Will Australia's dependence on China's growth come at a cost? Some analysts say there are worrying signs and it's time to take stock of the risks. Martin Roth reports.
Will Australia's dependence on China's growth come at a cost? Some analysts say there are worrying signs and it's time to take stock of the risks. Martin Roth reports. BHP Billiton's recent stunning financial results announcement - an after-tax profit of more than $22 billion in the year to June, the largest corporate profit ever recorded in Australian history - has skittish investors wondering whether the China story might, in fact, have many more years to run.At a time of intense financial volatility, with economies in trouble in many countries, such an outcome would be welcome news for our markets.For it is our fast-growing exports to China, along with that country's decades-long run of good economic growth (see charts, right), that have provided support for our economy over many years.They have also boosted stocks across many sectors, though most notably, of course, those connected to mining and energy. "There is no doubt that Australia is very closely tied to what is happening in China, thankfully, given what is happening around the world," says the investment strategist for Ord Minnett, Simon Kent-Jones, noting that one overseas fund manager has described Australia as a "call option on China".But this relationship has also led to fears that, in the words of the chief economist and head of investment strategy for AMP Capital Investors, Dr Shane Oliver: "If China does fall over, that would be a problem for Australia, there is no doubt about that."THE RISKSAnd certainly China appears to have a growing litany of problems that could undermine economic expansion, including inflation, property speculation, local government debt, official corruption, environmental troubles and an ageing population.Yet China experts contacted for this story - some of them regular visitors to the country - were, by and large, remarkably sanguine about the ability of the Chinese authorities to maintain growth, though almost certainly at a lower pace than before.Inflation, which started rising about June last year , and a looming housing bubble are the two issues most often cited by the doomsayers.However, the chief investment officer at Eight Investment Partners, Kerry Series, who recently returned from an inspection tour of some of China's underdeveloped rural areas, notes that food and commodity prices are now stabilising as a result of tightening measures enacted by the government.He believes that by the end of the year the inflation rate could be back down to about 4 per cent, which is the government's target.On concerns of a housing bubble, the managing director of Asia Pacific Asset Management, James Chirnside, compares the current property cycle in China to the image of the python swallowing its victim."The first excessive speculative forces were seen in cities like Shanghai and Beijing," he says. "Steadily that speculation grew out into the countryside and large inland cities."But now, in the bellwether cities, property prices have cooled. So although the numbers are showing that speculation and property price inflation are increasing, the fact is that they are just working their way through the system. Ultimately, they will cool to satisfactory levels."VOLATILITY TO STAYThanks to such trends, AMP's Oliver believes China will continue to record solid growth. "I certainly do not see any imminent collapse," he says. "Also, China is still well placed to stimulate their economy if the global economy starts to fall out of bed."They can cut interest rates and monetary policy. They can probably undertake another round of fiscal stimulus, albeit not on the same scale as they did last time."So, for Australia, China provides a pretty good buffer against the storms blowing in from Europe and the US. The Chinese authorities have shown themselves to be adept at managing monetary policy and managing their economy - far more adept than the Americans and Europeans have been."This suggests a promising near-term outlook for our resources stocks, many of which have been sold down on fears of a global economic slowdown."This is an incredible period," says the senior private wealth manager at Wilson HTM, Simon Robinson. "You will look back and express disbelief that you had the opportunity to buy BHP below $40 [late-August prices]."I am not a super-bull by any means. Volatility is here to stay. I am always a bit cautious. I was not buying BHP at $48. But if I am selling you a share and I cannot sell you BHP below $40, then you should not be in the sharemarket."Yet major changes are looming and it could be that our economic relationship with China is set for a transformation, with significant longer-term implications for our markets.In March, the Chinese authorities announced the country's latest five-year plan, with a range of goals.One of these was to bring annual GDP growth down to about 7 per cent from the 9 per cent-plus levels where it has been hovering for some years.SLOWDOWN OR SHARP DROP?Another was to address rising inequality, by moving from an infrastructure-led economy to one more reliant on consumption.It suggested an eventual slowdown - and quite possibly a sharp drop - in demand for our commodities."A shift like this is unprecedented," says the portfolio manager for the Platinum Asia Fund, Joseph Lai. "It is monumental. It means infrastructure-related sectors in China probably will not do as well compared to the last eight