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Can Australia's Economy Survive the Mining Scare?

Australia's Resources and Energy Minister declared the resources boom over on Thursday, pointing to tough times ahead for the country's economy, which has been powered by the mining sector for over a decade now. This has prompted the question: Is Australia resilient enough to grow without its main economic driver?

A Citic Pacific safety hat at the company's Sino Iron project in Karratha, Western Australia.
Carla Gottgens | Bloomberg | Getty Images
A Citic Pacific safety hat at the company's Sino Iron project in Karratha, Western Australia.

Economists tell CNBC that slowing investment in Australia's mining sector may push the export-oriented economy into a downward spiral as it struggles to transition away from resources to other lagging sectors for income.

"Nothing else is competitive in Australia," Andy Xie, an Independent Economist and former Morgan Stanley Chief Asia-Pacific Economist told CNBC. "So it's not going to be a smooth transition from the mining theme to other economic activities with Australia heading towards multi-year hardships."

There are growing risks that Australia could head into a recession as early as next year, according to Adam Boyton, Chief Australia Economist at Deutsche Bank, who says falling commodity prices will push the terms of trade — which measures the ratio of export prices to import prices — to fall by 15 percent by the end of the year.

"When we look back over the past 50 years, we've seen declines of the magnitude [in terms of trade] only five times. And in three of those five times, the economy has entered recession," Boyton said.

Concerns over Australia's economy come as global commodity prices likeiron oreand coal hit record lows on falling Chinese demand — Australia's biggest export market — forcing the country's miners to put major projects on hold amid declining profits.

The world's biggest miner — BHP Billiton — announced on Wednesday that it will halt plans for a $20 billion copper expansion in South Australia after it reported a 35 percent drop in second half profit from a year earlier.

While Australia's commodity boom may be far from bust with close to $500 billion resource investments in the pipeline over the next five years, doubts persist whether all that money will actually get spent. The pullback seems to be happening much faster than predicted by the Treasury Department, which said earlier this year that mining investments would ease from mid-2013.

Andrew Su, CEO of Sydney-based commodity brokerage Compass Markets says the amount of inquiries for the purchase and sale of commodity related assets in Australia has slowed significantly for his business in the past six to eight months.

"We would be getting two or three inquiries a week about the purchase of coal mine assets, and assets like that in Australia from Chinese related entities, to literally now, we don't get any," Su said. "I haven't got any over the past two or three months."

A combination of the high Australian dollar and a slowdown in the Chinese economy has made Australian assets a lot more expensive to overseas companies, according to Su.

As the mining construction boom winds down in Australia, Michael Blythe, Chief Economist at Commonwealth Bank of Australia says, the economy will slow down if Australia doesn't find other sources of growth.

"Mining construction will peak probably towards the end of 2013, so that means 2014 is when the downturn should start," Blythe said. "We will be looking for other sources of growth and if we don't get them, then the overall economy will slow."

Can Other Sectors Pick Up?

Australia's biggest mining boom since the gold rush of the 1860s has led to a thriving economy, with annual GDP (gross domestic product) growth at 4.3 percent in the first quarter of this year, the fastest pace in more than four years amid a global slowdown. But industries outside of mining like tourism, retail and education services have taken a big hit from the rising Aussie dollar.

The retail sector, which accounts for 18 percent of Australia's GDP and is the second biggest employer after the health industry accounting for 10.5 percent of all jobs, has seen a slight rebound in recent months with sales rising a surprising 1 percent in June on interest rate cuts and government handouts. But since then the effect of the sweeteners has petered out and consumer confidence took a dip in August.

The Westpac-Melbourne Institute index of consumer sentiment, a key measure of consumer confidence in Australia, fell 2.5 percent to 96.6 in August from a seasonally adjusted 99.1 in July.

Xie says that Australia is in a "foreign investment bubble" that has spilled into other sectors like property. He adds that foreign money is pumping the overall money supply and when investment slows in the mining sector, other sectors will feel the pullback as well.

"You need the exchange rate to be reset at a very different level for other sectors to be competitive, but if the currency let's say drops 30-40 percent — you're going to have significant inflation — then interest rate goes up...it's a big cost for the business sector," Xie said.

Other economists, however, argue that the Reserve Bank of Australia (RBA) has a lot of room to stimulate the economy with monetary policy, which will in turn boost sectors like housing, and retail as mining slows.

The RBA has cut interest rates by 1.25 percent since November to 3.5 percent in June — its lowest level since late 2009 but still far above those in the U.S., Japan or Europe. Analysts are pricing in as much as 100 basis points of further cuts within the year as the central bank has said in the past it will move to stimulate the domestic economy if global economic conditions worsen.

"Even if the transition was bumpier than what I expect, the policymakers here have got scope to cushion that transition anyway," Kieran Davies, Chief Economist at Barclays said.

Boyton backs that sentiment saying that "interest rate sensitive" parts of the economy have scope for upside, and other lagging sectors have already shown signs of recovery.

"I think you're starting to see a little bit of that perhaps in the building approvals data over the past few months, and maybe that little uptick we've seen in retail," Boyton said.

- By CNBC's Rajeshni Naidu-Ghelani.