Australia and China signed a declaration of intent for a China-Australia Free Trade Agreement (ChAFTA) in November 2014. The Abbott administration says the pact will boost the nation’s competitive position in key areas. But with dark mutterings in some quarters about the possible downsides of tying Australia’s fortunes even tighter to those of China, how chuffed should Australia really be about ChAFTA? Eleanor Wragg reports.
With a whopping A$150bn in annual two-way trade, China is by far Australia’s biggest trade partner. Australia’s exports to China were valued at A$102bn in 2013, an increase of 28% on 2012. China accounts for almost a third of Australia’s total goods and services exports, and is the largest buyer of Australian minerals and agricultural products.
Meanwhile, China is also Australia’s largest import source: in 2013, the country imported Chinese goods and services worth A$49bn, up 6% on the previous year and accounting for 15% of total imports.
From mining to dining boom
Australia’s resources account for four of the top five exports to China – sales of iron ore, coal, gold and crude petroleum hit around A$72bn last year. But China’s huge population, rapid urbanisation and growing middle class create the perfect market for Australian food and agricultural products, too. Billionaire businessman Anthony Pratt, executive chairman of packaging giant Visy, called in 2012 for a “dining boom” to follow Australia’s mining boom, which is winding down in part because of slowing demand from its giant Asian partner. “As a nation we can become the clean food bowl for Asia,” he said.
As ChAFTA provides Australia with an advantage over its major agricultural competitors – the US, Canada and the European Union – and will also counter the advantage Chile and New Zealand currently enjoy through their FTAs, could it help Australia rebalance its economy?
“Whilst the challenge of feeding an increasingly westernised and economically empowered middle class will tip the scale away from mineral exports, the FTA is about increasing the number of key sectors rather than just a shift in the relative weights of these two sectors,” says Gordon Sparrow, head of trade and supply chain finance at Westpac, which recently opened a sub-branch in Shanghai’s free-trade zone that will capitalise on the opportunities offered by ChAFTA.
It’s not the only one: its competitor NAB previously launched an agribusiness Asia desk to help initiate and strengthen trading ties for Australian agribusiness in Asia. “Although a number of larger Australian agribusinesses have been active in Asia for years, the next stage of the relationship calls for greater engagement from the small and medium-sized enterprise community,” says Steven Bennett, NAB’s general manager for trade and working capital solutions.
He says the bank has already assisted local clients in connecting with China, including wine exporters, milk processors, cheese manufacturers and meat processors.
But exporters face some issues. “What the FTA does is make it easier and cheaper and more competitive for the Australian agricultural food producers to ship out these goods,” concedes Adnan Ghani, head of trade product at Commonwealth Bank of Australia. “But there are some challenges. Many agri-goods are perishable so what we need to see is no red tape in any end-to-end process in the entire supply chain. You cannot be stuck either in Australia or in China with your goods. You have got to have a completely smooth supply chain to make this work.”
And red tape does still remain. Indeed, several major agricultural foodstuffs, including sugar, rice and cotton, are currently excluded from the FTA, with a review of their tariffs to be held in 2017. In a neat bit of political manoeuvring by Beijing, any changes will most likely depend on Australia relaxing its existing requirement that all investment proposals by Chinese state-owned entities be scrutinised by the Australian Foreign Investment Review Board.
However, the overall view for Australia’s agricultural sector remains positive. “Australia is already China’s primary supplier of beef,” says Alan Huse, acting managing director of global transaction banking at ANZ. “While the eventual elimination of tariffs is positive, timing on the FTA is important as the staged elimination on beef tariffs will benefit Australian producers at a time when competition from producers in the US and Brazil is likely to increase when they are fully allowed back into the China market.” That said, he warns that questions exist on the ability of Australian producers to meet China’s growing demand for beef, given that some exporters may be reluctant to switch export volumes to China and risk being shut out of the Indonesian market. He predicts further investment, though, in the sector as a whole, particularly in processing and production, as farmers look to build their brand to win market share.
Winning sectors
One area that looks set to do very nicely out of ChAFTA is Australia’s services industry. Already making up three-quarters of the country’s economic activity, it employs four out of every five Australians. China is currently Australia’s largest services market, with exports valued at A$7bn in 2013.
