China, Australia and a hard landing

China, Australia and a hard landing

Neil Hume | Jul 04 03:53 | Comment | Share

Australias-exposure-to-China-Barclays-e1372900110391

Kevin Rudd 2.0 has been quick to highlight the dangers posed by slowing Chinese growth since he was returned as Australia’s prime minister. For example: When I look at the challenges of rest of this year, and certainly for the upcoming three-year term, the huge outstanding economic challenge for us is the end of the China resources boom. This will have a dramatic effect on our terms of trade, a dramatic effect on living standards in the country, a dramatic effect also potentially on unemployment unless we have an effective counter-strategy. And… There are a lot of bad things happening out there. The global economy is still experiencing the slowest of recoveries. The China resources boom is over. China itself, domestically shows signs of recovery and when China represents such a large slice of our own economy, our jobs and our own opportunities for raising our living standards. But just how dangerous is a Chinese slowdown?Barclays economist Kieran Davies has some answers.

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. 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.

Importantly, though, a collapse of the exchange rate would help cushion the shock, with the Fund, somewhat optimistically in our view, estimating a completely offsetting effect (the budget would also blow out, and the RBA would cut the cash rate towards the cited 1% floor)

However, the most pressing challenge to Australian growth isn’t China, says Mr Davies. It’s the end of the unprecedented resource investment boom. Please take note Mr Rudd.

More generally, we are mindful that a hard landing is only a risk to our China team’s central case, with Australia’s exports to China reaching a fresh record high in May on strong growth in iron ore volumes over the past year. 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.

Quite, because it is a huge hole to fill.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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