Commodity price outlook remains grim
Global commodity prices have recorded steep declines over the last six months driven by lacklustre emerging market demand and rapidly expanding supply. Iron ore prices have fallen 10% since March, while coking coal has lost 20%. Prices are expected to remain soft over the next five years as lacklustre demand struggles to absorb the surplus in global markets. But the establishment of the Asia Infrastructure Investment Bank could unleash the next wave of investment posing some upside to the long term outlook.
View a summary of this month's edition.
The surge in Chinese domestic investment is at an end. Authorities have repeatedly stated the need for more consumption-led growth as additional investment in physical infrastructure is adding to the current glut. Real investment per capita across most developed economies over the last 30 years has plateaued at somewhere between US$5500 and US$7500 (Chart 1). China’s investment per capita is projected to reach US$5500 in 2015 and the authorities are keen to slow its rise, to avoid a correction of the sort Japan underwent in the late 1980s, which resulted in decades of stagnation.
To keep investment per capita in the US$6000 – 7000 range, investment spending in China would need to grow between 3% and 5% p.a. over the next five years; well below the double-digit growth recorded over much of the last 15 years. Our projections suggest investment spending is on track to grow 5% in 2015.
But the trouble with such a rebalancing is that it will damp global commodity prices even more, and Australia’s mining revenues along with it. The RBA estimates that every A$1 spent on Chinese investment requires twice as much Australian value added exports relative to the same dollar spent on Chinese household consumption. This isn’t surprising given our export basket to China is predominantly comprised of hard commodities.
Large scale mining investments commissioned at the height of the mining boom have increased productive capacity, creating a glut in global markets. In addition to weaker Chinese demand (Chart 2), this has prompted the Department of Industry to revise down its price forecasts of iron ore and coking coal. It now expects inflation adjusted (real) iron ore prices to average US$51 over the next two years and coking coal to average US$99. But there are risks that prices could fall further and stay weak. Simulations based on self-exciting threshold autoregressive model of monthly returns over the last 35 years suggests there is a 40% chance that average real iron ore prices over the next five years will remain below US$50 and a 10% chance they will fall below US$40. There is also a 50% probability of average real coking coal prices staying below US$90 over the next five years.
But there is also some upside potential to the long term outlook. The establishment of the Asia Infrastructure Investment Bank with its US$100b of capital could be the catalyst needed to unlock the US$8 trillion of predominantly energy and transport infrastructure needed across most of emerging Asia. This would have positive spillovers into global commodity markets.
Australian exporters more optimistic despite subdued global trade
Exporter optimism and ambition are on the rise — supported by a more competitive exchange rate, recently negotiated trade agreements and solid demand in key international markets. Yet export deliveries remain below the pre‑crisis average amid subdued global trade.
The 2015 Australian International Business Survey (AIBS) released last month is one of Australia’s largest and most in-depth surveys of internationally-active businesses. The survey revealed improving exporter optimism — 69% of respondents judge the outlook for their international operations as better this year than last. Expectations of improved prospects are fuelling increased ambition — 83% of respondents are planning to expand to additional countries over the next two years. The top target markets identified include the US (cited by 14% of respondents), China (13%), Indonesia (6%), the UK (5%) and India (5%).
While the AIBS has a relatively short history, the recent annual DHL Export Barometer similarly found Australian exporter confidence to have reached its highest level since 2011. Improved expectations have been fuelled by new trade agreements, solid demand in key international markets and a more competitive exchange rate.
Over the year to August 2015, the Aussie dollar fell 24% against the USD and 15% against a basket of trading partner currencies (Chart 4). This is primarily due to large declines in the price of Australia’s key commodity exports and the increasing likelihood of higher US interest rates. The RBA maintains that services exports will benefit further from the lower exchange rate given lagged pass-through effects. The correction should therefore provide continued relief to exporters.
The June quarter ACCI–Westpac Survey of Industrial Trends also confirms that expectations strengthened in the first half of 2015, after remaining flat for much of 2014 (Chart 4). Actual exports are also gradually moving in the right direction, but remain well below the pre-crisis average. ACCI attributes this to below-average global growth. In its latest World Economic Outlook (WEO) update last month, the IMF cut earlier global growth projections to 3.3% in 2015, marginally lower than in 2014, due to a slowdown in emerging market and developing economies. This forecast is well below the 4.5% average annual GDP growth achieved over 2000–2007.
Interestingly, despite lower expectations for global growth, the IMF expects growth in world trade volumes to increase more strongly — from 3.2% in 2014 to 4.1% this year and 4.4% next year. This coincides with the opening of the New Suez Canal. At a cost of US$8.2b, capacity has been expanded by around 25% allowing for the transit of 97 ships per day. But the number of ships in transit has been flat since 2008 and the canal was operating below capacity prior to the expansion.