years. But, at the same time, we will see this dramatic increase in consumption-related sectors."Whether to be bullish or bearish is impossible to know at this point, given that infrastructure spending has been such a big part of the economy."Can they slowly adjust it down and, at the same time, push consumption up without leading to other disruptions in the economy? That is the thing that worries me in the medium term."The chief investment officer for fund manager TAAM, Singapore-based Peter Sartori, believes our mining stocks are now entering a more demanding environment but that the markets are still struggling to digest this."On a five- to 10-year view I am not bearish on commodities," he says. "I still think Australian mining stocks are going to be an OK place to invest. In fact, right now, I think stocks globally are very oversold and I think Australian mining stocks like BHP are oversold. There is going to be a bounce. But it will be more challenging for them in the next five to 10 years. I think the very best of it could have been seen."He also believes that, while China should manage smoothly the transition to more moderate growth, the chance exists for a "hard landing", which he describes as an economic growth rate of less than 6 per cent."That would shake financial markets," he says. "Though it would create a fantastic buying opportunity if it did eventuate, because it would be just a hiccup for China. I do not think it would be the end of the story."ONE-TRICK PONYDr Michael Wesley is the executive director of the Lowy Institute for International Policy and author, most recently, of the book There Goes the Neighbourhood: Australia and the Rise of Asia. He worries that insufficient debate is taking place in Australia on the implications of our relationship with China."I think where Australia is a bit behind the curve is that other countries have started to think seriously about diversifying their investment and trade-exposure profiles," he says. "But our mineral markets are still, I think, very, very heavily dependent on the dynamism of the China market."Whether we can do anything about that, or should do anything about that, is a question for debate. But I guess the point I would make is that there is not really even much discussion of that."China seems to be seen very much in one-dimensional terms as a good-news story, whereas I guess the more pessimistic-minded of us would probably argue that we need to think about the possible risks as well."He expresses concern that many planned new mining projects in Australia seem to be based on a continuation of high commodities prices, without taking into account other similar projects around the world."I am particularly thinking about Africa, which has been invested in heavily by the Chinese and others as a response to the current commodity prices," he says. "I just wonder, once these alternative sources of supply come online and commodity prices drop, will our projects turn out to have been wise investments or mistaken investments?"There seems to be a bit of a Panglossian belief that all will turn out well. I am not so sure it will."Meanwhile, Asia Pacific Asset Management's Chirnside worries about other issues. "Australia has become such a one-trick pony that we are going to become more subject to the ebbs and flows of what happens with Chinese growth and construction," he says."That is dangerous for a society. Somehow we have to reinvent ourselves and we are finding that extremely challenging with a high Australian dollar. Looming in the background we have the dangers of the two-speed economy and the social disruption that that creates. I think we are probably going to experience slower growth than most people expect, combined with problems around the housing market."But is China going to continue growing? Yes, of course it will. Is it safe? No, I believe in the last 12 months it has become more vulnerable."New mining projects depend on high commodity prices continuingAnnouncing its June 2011 record profits, BHP Billiton also said it planned capital and exploration spending of $US20 billion ($18.7 billion) in the year ending June 2012, a steep jump from $US12.8 billion in the year ending June 2011 and $US11.1 billion a year before that.Meanwhile, Rio Tinto, whose financial results follow the calendar year, declared capital spending of $US1.8 billion in the June 2010 half, soaring to $US5.1 billion in the June 2011 half and with at least $US11 billion expected for the 2011 full year.The city dwellers of Sydney and Melbourne are often unaware of the extent our country is being transformed by the resources boom that China has unleashed.Figures from the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) show the rapid pace at which these developments are occurring.According to the bureau, in April this year, 94 minerals and energy projects were at an advanced stage of development in Australia. These represented capital spending of a whopping $173.5 billion, 31 per cent more than just six months earlier. The vast bulk of these projects were in Western Australia (63 per cent) and Queensland (28 per cent). By contrast, NSW accounted for just 5 per cent and Victoria 3 per cent.ABARES says mining industry capital spending in the past 30 years has averaged an inflation-adjusted $14.7 billion a year (see chart). Yet, in the June 2009 financial year it jumped to $40 billion, dipped to $36.2 billion a year later, then soared to an estimated $55.5 billion in June 2011. ABARES expects it to hit $73.7 billion in June 2012.