|Summary: Careful management of expectations that Chinese GDP will decline to 6-7% and strong Australian exports to China have protected the iron ore price from steep falls.|
|Key take-out: Chinese government moves to put growth on a more sustainable footing are a welcome development.|
|Key beneficiaries: General investors. Category: Economics and strategy.|
The iron ore price has, so far, remained stubbornly well above the sub-US$100 a tonne levels reached during 2012 when fears of a Chinese hard landing rattled the market, thanks in part to continuing strong levels of Chinese imports of Australian goods.
The ‘correlation’ between the Australian dollar and the iron ore price got a lot of airplay last year when Chinese hard landing concerns saw the iron ore price plummet to $US90 and speculation grew that the dollar should follow it down. While the Aussie stubbornly traded over parity at that time, there was a truckload of research demanding that the dollar collapse along with the Chinese economy. The local currency ignored it all and the iron ore price soon rebounded. And China didn’t collapse.
These fears have surfaced again as the Chinese government is targeting a sustainable 6-7% growth rate over the coming years. This defies growth-addicted analysts who demand that China drive global growth indefinitely, even if via shadowy credit growth and building condos that are not required. This week, sustainable GDP growth of 7.5% has been welcomed by the iron ore price, trading back at $US127/t and certainly not pricing in a hard landing, while in contrast the dollar has fallen 14 big figures in recent months.
Table 1: Iron ore not pricing a Chinese disaster
If slowing Chinese GDP growth is such a concern, why is the iron ore price climbing higher each week? At $US127.40/t, the iron ore price is a far cry from the sub-$100/t lows reached during the height of the first “Chinese hard landing” crisis. This disconnect can be partially explained by fairly robust Chinese imports of Australian goods. The chart below clearly demonstrates that while Chinese GDP growth may be in decline, the country’s appetite for Australian commodities remains in a clear uptrend.
Table 2: Chinese imports of Australian goods
So who is right?
Earlier this week we found out June quarter Chinese GDP rose by 7.5%/yr. Technically this should have surprised no-one, given the figure met consensus expectations, but an official mention of lower growth targets put the markets on notice. (Chinese Finance Minister Lou last week said: “we don’t think 6.5% or 7% will be a big problem” for GDP growth.) We don’t think these levels of growth are a big problem either, but markets believed this meant there was now downward risk on this week’s GDP report, rather than the minister referring to the bigger picture of growth in the coming years.
As is clear from Table 3 below, however, GDP growth of 6% (placed into 2014 for illustration purposes only) is well below the 35-year average of 9.9% and takes growth back towards the recessionary levels of the early 1990s.
Table 3: Chinese GDP to be sustainable
This is why such low-growth “projections” rattle the financial markets, and puts downward pressure on commodities and commodity currencies. However, a significant proportion of past double-digit growth has been via building vast numbers of condos and shopping centres in regions where they are not required, as well as millions of rural dwellers settling into the cities. Both of these factors are waning rapidly, and in fact are targeted by the Xi and Li government through “sustainability” policies, of building small villages in the rural areas and targeting excessive loan growth in the provinces.
Growth easing to 6-7% should be welcome
The official GDP target for this year is 7.5% and while next year’s target remains unknown, we believe it will be lowered again to 7%, with a small risk of 6.5%, despite the Finance Minister’s comments.
In March 2012 there was a global ‘risk-off’ panic-stricken reaction – with the Australian dollar, commodity prices and Asia-Pacific equities bearing the brunt – when the 2013 target was announced at 7.5% instead of the long-held 8%. But in recent months, thanks to ample and consistent communication from senior government officials in recent months, a 7% target is more or less baked into expectations.
Annette Beacher is head of Asia-Pacific Research for TD Securities. This is an edited extract of TD Securities' Asia-Pacific Weekly newsletter.