Australia-China Economic and Trade Relations Are Heading for a Hard Reset

Bilateral relations between China and Australia are deteriorating rapidly. A recent spat involved an incident in the Twittersphere. China’s Foreign Ministry spokesperson Zhao Lijian condemned the killing of innocent people by Australian soldiers in Afghanistan in a tweet that also included a computer-generated image appearing to show an Australian soldier holding a knife at the throat of an Afghan child, whose head was wrapped in an Australian flag. The incident drew the ire of Australian Prime Minister Scott Morrison, who demanded an apology, saying, “The Chinese government should be totally ashamed of this post. It diminishes them in the world’s eyes.” China’s Foreign Ministry spokesperson responded with a series of retorts. 

This tiff, however, was not the trigger for the deterioration of China-Australia relations, which had begun much earlier. From China’s perspective, Australia is closely following the United States in exerting geopolitical pressure on China, including over the issues of Hong Kong and the South Sea. Australia actively takes part in the Indo-Pacific strategy to counterbalance China; banned Huawei from its 5G rollout by non-market means; and proposed to hold China accountable for the COVID-19 outbreak. The two countries have built up quite a bit of friction over these issues.

The deterioration in geopolitical relations certainly will have an economic impact on each country. China and Australia, now locked in acrimony, actually have very important and close trade relations. According to statistics, the trade volume between China and Australia in 2019 was about $158 billion, while Australia’s trade surplus with China was close to $50 billion. Its exports to China were worth $103.90 billion, accounting for 38.2 percent of Australia’s total exports last year. Australia imported $55.07 billion from China, accounting for 25.8 percent of Australia’s total imports, an increase of 1.4 percentage points over the previous year. China remains Australia’s largest trading partner, largest export destination, and the largest source of imports.

To a considerable extent, the Australian economy needs the Chinese market. Hence it puzzles many ordinary Chinese that Australia takes a tough stand on China politically. Many Chinese wonder why Australia acts in this way, as it is not a global hegemon like the United States. This perception, which is prevalent in Chinese society, shapes public opinion, which in turn will influence Chinese policy to a considerable extent. There is no absolute separation of politics and economics in state-to-state relations, especially at a time when China is being “contained” by the West. Friction between Australia and China is bound to provoke a backlash from China. In fact, the deterioration of bilateral relations has already begun to hit the economic and trade relations between the two countries.

The trade conflict between Australia and China has intensified in 2020 as relations between the two sides deteriorated. In May, China imposed an anti-dumping duty of 73.6 percent and an anti-subsidy duty of 6.9 percent on Australian barley following investigations under WTO rules and domestic laws. In early November, Bloomberg reported that China would formally launch a crackdown on seven categories of Australian goods, including coal, barley, copper ore and copper concentrate, sugar, wood, wine, and lobster, with an effective date of November 6. On November 27, China’s Ministry of Commerce announced that some Australian wines had been dumped in China, causing substantial damage to China’s wine industry, so it imposed duties of between 107 percent and 212 percent on the dumped Australian wines. This measure, which shocked Australia, is undoubtedly a further blow to the economic and trade relations between China and Australia.

In addition, there are obvious signs that the coal trade has been banned. In October, foreign media reported that four Chinese state-owned utilities received verbal notice from China’s customs to immediately halt Australian coking and thermal coal imports on October 9. Since then, Chinese imports of Australian coal have indeed fallen sharply, from 9.44 million tons in May to 5.17 million tons in October and to a low of 1.79 million tons in November. The news that 53 Australian coal-carrying ships are stranded in Chinese ports has gone viral on the internet. According to Bloomberg, as of late November these coal-carrying ships had been stranded in Chinese ports for about four weeks or more. These ships were carrying about 5.7 million tons of coal worth over $500 million, a data intelligence company said. Also in late November, China signed a three-year agreement with Indonesia to import about $1.5 billion worth of coal from the country. This is seen as China’s first step in replacing coal imports from Australia.

Amid the deterioration of geopolitical relations, the damage to China-Australia economic and trade relations is a fait accompli. Researchers at Anbound predict a further blow to China-Australia economic ties as the conflict intensifies. Will China and Australia sever economic and trade ties? In that extreme scenario, the short-term impact on the Australian economy would be significant, because the bilateral trade between China and Australia accounts for 11 percent of Australia’s GDP.

However, geopolitical games do not usually go to extremes, and the two countries are not yet completely torn apart. The more likely scenario is that the two sides ratchet up to a point where the pain of economic losses balances out with the geopolitical gains. Then the two sides may stop the conflict and begin to seek a shift in strategy. But even so, China-Australia relations will be hit hard. In our view, the China-Australia trade relationship faces the possibility of a hard “reset” after a series of trade sanctions and suspensions. It will not return to the levels of the past. We expect structural changes in some commodity trade between Australia and China (e.g., wine and coal), and a certain degree of trade substitution is certain to occur. Australian manufacturers and traders will also learn the lesson that excessive dependence on the Chinese market is a significant risk.

There are also some sectors that will not be significantly affected, most notably the iron ore trade. Minerals exports, mainly metal ores, have been the mainstay of Australia’s exports to China, reaching $71.39 billion in 2019, an increase of 29.0 percent. Last year minerals accounted for 68.7 percent of Australia’s total exports to China. The two main exporters of minerals in Australia are BHP and Rio Tinto Group. Therefore, if mineral exports were to be affected, the impact would be large in terms of the trade amount but limited in terms of the number of companies impacted. In contrast, disruptions to Australian iron ore exports would have a greater impact on Chinese companies, as China imported 665 million tons of iron ore from Australia in 2019, accounting for 67 percent of the country’s total iron ore imports for the year. If iron ore imports were disrupted, a number of Chinese steel mills could be hit with a supply cut, which could have a significant impact on the domestic steel industry. A disruption to iron ore trade would cause substantial damage to China-Australia trade and is unlikely to be triggered by either country.

In conclusion, the deteriorating geopolitical relationship between China and Australia is having a serious impact on the trade relationship between the two countries, which we expect to be structurally damaged and “reset” to some extent. A reset does not mean a complete zeroing out of trade, but nor will it restore relations to their previous state.