A happy Chinese New Year for Australia

China is signalling strong policy settings for 2013. Combined with a remarkable iron ore price turnaround, this will boost Canberra's budget and could mean Australia is nearing the end of the easing cycle.

The prospects for a pick-up in China’s economy are getting better by the week, with more signs that 2013 could be a strong year. It is good news for the Australian economy, which has slowed in the past year in the wake of a sharp fall in the terms of trade and faltering national income growth.

Chinese stock prices are up sharply with gains of over 10 per cent in the last two weeks. Iron ore prices, having slumped to early October, have recovered a thumping 50 per cent in the last 10 weeks. If these sorts of trends are sustained, they would present further hard evidence that the Chinese economy is set to surge in 2013.

These market trends fit with news in the last two months that the economy has turned higher. China’s retail sales, industrial production and fixed asset investment have picked up and while inflation is still very low, it too appears to be bottoming out.

The meeting of China’s Central Economic Working Conference has also delivered a positive tone. The CEWC meets annually and sets the economic policy framework for the year ahead. The key strategies laid out for 2013 are a focus on domestic demand growth, driven by consumption and capital expenditure. This continues a trend in recent years for China to rebalance its drivers of economic growth away from exports, which remain volatile and problematic given the weakness in the eurozone and the US markets, and move the source of growth more towards domestic demand.

The critical aspect of the CEWC plan to foster growth in domestic demand is further urbanisation. The plan is to have 70 per cent of the population living in cities by 2030 from current levels around 50 per cent. Not only will this provide the labour needed for the higher value added sectors of the economy, it will mean an ongoing requirement for infrastructure spending on housing, roads, electricity generation, schools, shops, factories, office blocks and the like. In other words, there will be a huge and ongoing demand for raw materials to feed into the production process.

This is where the benefit to Australia is so clearly apparent.

China accounts for almost 30 per cent of Australia’s merchandise exports to be far and away the largest export market. Around 55 per cent of those exports are iron ore which is why the recent focus on the swings in the iron ore price have been so intense. Iron ore prices fell to around $US85 a ton in early October amid fears of a slump in demand, excess stockpiles or a surge in production or some mix of all three factors.

The rebound to over $US130 a ton this morning suggests the price fall a few months ago was a blip and that the demand for iron ore from China remains unrelentingly strong. It could even be strong enough to stem the decline in Australia’s terms of trade which would underpin stronger in national income growth and, from the government’s perspective, provide an unexpected boost to tax revenue.

There were a range of other key issues from China’s CEWC which will be closely watched in the year ahead.

Having fuelled an inflation breakout with over-stimulatory policy during the crisis in 2008 and 2009, 2013 will see a much more cautious policy approach with fiscal policy to be set in a "proactive” way and monetary policy changes to be implemented "prudently”. This is a sign of policy maturity and not a growth-at-all costs approach which cannot be sustained. Part of the policy approach is to keep the remnimbi exchange rate "basically stable” in the year ahead, a clear reaction to the problematic export climate. To tackle the risks that come with price bubbles, the CEWC will also "firmly regulate” the property sector.

Like the Chinese stock market, the Australia dollar has risen and this morning is around 1.0550. This strength is despite recent interest rate cuts from the Reserve Bank and generally soggy domestic data. The Australian dollar strength at the moment is probably a reflection of the way many global investors trade the currency as a proxy for momentum in the Chinese economy. That approach is to buy Australian dollars whenever the Chinese economy is strengthening and sell it when the Chinese economy is weakening.

It is a little too early to be sure whether the China is heading for GDP growth much above 8 per cent in 2013, but the recent market signals are supportive of such an outlook.

If this comes to pass and the recent rebound in iron ore prices is sustained, it would be great news for Australia and would mean the Reserve Bank is getting close to the end of the monetary policy easing cycle and it would help provide an additional boost to the government still striving for a budget surplus in 2012-13.