“China has offered Australia its best-ever services commitments in an FTA,” says Huse. “Most valuably, this includes new or significantly improved market access for Australian banks, insurers, securities and futures companies, law firms and professional services suppliers, education services exporters, as well as health, aged care, construction, manufacturing and telecommunications services businesses in China.”
The increase in the number of elderly people in China to more than 200 million presents a huge opportunity in health. NAB’s Bennett points out that the deal will allow wholly Australian-owned hospitals and care institutions to be established in China: “There are suddenly many new prospects on the horizon for Australian health and aged care businesses.” Indeed, with the removal of tariffs of up to 10% on pharmaceuticals, including vitamins and health products, the sector’s annual export figure of A$559mn is tipped to skyrocket over the coming years. “Australian biotechnology and medical technology companies will be increasingly looking to engage with China as the barriers to trade and investment are reduced,” said Ausbiotech chief executive Anna Lavelle, speaking to the Australian press.
ChAFTA also provides for the removal of tariffs on all resources and energy products including on coking coal, which is currently subject to a 3% tariff, and on thermal coal, which has a tariff of 6%.
This is welcome news for Australia’s miners, who have been battered by rising costs in tandem with a fall in commodity prices. Tariffs on transformed resources and energy products such as copper alloys, alumina, titanium dioxide and
zinc will also be eliminated.
But not all mining companies are convinced that the deal is an entirely good thing for their industry. Under the terms of the agreement, Chinese mining companies will be able to set up in Australia and bring in their own workers on three-month skilled visas. Speaking to reporters at the recent Asia Pacific Resources Conference, George Edwards, chairman of the Australian Mining Association, said: “The standards in mines in China are not as high as they are here. I believe they are used to lower safety standards in general and therefore it makes it difficult for them to operate in an environment with higher standards.”
Moreover, while many free trade agreements in the past have led to the displacement of one side’s manufacturing sector in favour of the other’s, Australia and China have little overlap in their export baskets of manufactured goods and therefore appear to be in a win-win situation. “The broader manufacturing sector will be exposed to increased competition from Chinese imports, but an often overlooked benefit will be that input products for Australian manufacturers sourcing from China will be cheaper, which will deliver a marginal increase in gross profit margins for some businesses,” highlights Huse.
Sydney as a renminbi hub
But the stand-out sector is the banking and financial services industry, which will gain access to the financial markets of one of the world’s most powerful economies just as it finally begins to liberalise. Almost immediately after the FTA was announced, the Australian Reserve Bank and People’s Bank of China signed an agreement to establish official renminbi (Rmb) clearing arrangements in Sydney, converting the city into a Chinese currency hub. China then announced it would give a Rmb50bn quota to Australia under the Rmb Qualified Foreign Institutional Investor (RQFII) programme, which will allow Australian financial institutions to invest offshore Chinese currency in Chinese financial products, including securities. The obvious winner is Australia’s funds management industry, particularly as demand increases for Rmb-denominated investments: Westpac estimates that in the first quarter of 2014, 18% of China’s trade was denominated in Rmb and expects this to rise to 30% by 2015. Australia’s banks have also been given the green light to expand branch networks in China.
“The simultaneous announcements of the FTA, Sydney as an Rmb hub and the Australian RQFII quota will see a step change in how our Australian and Chinese customer base is able to transact,” explains Westpac’s Sparrow.
“Having a Rmb clearing bank in Sydney presents a tremendous opportunity,” says Huse. He frames it as an international recognition of the importance of Sydney as an Asian financial centre through an official link to the Chinese currency, its financial system and the participants in its financial marketplace. It also presents yet another plus point for exporters looking to do business with China. “The Rmb clearing bank should provide a more direct link to the liquidity in Rmb which is provided by China’s central bank, the People’s Bank of China (PBoC),” he explains. “This should add further comfort that Rmb will be available when it is needed.”
The Bank of China will allow participants to make payments to each other through Rmb-denominated cash records in ASX’s Austraclear settlement infrastructure, which are then reflected in the participant’s accounts with the Bank of China. This service can make a connection to China’s CNAPS system, making clear payments through to Chinese recipients possible. “There is a complete method for the use of Rmb in Australia as a transaction and investment currency,” says Huse.
