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.
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).
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.
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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.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
