Council of Financial Regulators warns slowdown in China’s economy will hit Australia

The Council of Financial Regulators has warned about the fallout of a sharp Chinese slowdown, saying economic uncertainty around Australia’s largest trading partner has increased.

The Council of Financial Regulators has warned about the fallout of any sharp Chinese slowdown, saying uncertainty around the outlook for Australia’s largest trading partner has increased.

A cocktail of stresses in China’s property sector interacting with “longer-term financial vulnerabilities” has elevated the council’s focus on contagion risks, it cautioned on Monday.

The warning comes after Beijing last week flagged the possibility of interest rate cuts to stimulate its economy, which is grappling with a deflating property bubble.

On Monday, the council – which is chaired by Reserve Bank governor Michele Bullock and includes Treasury secretary Steven Kennedy and top officials from APRA and ASIC – said any sharp slowdown would spread to the Australian economy.

It “would principally transmit to Australia through trade channels and through an increase in risk aversion in global financial markets,” said the statement, published after the council’s quarterly meeting.

China’s economy has been in retreat for much of the year after a brief sugar rush following the removal of Covid-19 restrictions and lockdowns in January. GDP was up 0.8 per cent in the June quarter compared to 2.2 per cent in the March quarter, while it was also experiencing deflation for the first time in two years with CPI down 0.3 per cent in the year to July. Youth unemployment has also risen significantly to be above 20 per cent.

Sentiment about China’s economy has worsened in recent months amid the state of its housing market and authorities taking a conservative approach to more stimulus, much to the disappointment of financial markets which for months have been hoping for plans that will boost the demand for iron ore.

The RBA noted this month that China’s property sector “faced significant challenges” from stress among developers, and further defaults posed a risk to economic activity.

“A sharper deterioration in China’s economic growth posed a downside risk to the outlook for services exports and would also be expected to reduce the prices received for Australia’s commodity exports,” the RBA board said in its September meeting minutes.

“Lower output growth in China would also affect global output growth, which might in turn affect a range of Australian exports as well as the prices of Australia’s imports. However, if this downside risk were to eventuate, these effects would likely be partly offset by a depreciation of the Australian dollar.”

Sentiment about China’s economy has worsened in recent months amid the state of its housing market and authorities taking a conservative approach to more stimulus.

Australia’s GDP rose 0.4 per cent in the June quarter, taking the total increase in the latest year to 3.4 per cent. The RBA has forecast GDP will grow 1.25 per cent over 2023 and 2024.

Further weakening China sentiment was developer Evergrande Group, which said on Sunday it would be unable to issue new debt due to an ongoing government investigation into its Hengda Real Estate Group. This comes as it works to secure a long-pending debt restructuring plan.

AMP deputy chief economist Diana Mousina said there were multiple long-term structural forces that would result in lower Chinese GDP growth over the next few years of 3 per cent compared to 10 per cent the world has been accustomed to in the past decade.

“This means that China will make a lower contribution to world GDP relative to its recent outcomes and this will result in lower potential world economic growth,” she said. “Countries, including Australia, will be impacted by slowing demand from China.”

Ms Mousina said Australia might not be as tied to the world’s second largest economy as it once was with the country having grown its trade surplus despite a sizeable decline in Chinese imports, offset by a recent bounce in demand from Japan.

Australia’s top financial council will on Friday receive further data about the state of the China economy with the release of the purchasing managers’ index data for September, which is expected to shed more light on business activity. Markets expect manufacturing PMI to increase from 49.7 to 50 for the month.

It comes as the CFR noted that in advanced economies the sharp increase in inflation and interest rates over the past couple of years has put pressure on household and business finances. “It has also exposed some vulnerabilities in parts of the global financial system, requiring intervention by authorities,” the CFR said.

The CFR agreed it was important to ensure that additional Tier 1 capital operated as intended and that deposit guarantee schemes supported customer access to funds following the collapse of Silicon Valley Bank and Credit Suisse this year.

“These international experiences highlighted the importance of preventive measures, including a regulatory and supervisory framework requiring the banking system to manage risk appropriately and maintain high levels of capital and liquidity, combined with strong inter-agency crisis management arrangements.”

It said Australian households and businesses had been largely resilient to higher interest rates and cost-of-living pressures with the majority of borrowers, including those who had rolled off low fixed rates onto higher floating rates. It added those households had managed the transition by reducing discretionary spending, drawing down on savings buffers or gaining additional work.