China Turbulence Batters Australia

China’s economic sneeze has blown a cold chill over the Australian economy, with growth rapidly slowing, joblessness rising, and the local currency and stocks tumbling. Amid fears of an impending recession, the newly minted government of Malcolm Turnbull will need all the newfound confidence it can muster to keep the nation’s record 24-year economic winning streak intact.

The Middle Kingdom’s decades-long rise into Asia’s biggest economy produced enormous economic dividends for Australia, but the party may be over for the “Lucky Country.”

Surging Chinese investment over the past seven years has led to the world’s second-biggest economy becoming the fifth-largest accumulated investor in Australia, and the biggest single investor in fiscal 2014.

The communist giant overtook Japan to become Australia’s largest trading partner in late 2007, with total trade worth almost A$160 billion ($112.3 billion) in fiscal 2014. In comparison, two-way trade between Australia and Japan, the nation’s second largest trading partner, totaled around A$70 billion in the same period.

The push for even greater trade ties led to the signing in June 2015 of the China-Australia Free Trade Agreement, described by Australian Trade Minister Andrew Robb as “an outstanding agreement.” Under the pact, more than 95 percent of Australian goods exports will enter China duty-free on full implementation, although the deal is yet to be ratified by Australia’s Parliament.

Chinese investors have also become a growing force in Australia’s real estate sector, which accounted for almost half its total investments of A$28 billion in fiscal 2014. According to Credit Suisse, Chinese investors bought around a quarter of all new property in Australia’s biggest cities of Sydney and Melbourne in 2014, contributing to rising property prices that have sparked fears of a bubble.

China’s position as the world’s biggest consumer of resources has given it disproportionate influence over Australia’s key exports of iron ore and coal, with Chinese companies becoming major investors in Australia’s resource sector, agriculture, tourism, and other areas.

August Meltdown

However, following the August meltdown in Shanghai stocks, Australians have become more nervous about the health of their new benefactor.

On September 23, Australia’s benchmark stock index dropped below 5,000 for the first time since July 2013 as investors sold shares on fears over China’s economic health. The sell-off followed a key gauge of the Chinese manufacturing sector dropping to its lowest level since the global financial crisis, ending any prospects of an economic honeymoon for newly installed Prime Minister Malcolm Turnbull and his new cabinet, including Treasurer Scott Morrison.

Morrison quickly declared that the nation has “a spending problem, not a revenue problem,” flagging the need for spending cuts to bring the budget under control. But faced with the largest fall in the nation’s terms of trade – a ratio of export prices to import prices – in half a century, which has eliminated an estimated A$90 billion in tax receipts since 2013, the new treasurer faces a even tougher challenge than his predecessors.

Australia’s latest GDP data for the June quarter 2015 showed that the world’s 12th largest economy had slowed to a virtual standstill, with real GDP rising by only 0.2 percent. Ironically, government spending helped prevent a worse reading, with exports slumping by 3.3 percent and business investment, which was previously led by mining, “falling off a cliff.”

China’s slowdown and the resulting fall in commodity prices has battered the Australian dollar, with the local currency falling to a six-year low below $0.70 and expectations it could sink further amid the prospect of higher U.S. interest rates. Australia’s jobless rate also hit a 13-year high of 6.3 percent in July, with expectations it might climb to 6.5 percent due to a slowdown in the mining sector, while official interest rates have been slashed to a record low 2 percent.

While the Chinese government has stressed that its economy continues to grow as its target rate of 7 percent, other analysts suggest a more accurate reading is around half. Analysis by the Guardian newspaper suggests China’s 15 percent decline in imports during the first half of 2015 has slashed $25 billion off Australian exports, erasing the promised gains of the new trade treaty.

According to the International Monetary Fund (IMF), Australia will be the worst-hit advanced economy from slowing Chinese investment growth, cutting about one percentage point from Australia’s potential GDP growth rate through to the end of the decade and costing A$16 billion worth of GDP.

The Chinese investment slowdown is based on Beijing’s expectation that investment growth will drop from 9.5 percent a year to 4.6 percent over the next half decade, as it continues its effort to transition from investment to consumption-driven growth. However, it also assumes that China will maintain 6 percent plus GDP growth rates through to 2020.

Partly as a result of China’s slowdown, the IMF expects Australia’s GDP growth rate to cool to around 2.5 percent a year from 2020 onwards, below the Australian government’s official forecast of 3.5 percent annual growth and making it harder for Morrison’s budget targets.

“For 10 years, Australians drank the commodities Kool-Aid. We built our economy around the assumption that the China super-cycle would extend as far as the eye could see," Alphabeta economist Andrew Charlton told the Australian Financial Review.

"Successive governments loaded up the budget, the miners poured shareholder funds into unrestrained expansion and households took on unprecedented debt."

According to Charlton, Australia now needs to reposition itself to benefit from the “China of the future, not the past.” Alphabeta has identified eight sectors that could take advantage of the change: agriculture, clean energy, education, environmental services, financial services, healthcare, manufacturing, and tourism. The mining sector is a notable absence.

Turnbull’s installation as Australia’s 29th prime minister on September 15 has already produced an economic dividend, with consumer confidence rising to levels not seen since 2013.

But after pledging to build a nation capable of handling “disruption,” Turnbull is about to find out just how much disruption Australians can handle, should China fall further off its economic precipice.