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Originally published WA Business News – Duncan Calder Thursday, 25 June, 2009

IF we want to understand the current state of the Chinese economy, we actually need to look further back; before the full brunt of the global financial crisis hit.

Contrary to what is commonly thought, China’s economic slowdown started earlier, in 2007, as part of an orchestrated policy programme of the central government.

cent in the year to March and, on the consumer front, the declining growth in retail
The tight credit policies introduced by the government were to prevent the economy from further overheating. Quarterly GDP growth of 12.2 per cent in the middle of 2007 was seen to be unsustainable.
Like Western governments, the Chinese government did not foresee the extent to which the troubles of Wall Street would get out of hand and affect main street and, from there, the world.

In China’s case, the earlier, managed, slowdown was exacerbated by the severe fall in exports to its major markets as the global recession took hold.

From 11.9 per cent in the December quarter of 2007, China’s growth dropped for the next four quarters to 6.8 per cent in the final quarter last year.

When measured on a quarter-to-quarter basis, that growth rate was even more alarming at an annualised rate reportedly at between nil and 2 per cent.

In other words, China’s economy stood still; and stood still for the first time in a long, long time.
In the face of the global financial crisis, the Chinese government announced in November last year a 4 trillion yuan ($US586 billion) fiscal stimulus package to jumpstart the economy.

Such a package was badly needed, as much of China’s impressive economic growth during the past 30 years was built on the twin pillars of exports overseas and investment from overseas, both of which fell away dramatically from last October.

China has weathered the global financial storm much better than most and there are now tentative indications that its stimulus policies are starting to take effect.

China’s first quarter GDP growth in 2009 was 6 per cent on a quarter-to-quarter basis, which compares to the nil to 2 per cent at the end of 2008 mentioned earlier.

Industrial production, which is an indicator of China’s important heavy machinery sector, also rose by 8.3 per cent in March compared to an average of 3.8 per cent in the previous two months.

More importantly, fixed asset investment in China has jumped by a massive 30 per cent in the year to March and, on the consumer front, the declining growth in retail sales also appears to have plateaued.
One key factor behind these emerging ‘green bamboo shoots’ that suggest a relatively more rapid recovery in China is the explosive growth in lending by China’s banks.

China’s banks lent a record 1.9 trillion yuan in March, a six-fold increase over the previous year.
A caveat on this is the extent to which the debt finance is actually drawn down and how much is actually being invested, how much is being temporarily diverted, invested elsewhere or simply not invested.

It is important to remember that China’s investment figures are based on planned, not actual, investment.

With exports likely to remain anaemic for some time, China needs to find a new, sustainable engine of growth. The Chinese government is looking inwards to the country’s own huge domestic market to provide this growth.

This, however, may be more difficult than it appears. It is important to remember that many of China’s baby boomer generation went through the traumatic Cultural Revolution and they have been conditioned to save as much as possible to prepare for rainy days.

China’s 1.3 billion people are more super savers than consumers, with household saving rates at around 25 per cent.

GDP growth is not the primary goal in China. Recently, commerce minister Chen Deming claimed he was not worried about GDP growth but rather unemployment as China’s biggest challenge.

The crucial issue for China now is whether it will be able to rebalance its economy from an export-driven one to an investment and consumption-driven model of growth.

China’s early rebound, or the ‘reignition of the Chinese dragon’ will be good for Australia, and especially for Western Australia.

China is by far our largest export market, accounting for more than a quarter of our exports. Total exports to China last year were $22 billion, a whopping 50 per cent increase over 2007.We are fortunate that we have the Chinese market to provide a base level of demand for our commodities.

Along with the massive increase in our trade with China has been a more recent surge in Chinese investments into our resources sector.

During the past two years we have seen some large transactions. However, even with recent investments, China’s total investments in Australia are still very small compared to our traditional investors such as the US, the UK and Japan.

The reality is that further Chinese investment is essential to Australia’s national interest to add ballast to our trade relationship.

Of course, Chinese investment means Australian jobs, and that is incredibly important, particularly in an environment where an increasing number of Australians are out of work.

And for the larger projects, such as CITIC Pacific’s $5.2 billion Sino Iron project, which adds processing capacity, a pellet plant, power station and desalination plant, the jobs created go way beyond the 4,000 construction positions, creating significant levels of regional employment in ongoing operations for the next 25 years.

In this context, many people want to know what the collapse of the $US19.5 billion deal between Chinalco and Rio Tinto means for Australia.

From one perspective, the collapse of the deal may prove to be in Australia’s national interest, should cheques from Beijing fund new projects in Australia rather than buy-out London shareholders in Rio.

I suspect that Andrew Forrest and Gina Rinehart each danced a jig (probably separately).

Chinese investment may be encouraged now in alternate supply chains and mining operations to those owned by Rio and BHP, such as FMG, Aquila, Australasian Resources, Brockman Resources, BC Iron, Polaris Metals etc and for emerging significant nickel projects such as Heron Resources.

Of course there remains the threat of alternate Chinese investment into projects in Southern Africa and Brazil should disenchantment with Australia rise too high, but we hope not, as Australia has been a good partner for China.

During the past four or five years we have progressively discounted our ore against the price of our competitors. Our ore has, in fact, effectively become cheaper relative to others’.

Also, we have given China opportunities where other developed nations have not – we have the first Chinese EPC in the Sino Iron project and many sets of industrial equipment have first taken hold in the Australian marketplace.

However, China may feel that the delays in the federal government’s Foreign Investment Review Board approval process have contributed in a small way to this outcome.

Personally, I think the timeframe taken by FIRB to consider the complex Chinalco /Rio deal was appropriate. However, some of the FIRB delays, such as the six-month assessment period for the vanilla investment from Ansteel into Gindalbie appear difficult to understand.

Of course, another way to look at the collapse of the transaction and the proposed production JV between Rio and BHP is to consider how much lower the big two will move down the cost curve as a result of the significant benefits that are expected to be realised over time.

There is the potential that, should just some of these savings be passed on to customers as well as shareholders, other new projects, including the higher value- adding magnetite projects, may be squeezed out purely on cost competitiveness grounds, regardless of any strategic desire China may have to diversify to sources of supply.

Overall, in conclusion, I remain convinced that:
the long-term prize in China remains enticing, not just for Australia but for the global economy;
the super cycle of commodity demand from China and India is paused not halted; and
China is the key market for our commodities and the natural partner for developing our projects.

We, in turn, remain the most efficient, stable, cost-effective, long-term source of supply for China for these key commodities.

This is an edited version of a speech at a recent ACBC-CEDA seminar given by Duncan Calder, President, Australia China Business Council (WA) and partner corporate finance and chairman Energy and Natural Resources WA, KPMG.

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