Australia has been hit by a phenomenon not seen there for nearly thirty years: recession.
The pandemic is to blame but fraying relations with China threaten to make the downturn considerably worse. This week, Australia warned against travel to Hong Kong and suspended its extradition treaty with the territory, sparking a swift rebuke from China.
Bumper sales of iron ore and coal had pushed Australian exports to its biggest trading partner to a record A$150.5bn (US$105bn) a year by May. Yet beyond mining, geopolitical tensions are casting a shadow across Australian businesses from banks to agriculture, housebuilders and airlines.
Canberra’s travel warning, made in response to a new national security law China has imposed on Hong Kong, is only the latest salvo in a growing row between the two countries.
In May, China imposed an 80 per cent tariff on barley imports from Australia, hurting the country’s farmers — a politically important group — and banned beef imported from four of the country’s abattoirs.
The measures were taken after Australia called for an inquiry into the origins of Covid-19. Chinese authorities have also taken aim at Australia’s tourism, education and wine sectors in a series of blistering statements and are expected to promote domestic coal at the expense of Australian exports.
The row “will not only affect large-caps and specific stocks, it affects higher education, small business, foreign exchange,” said Con Michalakis, chief investment officer of Statewide Super, a pension fund in South Australia. “There’s a lot of things that are really worrying about this.”
A truck driver checks her paperwork at the Port of Brisbane © Bloomberg
China’s expanding economy has been a rocket booster for Australian growth.
In the past five years, its exports to China have doubled, helped along by a 2015 free trade agreement and a surge in the price of iron ore from the lows of four years ago. At the same time, exports have broadened beyond mining into the services sector.
Demand among wealthy Chinese families to educate their children at Australia’s universities has helped the education sector expand by 80 per cent to A$32bn over the past decade. It is the country’s third-largest export after iron ore and coal.
In the coming weeks, investors will have their first chance to gauge the impact of the deteriorating relations and the broader downturn in the stock market when companies begin to report results for the financial year, which ends in June in Australia.
Last month, Morgan Stanley analysts said the “continued escalation in trade friction between China and Australia, spilling into real earnings and growth impacts”, was one of the biggest risks to Australian stocks.
Profits on a per share basis for the ASX 200, the benchmark of Australian blue-chips, are forecast to fall 14.5 per cent in 2020, according to analyst estimates compiled by Goldman Sachs.
Earnings per share for banks, which make up a fifth of the ASX 200 index, are set to contract by a quarter in 2020.
Weaker Chinese demand for Australian property, partly because of the political tensions, is weighing on banks and housebuilders, said Damian Boey, an economist at Credit Suisse. “Chinese demand for Australian property has fallen to historically low levels,” he said.
The drop in Chinese visitor and student numbers has also affected tourism. Qantas, the national carrier, and travel booking groups Flight Centre and Webjet, are among the worst performers in the ASX 200 this year while Virgin Australia, the country’s second-largest airline, went into administration before private equity group Bain bought a controlling stake last month.
Other companies that have benefited from the growth in exports to China are also vulnerable. Treasury Wine Estates, Australia’s biggest wine group, noted a fall in China sales in February, before the virus was classed a pandemic. Blackmores, the vitamin and supplement company that has expanded in China in recent years, is also bracing for reduced demand.
Australian listed groups that own Chinese businesses may also feel the pinch. CSL, the Melbourne-based pharmaceutical group that is working on treatments and a vaccine for Covid-19, has increased revenue in China by more than a fifth over the past two years to $626m after buying a majority stake in Ruide, a Chinese biopharma group.
Seek, the Melbourne-based online job search group, last year made around half of its A$1.5bn in revenues from its Chinese subsidiary, but earlier this year warned investors about a sharp drop in revenue from that part of the business.
In a sign of the resilience of the resources sector, mining groups are expected to increase profits per share by 4 per cent in 2020 and Australian gold miners — which have enjoyed a sharp rise in sales to China during the pandemic — are set to increase profits by 54 per cent.
A student at the University of Sydney. Chinese demand has helped the education sector expand by 80 per cent over the past decade © Bloomberg via Getty Images
Groups such as BHP and Rio Tinto, which dominate iron ore and coal exports to China, would suffer if the country reduces its overall demand, rather than simply importing from other countries.
“For Australian bulk commodities, the primary question is not whether China buys from us, but whether China buys at all,” said David Plank, head of Australian economics at ANZ. “Australia’s iron ore, coal and [liquid natural gas] depend on global supply and demand, not whether Australia sells to one specific country.”
Craig James, chief economist for CommSec, the Commonwealth Bank’s securities division, said the current situation underlines the need to diversify Australian exports.
“At the geopolitical level we have these spats from time to time,” he said. Over time, Australia will need to “reduce the risk of being reliant on one or two exports and one or two export countries, which is something Australia is going to have to work on”.