A booming natural resources industry has underpinned Australia’s relatively healthy macro-economic fundamentals over the past decade. Nicknamed ‘the Lucky Country’ after a book of the same name published in 1964, as the commodity super-cycle turns Australia’s good fortune may be at an end.
China’s slowdown is a game-changer for commodities, and for base metals in particular. The price of iron ore – which makes up around a quarter of Australia’s total exports – has halved since the end of 2012, and is now hovering at around $80 per metric tonne. Even if China’s policy makers manage to engineer a soft-landing, we expect growth in what, according to IMF estimates, is now the world’s largest economy to be weaker next year than this. And this has important implications for Australia, which has become increasingly reliant on Chinese demand, with exports to China rising from 1% to 6% of GDP over the past ten years.
Skyrocketing base metal prices in the past decade led to substantial overinvestment in the Australian mining industry, with iron ore production up more than 40% over the past four years. At the same time, the large producers seem prepared to engage in a price-war aimed at forcing their smaller, higher cost competitors into distress. BHP Billiton recently said that it plans to ramp up iron ore output, despite acknowledging that supply growth would exceed demand ‘in the short to medium term’, and Rio Tinto confirmed that it would go ahead with a planned expansion of mining production. So not only has global demand for Australia’s key natural resource fallen, that country’s ability to extract it has, with characteristic bad timing, risen too, putting further downward pressure on prices.
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Further reductions in the price of Australia’s major export will, of course, put additional downward pressure on that country’s terms-of-trade, which had more than doubled since the turn of the century, and on the AUD. In addition, a rising dollar environment implies a further squeeze on commodity prices; and if the recent dollar uptrend evolves into a lasting bull market, akin to those witnessed in the early 1980s and late 1990s, then there could be a lot more downside. Taken together, these forces suggest residents of the Lucky Country are likely to feel distinctly less well off.
This backdrop suggests serious headwinds for Australia’s public finances. This week, Treasurer Hockey said that “there has been a hit to the budget” from lower iron ore and coal prices, frustrating the authorities’ effort to move public finances back into the black. As result, the government is likely to revisit its forecast of a A$30 billion deficit for the current fiscal year, following the shortfall of A$50 billion recorded in the twelve months to June. What is more worrying, in our view, is Mr Hockey’s conviction that the Chinese government will not “permit … a significant economic deterioration from what is near 7.5% growth”. This year, he may have a point. But next year is much harder to judge. We see around a one in three chance that China is already in a hard-landing scenario. If this risk materialises, growth next year is likely to be in the low single digits at best....MORE
