If China were to sneeze, how contagious would it be for the Australian economy? Well, according to HSBC’s global research team, it could bring on something akin to pneumonia.
In research issued this week the HSBC strategists look at the implications for a deflation of the property bubble in China for the Australian dollar and economy, arguing that while it could happen gently, the attempt by the Chinese authorities to end the speculative cycle in property could have significant ramifications for the Australian dollar.
Their starting point is that Australia has a very robust fiscal position, a resilient financial sector and, through the resources sector, a big exposure to the growth and expansion in China. In terms of the Australian dollar, they say it trades more like an Asian rather than currency, with a close correlation to China’s industrial sector and its economic cycle.
Because of that, if there were a negative event in Asia there could be significant downward pressure on the Australian dollar – which some might argue is already occurring amid signs that China’s economy is slowing.
The analysts are concerned about the Chinese property market, which has a value equivalent to 3.7 times China’s GDP. That is, they say, nearly double that of the US ahead of the sub-prime crisis and approaching the 3.8 times GDP Japan reached in the late 1980s. They say China’s authorities are determined to break the property cycle and are likely to use quite harsh policy measures if necessary.
They see linkages between the Chinese and Australian property markets, saying a “bump” in the Chinese market would be likely to make investors nervous and lead to selling of the dollar because of the implications for commodity prices and house prices in Australia – and the Australian banks.
The Australian banks weathered the global financial crisis easily, partly because they are so domestically-focused and have such large proportions of their balance sheets devoted to domestic housing. However, as discussed in Business Spectator on many occasions previously, their point of continuing vulnerability is their reliance on wholesale funding offshore for nearly 40% of their funding requirements.
The HSBC team says that Australian banks have to refinance $US435 billion of debt by 2015 – plus whatever else they need to raise to expand their balance sheets. That represents about 50 per cent of GDP. The refinancing task for the ravaged UK banks, by contrast, is only about 30% of GDP.
That illustrates the Australian system’s vulnerability to refinancing risks and any loss of confidence in the economy, the banks and the Australian dollar.
“If China’s house price bubble bursts rather than deflates in an orderly manner and impacts sentiment regarding Australia, it could lead to a deep examination of the Australian banks, as the market did to the US, the UK and now in the eurozone,” the analysts said.
As has happened in Europe, that could lead to a destructive and not necessarily completely rational self-reinforcing loop in terms of access to wholesale markets, contractions in bank balance sheets, the undermining of the property markets and the economy and a diving dollar.
That may, of course not happen and may, indeed, not even be probable. The Chinese authorities have shown a surprising ability to pull their economic levers and maintain control over their own credit flows. If they deflate their property sector gently, and maintain domestic growth, the Australian dollar will have a floor under it provided by continuing strong commodity prices and resource sector profits and our banks’ access to debt markets will be maintained.
However, the basic point made by the HSBC team is valid. Despite all the back-patting about the resilience of our economy and banking system, our historic reliance on foreign capital – and on our banks ability to borrow to finance the current account deficit – constitutes a major point of vulnerability. Any loss of confidence in the dollar or our banks would represent a grave threat to the stability of the economy and financial system.
The HSBC team, incidentally, say that the controversial Rudd government proposal to introduce a resource super profits tax has “generally been perceived to be a negative” for the value of the dollar.
This article first appeared on Business Spectator.
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