Ric Battellino: Australia's foreign trade and investment relationships
Remarks by Mr Ric Battellino, Deputy Governor of the Reserve Bank of Australia, to the 3rd
Annual Australian Parliamentary Conference, Perth, 6 November 2009.
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Thank you for the invitation to take part in this panel discussion.
Given the international focus of this session, I thought I would make some observations
about the changes taking place in Australia's trade and investment relationships with other
countries and what they mean for the domestic economy.
1. Facts on international trade
Let me start with some facts on international trade. After a period of relative stability in the
1980s and early 1990s, Australia's trade relationships have changed significantly in the past
decade. This has been driven by the rise of China and, more recently, India.
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China has now become Australia's largest export market, taking almost one quarter
of our exports; 10 years ago, less than 5 per cent of our exports went to China;
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India has gone from being a relatively insignificant export market 10 years ago to
taking 7 per cent of our exports now.
Interestingly, the rise in the share of exports going to China and India has not come at the
expense of our other large markets in Asia - Japan and Korea. Rather, the offsetting decline
has been in exports to the United States, New Zealand, South America and Africa. The result
is that the share of our exports going to the Asian region, which was already high, has risen
further, to around 70 per cent.
Many people have noted that, with China and India still at early phases of their economic
development, it is likely that they will continue to grow strongly for many years yet, and so will
their demand for resources. It is hard to argue with that conclusion, though we should keep in
mind that, like all countries, China and India will experience economic cycles around this
trend.
In the case of our imports, China has also increased its share sharply over the past decade,
from 6 per cent to 17 per cent. While Europe as a whole, and the countries of South East
Asia as a group, have larger shares, China is the single largest individual country supplying
goods to Australia. China's growing share of Australian imports in recent years has mainly
been at the expense of the United States and Japan, though part of this change in shares
has been due to United States and Japanese companies relocating some manufacturing
plants to China.
In short, over the past decade there has been a very significant refocusing of Australia's
international trade towards China and, more recently, towards India.
2. Facts on foreign investment
In the public consciousness, China has also figured prominently when it comes to foreign
investment. The facts, however, show that, even though Chinese investment in Australia has
increased in recent years, it currently accounts for only a very small share of foreign capital
invested in Australia.
Australian Bureau of Statistics (ABS) data indicate that, at the end of 2008, Australian assets
owned by Chinese entities stood at around $8 billion. This is less than half of one per cent of
total foreign investment in Australia, and puts China a long way down the list in terms of
importance as a source of investment. Looked at from China's perspective, Australia
accounts for an even smaller share of its total offshore investment - less than one quarter of
one per cent. Furthermore, this share has not changed much in recent years suggesting that
China's investment in Australia has grown in line with its accumulation of foreign assets
globally. This would indicate that China does not have a particularly strong bias towards
Australian investments.
The ABS figures probably understate the true level of Chinese investment in Australia,
because they do not identify as Chinese any investment from China that was channelled
through custodial accounts held in third countries (typically those in major financial centres
like London). Any such investment, however, would be of a portfolio nature rather than direct
investment resulting in the control of companies.
One of the reasons why China may be getting a higher public profile in the area of foreign
investment is that in the past couple of years it has accounted for a large share of the
proposals put to the Foreign Investment Review Board (FIRB). In 2007/08, for example, over
20 per cent of the number of investments approved by FIRB were from China. However,
most of these entailed only small projects and, by value, the share was less than 5 per cent.
The figures for 2008/09, while not yet available, are likely to be higher due to the approval of
Chinalco's intended investment in Rio Tinto, though in the end that investment did not
proceed.
When it comes to foreign investment, Australia's main relationships are still very much with
traditional partners such as the United Kingdom and the United States. The largest holding of
foreign investment in Australia is by the United Kingdom, reflecting a history of over 200
years of investment and the fact that, as a major financial centre, a lot of investment coming
to Australia from other parts of the world is channelled here via UK funds managers. The
United Kingdom accounts for 25 per cent of the outstanding value of foreign investment in
Australia. The United States is not far behind, at 24 per cent. In terms of the flow of new
investment, the United States has been by far the largest source over the past decade.
