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The Wrap: Barriers, Borders & Biden

Weekly Reports | Jan 29 2021

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The ongoing Australia-China spat; Australia's delayed border reopening ; Biden versus China; boost for local engineering & construction.

-Australian exports to China will likely recover in 2021
-Delayed border reopening: Negligible migration to hit GDP
-Brains over brute force: The new Biden administration
-Strong activity forecast in E&C

By Angelique Thakur

Australia-China spat: Not really in a tight spot

We’re all aware in some capacity or the other of the importance Chinese markets represent to the Australian economy. But, just to put things into perspective, let’s looks at some hard stats.

China is Australia’s most important export destination, with one-third of our exports making their way to the country.

While the tensions between these two nations over the last six months are well known, Oxford Economics believes tensions will continue at least for the foreseeable future.

To date, this has affected exports of goods like beef, lamb, barley, seafood, timber, wine, coal and cotton on account of stricter tariffs and inspections or simply discouraging Chinese firms from buying from Australia.

To answer the million-dollar question about which sector is or will be the most impacted by these trade tensions, Oxford Economics developed an “export vulnerability scorecard”. This scorecard aims to quantify those sectors that are most vulnerable to any future trade sanctions by China.

The aim is to gauge just how exposed Australia’s export sectors are to the trade barriers put up by China.

Among other factors, the scorecard measures how much of a sector’s exports go to China. This helps understand how important Chinese markets are for that specific sector.

The scorecard also measures how dominant is China as an importer for a specific commodity/sector as a predominance of China will make it tougher for Australian exporters to find new markets.

The lower the vulnerability score, the better is for the sector.

We have some great news, good news and some not-so-good news. Let’s start with the not-so-good.

According to the scorecard, cereals and seafood are highly exposed to trade tensions with Australian exporters dependent on China and having little market power.

Machinery, equipment, processed goods and chemicals also have a high vulnerability score. But the silver lining in this is their impact on the broader economy is relatively muted since they do not form a huge chunk of Australia’s exports.

Rural goods, processed or otherwise, are also exposed to the vagaries of China with most products offering very little leverage with the exception of wool, of which Australia is a major supplier.

Now for the good news. Meat and barley exports have a relatively low vulnerability score, suggesting exporters should be able to find alternate destinations for their products. But where China is a very important destination for Australian barley, Australia too is a large supplier globally, a feat that should help temper restrictions imposed by China, gauges Oxford Economics.

Food and beverage exporters are somewhat more vulnerable with a smaller market share but their vulnerability is below average compared to other export categories.

Now for the best news. Mining is the least vulnerable which is really lucky for us since Australia’s export basket is dominated by mining commodities (two-thirds of total exports).

Australia supplies around 60% and 50% for iron ore and coal and accounts for around 5% of global trade.

As such, it would take a major rise in trade tensions and consequent rise in tariffs for total exports to fall significantly, forecasts Oxford Economics.

The silver lining for the Australian economy is that the least vulnerable sectors are the largest while the most vulnerable sectors are relatively small.

As a result, there will be some exporters that face pressure, but Oxford Economics expects exports to recover in 2021.

Closed for business

It looks like borders will likely remain shut for longer than previously anticipated, a conclusion cemented by Brendan Murphy’s warning of “substantial” border restrictions remaining in place this year along with a slower than expected rollout of the vaccine here and overseas.

This puts ANZ Bank’s research team in a bit of a pickle since in its December forecast, which had presumed international borders to begin easing from mid-2021 and return to pre-pandemic levels by December 2022.

Now the team’s analysis pegs the border reopening from late December this year or even the first quarter of 2022. This of course will have implications for the economy’s GDP growth.

The first sector we will look at is travel (no surprises there).

A longer restriction on travel implies an extended period of negligible migration from overseas. Net overseas migration (NOM) went into negative territory in the June quarter for the first time since 1993 with the outflow of temporary migrants continuing unabated through to the December quarter.

Migration is a key driver of Australia’s economic growth, accounting for 35% of its GDP (rising to almost 50% in 2018-19). It is but inevitable that any delay in the border reopening would mean lower GDP growth in 2021.

An extension of international border closures will also affect the labour market outlook, state the ANZ analysts, leading to slower employment recovery in the affected sectors, lower growth in both labour supply and demand and an Increased likelihood of skills mismatches.

A case in point is the tourism sector with almost one in five jobs lost between December 2019 and June 2020, compared with 1 in 17 non-tourism jobs lost during the same period.

In the September quarter, tourism jobs were still down -15%, with only part-time jobs starting to recover. Currently, there are more part-time than full-time tourism jobs for the first time since 2004.

The external sector is probably the only sector that would see a small net gain with a delayed border reopening, led by a rise in Australians travelling domestically rather than overseas.

What impact will Joe Biden’s presidency have on US-China relations?

Oxford Economics expects the Biden administration to pursue a more constructive stance on China with less aggressive and more predictable policymaking. But this does not necessarily mean any major easing of trade tariffs or restrictions anytime soon.

The US will undertake a strategic review of the former president’s trade and investment policies with those considered unhelpful for the US forming the basis of negotiation. But this is a slow process with trade issues unlikely to be of high priority.

Biden has also indicated that he wants to “make investments in US workers” before agreeing on new trade agreements.

Oxford Economics predicts a more forceful stance on non-economic issues like Hong Kong and Xinjiang. Also, US foreign policy is expected to be more multilateral, with the emerging of a ‘common front’ more likely towards China among developed countries.

On the whole, Oxford Economists consider it unlikely any dramatic decoupling is in the offing since most developed countries want to remain economically engaged with China and US firms are keen as well to expand their China business.

Strong activity expected in Engineering and Construction

Bell Potter believes the Engineering and Construction sector is likely to see higher activity led by currency debasement and stimulus measures over the recent months. This, Bell Potter believes, will give a boost to Infrastructure investment, already slated to be substantial in Australia.

In December, over $1bn of contracts were awarded to the E&C sector. This continues the trend of higher contract activity, which has rebounded sharply from the covid lockdown induced low of $56m in April 2020.

These higher activity levels, in turn, will lead to significant growth in E&C contractors’ order books and help struggling contractors like Decmil Group ((DCG)) and SRG Global ((SRG)), asserts Bell Potter.

Also, coupled with industry demand tailwinds and easy access to capital, M&A activity is likely to remain a recurring theme in 2021.

Unfortunately, currency debasement and stimulus activity are double-edged swords, cautions the broker, and will increase project costs and cost pressures (wages, construction inputs).

These cost pressures will hamper margins and create a very competitive tendering environment. An example is Monadelphous ((MND)) first half contract awards which were the weakest since FY18 despite strong activity in its core markets.

GR Engineering is rated as Buy along with Lycopodium ((LYL)) while both Monadelphous and Service Stream ((SSM)) are rated as Hold by Bell Potter.

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