Unpromisingly, over 2015 to date, trade volumes have shown little sign of turnaround. Monthly data to May collated by the CPB Netherlands Bureau for Economic Analysis show world merchandise trade volumes actually shrinking. Trade activity in emerging Asia is particularly subdued (Chart 5). China’s recent surprise RMB devaluations (the largest change in nearly 20 years), followed the release of data showing the extent of its trade recession. The depreciation will help to restore China’s international competitiveness but could cause weakness in other major regional trading partners. The extent to which improved global trade conditions provide additional help to Australian exporters on top of the more competitive exchange rate and greater market access remains highly uncertain.
Australian investment abroad climbs amid global slowdown
Australian investment abroad increased strongly over the year to 2014 amid a global investment rut. Rapid inflows into Asia continued to reduce the heavy skew of Australia’s overseas investment profile towards OECD countries, while 2014 saw finance and insurance overtake mining as Australia’s largest direct investment by industry.
Australian investment abroad increased by 14% to A$1.9t in 2014. Portfolio investment accounts for 40% of Australia’s total investments abroad, and direct investment 28%. Portfolio flows are also the faster growing — increasing by 15% over the year to end 2014 — compared to a 6% increase in direct investment.
Australia’s overseas investments remain heavily skewed towards the OECD, particularly the US and UK. The OECD comprised A$1.37t or over 70% of Australia’s total overseas investment stock, and the US and UK A$880b or 46% (Chart 6). Yet consistent with Australia’s export pivot, rapid inflows into Asia have continued to reduce this skew.
Average inflows into China have increased by 55% p.a. over the past five years, despite accounting for just 3% of Australia’s total overseas investment stock. Flows into ASEAN countries have also shown above average growth of 14% p.a. Over the same time period, average inflows into the OECD increased by just 10% per year.
In 2014, finance and insurance overtook mining as Australia’s largest direct investment abroad by industry (Chart 7). While Australia’s total direct investment in overseas mining fell 6% over the year to end-2014, it grew by the same amount in the finance industry. The increasing trend towards greater services investment is likely to continue given lower global commodity prices and increasing liberalisation, tradability and demand in the services sector.
Globally, FDI inflows fell by 16% to US$1.2 trillion in 2014, mostly because of the fragility of the world economy, policy uncertainty and elevated geopolitical risks, according to UNCTAD’s recent World Investment Report 2015. Consistent with the pivot of Australia’s investment profile towards Asia — FDI inflows to East and Southeast Asia rose 10% while China became the world’s largest recipient of FDI. By sector, the shift towards services FDI also continued. UNCTAD expects global FDI inflows to recover in 2015 — rising by 11% to US$1.4 trillion. They cite stronger US growth prospects, the stimulatory effects of lower oil prices and interest rates, and continued investment liberalisation measures. Yet they warn of significant risks to FDI recovery, including Eurozone uncertainties, geopolitical spillovers, and persistent vulnerabilities in emerging markets.
Better China market access helps offset more difficult export conditions
New trade agreements provide Australia with unprecedented access to the Chinese market. Because exporters face heightened operating challenges in China relative to Australia’s traditional offshore markets, securing preferential market access is critical.
After nearly a decade and 21 rounds of intense negotiations, the landmark China-Australia FTA (ChAFTA) was signed in June. ChAFTA allows for 85% of Australian goods exports to enter China tariff-free upon entry into force, rising to 95% on full implementation. Both sides now must complete their domestic treaty-making processes to enable implementation — the Australian government is aiming for this to occur before the end of 2015.
Australia also became the first country to secure a live cattle agreement with China last month — allowing for the export of feeder and slaughter cattle. The deal has been in negotiation for the past decade, with health standards the persistent sticking point. The health protocol agreement could see Australia export an additional 1m head of cattle to China per year, worth an estimated A$1b‑2b. It could therefore eventually see Australia raise live cattle exports by 75% compared to 2014 levels. While supply is currently inadequate to fully exploit the agreement, securing China as a reliable customer will give producers the confidence to expand. Indonesia is Australia’s largest current market for live cattle exports (Chart 8), but permit allocations were reduced to 50,000 cattle for the current quarter from 250,000 permits in the previous quarter.
China overtook Japan to become Australia’s largest trading partner in 2009. Unprecedented access to the Chinese market will help Australia to broaden its export performance and provide new opportunities to SME exporters.
This comes amid several reminders that China provides a thornier operating environment compared to traditional export markets. China’s performance in the OECD’s updated 2015 Trade Facilitation Indicators (TFIs) is ranked well below Australia’s traditional trading partners and the OECD average (Chart 9). While China’s performance in the TFIs has improved over the past several years — in the areas of advance rulings, involvement of the trade community, and streamlining of border procedures — ground has been lost in governance and impartiality, appeal procedures and fees and charges.
