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Special Topic 2: Impact on New Zealand of a sharp slowdown in China

The IMF has revised down its outlook for developing economies’ growth and there has been increasing concern about a sharp slowdown or “hard landing” in China. [2]  While we expect growth to slow in China, we consider it unlikely that it will fall dramatically.  Nevertheless, this special topic looks at the impact on the New Zealand economy of such a development.

China’s growth is slowing...

As detailed in the international section above (p.5), China’s economic growth has been slowing recently.  Like other emerging economies, China’s growth has been affected by tighter domestic monetary conditions and by weaker growth in developed economies.  The US Federal Reserve’s announcement that it would begin tapering its asset purchases later this year led to higher US long-term interest rates and concerns that they might derail the economic recovery.

Concerns of a slowdown in China peaked in late June when the central bank initially refrained from increasing liquidity in the interbank market, pushing short-term interest rates higher and prompting fears about credit risk.  The new leadership in China appears to be taking a firmer line on reducing debt levels and rebalancing the economy from export- and investment-led growth to more consumption, which would lead to slower but more sustainable growth.  Efforts to cool the housing market may have also slowed consumption growth.

...but a sharp slowdown is unlikely...

While China has some risk factors, chiefly high house prices and elevated private and local government debt following the rapid expansion of credit following the global financial crisis, we do not consider that a hard landing is likely.  Even if growth did slow sharply, the authorities have room to stimulate the economy by lowering interest rates and expanding credit, and through fiscal stimulus (central government debt is relatively low at around 23% of GDP).  The leadership has recently reaffirmed its commitment to its 7.5% annual growth target for 2013 and a minor fiscal stimulus package was announced in July.

...however, forecasts have been revised down

Most forecasters have revised down their outlook for China for this year and next.  The OECD and IMF have reduced their forecasts for 2013 from 8.5% and 8.0% (respectively) to 7.8% (in both cases).  The OECD expects a recovery to 8.4% in 2014, but the IMF sees growth of only 7.7% next year.  Consensus forecasts (an average of international forecasters) have fallen from 8.2% growth in 2013 and 2014 earlier this year to 7.5% and 7.6% in July.  Our BEFU forecasts were for growth of 8.0% and 7.6%, respectively.

Slower growth would impact Australia...

A sharp slowdown in China would have an impact on other economies, but the extent of the impact would depend on the specific causes of the slowdown (eg, whether it was a result of domestic or external factors) and the extent of any policy response in China and/or the rest of the world.  In the case of a China-specific slowdown which affected investment, Australia would be likely to be adversely affected with around 30% of its goods exports destined for China and heavily concentrated in coal and iron ore.  By contrast, China accounted for 17% of New Zealand’s goods exports in the year to June 2013, spread across dairy, wood, meat, wool and seafood products.

The difference in the potential impact on Australia and New Zealand can be seen in recent movements in commodity price indices, with the Australian index falling 25% from its peak in mid 2011, while New Zealand’s was 8% above its previous peak in the same period (Figure 1).  Reduced dairy supply as a result of the 2013 drought has also contributed to the increase in New Zealand commodity prices.

Figure 1 – Australian and New Zealand commodity price indices
Figure  1 – Australian and New Zealand commodity price indices   .
Source:  Reserve Bank of Australia, ANZ Bank

A similar impact can be seen in the two countries’ currencies, with the Australian dollar down 12% from its recent peak against the US dollar, while the NZ dollar is down only 7%, resulting in an appreciation of 5% against the AUD.  While the intended tapering of asset purchases in the US has been the major factor in the fall of the currencies, a weaker outlook for China has also been a factor and has affected the Australian dollar more and brought it into line with recent commodity price movements.

...but it may slow in any case

A sharp slowdown in China would have a significant impact on Australia, but there has been increasing concern about slower growth in Australia recently in any case as the peak in mining investment passes and is not yet replaced by other sources of demand.  Investment’s contribution to quarterly growth has been declining recently and the contribution of other components of expenditure GDP has been modest (Figure 2).  Net exports are expected to increase their contribution to growth from 1% point in the March quarter 2013, but there may be a period of lower overall growth if they do not offset the fall in investment in the short term.

