Thinktank says Australia won’t be able to avoid economic disruption if Chinese economy is forced into hard landing

Australia would be thrown into a deep recession and face huge disruption if China’s economy crashes, according to a new report that points to the potential loss of billions of dollars in income, half a million jobs and the dream of a federal budget surplus.

The risks to China’s economy are growing – among them the US-China trade war, colossal corporate and household debts, and the mounting political crisis in Hong Kong – placing the leadership in Beijing under increasing pressure to sustain the growth that has propelled it to superpower status in the past three decades.

If the country does experience its first recession or serious downturn of the capitalist era, Australia “will not be able to avoid economic disruption”, says the report by the thinktank China Matters.

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In the worst-case scenario modelled by Deloitte, if China’s economic growth were to shrink from the current 6.5% to 3%, Australia would stand to lose $140bn in income and more than half a million jobs.

In a less gloomy outcome, the Reserve Bank of Australia has found that a slowdown of 5% in the Chinese economy would see Australia lose 2.5% growth over three years.

“While Australia has benefitted from the growth of the [Chinese] economy, it also leaves us relatively more vulnerable in the event of a downturn,” writes the report’s author, Jeremy Thorpe, who is chief economist at the consultancy PwC.

The most obvious impact would be on commodity prices. The export of raw materials to China makes up a huge chunk of Australia’s massive $8bn trade surplus with China. But earnings from resources such as iron ore and coal – and the range of consumer goods now increasingly traded to China, such as wine, beef and baby formula – would slump if Chinese demand dried up in a recession, leaving a huge hole in federal and state budgets.

Although a falling Australian dollar could offset some of the damage by making Australian products more competitive, an accelerated slowdown in China would “likely result in mine closures or mothballings, with consequent job losses in pockets of regional Australia and lower royalties. Hence, in addition to the revenue shock for Australian governments, there would also be additional budgetary costs from a [China] slowdown”, the report says.

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Sectors such as tourism and education, both of which are attractive to Chinese visitors, would also feel the pain.

The trigger for a China downturn could come from a number of points, the report says. Most obviously, the current trade standoff with the US has given international markets the jitters and injected sharp volatility into stock and currency movements. The Chinese yuan, for example, has fallen to an 11-and-a-half-year low under the pressure of weakening exports.

China is also sitting on a huge debt pile. Total government, corporate and household is close to 300% of gross domestic product. The collapse this year of Baoshang bank – the first in the sector for 20 years – suggests that the Chinese economy may have deeper-seated problems than the headline growth figure of 6.5% might indicate.

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Philip Lowe, the governor of the Reserve Bank, said last year that “the single biggest risk to the Chinese economy … lies in the financial sector”, with the opaque nature of the country’s shadow banking system a particular area of concern to economists.

Then there is Hong Kong. The former British colony is witnessing the biggest political crisis since the handover to Beijing 22 years ago and economists are predicting that its economy will fall into recession this year. Intervention by Chinese security forces could further damage the economy and would threaten the city’s reputation as a hub for international corporations.

China Matters says Australia’s response to these possible shocks should be to continue to promote free trade agreements. A priority should be a regional deal taking in south-east Asian nations plus Japan, India, New Zealand, China and South Korea. A free-trade agreement with the European Union would open up a market of half a billion people.

In addition, Josh Frydenberg, the treasurer, should also be prepared to “sacrifice projections of the budget returning to surplus given likely tax revenue shocks and the need to increase spending to stimulate the economy”.

The government and regulators should also redouble efforts to ensure that Australia’s banks are equipped with sufficient reserves to withstand any China shock to their balance sheets.

Eleanor Creagh, at Saxo Capital Markets in Sydney said China’s economy was at a crossroads. “China has seen credit growth at extreme levels but there has been a delveraging campaign going on which has had an impact on economic growth. It’s a fine line for China right now between deleveraging and maintaining growth levels.”

Although she sees any significant China downturn as a prospect for the longer term, Creagh said policymakers and investors in Australia should have the possibility of a hard landing on their radar.

“It goes without saying that it would not just be Australia that would feel it. The knock on effect would be for the whole global economy. Australia would therefore feel a double hit as a small, open economy. And the RBA doesn’t have as much ammo as they had in 2008 to fight the next crisis.”