August 2022
Michael Courtney
Managing Director
Economic Environment & Local Government – Where to from here?
The economic environment is unique – concurrent record low unemployment, low interest rates and labour and skill shortages.
We also have experienced record growth in property market (record rates in regional Australia) coupled with a high growth rate in the share market, though this is starting to decline.
How will this economic environment impact Local Government?
As the economy continues to reopen and we get back to ‘normal’, it is likely that Councils will need to continue to adapt to life after, or indeed ongoing life with COVID.
Councils that can evolve their business models to capitalise on this paradigm shift will be rewarded, – a time for review and adaptation is required to ensure a sustainable footing into the future.
We believe risks for Councils include:
- More of the community under mortgage stress with 30% of mortgages predicted to fall into this category – this will probably have a disproportionate impact on urban fringe Councils.
- Declining share market may impact retirees on fixed incomes though increase in interest rates may compensate.
- Rising inflation will impact the community’s confidence and capacity to pay.
- Employment rate will force Council to develop increasing flexibility for employees as demand for skilled workers is at an all-time high.
- Efficiency of capital expenditure delivery will need to be addressed across the sector.
- Pressure to increase wages for employees to keep pace with inflationary environment will be a reality as Enterprise Agreements are re-negotiated.
In our view Local Government should consider:
- A period of consolidation and focus on assessing its long-term financial sustainability and understand its capacity and priorities for future service expenditure and capital investment.
- Borrowing to expand capital investment will be inflationary and at this point in the economic cycle (post COVID 19); though, there is adequate financial capacity to increase borrowings across the sector.
- Commonwealth and State government capital projects have absorbed most of the capacity in the contractor market.
- Also, the upcoming Commonwealth Games will continue to ensure contracting prices remain high and market remains constrained.
From an advocacy point of view should there be a greater focus on:
- Lobbying state government for percentage of the stamp duty receipts given the enormous increase in receipts arising from the recent property boom – this could assist particularly developing Councils meet DCP obligations.
- Lobbying for a realistic rate cap given the predictions and impacts of inflation and the need for Councils to maintain a revenue stream to match the ever-pressured cost structures.
After 6 years Councils (Vic) are also feeling the impact of rate capping (average increase of 2.15%) compared to pre rate capping of 6% – loss of 3.85% p.a revenue recurrent capacity over the last 6 years!
Having assessed over 40 Councils in our Service Planning program it is clear that many Council’s long term operating expenditure is unsustainable due to impact of rate capping, cost shifting from the state and the increase in service standards from the community.
We believe Council’s provide an excellent range and levels of service however whether this investment is sustainable in the long term is questionable.
The response to this dilemma is for Councils to:
- Undertake a strategic service planning review to determine the range and levels of service, future service demand and to ascertain the true priorities in service delivery.
- Answer the fundamental question as to whether the current range of services at their current level of service is sustainable in the long term?
- Engage the community to establish alignment to their service priorities through comparative choice options across the full services spectrum.
- Improve the efficiency of the capital investment presently on average at around 80% p.a. across the sector.
- Ensure Asset Plans look to sustain assets that underpin services with the balance of these assets to be rationalised – sold or handed back to the community.
- Look to regionalise/centralise and shared services between Councils – Asset Management Virtual Office now achievable in many jurisdictions through the establishment of beneficial enterprises.
- Improve workforce and succession planning – our demand for placements has significantly increased post pandemic reflecting a lack of trained staff within the sector.
We will continue to encourage Councils to consider these issues and accordingly rely on our Associate teams to support the Councils through these unique times.
All Councils can be financially sustainable – some may not have the capacity to provide as higher level of service, or as many services, but nonetheless it is imperative that Council understands its long-term capability and capacity to deliver services and renew its asset base.
If we look to the general economic conditions:
General outlook
- Australia’s economic growth is expected to peak at 4.25% this financial year.
- Economy is growing at a faster rate than the global average of 3.75%, and ahead of the US and Europe, which helps explain why Australian shares have performed strongly.
- Growth is expected to taper off to 2.5% by 2023-24, as key commodity prices fall from their current heights by the end of September 2022.
- Ukraine, accounted for much of the increase in inflation due to impacts on global supply chains.
- Global factors, including COVID-19-related issues have also disrupted supply chains.
- Domestic factors also played a role in increasing inflation – strong demand, tight labour market, capacity constraints & impact of floods.
