AIIB offers new export opportunities
View a summary of this month's edition.
View a summary of this month's edition.
Australia recently joined the new Beijing-based Asian Infrastructure Investment Bank (AIIB) as one of 57 ‘prospective founding members’ (Chart 1). The AIIB will partner with the private sector to boost funding for infrastructure investment in Asia. If done well, the Bank’s success will boost regional economic growth and demand for Australian exports.
The development bank currently operating in the region, the Asian Development Bank (ADB), estimates Asia’s infrastructure investment needs at US$8t over 2010–20. Priority areas include energy (US$4.1t), transport (US$2.5t), communications (US$1.1t) and water and sanitation (US$0.4t). Demand is concentrated in ‘Chindonesia’ — China, India and Indonesia (Chart 2) — and well exceeds the funding capacity of other multilaterals in the region. But the AIIB will become a significant financier once established by the end of the year — backed by initial subscribed capital of US$50b and total authorised capital of US$100b. If all goes well, it will be able to lend US$20b a year by 2020. To put that in perspective, the World Bank makes annual loan commitments of around US$30b a year worldwide. The AIIB will thus be capable of putting a sizeable dent in Asia’s infrastructure dExport Finance Australiait.
The AIIB will provide a financing arm for the ambitious 'Belt and Road Initiative' — a revival of China’s ancient overland and maritime silk routes to Europe. Authorities released an ‘action plan’ for the Initiative in March, after it was first proposed by Chinese President Xi Jinping in late 2013. It is now the centrepiece of the President’s foreign policy and has two parts — a ‘Silk Road economic belt’ links China to Europe via Central Asia; while the ‘maritime Silk Road’ links China's ports with the African coast and Mediterranean Sea via the Suez Canal (Chart 1). The all‑encompassing initiative entails a network of transport infrastructure, energy pipelines, fibre optic and communications systems, and trade facilitation policies.
The AIIB and its associated infrastructure initiatives will create new opportunities for Australian exporters through three channels. First, direct opportunities for Australian companies to sell their infrastructure expertise by competitive tender. Second, improved infrastructure in Australia’s major export markets will facilitate higher export volumes via logistical gains. For instance, iron ore shipments have been frustrated in the recent past by a lack of port infrastructure in India. Third, more broadly, lifting economic performance and creating a more stable geopolitical environment in the region will yield sustained demand for Australia’s major export products — in resources, services and agriculture. The AIIB may also boost the Chinese domestic economy by offsetting the effects of a falling investment rate and rising overcapacity. Australia has high stakes in the long term prosperity of Asia — the AIIB will help shore up this prospect.
Service exports, led by tourism and education, have overtaken iron ore to become Australia’s top foreign exchange earner (Chart 3). Strong service export growth is expected to continue — supported by a lower AUD and rising demand from Asia’s middle class.
Australia’s service exports were worth A$62b over the year to March 2015 — eclipsing iron ore exports (A$60b over the same period) for the first time since 2010. While merchandise exports — from mine, farm and factory — remain the cornerstone of Australia’s export earnings (Chart 4), services are increasingly driving export performance (Chart 5). The Reserve Bank attributes this strong service export growth to the expanding economies and middle class populations of Asia. Improved competitiveness via recent currency depreciation is expected to provide further support. Asialink recently forecast that by 2030, annual services exports to Asia could be worth A$163b (a 135% increase from 2013). Moreover, sales by Asian branches of Australian services companies could grow from A$14b to A$78b by 2030.
Australia’s main services exports, tourism and education, have both seen strong growth recently (Chart 6). A recent report by the consultancy Deloitte Access Economics suggests the current outlook for tourism is the brightest it has been since the GFC. International visitor arrivals grew by 8% over the year to September — the fastest rate in over a decade — driven by improved airline access, currency depreciation and lower oil prices. Meanwhile, International Education Group, an offshoot of the federal education department, reports that Australia hosted 413,000 full-fee paying international students over the year to March 2015. This represents a 12% increase from March 2014 and compares with average annual growth rate of less than 5% over the preceding 10 years.
China is the main impetus behind these impressive growth rates. Chinese visitor arrivals to Australia have doubled over the last four years. Strong growth is expected to continue as the economy moves towards more consumer spending. Total spending by Chinese outbound tourists — estimated at US$500b in 2014 — already exceeds total household consumption spending in Indonesia. Yet the Chinese outbound tourism trend is at a relatively early stage. Although the number of Chinese outbound trips grew 20% in 2014, less than 6% of the population hold a passport. Importantly, Chinese travellers are increasingly stressing experiences over luxury purchases according to survey data by China Confidential, a Financial Times research service. This will broaden the sectors benefiting from the Chinese tourism trend. With travellers also increasingly seeking to venture off the beaten track — opportunities will grow in regional areas.
