China's economic transition holds the key to what's happening in Australia's economy

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Australia is in the middle of a major economic transition. Having been propelled ever further from 2009 to 2013 by a massive mining-led infrastructure boom, growth is now below trend as non-mining sectors of the economy struggle to offset the winding back of mammoth mining sector spending.

According to HSBC Australia’s chief economist Paul Bloxham, the economic re-balancing to date has largely been spurred by a pickup in housing activity and household demand, however, Australia’s massive services sector, led in particular by tourism, healthcare and professional services, will soon emerge as the next key driver to propel Australia’s economy forward.

Here’s Bloxham on the economic re-balancing act, and the factors that have hindered its progression in recent years.

Australia’s re-balancing act is underway, although the transition from mining to non-mining led growth has not been perfectly smooth. This has left GDP growth below its 2000s average (3.0%) for the past three years. This year has delivered more downside surprises. Back in January we were forecasting near-trend GDP growth of 2.8% for 2015, but we now expect growth of 2.4%.

The pace of re-balancing has been hindered by further falls in commodity prices, an unhelpfully high AUD and the federal and state government’s fiscal consolidation efforts. Falling commodity prices have seen Australia’s terms of trade (the ratio of export prices to import prices) decline by 28% since its peak in mid-2011, largely driven by falling iron ore and coal prices. The fall in commodity price has been greater than had been expected.

While the economy is struggling to achieve the lofty levels of growth seen over the past two decades, according to Bloxham, Australia’s massive services sector looks set to pick up the slack following the mining infrastructure boom.

While his analysis determines domestic demand for services will remain firm, perhaps the real opportunity lies in exporting services unique to Australia to the rest of Asia.

Foreign demand for Australian services is rising and is expected to pick up further, supported by increasing Asian middle class incomes and shifting consumption preferences. Australia’s tourism and education export industries are already getting significant support from rising demand in Asia, particularly China.

This is certainly evident in recent data released by the ABS. Short-term visitor arrivals to Australia, particularly from China, have surged in recent years, as have the number of foreign students currently studying down under.

Here’s Bloxham on the potential opportunity that exists for Australia from rising Chinese international travel.

In 2014, there were 109m outbound visits by Chinese people. Excluding visits to Hong Kong and Macau, the numbers have risen from 14m to 32m (Chart 28). At this rate, Australia has actually seen its share of China’s visitors fall from 3.5% in 2005 to 2.5% in 2013. There remains significant scope to see further growth in Chinese visits to Australia. This is not least because the Chinese passport penetration rate is still low, at around 4% of the population. HSBC expects Chinese outbound travel to double over the next decade.

And for education exports:

In 2014, output from Australian onshore education facilities accounted for around 1% of GDP. International student enrolments reached a new record high at the beginning of 2015 with nearly 147,000 students starting course in Q1, ahead of the previous quarterly record of 142,000 in Q1 2009.

This partly reflects new visa arrangements, which have reduced requirements for many prospective students and made it easier for international students to stay and work in Australia after the completion of their studies. The fall in the AUD is also helping to support demand, along with the ongoing rise in Asian middle class incomes, which is making studying in Australia more affordable for a larger group of students.

Education exports – which are measured to include spending by international students on goods and services in Australia, such as housing – reached AUD17bn in 2014, surpassing the previous peak of AUD16.1bn in 2009. This makes education Australia’s fourth largest individual export by value, behind iron ore (AUD66bn), coal (AUD38bn) and natural gas (AUD18bn).

They’re massive numbers and are likely to increase in the coming decades. However, whether they will be able to completely offset huge declines in business investment spending in the years to come remains debatable, particularly should economic conditions in China not transpire as many analysts currently expect.

There’s a very good reason why the world now pays such close attention to the developments in China’s economy. How it evolves in the years ahead will impact the prospects for global economic growth, particularly for Australia, whose economic prosperity looks set to be determined yet again by its giant neighbour to the north.

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