The health of the New Zealand and Australian economies and the performance of stock markets globally, in 2012 will in large part depend on the narratives emerging out of China and Europe.
Continued Chinese demand for NZ soft commodities and Australian hard commodities will be important. Just how important, is illustrated by some statistics. Currently, two-way trade between Australia and China is over A$120bn per annum, representing 20% of total Australian exports. Nearly 70% is coal and iron ore. Two-way trade between NZ and China sits at NZ$11bn, and represents 10% of total NZ exports.
Chinese growth will slow next year, from over 9% GDP growth in 2011 to around 8.5% in 2012. This is consistent with a soft landing scenario. More relevant for Australian exports is the growth in fixed asset investment (FAI), which has grown at rates in excess of 20% over the last 5 years. The outlook for FAI should remain positive, but is dependent on the fiscal and monetary policies pursued by Chinese authorities. Inflation, which peaked at 6.5% in July, has abated significantly, to 4.2% in November. This should mean that inflation won’t be a barrier to reducing interest rates, after a prolonged period of tightening.
If China is potentially a positive story for the antipodean economies, the imbalances out of Europe pose a risk on two fronts. Firstly, through the threat to Chinese growth. Around 40% of the Chinese economy remains export related and one-third of total Chinese exports go to Europe. A severe European contraction would see Chinese growth slow, and threaten demand for our commodities. Secondly, risks exist through the pressure on the funding costs of the Australasian banks. Around one-third of Australasian bank funding comes from offshore, with significant amounts from Europe. If banks find offshore funding avenues closed in an extreme scenario, they will need to shrink their balance sheets by withdrawing credit from the economy. This would be negative for growth and asset values.
We continue to believe that a resolution to the immediate problems in Europe will emerge. However, markets are eager to see more decisive and coordinated action from authorities before confidence will return.