Vic Edwards

The Australian dollar has fallen almost one US cent on fears that China could be about to witness a sharp economic contraction. China’s National Bureau of Statistics on Tuesday showed profits in the country’s industrial sector fell 5.2 per cent in the first two months of 2012.

Although the World Bank has played down fears of a hard landing in China, the dynamics of Australia’s relations with China are undergoing a rapid process of change, and this will reshape international and foreign policy between our two countries. This comes as China prepares its 12th Five Year Plan – an unstable time for its economy.

China’s growth this year is below last year’s level as weakening external demand has hurt investment and exports. Very poor Chinese manufacturing data shows it is at a 32 month low. Alas, contagion from Europe is impacting China, and that is causing pressure on Australia.

China is the world’s biggest energy consumer and steelmaker. And yet fuel prices are rising for the second time in less than six weeks and the nation’s steel production is slowing. The World Bank has forecast that inflation will fall further, down from the 37 month high of 6.5 per cent in July, as its economy slows.

The world’s second largest economy fell heavily into the red last month after running huge trade surpluses for much of the past 10 years. A surge in imports saw the country post a US$31 billion trade deficit, which follows a string of other disappointing economic data, including weak car sales which may miss industry forecasts this year as economic growth slows to 7.5%, the lowest since 2005.

A blow-out in China’s trade deficit raises concerns about the country’s future economic growth, raising questions about whether the country’s economy is tailing off more rapidly than anticipated. The only bright economic star was that inflation slackened more rapidly than expected.

The overall results prompted analysts to predict that China will ease monetary policy over the coming months to bolster growth—but few expect a package remotely on the scale of the stimulus spending and lending that occurred in 2009 and 2010 in response to the global financial crisis. The market treats the Aussie dollar as a proxy for China so that slowdown in exports in China is perceived by the market as being a bad sign for Australia. However the recent $30 billion swap agreement between Australia and China augurs well for bilateral trade and investment between the two countries over the next few years and may set things back on track for free trade agreement discussions. Australia will need to improve its trade standing with China in order to preserve its position as a major supplier of raw materials, as China is actively pursuing other sources particularly through its new BRICS arrangements, particularly with South Africa and India.

Vic Edwards is a Visiting Fellow in Banking and Finance at the Australian School of Business.