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Published 26 March 2013 08:25, Updated 27 March 2013 06:29
China rebalancing its economy toward consumption could take enough steam out of the country’s manufacturing to give other countries’ manufacturing sectors a chance to fight back. Photo: Reuters
China is about to undergo a rebalancing of its economy from investment to consumption that over the next three to four years could see the global price of hard commodities halve, Peking University-based finance professor and former investment banker Michael Pettis says.
The new leadership team of President Xi Jinping and Premier Li Keqiang understands the urgency of China making the policy changes necessary to implement this shift in growth, said Pettis ahead of a speech on Monday at the University of Sydney Business School.
“It’s still politically quite difficult but my guess is that this year or next year we’re going to see major steps towards rebalancing,” Pettis told BRW. “The rebalancing is going to be difficult. It always is difficult. From an Australian point of view, the key takeaway is that it almost by definition is going to result in a significant drop in Chinese demand for hard commodities.”
The massive investment in infrastructure that, for example, will see China building 45 airports over five years – an average of a new airport every 40 days – has buoyed demand for Australian iron ore and coal, and helped keep the economy growing throughout the global financial and economic crises.
But a country that accounts for 12 per cent of the global economy cannot indefinitely consume 40 per cent of its copper and 60 per cent of its iron ore. The timing question is how and when that slowdown will occur and what effect it will have on miners such as BHP Billiton, Rio Tinto and Fortescue Metals – and on Australian government revenues.
Bank of America Merrill Lynch chief economist for Australia Saul Eslake says that if iron ore falls from its current $130-a-tonne level, it will hurt.
“If it went down to $80, yes that would cause some problems for Australia and in particular for the government’s budget,” he said.
But that has happened before, he said.
“Australia has survived for quite some time with iron ore prices south of $100.”
Pettis says China’s investment has been funded by debt that is unsustainable, and the necessary correction will lead to a sharp reduction in the rate of growth or even a reduction in investment.
“China’s reached the point where investment has been misallocated,” he said. “It’s being supported by a growth in debt that exceeds the growth in value created. That’s clearly unsustainable.”
Other economists are more sanguine about the effect of China’s slowdown. Eslake says that while the full extent of China’s debt is unclear, much of it is owed by one part of the government to another.
“There is the potential for writing off unsustainable obligations that doesn’t necessarily exist in other situations,” Eslake said. “I’m not disputing there are problems there and there is an opaqueness about the size, breadth of the debt problem, but it doesn’t automatically follow that China is facing its own Lehman Brothers moment.”
In a January report, HSBC said the level of debt owed by the country’s central government and local governments (which have funded much of the infrastructure investment) was still manageable. The combined debt of the two tiers of government, worth about 20 trillion yuan ($3 trillion) in 2011-12, was little changed from the previous year at about 38 per cent of gross domestic product and down from 44 per cent in 2009.
Pettis says that while China’s rebalancing will bring a loss of competitiveness in its manufacturing – potentially offering a boost to industry in countries like Australia – any such gains will happen far more gradually than the effect on commodity prices.
Further, China’s rebalancing is likely to be accompanied by an increase in capital outflows, which could buoy the Australian dollar and prevent it from falling in value – just at the time when the country needs all the benefit it can get from a weaker currency, Pettis said.
“If a slowdown in China is accompanied by an increase in capital outflows, one of the consequences might be that more money flows into Australia and so it slows down the adjustment rate of the Australian dollar,” he said. “So Australia could be stuck with lower growth but an expensive Australian dollar.”
Eslake – who agrees that China’s new “Xi-Li regime” is more committed to weaning the country off investment-led growth than the previous leadership of Hu Jintao and Wen Jiabao – is less convinced of the negative effects that could come from this change in economic policy.
“We may well for other reasons, as we have had over the last 18 months, have a problem in that commodity prices and interest rates fall and the currency doesn’t,” he said. “That’s a problem. Whether that would be exacerbated by anything that would happen in China, I’m not sure.”
The post-global financial crisis world has created a race for would-be prophets of doom, he added.
“There’s possibly rich rewards to be had for the person who’s identified as picking the next major crisis,” Eslake said. “Given how well [US economist nicknamed Dr Doom]Nouriel Roubini has done out of that, there is competition among some circles to be the next Nouriel Roubini.”