revenue by approximately AUD33mn in 2011-12; and
§ Commodity price declines leading to a possible scaling back of mining capex (Figure 4).
Figure 4: Mining capex vs non-rural commodity price index
Nonetheless, current semi-government bond relativities (Figure 5) present an opportunity for investors who expect the mining capex boom to continue to buy Queensland Treasury Corp (QTC) bonds versus New South Wales Treasury Corp (NSWTC) and Treasury Corporation of Victoria (TCV). To that end, stable/stronger global PMI data in December lend support to this trade idea. The fact that QLD state revenues, and hence QTC spread relativities, should also benefit from recent Reserve Bank of Australia (RBA) easing, given that the diversified nature of the QLD economy only strengthens the value proposition of QTC bonds. Indeed, to the extent that mining capex is actually scaled back over the near term, we would expect the RBA to ease policy further to foster growth in the interest-rate-sensitive sectors. Once again, we would expect QLD’s diversified economy to work towards protecting state revenues, and hence QTC spread relativities.
Figure 5: Semi-government spreads to swap
Barclays Capital