Figure 2 – Contributions to Australian GDP growth
Figure  2 – Contributions to Australian GDP growth   .
Source:  ABS, NZ Treasury calculations

Forecasts of economic growth in Australia have been revised down over the course of this year, but not to the same extent as for China.  Growth in Australia will be supported by the fall in the currency, increasing the competitiveness of the tradables sector, and the reduction in the policy rate from 4.75% in October 2011 to 2.75% in May 2013, supporting parts of the domestic economy.

China’s growth expected to slow gradually...

Recent Treasury research [3] concluded that China’s rapid growth over the past decade has had a major impact on the New Zealand economy through increased demand for dairy and wood products, but that China’s growth is likely to slow in the coming decade as it loses competitiveness, population growth slows, the economy rebalances and income levels converge with other economies.  Nevertheless, per capita incomes will continue to grow and demand for western-style, high-protein food products will continue to grow, sustaining demand for New Zealand products.

...but a hard landing would have a significant impact on the New Zealand economy...

Further Treasury research [4] found that growth spillovers from China to New Zealand are important, with estimates of the accumulated impact on NZ GDP from a one percentage point change in China’s growth being in the range of 0.2 to 0.4 percentage points.  The transmission channel via commodity prices is important for the impact on nominal GDP, as well as second-round impacts on volumes via an income effect.  Figure 3 illustrates the transmission channels from the world economy (represented by the US) and China to Australia and New Zealand.

Figure 3 – Transmission channels for global and China growth shocks to Australia and New Zealand
Figure  3 – Transmission channels for global and China growth shocks to Australia and  New Zealand   .
Source:  Osborn and Vehbi (2013)

These results are supported by other international research.  Roache (2012) finds that a 1% shock to China’s industrial production growth has the largest effect on oil and copper prices, and that a decline in China’s activity has a smaller impact than an equivalent shock to US activity, consistent with our own findings.  Previous IMF research also supports our conclusions. [5]

...similar to Budget 2012’s downside scenario

The impact of a fall in China’s growth to 3% and a consequent slowdown in Australia’s growth would be likely to reduce New Zealand’s trading partner growth by around 2 percentage points according to our estimates.  This would be similar to the downside scenario in Budget 2012 in which lower growth in emerging Asia, especially China, led to real GDP growth in New Zealand being 2.1 percentage points lower over the forecast period, the terms of trade falling 9% in the first year, the current account deficit increasing by nearly 1.5% of GDP after two years and nominal GDP being around $25 billion lower over the 5-year forecast period as a whole (approximately 2.5%), with a commensurate impact on tax revenue.  We do not expect such a scenario to occur, but if it did it would have a significant negative impact on the economy and the government’s finances.  Automatic macroeconomic stabilisers, coupled with room for further monetary and fiscal stimulus, could provide some offset to this.

References

Ahuja, A and Myrvoda, M (2012) “The Spillover Effects of a Downturn in China’s Real Estate Investment”, IMF Working Paper 12/266

Ahuja, A and Nabar, M (2012) “Investment-led Growth in China: Global Spillovers”, IMF Working Paper 12/267

Bowman, S and Conway, P (2013a) “China’s Recent Growth and its Impact on the New Zealand Economy.”  NZ Treasury Working Paper 2013/15

Bowman, S and Conway, P (2013b) “The Outlook for China’s Growth and its Impact on New Zealand Exports.”  NZ Treasury Working Paper 2013/16

Osborn, D and Vehbi, T (2013). “Empirical Evidence on Growth Spillovers from China to New Zealand.” New Zealand Treasury Working Paper 13/17

Roache, S (2012) “China’s Impact on World Commodity Markets”, IMF Working Paper 12/115

Sun, Y (2011) “From West to East: Estimating External Spillovers to Australia and New Zealand”, IMF Working Paper 11/120

Notes

  • [2] For example, Barclays considers it increasingly likely that growth drops to 3% sometime in the next 3 years.
  • [3] Bowman and Conway, (2013a and 2013b).
  • [4] Osborn and Vehbi, (2013).
  • [5] See Ahuja and Nabar (2012), Ahuja and Myrvoda (2012) and Sun (2011).
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