China’s not the worry – but Australia is

Most significantly, there aren’t the excesses in the commodity sector which existed during the previous cycle. Even with the gains of the past year most commodity prices are substantially below 2013 levels and the sector looks to be much less frothy. 

" [China] is much better positioned this time than when it began its last tightening cycle in 2013.” - Richard Yetsenga

China’s steel inventories are only 55 per cent of 2012-2013 levels, meaning far less over-supply. China is also in the midst of a substantial steel capacity reduction program. 

China’s steel inventories are only 55 per cent of 2012-2013 levels, meaning far less over-supply. China is also in the midst of a substantial steel capacity reduction program. 

Steel capacity reduced 10 per cent in 2016 and another five per cent of the industry should be mothballed by the end of 2017. China’s raw material sector is likely to be subject to less-violent swings as this very marginal productive capacity shrinks.

The housing sector is also much-better balanced. Fixed-asset investment in the property sector peaked in 2011 although house sales have continued to run relatively strongly. The result is the effective stock of excess inventory has continued to decline.

The inventory to sales ratio is down to 2.3 years from 3.1 years at the end of 2015, the lowest level since 2012. There are even reports around rising occupancy in some of the ‘ghost-city’ hotspots like Tianjin where office vacancy rates have been as high as 50 per cent.

Vulnerabilities

China’s currency does not present the same vulnerabilities which emerged when the economy began to decelerate in 2014.

Previously, depreciation was a shock to expectations after a decade-long bull run in the currency. Gaping holes in the capital account emerged as the RMB’s cycle turned and the US Fed’s shift towards tightening for the first time since 2006 drove a global adjustment in asset prices.

This time around any RMB depreciation is likely to be very modest, at least partly because China’s interest rates have risen faster than the US. Moreover, China’s foreign reserves have been rising since February.

Perhaps most importantly, the service sector has proven it can be a meaningful driver of growth even when the industrial cycle is under some duress and growth slows.

During my last visit to China I noted the pervasiveness of digital activity, at least in the major cities. China’s e-commerce sector in particular now looks to have reached critical mass as a driver of growth.

Tencent is China’s largest company with a market capitalisation of $US330 billion (and recently reported profit of $US14.5 billion). Alibaba is not far behind at $US309 billion and China Money Network reports China has 102 internet unicorns (individual market caps of over $US1 billion) with a combined market cap of $US435 billion.

Fallout

China’s growth might be slowing as policy continues to tighten but don’t expect the fallout to be abrupt.

For Australia, therefore, China is less of a worry than previously. Australia’s issues are more home grown as the economy searches for new growth drivers.

Higher GDP per capita (which should naturally bring down rates of growth), mortgage penetration which is very mature, a bank regulatory environment which effectively removes bank credit as a driver of growth (in exchange for structural benefits to be sure) and slower population growth all imply the future will be harder work than the past.

Certainly Australia can keep growing in absolute terms by virtue of its still robust population growth. But without meaningful change, a return to rates of growth anything close to what the country has averaged historically seems unrealistic.

It’s surprising then how the onus remains almost entirely on a return to a more ‘normal’ economy to fix the budget, rather than on genuine policy reform.

Governments typically don’t do the heavy lifting on budget repair; the economy does. The economy this time is missing in action.

Until the policy debate accepts a more ambitious reform program is virtually the only approach which can take the economy forward - particularly a program which is focussed on removing blockages rather than creating them - Australia will struggle to get closer to the carrot of growth which constantly and tantalisingly seems to remain out of reach.

Richard Yetsenga is chief economist at ANZ