Dramatic falls in iron ore prices have been driven by slowing demand in China and surging low cost supply from Australia. While most Australian production remains profitable and producers continue to expand capacity, iron ore accounts for close to a fifth of Australia’s total exports and 4% of GDP. Continued lower prices will have important implications for our export performance.
Iron ore prices have consolidated and established a new trading range around US$60/t, after reaching a nadir of US$47/t last month (Chart 7). While prices remain well above pre-boom levels, they have fallen almost 70% since their peak in early 2011. This plunge reflects two factors.
First, slowing Chinese demand (which last year comprised almost half of the world’s total usage). The World Steel Association reports Chinese steel demand actually shrank in 2014 for the first time since 1995. It forecasts continued shrinkage of 0.5% in both 2015 and 2016 driven by the government’s rebalancing efforts and a property market correction (1). Both the Chinese government and Australian economist Ross Garnaut believe annual steel production will fall by more than a quarter over the next 15 years to about 600m/t. This estimate is well below BHP and Rio Tinto’s peak forecast of 1b/t between 2020 and 2030, which was drawn from a McKinsey report on the scale and pace of China’s urbanisation.
Also weighing on prices is the long term strategy of miners to ramp up production. Despite the low price environment, February shipments from Port Hedland were 42% higher than the same month a year before. Rio Tinto is targeting a 10% increase in production to 330m/t this year. BHP Billiton said it would defer a US$500m port upgrade and slow expansion plans, but it remains committed to a 290m/t a year target (from 225m/t in 2014). Brazilian iron ore giant Vale is also ramping up production — aided by a US$4b loan from the Industrial and Commercial Bank of China announced last week, and US$2.4b from China EXIM Bank that will fund Chinese shipping services and may materially lower Vale’s costs.
Productivity improvements and lower costs, as well as higher export volumes and the lower AUD are helping to dull the pain from lower prices. But pressure is mounting on smaller Australian miners. Atlas Iron announced last month that it would mothball its operations, before restarting production last week after reaching an agreement with contractors to cap production costs. Fortescue — Australia's third largest iron ore miner — was recently downgraded by Moody’s. Low commodity prices reduced the total value of Australia’s mining projects in Deloitte Access Economics’ Investment Monitor to A$405b in March — down A$26b from a year earlier and A$73b from the 2012 peak.
The price outlook depends heavily upon how soon and how much high cost production is mothballed. Rio Tinto chief executive Sam Walsh estimates 22m/t fell out of production in the first quarter of this year — with a total of 165m/t to retire in 2015. About half of all production cuts are expected to be from China, which occupies top position on the global cost curve, well above the current spot price (Chart 9). This is despite recent state assistance to support China’s domestic iron ore miners. Indeed, industry surveys estimate the closure of 10% of China’s iron ore mines in March. The other half is expected to be split evenly between junior producers and non-traditional suppliers from Indonesia, Iran, Chile and Malaysia.
China’s recent infrastructure-focused policy stimulus and low inventories will also support prices. Imported iron ore inventories in the major Chinese steel mills dropped to 24 days of use in late-April, the lowest since September 2012. The steel product inventory index is now 30% lower than the average level over 2011-2014.
The Australian Federal Treasury’s latest budget forecasts assume iron ore prices of US$48 a tonne for next two years. The RBA suggests that further depreciation of the AUD is likely due to such a dramatic decline. This will boost Australia’s international competitiveness and encourage a more diversified export profile.
Exporters welcome a lower currency because, all else equal, it improves their competiveness abroad, but the benefits differ among exporters. Based on a forthcoming study we find agricultural exporters to be the largest benExport Finance Australiaiaries of a weaker exchange rate.
Australia’s trade weighted index (TWI) — which tracks the AUD’s exchange rate against a broad basket of trading partner currencies — is down 20% since its peak in July 2011, led by falling commodity prices and the stronger USD. Over the same period, the so-called real exchange rate fell 13%. This is an index which adjusts for inflation in Australia and its major trading partners, to give an idea of the combined effect on competitiveness of exchange rate movements and inflation rates. The weaker currency, if it persists, will benefit exporters.
Using the historical relationship between export volumes, trading partner growth and the real exchange rate as a guide, we have estimated the likely benefits of a softer exchange rate. We find that a permanent 10% depreciation in the real exchange rate lifts export volumes 5½% within three years. But magnitude and timing differ across export industries (Chart 10).
Agriculture is the biggest winner from a weaker exchange rate. The homogeneity of agricultural exports and stiff competition from Brazil, the US and Europe mean the exchange rate plays an important part in maintaining farm competiveness. Our model suggests a 10% fall in the exchange rate could lift agricultural export volumes 7% over time. The boost is felt more quickly than for most other export industries with the weaker exchange rate completely passing through to stronger agricultural exports within 12 months of the depreciation.
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.
(1) Property construction accounts for 42% of total Chinese steel consumption.
Photo credit: © Morag MacKinnon / REUTERS / PICTURE MEDIA