“Australian exporters or importers will now be able to settle their payments in Rmb for goods and services, which will definitely help in expanding the number of customers and making it easier to do business with China,” adds Ghani.
Chinese money
As part of the ChAFTA, Australia will raise the Foreign Investment Review Board (FIRB) screening threshold for private companies from China in non-sensitive areas from A$248mn to A$1.078bn, opening the door to Chinese investment across the Australian economy. But not everybody is happy. Conservative radio host Alan Jones, usually a supporter of Tony Abbott, thundered in an interview with the prime minister that the agreement didn’t pass the “pub test,” and that while it would allow China to buy up Australian companies and land, China would “never allow Australians to buy up Chinese assets”. But with US$4tn in government-administered foreign exchange reserves and a state policy of supporting offshore acquisitions, Chinese money has to go somewhere, and Australia would, naturally, prefer it came to its shores. “The Chinese leadership has committed to US$1.25tn of additional global direct investment in the next decade, matching the scale of Australian infrastructure assets coming to market in 2015-17,” points out Sparrow.
And despite claims to the contrary, the deal does in fact pave the way for Australian businesses to set up shop, within certain limits, in China. “Australian financial service companies will be able to set up joint venture futures companies with 49% Australian ownership, where foreign ownership was previously not allowed,” says Sparrow. Meanwhile, Australian insurance companies, for example, will have access to China’s third-party liability motor vehicle market.
Avoiding pitfalls
One very important aspect of the deal is its Investor Dispute Settlement Mechanism (IDSM) which will permit compensation claims against government regulation that negatively impacts investments, providing a safety net and greater confidence to those companies that make the leap into China. Even so, the country remains a great unknown for many ordinary Australian firms. “For our customers who are looking at going into China from an exports perspective or establishing business relationships in China, one of the big challenges is a lack of understanding about the regulations, the culture and the market,” says Ghani. “It’s all well and good to say that China is a big market but China is also a very competitive market.” To smooth the way for potential investors, CBA has opened up its own China desk, bringing in subject matter experts from the Chinese market to explain in English the opportunities available and the risks involved.
“The first pitfall is the understanding,” says Ghani. “The other aspect is that you want to make sure you can get paid.” He says his bank has seen an upturn in the number of customers seeking guidance around the options available to reduce the risk of non-payment and about the trade finance options theyhave to reduce their costs.
It’s not just exporters who need to brush up on their knowledge. Banks, too, are changing their approach in anticipation of greater trade flows.
“Mitigation of country, bank and counterparty risk is foundational in export-dominant markets and as the value of trade in goods and services with China increases, Australia’s banking sector will face the challenge of managing significant increases in their sovereign, bank and corporate risk positions,” says Sparrow. He predicts that increased demand on scarce risk appetite is likely to drive changes in how banks distribute risk and could lead to an increased role for non-bank financial institutions, such as the insurance sector. “Changes in investment options could also drive geographical shifts of liquidity pools for banks, changing the pricing dynamics and capital or liquidity cost drivers for onshore versus offshore funding solutions,” he cautions.
Collaboration with their Chinese counterparts, as well as increased localisation within the Chinese market, is the name of the game for Australia’s banks. “As China’s financial institutions seek to support growing cross-border flows and client needs as a result of the ChAFTA, collaboration will become a strategic imperative for many institutions in light of the challenges posed by heightened regulation and relative scale,” says Huse.
Is now really the best time to link up with China? Given the Asian country’s well-publicised slowdown over recent months, there are some concerns that Australia, by linking its economy even closer to that of China, is in for a bumpy ride. “Whether or not there is a trade deal, we’re talking about the second-biggest economy on earth,” says Ghani. “If it slows down, the world slows down.” In fact, some pundits have said that the deal comes just in the nick of time for Australia, and allows it to make up lost ground from commodities in other exporting sectors which will now have near-unfettered access to a 1.4 billion-strong market.
Now that Australia has secured what trade minister Andrew Robb refers to as the “power trifecta” of deals with China, Japan and Korea, its rebalancing act is almost complete. The icing on the cake will be a similar agreement with that other Asian giant, India, which Abbott has said will come by the end of 2015. With a further pact with the EU also on the cards, Australia looks to have a bright future ahead of itself as an important player in global trade.