Poor TFIs are consistent with China’s relatively low ranking in the World Bank’s ease of doing business and governance metrics compared to other key export markets. The recent 2015 Australian International Business Survey found that while China is the second most popular new target market, 70% of respondents perceived it to be more difficult to do business in when compared to Australia. By comparison less than 40% of respondents judged the US to offer a more difficult business environment relative to the domestic market. These rankings highlight the heightened challenges facing exporters and the importance of securing preferential market access to ease the burden.
Growing weight of service exports and new opportunities in China
The continued increase in service exports is critical to Australia’s export rebalancing. Service exports will benefit from a weaker AUD, rising regional living standards and global economic recovery. In particular, opportunities for Australian health exporters will arise — fuelled by China’s large and ageing population, rising disease burden, favourable household economics and public policy prioritisation.
Official figures suggest Australia’s services exports are now on par with metal ores and minerals (Chart 10). Yet many services exports escape these figures given that they are delivered via offshore joint ventures and as inputs in global value chains. The Productivity Commission recently estimated services to account for 41% of exports in value-added terms in 2013, compared with 17% in total value terms. Respondents to the Australian International Business Survey suggest services now account for about 35% of total export revenue, while IP sales account for a further 11%. Only 35% of respondents said their international services revenue is earned by the ‘traditional’ route (sales made in Australia and delivered to overseas markets). Around 29% is derived from sales through a foreign sales branch or subsidiary.
The lower AUD will provide a continued boost. Export Finance Australia’s economic modelling shows a high sensitivity of services exports to exchange rate changes. Since early 2013 the AUD has depreciated by 20% on a trade-weighted basis and service exports have risen by 12%. Yet the RBA commented last month that services exports would benefit further from the lower exchange rate given lagged pass-through effects. Research by Citi suggests that services export volumes could grow over 7% p.a. in the next few years.
Services exports will also continue to benefit from China’s economic transition — from one driven by investment to consumer demand. ANZ estimates that by 2030 disposable per capita urban incomes in China will almost quadruple and an enlarged consumer class will spend three times as much as they do now. Australia’s tourism and education exports will be key benExport Finance Australiaiaries.
New export opportunities will also emerge in healthcare with strong demand driven by the following factors.
1) A large and ageing population. China’s population is expected to peak in 2026 at 1.4b people. This population is getting old fast. The share of citizens aged over 65 years is forecast to treble between 2010 and 2050. China’s age dependency ratio will overtake the world average by 2020 and the Australian average by 2040 (Chart 11).
2) A rising disease burden. While China’s economic boom has dramatically improved living standards, chronic diseases are proliferating due to changing lifestyles and preferences. In particular, Chinese citizens are three times more likely to contract cardiovascular disease and respiratory problems than their Australian counterparts (Chart 12).
3) Favourable household economics. China’s economic expansion has lifted more than 300 million people out of poverty since 1980. Despite the ‘new normal’ of slower growth, economic output hit US$10.3 trillion in 2014 — a five‑fold increase from a decade ago. China’s increased economic size means that slower growth still generates as much additional demand as its turbo-charged growth did in the recent past. Moreover a greater proportion of the economy is now comprised of more labour-intensive services, and continued urban job creation is supporting the rapidly expanding middle class (Chart 13) and rising per capita incomes.
4) Policy prioritisation. China’s 13th Five Year Plan (2016-20) will see policymakers continue to focus on health as both a social and strategic priority. Healthcare spending is viewed as a rational long term state investment. The Ministry of Health estimates that every 1 RMB invested in healthcare injects 6 RMB into the economy. Indirectly, state healthcare provision also boosts consumption by reducing the need to self-insure via high precautionary savings rates. Public health spending has grown six-fold over the decade to 2013. Yet it remains low relative to international standards — accounting for 5.5% of GDP in 2013 (Chart 14) compared to 9% in the UK and 17% in the US. A large demand gap persists — fuelling an expected doubling of healthcare expenditure to US$900b by 2018 (from 2012 levels).
Cassandra Winzenried, Senior Economist
Fred Gibson, Economist
The views expressed in Export Monitor are Export Finance Australia’s. They do not represent the views of the Australian Government. The information in this report is published for general information only and does not comprise advice or a recommendation of any kind. While Export Finance Australia endeavours to ensure this information is accurate and current at the time of publication, Export Finance Australia makes no representation or warranty as to its reliability, accuracy or completeness. To the maximum extent permitted by law, Export Finance Australia will not be liable to you or any other person for any loss or damage suffered or incurred by any person arising from any act, or failure to act, on the basis of any information or opinions contained in this report.
Photo credit: © Aly Song / REUTERS / PICTURE MEDIA
 The Department of industry previously forecasted real iron prices would average US$56 between 2015 and 2016 and a real coking coal price of US$113 in their March outlook. Prices were adjusted for inflation using 2012 as the base year.
 Self-exciting threshold autoregressive models better capture price movements over the commodity cycle.