In recent times, Australia’s relations with two rising powers in Asia have come under a cloud. One is with India, and that happened over attacks on Indian students. Who instigated them and what was their motive might still be debated. But there is no doubt that they were systematic. The second is the relationship with China. The romance appears to have ended rather abruptly with the arrest of Chinese executives of the Australian mining company Rio Tinto for alleged spying. The issue is far from resolved. It sprang up close on the heels of the collapse of the strategic hike in the stake held by Aluminium Corp. of China in Rio Tinto. Why are these two developments important? They’re important because Australia appears to be banking on these two countries for its future growth.
Every year, the International Monetary Fund (IMF) conducts annual discussions with each member country under Article IV of the Articles of Agreement. It is a good place to get a comprehensive overview of the country’s economic health, even if the language is guarded. This year, the report on Article IV consultation with Australia came out in July.
On page 18, it is said that the Australian officials disagreed with the staff assessment of medium-term growth prospects of the country. They thought the IMF staff were too pessimistic. Among other things, they pointed to the robust demand for commodities and high immigration expected over the next few years.
For the moment, financial markets appear to concur with the assessment of the Australian government. Even though the Reserve Bank of Australia (RBA) had cut the official policy rate from 7.25% to 3% in the wake of the collapse of Lehman Brothers, investors treat the currency as a high-yielding one. In relative terms, they are right. Further, the governor of RBA recently announced that Australia might be one of the first central banks in the world to push up interest rates, given that the Australian economy had fared relatively better than other economies.
IMF’s financial stress index for major economies shows that Australia’s has come down farthest compared with that of Canada, the US and UK in that order. Unsurprisingly, financial futures contracts on Australian interest rates show that investors expect the Australian bank bill rate to reach 5% by mid-2010, from around 3.3% now. Further, speculative long position in the Australian dollar is now approaching levels that prevailed during the gung-ho days of July-October 2007.
This confident talk masks vulnerabilities. Rapidly increasing dependence on export of iron ore and coal to China is one such vulnerability. The share of Australian exports to China is now well over 25%. Dependence on China has grown fivefold in the last decade and a half. That is a clear and present danger. China’s growth model is likely to come under pressure in the coming years, given the likely sluggish path of global growth. China’s supply-driven mercantilist growth model may not come under pressure from US policymakers. They’ve given up trying to persuade China to revalue the currency since they want Beijing to continue to accumulate US debt. However, it is likely to come under pressure because the end-American demand has vanished. Consequently, if China’s appetite for commodities shrinks, one major pillar of Australian growth would be considerably weakened.
Second, pertinently, IMF mentions that one of the other reasons the Australian economy was spared the blushes that other economies were not, was its lack of high-end manufacturing. That might have been a blessing. But it also reveals that, at its core, the Australian economy is a cash-and-carry commodities export economy. To be sure, the previous government, over its long tenure, had done a lot to remove the “banana republic” tag from Australia, with its boom and bust economic cycles coupled with high inflation. Public finances have been put on a sustainable path.
In particular, Indian readers would be interested to know that Australia has a Charter of Budget Honesty, which requires the government to specify “fiscal policy actions that are temporary in nature, adopted for the purpose of moderating cyclical fluctuations in economic activity, and indicate the process for their reversal”.
The structural improvement in public finances helped the Australian government to unleash an aggressive fiscal stimulus in response to the crisis. The hope is that continued population growth via immigration would help to reduce public debt and deficit. Actually, Australian household consumption prospects also depend on immigration and population growth to sustain home prices which are, by most conventional measures, overvalued.
Near term, Australian economic prospects may not appear as daunting as that of the UK or US. Long term, its two pillars of growth are not as strong as they appear at first glance. Given that financial markets have already recognized the short-term good news, it is hard to see further upside for Australian assets—particularly its currency.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at email@example.com