Much of the financial news media in Australia is dominated by coverage of the fortunes of the Chinese economy. So it’s perhaps not surprising that a common question that clients have been asking of their adviser is “why has China become so important to Australia?”
why has China become so important to Australia?
Over the last decade the importance of trade between China and Australia has grown four-fold. Australia now buys more manufactured goods from China while we also export much larger volumes of raw materials. This has had a big benefit for our resource companies and it has been one factor in the rise of the Australian dollar. The chart below shows the weighting of three key countries in Australia’s Trade Weighted Index.
Source: RBA website
The Trade Weighted Index country weights are calculated and released by the Reserve Bank of Australia every October. The bigger the weight of a country’s currency in the index – the more important they are as a trading partner. In the chart you can see how China has grown rapidly in importance such that it is now our largest trading partner while the importance of the United States and Japan has declined.
why has this happened?
Over the last decade, China has developed very quickly. Urbanisation and industrialisation has seen millions of workers leave rural areas and move to jobs in the fast growing cities. This has propelled demand for steel to build houses, factories and infrastructure.
This development is likely to continue at pace for some time as living standards continue to increase and the Chinese government invests heavily in infrastructure projects such as railways. In the next four years, for example, China plans to build a further 35,000 kilometres of high-speed railway.
Australia’s proximity a big advantage
There are two key reasons why China’s development has had such a powerful impact on Australia. The first is distance. In the global iron ore market, Brazil is the world’s other major supplier. Australia is closer to China and can deliver iron ore more quickly and more cheaply. Australia enjoys a price advantage estimated at $12 US dollars per tonne.
The second reason is that Australia’s coking coal (the type of coal used to make steel) is of a very high and desirable grade – substitution is not easy. That said, this is gradually changing with the development of high-grade deposits in Africa.
Based on these advantages, and the likely course of economic development in China, it is clear that China will remain a very important trading partner for Australia in the coming decades.
what does this mean for investors?
Continued strong demand for resources is good news for Australia’s resource companies. Resource and Energy companies make up 38% of the S&P/ASX 300 Index. Income produced by these companies trickles down into the rest of the economy and benefits other sectors.
The stronger Australian dollar makes our imports cheaper. This puts downward pressure on inflation, allowing the Reserve Bank of Australia more leeway with how they manage interest rates. A lower interest rate benefits households with mortgages and reduces companies’ interest payments.
These strong linkages between China and Australia explain the strong investor focus on policy developments in China. The Chinese government still exerts a considerable degree of control over the economy. Policy decisions aim to ensure growth is sustainable and inflation manageable. So far, they have managed this task quite successfully.
Investors will continue to maintain a careful watch on how the Chinese government manages this task.
This article has been written by Hilary Inglis, ipac’s Senior Investment Consultant