China signals diplomatic rift is alive and well

China today announced the "indefinite" suspension of all activity under a China-Australia Strategic Economic Dialogue, underscoring the ongoing diplomatic rift between the two countries. The last meeting under the China-Australia Strategic Economic Dialogue was in 2017, so the announcement today seems largely emblematic of the ongoing diplomatic rift with limited immediate impact. Although a clear confirmation of the continued tensions.

We have outlined before and our view has not changed - As is customary of geopolitical stresses and strains, the tensions will fluctuate, with periodic flashpoints, but the long run trend is set. Australia will pivot toward other export markets and China will gravitate toward self-reliance as telegraphed at the 5th plenum and in the touted “Dual Circulation” strategy. However, its not as simple as it sounds and these shifts will take time as new relationships are forged - the path will be bumpy and winding as goods are diverted elsewhere, but China’s dominant purchasing position for Australian goods comes with a price Australia is not willing to pay.

Australia’s export economy is incredibly interconnected with China, China is Australia’s largest trading partner and Chinese immigration/tourism has underpinned demand for Australian property and services exports like tourism and education.

For some Australian assets, a geopolitical risk premium should be considered by investors as there is no doubt these diplomatic tensions can manifest in a painful way for the individual industries targeted. Winemakers have felt the squeeze of China’s tariffs and a barrage of other attacks on Australian exports from coal and copper to barley and other agricultural products have also been amongst the industries bearing the brunt of this deteriorating relationship.

China’s embassy in Canberra has previously warned of a consumer boycott on Australian goods and produce, causing concern to producers fearing they could be the next targets in China’s economic coercion. Treasury Wine has felt the pain of souring ties with China, alongside beef, barley, coal and even lobster exports, but other companies like Bubs Australia, A2 Milk, and Blackmores have long relied on Chinese demand and could find themselves impacted by any boycott.

The warning also alluded to a potential bypassing of Australia as a destination for both tourism and education, both tourism and education are major service export industries in Australia - Think Qantas, Sydney Airport, Crown resorts, Star Entertainment and IDP Education.

Declining Chinese demand for these products and services would be negative for the industries at stake, although beyond the volatility that comes with the headline risk it would be hard to ascertain the impact of various risk events without further details. With the hostilities between Australia and China having been on the boil for over a year now - the rift goes as far back as Australia's 2018 ban on Huawei's participation in 5G rollout on the basis of security grounds - many businesses have begun to respond or put contingency plans in place for these shifting geopolitical tides. With many pivoting their focus to the long-term potential of other Asian economies.

These threats hold repercussions for the Australian economy as China remains the number one purchaser of both Australian goods and services exports – a strong contributor to GDP. While de-risking via diversification of Australian exporters into other markets like India and the rest of South East Asia would support long-term goals, reduced Chinese demand for Australian goods and services poses a near term risk, particularly if other large-scale exports like Iron Ore were to be targeted in the worst-case scenario. Although at present, China needs Australian iron ore just as much as Australian exporters need China.

A ban on Australian iron ore would be the true “black-swan” and is unlikely to happen at this stage. China still needs Australian iron ore and cannot substitute yet – there is a structural dependence. Diversifying supply away from Australia will be challenging, however, over the coming years it would be reasonable to expect China to pivot from Australian iron ore exports if tensions continue along the current trajectory. But by the same token Australia can also diversify to other Asian markets - Indonesia, Vietnam, Bangladesh and India for example. Although these shifts will take time as new relationships are forged and goods are diverted elsewhere.