Australia's economy is weathering the Coronavirus storm, but global challenges remain. Australia's economy has showed remarkable resilience since the onset of the COVID-19 global pandemic. While the effects of COVID-19 and related public health measures have so far resulted in two of the worst non- consecutive quarterly GDP contractions in Australia's economic history, Australia's GDP ended the third quarter of 2021 almost the same size as at the start of the pandemic.

Australia's strong economic performance during the pandemic to date is partly attributable to trade and its growth in export earnings – driven by high prices and strong demand for iron ore from China in the first half of 2021 and then by significant demand for thermal coal and LNG from northern hemisphere economies. The gains in commodities exports during this period even outweighed the decline of Australia's services exports (chiefly international tourism and education) induced by COVID-19 travel restrictions. In December 2021, Australia recorded its 45th consecutive month of trade surpluses, with year-to-date total export earnings increasing by 19 per cent to $518 billion.

As we enter 2022, the rapid onset of the new Omicron variant is generating uncertainty about the short-term outlook for the Australian economy and presents numerous health and economic challenges that might yet hobble a global recovery. These include a deterioration in health outcomes from the continued spread of Omicron to major economies with lower rates of vaccination, such as India and those in Southeast Asia and Latin America, and the adverse effect of this on workforces and productive capacity.

Further disruptions to global supply chains and transport networks are also likely driving costs higher and prolonging the global imbalance between constrained supply and a growing demand for goods. This is likely to contribute to sustained inflationary pressures, particularly on prices for food, energy, labour and shipping, all of which will place pressure on central banks in advanced economies to tighten monetary policy settings through the withdrawal of quantitative easing measures and interest rate rises.

Action on inflation in advanced economies also has the potential to further exacerbate the two-track recovery between developed and developing economies. Already held back delays in vaccine availability, higher and more severe infection rates, and limited fiscal capacity to shoulder the cost of a prolonged crisis, action on inflation would further limit growth in developing economies – reducing the competitiveness of exports, raising import costs, imposing liquidity constraints, and lifting the cost of public debt.

Finally, the prospect of slowing growth in China, which is grappling with electricity supply constraints, a weakening property construction and finance sector (think Evergrande), and lockdowns in pursuit of COVID-zero, has the potential to dampen demand in the global economy, which in turn could affect Australian exports.

Despite the strain the Omicron variant is currently placing on Australia's economy, its effects are expected to be temporary – delaying rather than downgrading our economic recovery in 2022. As the fast-moving Omicron wave passes, the domestic drivers of growth look positive. A recovery in business confidence and investment, tightening labour market conditions favouring wage growth, combined with elevated levels of household savings, are all expected to drive higher consumption as conditions improve. These will also likely offset any declines in goods exports that might be experienced as commodity prices recede from pandemic highs.

David Woods

David Woods joined DFAT as Chief Economist in November 2021. David previously worked in Treasury, serving most recently as head of the team responsible for assessing FIRB applications. Before that, David spent five years in Beijing as the head of the Treasury office in the Australian Embassy. David led a division working on the regulation of the financial system following the global financial crisis and he has extensive experience working on fiscal policy in both The Treasury and The Department of the Prime Minister and Cabinet. He holds degrees from the University of Sydney and the London School of Economics.