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Here's a great summary of where China's economy is at, and why it matters for Australia

Photo: China Photos/Getty Images

China might be telling the markets that growth in the world’s second biggest economy is still pumping along close to 7% but Westpac and Australia’s Department of Industry Innovation and Sciences beg to differ.

In their latest China Resources Quarterly (CRQ) – published jointly – Bill Evans, Westpac’s chief economist, and Mark Cully, the chief economist at the Department of Industry, Innovation & Science, say the latest edition “has been compiled against a discouraging economic backdrop”.

They highlight that China’s domestic growth outlook is “fragile and exports are falling”. But they highlight what every trader and investor feels like they know but the Chinese won’t yet concede.

That is, as a result of a fragile domestic outlook and falling exports, China’s “nominal activity growth is extremely subdued vis-a-vis the double-digit percentage growth rates that were de rigeur for much of the last decade”.

That is one of the reasons capital has been rocketing out of China at an alarming and increasing rate.

Obviously the weakness in the Chinese economy, the capital outflows and the People’s Bank of China’s battle with hedge funds over the yuan’s value have all been a big part of the market ructions in 2016.

But that has also has weighed on sentiment toward, and the outlook for, the Australian economy as well.

The RBA highlighted this last week in its Statement on Monetary Policy:

“…weak conditions in the industrial and construction sectors in China have affected other economies in the Asian region as well as commodity exporters, including Australia, and have been associated more generally with declining growth in global industrial production and trade volumes”.

On the outlook for China and its impact the RBA went further, noting (our emphasis):

The outlook for China continues to be a key source of uncertainty for the forecasts. While growth in China has been expected to slow gradually for some time, the recent bout of global financial market volatility has been characterised, in part, by concerns about the evolving balance of risks in China and the ability of the Chinese authorities to manage a challenging economic transition. The authorities still have scope to respond if the economy turns out to be much weaker than expected, but any sharp slowing in economic activity or increase in financial stresses in China could spill over to other economies in the region and adversely affect commodity prices, including those that are important for Australia.

The Australian government is already suffering a fall in expected receipts from the collapse in the value of Australia’s mining exports (which impacts our terms of trade). But Evans and Cully highlight it is not just the Chinese slowdown responsible for the weakness in prices. Australian miners’ attitude toward production are also a key part of the collapse.

“In the resources sphere, the intersection of increasing Australian supply potential and the fact that it is the most resource and energy intensive parts of the Chinese economy that have slowed the most has produced steep declines in the prices of a number of important commodities,” they wrote.

That’s important for Australia because it’s local producers who are the driving force behind lower prices for our key exports.

But Evans and Cully point out Australian producers are doing it to themselves, ourselves:

The global supply trend has been exemplified by Australia’s bulk commodity export volumes, which have continued to increase despite substantially lower prices. Even so, as the period of time that commodity prices spend around their current levels extends, the more pressure will be brought to bear on those mines, in Australia, China and elsewhere, that are operating in the upper quartile of their respective industry cost curves.

The Australian economy is growing below trend at the moment and undergoing a painful transition.

But when viewed against the backdrop of a sharply slowing China, a collapse in our terms of trade, and the uncertainty around the global outlook for markets and the economy, the fact that consumer sentiment remains strong and the economic transition appears to be gaining traction is remarkable.

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