Australia could stumble as China looks uncertain

FX360

OVER the last decade, the Australian economy has grown significantly. It’s become a key supplier of raw materials to the emerging Bric economies, and China has been at the heart of this demand. For a time, materials like iron ore couldn’t be shipped out of Australia fast enough to sate huge Chinese demand – on the back of unparalleled infrastructure projects, rapidly growing cities, towering skyscrapers and a vast high speed rail network. To put this into context, in 2001 Australia’s GDP was $380bn (£236bn). By 2011, it had reached $1.37 trillion.

But the question is just how sustainable such growth can be, and whether any slowdown in Chinese economic expansion is likely to be mirrored – if not amplified – in Australia. Granted, headline growth numbers coming out of Beijing continue to impress, especially when compared to lacklustre growth in Europe and the US. However, with Chinese businesses reporting an increase in cashflow problems, company debts are growing as the country’s business climate weakens. And this is just one sign that the tide is perhaps starting to turn for the new economic powerhouse. But just how long will it take for any impact to trickle down to Australia?

Some of Australia’s largest exporters are arguably been well ahead of the curve in calling this slowdown. In August, BHP Billiton shelved a planned expansion project at the world’s largest iron ore harbour at Port Hedland. Over the last six months, other Australian miners have also been making redundancies to account for lower demand. National unemployment in Australia is also creeping up again. Even though the rate remains impressive compared to Europe and the US, it stood at 5.4 per cent in September – the highest in almost two years. This will be a trend worth watching as an early indicator of what may be ahead.

So where are the trading opportunities? The Australian dollar-dollar pair has been hugely range-bound of late, holding above parity despite occasional wobbles in the fundamentals. However, there’s no shortage of analysts happy to call the pair overvalued. With the US economy seemingly finding its feet once again, this doesn’t yet seem to have been priced in. Australian equities are a slightly tougher call, with the Australian All Ordinaries index having underperformed the Dow repeatedly in recent years. Against the prospect of a relatively quick depreciation of the Australian dollar, local equities may well end up looking somewhat undervalued on the global stage.

Obviously any stimulus measures – especially from the People’s Bank of China – would certainly have the scope to stave off any wholesale correction for the time being. But will this happen? China is likely to be increasingly wary of rhetoric coming out of the US, after a bill was passed in the US Senate, allowing the country to target nations with undervalued currencies. But with Beijing the biggest holder of US sovereign debt, picking a fight with the Chinese would seem foolhardy.

Australia has done phenomenally well in recent years. But simply maintaining the status quo – never mind hoping to maintain past growth rates – may well prove a stretch too far. Inflated prices for resources have given the economy an enviable boost. But as production capacity nudges upward at the same time as demand falls away, it’s becoming increasingly difficult to see how this ends well.