Promising signs of a China bounce

A few solid statistics don't amount to a turnaround, but evidence that China's economy is stabilising is mounting. If the recovery is confirmed, Australia's miners and its economy will be in better shape than expected.

China needs to grow at 7 per cent or more a year to create enough jobs and cope with massive internal migration. Australia needs China to grow at 7 per cent or more because China is the biggest influence on commodity prices.

There's a series of feedback loops: domestic demand is becoming a more important growth driver in China, for example, but exports are still crucial. The improved growth numbers it has been posting recently are flowing partly from the economic recovery in the West that the United States is leading.

But the mechanics of China's bounce are less important than the fact that the bounce is apparently under way.

It won't markedly affect the structural change that Kevin Rudd referred to ahead of last Saturday's election, when he argued that he was best-placed to deal with what he called "the end of the decade-long China resources boom". He was referring to a tapering of investment in new resources sector production capacity here that is under way, and will continue as big projects are completed.

Sub-7 per cent growth in China would have overlaid that trend with a sustained slide in export volumes and export prices, however, undermining the production phase of the boom that has been primed by Australia's investment in new capacity. It is the risk of that happening that is receding as China posts stronger growth numbers.

The Chinese government is aiming at average growth of 7 per cent a year in its current five-year plan, and in March it said it was aiming at growth of 7.5 per cent this year. This year's 7.5 per cent target is now looking secure.

Credit in China expanded in August at almost twice the rate it did in July. The growth rate of 14.7 per cent was the fastest in three months. Industrial output in August was 10.4 per cent higher than a year earlier, and rising at its fastest pace in 17 months. Thirty-nine of 41 industries reported growth. Electricity output, always a crucial indicator of activity, expanded 13.4 per cent. Steel production rose by 15.6 per cent, and retail sales rose by 13.4 per cent.

China's exports in August were also 7.2 per cent higher than the same month last year. The consensus market prediction was for a rise of 5.5 per cent.

The key thing to consider is that if the economic bounce continues, Australia's economic and sharemarket outlook will change.

Commodity prices will be stronger because China's demand for commodities is the main price driver. All other things including exchange rates being equal - more about that later - miners will book more revenue, make more money and pay more tax, easing the budget pressure on the government as they do so. Most commodity prices are firmer this month, but just two companies and one commodity, iron ore, illustrate the potential.

Iron ore averaged $US126 a tonne in the year to June, but it was down around $US110 a tonne in the final month amid predictions that increased iron ore supplies and a regular autumnal slowdown in China's demand for steel-making materials would see it repeat a weak period a year ago, when it hit $US86.70 a tonne.

It is priced in the spot market at $US135 a tonne now, 16 per cent higher than it was at the end of June: and when it reported on its June half year, Rio Tinto said that a 10 per cent change in the iron ore price could change its underlying profit by $US1584 million. BHP Billiton said in its June year profit announcement that a $US1 a tonne iron price change could change its after-tax profit by $US115 million.

The full impact of a China bounce would have to take some headwinds into account.

Higher commodity prices, revenue and profits would for example make it less likely that the Reserve Bank would need to deliver more stimulus of its own through another cut in the cash rate. That would tend to push the value of the Australian dollar up, erasing some of the US-dollar commodity price gains, and making Australian companies and their products more expensive in export markets, and less competitive against imports.

There are already signs that this is happening. The dollar is still well down from mid-April levels around $US1.06, but it was struggling to hold above US89¢ at the end of August before China's statistical blitz, and hit $US1.03 on Tuesday.

The $A needs to be watched. It will weigh the economy down again if it continues to rise. The coming tightening of money supply in the United States as the US Federal Reserve begins to phase out quantitative easing should restrict the $A's gains, however, and for the time being investors are buying the China bounce. The materials sector of the Australian sharemarket that houses the miners is up 13.4 per cent since the end of June, twice as much as the market as whole.

mmaiden@fairfaxmedia.com.au