Australia could face a balance of payments crisis if a sharp slow-down in China results in a slump in export earnings at the same time that imports of capital goods soar as miners hurry to finish their major investment projects.
According to the latest budget projections, Australia’s current account deficit is expected to swell to 4.75 per cent of GDP in 2012-13, and to 6 per cent of GDP the following year.
According to Treasury, the deterioration reflects the fact that the trade balance is likely to fall into deficit as miners step up their imports of foreign-made investment equipment while export earnings sag as a result of lower commodity prices.
At the same time, Treasury expects that Australian consumers will take advantage of the strong Australian dollar by spending more on overseas travel and imported consumer goods. Import volumes, it says, are likely to rise by 7.5 per cent in 2012-13 and by 5.5 per cent in 2013-14.
Even though commodity prices appear to have peaked in the third quarter of 2011, Treasury expects that our export earnings will remain relatively buoyant in the next two years, due to continuing strong demand from China and India.
Australia’s coal and iron ore exports are likely to rise, following major expansions in resource projects in Western Australia and along the east coast, while rural exports are expected to remain at historically high levels.
Still, the strength of the Australian dollar is proving to be a handicap for exporters of elaborately transformed manufactured goods, and for firms that sell services – such as tourism and education-related travel – to foreigners.
But Treasury’s forecasts are based on the assumption that China’s economic growth will remain robust, even though its largest export market, the European Union, is slumping deeper into recession. Treasury is forecasting that China will notch up a growth rate of a little over 8 per cent a year for the next three years.
If China’s growth rate stumbles, we could see an alarming blow-out in Australia’s current account deficit.
The problem is that the extremely long lead times involved in developing major resources projects means mining companies are committed to spending huge amounts of money buying foreign-made capital goods and equipment. As Treasury itself notes, despite the continued uncertainty over the global economy, "the resources sector has committed to, or commenced construction on, over half of the estimated $456 billion resources investment pipeline.”
Even if a sharp drop in Chinese demand caused global commodity prices to slump, it would be difficult for the large mining companies to pull out of major investment projects now under way. As a result, miners will find it difficult to scale back their purchases of foreign-made capital goods and equipment, which will mean that our import bill will continue to soar.
A slump in commodity prices, however, would see our export earnings collapse. Already Treasury is expecting that increased global supply will weigh on commodity prices in the next two years, and that our terms of trade (the relation between export and import prices) will decline by 5.25 per cent in 2012-13 and 3.25 per cent in 2013-14.
The risk is if Treasury’s assumptions about China’s growth prove to be overly optimistic. If the brutish combination of surging imports and a collapse in export earnings were to push our current account deficit to, say, 8 or 9 per cent of GDP, we could see international investors become very anxious about lending to Australia. In that situation, our banks could find it much harder to raise money in offshore markets, and would likely have to pay higher interest rates to access funding.
Meanwhile, the Australian dollar would collapse, pushing up the cost of servicing our foreign debt. And it would probably take some time before Australia’s tourism, education and manufacturing sectors felt the benefit of the lower exchange rate.
Australia would be caught in a current account deficit trap, unable to curb its voracious appetite for imports, despite a slump in export earnings.