- Australia sits 38th in the OECD inflation nations at 6.1% which is led by Turkey at 70% and Estonia at 18.9% – New Zealand is at 6.9%.
- Inflation is forecast to peak later in 2022, possibly 7.8%, and then decline towards the 2 to 3% range in late 2023.
- Unemployment is lowest since records began in 1978 at 3.5%.
- Increase in business investment is resulting in a large pipeline of construction work.
- Higher commodity prices have provided a boost to national income.
- Resilience of the economy is most evident in the labour market:
- employment has grown significantly in preceding months,
- unemployment rate is at a multi-decade low,
- job vacancies and advertisements are at high levels,
- further declines in unemployment and underemployment are expected,
- wages growth to increase as firms compete for staff in tight labour market.
- Household saving rate is higher than it was before the pandemic.
- Households have built up large financial buffers during pandemic.
- Macroeconomic policy settings are also supportive of growth.
- Despite COVID and the recent wall of worries on global markets, Aussie shares soared 64% in the two years from the pandemic low in March 2020 to the end of March 2022.
- Aussie shares are on the increase following recent declines.
Medium term outlook
- Commodity prices have increased following supply chain disruptions during the pandemic and the war in Ukraine.
- While much depends on the situation in Ukraine, Treasury estimates that prices for iron ore, oil and coal will all drop later this year.
- Financial conditions are tightening, as central banks increase interest rates.
- Ongoing uncertainties related to COVID-19, especially in China.
- RBA agree that further steps will be taken to normalise monetary conditions in Australia over the months ahead – in other words ongoing increase in interest rates.
- Past 3 months regional house prices in Victoria have increased by 1.2% and 15.2% over the last 12 months off a previous year growth rate of 21%.
- Auction clearing rates in mid-July were 65% – plenty of buyers and demand but are on the decline.
Future impacts – who is affected
- Approximately 2 million out of 6 million mortgages under severe stress with rising interest rates, petroleum increases and supply chain impacts on supermarket prices.
- Capital gains on property are significant adding tax receipts for Federal government and increased house prices have increased stamp duty receipts for state governments.
- Domestic demand for tourism is high with occupancy rates (tenancy and prices) high throughout tourist destinations
- Rising commodity prices have been a boon for Australia’s resources sector and demand should continue while interest rates remain low and global economies recover from their pandemic lows.
- Government spending commitments in the recent Budget will put extra cash in the pockets of households and the market sectors that depend on them – good news for companies in the retail sector, from supermarkets to specialty stores selling discretionary items.
- Elsewhere, building supplies, construction and property development companies should benefit from the pipeline of large infrastructure projects combined with support for first home buyers and a strong property market.
- Increased Budget spending on defence, and a major investment to improve regional telecommunications, should also flow through to listed companies that supply those sectors.
- Global bond markets are already anticipating higher rates, with yields on Australian and US 10-year government bonds jumping to 2.9% and 2.7% respectively.
- Rising inflation and interest rates may slow economic growth and put a dampener on shares.
- At the same time, higher interest rates are a bonus for retirees and anyone who depends on income from fixed interest securities and bank deposits.
- While rising interest rates and volatile markets generally constrain returns from shares, some sectors still tend to outperform the market – including banks, (because they can charge borrowers more), suppliers and retailers of staples such as food and drink, and healthcare.
- Another headwind for the market is likely to be gradually rising bond yields as central banks ease back on the degree of extreme monetary support they provided during the COVID crisis.
- In the 10 years 2009 to 2019 Victorian Councils delivered 86% of their budgeted capital works meaning over 4.2bn was retained in working capital.
- 37% of renewal investment was made in that period against the value of depreciation charges
- This trend continued in 2020/21 with 79% of the capital program delivered.
- At the same time rate capping compounded the previous rating effort at the rate of approximately 4% p.a since 2016/17 culminating in billions of dollars of lost capacity.
- Labour shortages have exacerbated performance as appropriately skilled personnel are not available in the labour market.
Where to from here
As the economy continues to reopen and we get back to ‘normal’, it is likely that Councils will need to continue to adapt to life after, or indeed ongoing life with COVID.
Councils that can evolve their business models to capitalise on this paradigm shift will be rewarded, – a time for review and adaptation is required to ensure a sustainable footing into the future.
We will continue to encourage Councils to consider these issues and accordingly rely on our Associate teams to support the Councils through these unique times.
Michael Courtney
Managing Director
CT Management Group