Europe is hitting home

I was chatting with an entrepreneur the other day about the impact of the European crisis on the Australian economy and more particularly, businesses and consumers.

I was arguing that measuring the impact isn’t easy – the problems have dragged on for so long without a solution in sight that most consumers have probably lost track of where we actually are.

But the entrepreneur had a simple and pretty realistic take.

“They might not know what’s happening over there, but they definitely know it isn’t good.”

Unfortunately, the crisis now seems likely to have an effect on more than just confidence.

This morning it was revealed that the Australian Prudential Regulation Authority has asked Australia’s banks to perform a sort of snap “stress test” and model what would happen in the event of a meltdown in Europe spreading to Australia.

According to the Australian Financial Review, the banks have been given a week to model what would happen if unemployment hit 12%, residential property prices fell 30% and commercial property values fell 40%.

To be clear, that is an extreme scenario and one that I don’t think any economist could see happening in the next few years.

But it does underline the growing anxiety among officials about how Australia will be impacted by what is happening in Europe.

A few days ago, Treasury Secretary Martin Parkinson that Europe would almost certainly go into recession, with the only question how deep and long it is.

While he said Australia is well placed to withstand a crisis – thanks mainly to our exposure to China – he did say Government tax revenue could be sluggish for a decade. That suggests the outlook for business profit growth is pretty bearish.

Yesterday, RBA deputy governor Ric Battellino warned that Australia’s China defence isn’t impregnable.

“History shows that when exports slow, domestic demand in Asia also slows,” he said.

“It would be prudent to assume that, if the European economy were to slow markedly over the next year or so, Australia would be affected, particularly through indirect trade exposures.”

The most direct impact for SMEs from Europe will most likely be through higher interest rates if credit markets seize up.

Westpac CEO Gail Kelly has already warned funding markets overseas are right and overnight, ratings agency Fitch lowered the long-term ratings on six big global banks: Bank of America and Goldman Sachs in the United States, British bank Barclays, French bank BNP Paribas, German bank Deutsche Bank and Swiss bank Credit Suisse.

SMEs need to watch the situation in Europe closely, but they also need to do a bit of scenario planning around higher funding costs.