Raphael Gallardo, Natixis Asset Management, says the inevitable slowdown in Chinese real estate is set to hamper commodities prices, and explains why this is bad news for Australia.
“A real estate downturn in China against the backdrop of a strong dollar will be bad news for commodities prices across the board – both energy (oil, gas, coal) and industrial metals, while a stronger dollar will worsen the external debt service burden for countries with dollar-denominated debt. A number of emerging countries from Latin America to Africa will suffer a squeeze from this external constraint double whammy.
“However, three developed countries also share this twofold feature, which is further aggravated by domestic real estate bubbles: Canada, Australia and New Zealand.
“These three countries are major commodities exporters to China: oil and non-ferrous metals for Canada, iron ore, gas and coal for Australia, and agricultural commodities for New Zealand. The great irony of the situation is that their real estate bubbles were partly fueled by Chinese capital outflows: part of the People’s Bank of China’s foreign exchange reserves was de facto turned into real estate investments in Vancouver, Toronto, Sydney, Brisbane, Melbourne and Auckland.
“Furthermore, Australian and New Zealand banks remain highly dependent on access to US dollar financing, as indicated by the persistence of a positive basis on the cross-currency swap market for AUD and NZD (+20bps) vs. a negative basis (-10bps) for CAD. With external debt of 50% and 40% of GDP respectively, Australian and New Zealand banks are very vulnerable: if the turnaround in the real estate sector that has already kicked off in major cities turns into a market crash, they will be faced with the risk of downgrades from the ratings agencies, which will make it difficult to renew their external debt at a time when the dollar is poised to become a rare commodity on the off-shore markets due to the Fed’s balance sheet pruning.
“In this adverse scenario, Pacific banks would be able to rely on support from public authorities as sovereign debt remains limited (36% of GDP in Australia, 24% in New Zealand). But unlike in 2008, a Chinese credit boom seems unlikely to come to the rescue, and given the weight of external debt, it will be difficult to rely on the exchange rate as the only adjustment variable. A painful adjustment in real variables (recession, unemployment, emigration) would therefore be inevitable.”
Read the market outlook and full editorial Fresh bubbles in the Southern seas.
