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As China turns to consumers, Australia confronts end of iron age

[SYDNEY] Just as China's industrialization helped reshape Australia's economy, the Asian giant's pivot toward consumer-led growth is challenging Down Under anew.

Chinese demand for food and energy will only partly offset slowing growth in iron ore exports that funneled cash throughout Australia for more than a decade, according to the Reserve Bank of Australia.

That means the nation must find new growth drivers at a time a housing boom falters and a resurgent currency compound difficulties posed by the slowdown in Australia's biggest trading partner.

Central bank Governor Glenn Stevens acknowledged last week it's impossible to know how China's transition will unfold given nothing on the scale has been tried before, signaling elevated risks ahead for the developed world's most China-dependent economy.

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Minutes from its March 1 board meeting - where interest rates were kept at a record low 2 per cent - showed a bigger chunk of policy makers' time was spent discussing China.

"The Australian economy at the moment is being buoyed by the confidence that comes from extraordinarily low interest rates driving up asset prices," said Andrew Charlton, director of consultancy AlphaBeta in Sydney and one-time adviser to former Prime Minister Kevin Rudd.

The subsequent housing boom and wealth creation "have been temporary policy stimulus holding up what will be a long-term negative impact of the changing Chinese economy on Australia."

The stakes are high for Australia, with China accounting for about a third of its trade and earning the mineral-rich country about 5 per cent of its gross domestic product.

Furthermore, resources will still comprise a larger share of Australia's commodity exports to China than food in the coming two decades, the RBA's chief China specialist Ivan Roberts said in a research paper released March 18.

The pressures aren't restricted to Asia. China's steel production could be materially cut by a European Union move to consider tougher steel-import tariffs amid concern that Chinese producers pose a threat to their continental counterparts, Fitch Ratings warned on March 24.

That would inevitably flow onto Australia's iron ore industry, where prices have already slumped about 75 per cent in the last five years.

While iron ore rebounded 23 per cent in the first quarter to as high as US$63.74, McKinsey & Co predicts the steel making ingredient will snap back to between US$45 and US$50 this year as evidence of any real improvement in demand is scant.

To date, the Australian economy's flexibility has seen it navigate a changing China. Australia's expansion accelerated to 3 per cent at the end of last year - fueled by consumer spending as the household savings rate dropped - and in three months' time the economy will have gone a quarter century without recession.

Australian data show that China's transition to consumption-led growth is intensifying and helping to boost non- resources industries Down Under at a crucial time for both economies.

At the same time, Australia is seeking new opportunities to provide food, services and health products to its biggest trading partner, and more mainlanders are flying to Sydney and other cities than ever before.

Net services exports in Australia added about 0.5 percentage point to economic growth over the past year, after having been a drag on growth only a few years earlier, according to HSBC Holdings Plc.

"The rise is driven by rising Asian middle class incomes and shifting preferences for more spending on travel and education services," said Paul Bloxham, chief economist for Australia and New Zealand at HSBC, adding that just four per cent of the Chinese population has a passport.

"The recent lift is likely to prove persistent."

Still, the tourism boom from China's cashed up visitors won't be enough to fill the gap left by the commodity slump, argues Andrew Batson, an economist at GaveKal Dragonomics in Hong Kong.

"Australia's resilience in the face of the mining bust does not actually owe much to a surge of new demand from Chinese consumers," he said.

"To put it simply, Australia dealt with the end of the Chinese housing boom by unleashing a housing boom of its own."

Australian home purchases by foreigners, many with a connection to China, helped drive an almost 55 per cent jump in prices across its capital cities in the past seven years as mortgage rates dropped to five-decade lows.

Sydney prices have since fallen after a regulatory clampdown led to a slowdown in mortgages to landlords and lenders' first increase in borrowing costs in five years.

The Aussie dollar has ceased doing the right thing for the economy too: in the past two months it has jumped as doubts emerged about the extent of policy tightening by the Federal Reserve and amid stabilization in commodity prices.

At a time when Australia needs the currency on its side, the risk is that further appreciation could be a drag on its service industries.

With property investment taking over once mining investment came off, the question now is what comes next, said Jeremy Lawson, chief economist at Standard Life Investments.

"That is the issue: what drives growth?" said Mr Lawson, who previously worked at Australia's central bank.

Given reduced fiscal space and a constrained household sector, "Australia is particularly vulnerable to the next global downturn."