Australia: Frosty China Ties

Australia caught between superpowers is bearing the brunt of escalating tensions with China and balancing the ideological and national security allegiance with the US, and the trade relationship with China, leaves Australia in a difficult position. Although the Australian government have asserted that Australia is not under pressure to pick sides. Recent actions and commentary from both China and the US appear to the contrary.

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 5^th 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 investigation and inquiry into the COVID-19 breakout. 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”. We have previously detailed the deteriorating relationship and some potentially impacted businesses on the ASX 200 here.

China has recently indicated that it wants Australia to act to improve strained relations, saying Canberra should know what needs to be done to get ties back on track but China’s dominant purchasing position for Australian goods potentially comes with a price Australia is not willing to pay.

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. 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. 

Most recently today, Victorian timber log exports have been blocked from entering China due to bark beetle. 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.

A ban on Australian iron ore would be the true “black-swan” and seems 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. 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 our largest trading partner.