Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Chinas hit on Australian wine exports is the latest escalation in an ongoing diplomatic rift between the two countries.
Chinas hit on Australian wine exports is the latest escalation in an ongoing diplomatic rift between the two countries.
Winemakers have long relied on Chinese demand and China is the largest purchaser of Aussie wine. A blow for Treasury Wine Estates whose share price has nosedived on the news. Treasury has said demand in China will be “extremely limited” while the duties are in place. The company will have to diversify away from China and find new markets to sell their Penfolds wine into. A strategy which clearly won’t happen overnight, given China’s dominant purchasing position (30% of earnings last fiscal year), the demand could take some time to replace.
The tariffs on Aussie wine follow a barrage of other attacks on Australian exports from coal and copper to barley and other agricultural products.
The backstory
Strategic alliances are shifting as we have seen most potently with the China/US hegemonic struggles. Australia is caught in the crossfire and the pandemic has been a pivotal moment for the relationship. As is customary of geopolitical stresses and strains, the tensions will fluctuate, with periodic flashpoints, but the long run trend is set. Australia will pivot toward other export markets and China will gravitate toward self-reliance as telegraphed at the 5th plenum and in the touted “Dual Circulation” strategy.
At present, Australia’s export economy is incredibly interconnected with China, China is Australia’s largest trading partner and Chinese immigration/tourism has underpinned demand for Australian property and services exports like tourism and education. In 18/19 China accounted for around 26% of total 2-way trade, Japan was 2nd at 10%, and the US 3rd at 9%. Digging deeper, goods and services exports to China accounted for 33% of Australia’s total exports. In that period, Australia’s total exports accounted for ~22% of GDP meaning through the export expenditure channel as a determinant of net exports China governs around 7% of Australia’s total aggregate demand.
Diplomatic tensions between the two countries have mounted as Australia called for an independent investigation into the origins of the COVID-19 breakout, which brought the global economy to a standstill earlier this year. Since then Australia has refused to be strong-armed by Chinese threats unwilling to fall victim to China’s tactics of economic coercion. As a result, the tensions have not cooled, and China seems determined to make an example of Australia with no holds barred “punishment”. However, China’s dominant purchasing position for Australian goods comes with a price Australia is not willing to pay.
We have previously detailed the deteriorating relationship and some potentially affected businesses listed on the ASX 200 here.
The rift between the two nations goes further back than COVID-19. Tensions were brewing with Australia's ban on Huawei's participation in the nation’s 5G rollout based on national security grounds back in 2018. In addition, claims over the South China Sea have contributed as Australia sided with Japan and the US, infuriating China. The turbulent tit-for-tat that has ensued has also included blocking a $600 million deal to sell an Australia-based dairy business to a Chinese company, China Mengniu Dairy and a more broad based crackdown on China’s influence in Australia.
As trade tensions between China and Australia have escalated in recent months, China has already imposed tariffs on various Australian agricultural imports.
On the trade front, Chinese importers have been told to stop buying Australian coal, barley, copper, sugar, timber, wine, and lobsters, however, imports of Australian iron ore have been maintained. In fact, despite trade tensions increasing, imports of iron ore have increased this year according to the ABS.
These boycotts were warned by China’s embassy in Canberra months ago as we discussed prior here, but now we see with certainty that China is intent on following through on these threats.
No doubt, these actions will be painful for the individual industries. Winemakers have long relied on Chinese demand and coal accounted for 9% of Australia’s earnings on exports to China last year. At present around 60 ships transporting more than $500mn of Australian coal are reportedly stranded near Chinese ports.
A ban on Australian iron ore would be the true “black-swan” and is unlikely to happen at this stage. China still needs Australian iron ore and cannot substitute yet – there is a structural dependence. Diversifying supply away from Australia will be challenging, however, over the coming years it would be reasonable to expect China to pivot from Australian iron ore exports if tensions continue along the current trajectory. But by the same token Australia can also diversify to other Asian markets - Indonesia, Vietnam, Bangladesh and India for example. Although these shifts will take time as new relationships are forged and the path will be winding as goods are diverted elsewhere.
China’s embassy in Canberra previously warned of a consumer boycott on Australian goods and produce. The warning also eluded to a potential bypassing of Australia as a destination for both tourism and education, both tourism and education are major service export industries in Australia.
These threats hold serious repercussions for Australia’s services economy, as China remains the number one purchaser of both Australian goods and services exports. While de-risking via diversification of Australian exporters into other markets like India and the rest of South East Asia would support long-term goals, reduced Chinese demand for Australian goods and services poses a near term risk for the Australian economy - inbound Chinese immigration has been a strong contributor to Australian GDP, and China is Australia’s largest trading partner.
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