What a China hard landing means for Australia

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By Leith van Onselen

Barclays has produced an interesting new report looking at the spillover effects from a China hard landing on the Australian economy:

Our China team’s central case is for China to average GDP growth of 7.4% over 2013 and 2014, but it sees an increased risk that China may briefly experience a temporary hard landing (ie, growth of 3% or less) at some point in the next three years as the authorities reform the economy and reduce leverage.

Australia would be hit hard in that scenario as it has the most exposure to China of any western country, with China accounting for 35% of exports, or 5.7% of GDP.

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It is worth noting that the comparison is even starker when state exposure to China is considered. Calculating exports of goods to China as a share of state GDP, Western Australia had an exposure of 23% in 2011-12. Although there has not been a major secessionist push in the state since the 1970s, this would mean that Western Australia would be second to only Singapore if it was included in the country rankings.

In the rest of the country, the Northern Territory is also above the national average (6%), while the other states and the Australian Capital Territory are below average. Queensland has less exposure than you might expect (3%), while the largest states, namely New South Wales and Victoria, have little exposure to China (1% each).

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Modifying some recent IMF analysis, we calculate the direct hit to Australian growth from a slump to 3% growth in China as 1.4pp, which could be enough to tip Australia into recession given the Japan-led boom in mining investment is starting to roll over.

Also, 3% GDP growth in China could actually see a contraction in Chinese steel production. Against that, the exchange rate would likely drop like a stone, acting as a shock absorber for growth, while automatic stabilisers would see the budget slip further into deficit, and the Reserve Bank would likely cut the cash rate towards its cited 1% floor for the cash rate.

In the short term, Australia’s trade with China remains extremely strong… At present, the tangible challenge to growth in Australia is the end of the Japan-led boom in mining investment, where mining capex may have already peaked. This boom is already starting to pay dividends via a surge in bulk commodity exports, but we still think that overall growth will be weak next year as stronger exports (combined with a lift in interest-sensitive spending) is unlikely to be enough to offset the shortfall left by mining investment returning to a more normal level.

The adjustment in mining investment is likely to take a few years as capex returns to more normal levels, with the exchange rate likely to trend lower as increased commodity supply drags commodity prices down. At the same time, the Reserve Bank should retain an easing bias and seems likely to keep rates at a record low of 2.75% for an extended period to help the economy adjust to lower mining investment.

Overall, the Barclay’s report comes across as overly positive, since it misses a number of potential second round effects, such as rising bank funding costs (as Australia’s risk premia rises) and tightening liquidity (as capital shifts away from Australia). It also probably overplays the extent to which the non-mining economy will fire as interest rates are cut and the Australian Dollar depreciates. Dutch disease has gutted Australia’s non-mining economy, and it will take some time for these sectors to rebound.

More broadly, whether Australia experiences a technical recession – two consecutive quarters of negative real GDP growth – is beside the point. As explained in our June member’s report, it will feel like a recession given:

  • Unemployment will be rising as the economy transitions from labour-intensive mining investment to less labour-intensive mining export production;
  • Per capita real GDP, which has barely grown since late-2008, will likely turn negative;
  • Per capita real national disposable income will likely fall as commodity prices and the terms-of-trade continue their retracement from 140-year highs; and
  • Inflation in the tradeable goods sector (circa 40% of the CPI basket) will rise strongly as the Australian Dollar devalues.

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Comments

  1. “Inflation in the tradeable goods sector (circa 40% of the CPI basket)..” will be disastrous for most families if it happens.

    • Amazing, the very same people that tell you how exporters needed to just toughen-up when the AUD was at $1.10 and trending up, are crying poor mouth because suddenly the average Aussie will see imported inflation. I for one strongly believe the RBA should send the same unequivocal “just-toughen-up” message to Mr & Mrs average Aussie.

      • Good policy wouldn’t allow this kind of price shocks to happen, nigher for the export, nor for the import. And no one was happy to hear our manufacturing is dieing when the mining has been booming regardless of the high AUD. You are obviously in the mining sector enjoying the rise and the fall of AUD, so the lack of sensitivity for the majority of average families and young people is totally understandable.

    • will be disastrous for most families if it happens

      Tough Titties. Australian families buying power has been inflated way beyond fundamentals for 2-3 years now. Say goodbye to cheap petrol, cheap overseas holidays and cheap online shopping. You didn’t earn it and you don’t deserve it. Back to reality with a thud.

      • I totally agree that the buying power of Aussies has been inflated, but is it them who are policy makers? Or is there someone who can argue that this is a result of a mindless policy, not people’s own decision?

        Why when there is a great success and wealth it is always appropriate to a private person and his ability to make it happen, but when there is a huge failure than it is always appropriate to all of us?

        People are not much different from any other creatures and they react to stimulus and rewards. Bad stimulus creates undeserved rewards and this is true not only for the average person, but much more for the top 10%, because of their much greater personal voting market power and huge political influence.

      • It was ordinary people that cheered the Aussie dollar higher.
        It was ordinary people that went on the cheap overseas holidays.
        It was ordinary people that bought sixteen iPhones and iPads per household.
        It was ordinary people that bought lard arse imported SUV gas guzzlers.
        It was ordinary people that bought everything online (GST free!) from overseas and shunned Aussie retailers.

        Our economy has been eating itself alive for five years now, propped up by a mining boom that wasn’t supposed to end. Well guess what? Its ended. Deal with it.

  2. Lorax, I can deal with it, because I don’t have iPhone, I don’t have a car, I don’t buy anything on line, and all that not because I can’t afford it, but because I was eager to buy something Australian of quality, not Chinese, and I am no even native Australian. So, if you don’t like your own culture of exuberance, tell me how can someone else like it?

    I would like to see you so angry to all NG-ed investors and other suckers, not to people who didn’t know and didn’t see it coming, because they are no educated like you are (maybe).

    I am concerned about people who are not like me, because I can survive economically much worse than you can imagine, as I am not a spender and I am not spoiled, but I didn’t expect someone Australian to care so little about his own fellows.