Behind the investment news

How much can the drought really affect the economy?
by Michal Park, 16/11/2006

The drought gripping the majority of Australia has been getting a lot of media attention of late, not least due to the affect it is anticipated to have on the economy as a whole.  The Reserve Bank of Australia released its latest Statement on Monetary Policy on Monday stating:

“In its policy deliberations in recent months the Board took careful note of the effects of the drought, which will lower the supply of rural produce, reduce farm incomes and may temporarily affect some food prices. At this point, these developments appear unlikely to affect significantly the medium-term inflation outlook.  Farm output could fall by around 20 per cent, which would directly reduce GDP growth in the year ahead by around half a percentage point, with some additional indirect effects flowing on to other parts of the economy.”

This is a direct reflection of the reduction in agricultural supply  (most predominantly livestock production) rather than a reduction in demand of the economy.  The indirect effects refer to rural communities, however, there will also be flow on effects to the rest of the economy as farmers’ consumption and investment spending is reduced.

On a positive note, the effect of droughts on consumer prices (CPI) has historically been relatively small.  It looks like we can leave that to oil prices and bananas!