Growing Your Income

Australia Lowballs Iron Price That Boosts Economy and Budget

(Bloomberg) —

Australia is lowballing the price estimate of its largest export — a key ingredient in China’s stimulus — setting up a buffer for the economy and the government’s books as the Covid-19 crisis clouds the broader outlook.

Treasurer Josh Frydenberg’s economic and fiscal update last week was based on a $55 a ton iron ore price at a time when the market level was almost double that. Higher prices boost profits, the tax take and nominal gross domestic product. While this won’t prove decisive for Australia’s largest budget deficit since World War II, it does provide insurance against fiscal slippage.

The “conservative commodity price assumptions effectively means that both GDP and tax receipts for the Australian government are likely higher than currently forecast,” said Vivek Dhar at Commonwealth Bank of Australia. “China’s plan to boost infrastructure spending this year, most of which has already been allocated, is the primary driver” of steel demand.

Treasury has opted for conservative commodity forecasts in recent years after facing criticism for excessive optimism that failed to materialize. An additional A$9 billion ($6.5 billion) of nominal GDP and A$1.2 billion of tax revenue would be generated in fiscal 2021 if iron ore remains elevated until Dec. 31 2020, a budget sensitivity analysis shows.

Secretary to the Treasury Steven Kennedy, in testimony to a parliamentary panel in Canberra Thursday, acknowledged that a forecast drop in nominal GDP this year was heavily influenced by the price assigned to iron ore. Data released Thursday suggest that the terms of trade — the ratio of export prices to import prices — fell modestly in the three months through June as gains from iron ore were offset by a collapse in oil prices.

The strength of Chinese demand for the metal has helped underpin the local currency’s 25% rebound from a March nadir. Yet that also erodes some of the windfall profits from miners, with commodities largely priced in dollars.

But higher prices overall are encouraging renewed investment following years of cost-cutting at resource companies, helping offset some of the economic damage from the collapse of industries like international tourism and education. Miners probably boosted spending in the 12 months that ended in June for the first time in seven years, and investment is expected to swell by 9.5% in fiscal 2021.

The tailwinds aren’t just in iron ore. Increasing jitters about the global outlook have seen investors flock to gold, driving the spot price to a record high. Australia’s gold export volumes are expected to surge by 15% this fiscal year, and booming exploration reinforces the favorable investment outlook. Dhar calls gold “the brightest spot in Australia’s commodity mix.”

While Australia’s status as the most China-dependent developed economy delivers major economic benefits, it also leaves it vulnerable to a Chinese backlash. Prime Minister Scott Morrison’s call for an inquiry into the origins of the Covid-19 outbreak drew swift Chinese condemnation, and also tariffs and bans on some agricultural exports, which many in Australia saw as retaliation.

Read more: Australia’s China Ties Fray Even as Two-Way Trade Booms

However, iron ore shipments continue to expand because China needs steel for infrastructure projects that are part of its stimulus program.

Flows from Port Hedland, the gateway to Australia’s mineral heartland and used by top miners including BHP Group and Fortescue Metals Group Ltd., topped a record 50 million tons in June. Iron ore exports broke A$100 billion in that 12-month period, with 87% sent to China.

“This tailwind is unlikely to disappear, because Australia has a dominant position especially in the global iron ore market,” said Alicia Garcia Herrero, chief Asia Pacific economist with Natixis SA. “China would find it difficult to substitute its imports of Australian iron ore without affecting prices.”

(Updates with treasury secretary, export prices in fifth paragraph.)

For more articles like this, please visit us at bloomberg.com

Subscribe now to stay ahead with the most trusted business news source.

©2020 Bloomberg L.P.