Investment in Australia by Asian countries, whether measured in terms of the stock
outstanding or the flow of new investment, remains small in comparison. Japan is by far the
largest Asian investor in Australia, with a share of 5 per cent; other Asian countries'
investments in Australia are noticeably smaller.
If we look at Australian investment overseas, the relationship is even more skewed to the
United States; over the past decade almost half of all the foreign investment by Australians
went to the United States. Europe was the next largest destination for our savings, while the
amounts going to Asia were relatively small.
As a broad summary, the conclusion I would draw from these figures is that while Australia is
very much linked into Asia (and particularly China) in respect of trade flows, in terms of
investment flows it is mainly linked to the United Kingdom and the United States.
3. What does this mean for the Australian economy and Australian markets?
Let me start with financial markets.
One does not have to follow financial markets too closely to know that developments in US
financial markets have a big influence on our markets here in Australia. The correlation
between the Australian and US stock markets, and between the Australian and US bond
markets, is very high. Most mornings, one can get a pretty good idea of how the Australian
share market will open simply by looking at what happened to US share markets overnight.
Similarly, US news has an important influence on the Australian dollar exchange rate and on
the price of many of the resources that Australia sells.
It used to be the case that the US economy also had a big influence on Australia's real
economy. For much of my working life at the Reserve Bank, if one was able to pick what was
happening to the US economy, one had a pretty good indication of what was going to
happen to the Australian economy. Correlations between Australian and US GDP growth
used to be very high.
US news still dominates the daily flow of economic and financial information from overseas,
and so still plays a dominant role in shaping perceptions about what is happening in the
world economy. But the correlation between the United States and the Australian economies
has nonetheless declined noticeably over the past decade. In particular, the United States
has had two recessions - one in 2001 and the current one - which have had a relatively
muted impact on Australia.
There are no doubt many factors that have contributed to this. One of them is that the
growing trade linkages between Australia and China are increasingly pulling the Australian
economy away from the United States towards China. China is our largest export market,
and Australia is the largest supplier of bulk commodities to China, so our economies are
becoming very intertwined.
Various people, including Glenn Stevens and Phil Lowe from the Reserve Bank and Ken
Henry from the Treasury, have recently spoken about the implications of this for the
Australian economy in the medium term. This topic is also attracting considerable attention in
the media.
Three themes emerge when people look at these issues.
The first is that Australia will most likely face an extended period of prosperity in the years
ahead. Some of this will come about through strong real economic growth, due, for example,
to increased investment and higher export volumes. Some of it could also come via high
commodity prices. If, as has occurred over the past five years, the supply chain involved in
the production of resources in Australia (and elsewhere) struggles to keep up with rising
Chinese demand, commodity prices will remain high. The fact that commodity prices are still
at a level that is historically high, despite the severity of the global recession, indicates that
the demand/supply balance in commodity markets remains fairly tight. It could tighten further
as the global economic recovery gets under way.
A second theme is that this prosperity could put strains on the economy, and not all sectors
may share in it. It is possible, for example, that some sectors of the economy will suffer as
labour and capital are competed away by the faster-growing sectors.
In general, workers are likely to be in short supply, leading to strong demand for skilled
migrants and therefore fast population growth. This, in turn, will have flowon effects for
housing markets.
Investment, which is already high by the standards of developed economies, will need to rise
further. A large part of this is likely to be imported. Similarly, the financing of this investment
will most likely require increased capital inflow. We could therefore see a widening in the
current account deficit, possibly to higher levels than previously experienced, matched by
increased capital inflow.
The third theme is that the forces affecting the economy could pose a number of policy
challenges. Glenn Stevens dealt with these at some length in his talk last night, so I won't go
over that ground again here. It is worth keeping in mind, however, that these challenges are
about the medium term, not the immediate future. There is also no reason why they should
be beyond our capacity to handle.