Australia’s coronavirus double whammy: China’s dependence and leveraged households

• The outbreak of the Covid-19 (coronavirus) is hitting Australia where it hurts the most, namely on its exports to China as well as households’ income, which support Australia’s stubbornly high household debt after a long and massive increase in housing prices.
• As regards Australia’s dependence on China, Covid-19’s severe economic impact on the Chinese economy so far has damped demand for Australian metals as well as services (be it tourism or education). China is Australia’s largest trading partner with a 38% export share. In addition to exports of goods (mainly metals and, to a lesser extent, agriculture products), Chinese visitors are the largest contributors to Australia’s tourism sector. All in all, the sudden stop in income from China has reverted the improvement in Australia’s current account balance, which had finally reached a surplus last year, the first since 1975. Moving forward, a growing current account deficit needs to be expected adding to the large Dollar funding needs of the Australian economy.
• Beyond the heavy dependence on China, Covid-19 has forced the Australian government to reduce mobility, by imposing social distancing with a very negative impact on economic confidence, which collapsed in March to the lowest level on record. The Treasury has estimated unemployment to reach 10% and a recession, the first since 1991.
• Such severe economic slowdown constitutes an obvious headwind to the housing market with households facing subdued wage growth to serve their mortgages. Given households record high housing debt, the risk of a surge in delays in mortgage payments is likely.
• To counter balance these negative developments, the Reserve Bank of Australia (RBA) aggressively eased in March by lowering the cash rate by 50 bps to 0.25% and introducing a QE geared to flatten the yield curve in the spirit of the Bank of Japan’s Yield Curve Control (YCC). Another important measure introduced by the RBA is a new liquidity facility to support SMEs facing liquidity shortages. Finally, the RBA has also reopened a bilateral swap line to receive USD liquidity from the FED. This is particularly important given Australian banks’ structurally short dollar position, as overseas funding has been used to finance the rapid increase in mortgages.
• Beyond very broad monetary measures, the government has introduced three stimulus packages amounting to AUD 194 billion (9.7% of GDP), largely providing subsidies and supports to employees and, to a lesser extent, SMEs. It is uncertain whether more measures will be needed to help Australia move out of a deep recession.
• As global economic uncertainty lingers, we anticipate the Aussie to depreciate further, possibly all the way to 0.58 to the Dollar in the near term, on the back of falling commodity prices and terms of trade. However, some appreciation should happen in 2021 as the economy recovers.

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