Is Australia’s strong economy headed for a downturn?

One of the nations least affected by the worldwide recession of 2007 to 2009, Australia has enjoyed nearly 28 years of solid economic growth. But recent threats, including trouble in China and global currency devaluation, could turn Australia’s good fortunes around. If China’s economy suffers a “hard landing,” consequences could be especially dire.

Strong economic history

Australia is the world’s 14th-most competitive nation among the 140 countries ranked by the World Economic Forum’s 2018 Global Competitiveness Report. A strong domestic economy, steady exports of coal and iron ore to China, and an influx of immigrant workers have fueled the country’s expansion.

Sound fiscal management has also played an important role. While other countries suffered from the dot-com crash in 2001 and even more from the global financial crisis, Australia weathered both crises relatively unscathed, having learned its lesson about risky investments a couple of decades earlier.

After a recession in the 1980s, caused by risky loans and dubious overseas ventures, Australia implemented banking controls to decrease risk. As a result, the country didn’t create the dodgy mortgage securities that caused the financial crisis. And because it limited foreign exposure, it didn’t suffer from contagion.

Since then, Australia’s economy has strengthened further. Growth was strong in the first half of 2018, though it slowed in the second half of the year, a February IMF report said. Inflation remains below the central bank’s target and employment remains robust, though wage growth has lagged.

Winds of change

Despite this mostly rosy picture, Australia’s household debt is high and real estate is overpriced, even after a recent correction, the IMF report said. Dependence on foreign markets, especially China, creates vulnerabilities.

In addition, business investment is falling, and wealth and consumer spending are decreasing, according to an OECD report. While the economy is still expanding, growth has slowed, and some economists say the country is heading for the weakest GDP growth in 20 years.

U.S.-China trade war

China, Australia’s largest trading partner, naturally has an outsize effect on its economy. A trade war with the U.S. is causing Chinese manufacturing to slow, lessening the need to import natural resources from Australia.

A new round of tariffs went into effect in September, on top of others that already exist or are being phased in. By the end of the year, $550 billion of Chinese goods — nearly everything China exports to America — will be exposed to tariffs. In retaliation, China has imposed its own tariffs on $75 billion of American goods.

Though China has grown its domestic economy in recent years, it remains dependent on trade with the U.S. The trade war has already slowed industrial production, and as more tariffs take effect, manufacturing will decline more. U.S. President Trump has said he regretted not raising tariffs even more, raising the possibility of further escalation.

China’s other economic problems

Trade wars don’t last forever, and as tariffs start to affect the U.S. economy as well as China’s, pressure will increase in both countries to negotiate a solution. But even when the trade war ends, China’s economy faces structural problems that will have a negative effect on Australia, according to a recent report by the Australian policy institute China Matters.

One is massive debt. Total government, corporate and household debt amounts to nearly 300 percent of gross domestic product, an unsustainable rate.

China’s debt problem is exacerbated by unregulated lending. Since state banks refuse to lend to some industries and offer unfavorable terms to others, about two-thirds of all lending is made by shadow banks. The IMF has warned that shadow banking poses a high risk to China’s financial stability.

China also faces problems with the ongoing protests in Hong Kong, which has the world’s fourth-largest stock market and serves as regional headquarters for many Western companies, which could decamp to Singapore or elsewhere if the situation deteriorates.

In a worst-case scenario, economic problems in China could cut Australian GDP in half, according to a Goldman Sachs report. Another report said that a hard landing for the Chinese economy could cause Australia to lose $140 billion of national income and 550,000 jobs.

These problems would occur in Australia over time. In the near term, lower interest rates would cause exports to countries other than China to increase. In the long run, however, falling trade with China could lead to a slowdown and/or closures in the recovering mining industry, lower natural resource royalties, fewer jobs and lower government revenue.

Competitive currency devaluation

Another factor that could affect Australia’s economy is global currency devaluation. To boost exports, decrease trade deficits and lower long-term sovereign debt, Europe, Japan and the U.S. have been cutting interest rates. More than 30 central banks have cut rates this year in response to slowing global growth. Australia recently cut its own rate twice, in June and July.

In a globally-entrenched economy, when major powers devalue their currencies, other countries feel they need to follow suit to remain competitive. “If the world interest rate changes, we have to change ours, too,” Philip Lowe, head of the Reserve Bank of Australia, said at a recent economic symposium. But with Australia’s interest rates now at a record low of 1 percent, the country, like others, risks lacking the tools it may need to deal with a future recession.

Australia’s robust financial structure, influx of immigrants and trade with China have made its economy exceptionally strong over the past three decades, and though growth has recently slowed, the country remains in good shape.

But serious problems in China and currency devaluation could change that picture. If an economy as robust as Australia’s suffers a downturn, it doesn’t bode well for the rest of the world’s markets.

Dafydd Williams, Senior Director, Advisory Services, contributed to this article.