China’s aiming for 8pc growth. Can it do it without Australian coal?

China’s exports grew a modest 3.6 per cent last year but accelerated as the pandemic hit and demand for PPE and the effects of the lockdowns and changed consumer behaviours in most of the developed world caused a massive spike in demand for its products.

There has been a surge in consumer spending, particularly in online spending, throughout the developed world that was reflected in the 18.1 per cent growth in China’s December quarter exports relative to the same period of 2019 and which helped power the 6.5 per cent increase in December quarter GDP.

Add China’s fiscal and monetary responses to the pandemic, even though they were relatively modest in comparison to those of governments in the US, Europe – or Australia – and the claimed growth in GDP is more than feasible.

With most forecasters, including the International Monetary Fund, expecting China to post growth this year at or above 8 per cent – well above any expectation for the US or Europe – it would seem China has made a great leap forward in its ambitions for global economic leadership.

There are some caveats unrelated to the credibility of its data.

China went into the pandemic trying to deflate a credit bubble and improve the productivity of a vast but unproductive state-owned enterprise system, an effort that was sidelined by its response to the outbreak of the virus.

The relative modesty of its fiscal and monetary response to the outbreak was a result of its concerns about the pre-pandemic structure of its economy and financial system, concerns validated by the unprecedented spate of defaults on their debts by state-owned enterprises late last year.

Even last week the People’s Bank of China began tightening credit, including some caps on bank lending for property development and housing, with the authorities signalling a gradual withdrawal of the monetary and fiscal stimulus programs they effected to respond to the pandemic.

To achieve what seems an ambitious level of growth expectations this year, even as liquidity is withdrawn from China’s system, China will be relying on domestic consumption (which has been weak) to lift and on a recovery in the global economy as vaccines are rolled out.

It is instructive that, despite the deeply negative impacts of the coronavirus on the global economy, China had record steel production last year – 1.05 billion tonnes – which resulted in record demand (1.2 billion tonnes) for the iron ore to feed its mills.

If China is to grow at 8 per cent-plus this year it would appear reasonable to expect that it will need similar volumes of iron ore and coal.

The strength of its demand for iron ore has been reflected in a surge in iron ore prices, which started last year around $US80 a tonne and ended at about $US156 a tonne. Iron ore has been trading around $US174 a tonne this week.

Coal prices, thanks to China’s ban on Australian coal, have been bifurcated. Australian energy and metallurgical coal prices have slumped but China’s domestic prices and the price of the imports that have replaced the stranded Australian coal have soared.

Australian metallurgical coal shipments to China slumped in the December quarter and prices for that premium coal were 23 per cent lower than in the preceding three months at just over $US100 a tonne. Prices for the replacement volumes shipped in from Canada, the US and elsewhere were about double that level. China’s domestic coal prices have also risen sharply.

The mills are therefore paying a lot more for generally lesser quality coal – its domestic coal has lower calorific values and more impurities – and for their iron ore, putting immense pressure on their margins and profitability even as that cheap high-quality Australian coal is increasingly starting to flow to their competitors as miners look for new customers.

While metallurgical coal is more strategic and central to China’s industrial production, the ban on Australian energy coal is having similar effects on China’s power generation sector, leading to rationing and blackouts.

Are those impacts sustainable? There is an expectation that the bans will be extended but there is an increasing cost to China’s industry and economy associated with them. The mills are screaming about the impact on their profitability, the quality of their steel will be degraded and they will lose competitiveness with their Japanese and South Korean counterparts.

Coal and iron ore are the feedstocks for China’s industrial base. It can replace the Australian products with higher cost and lower quality products from its domestic reserves and offshore but not without risking the quality and competitiveness of the end products and the viability of their producers.

If China wants to expand its economy by 8 per cent or more this year and improve the productivity and financial stability of its industrial base there is going to be increasing pressure to lift the ban on Australian coal.

The ban might demonstrate China’s ability to damage Australia’s economy but it is by no means costless or without risk, particularly in a global economy shaped by the continuing effects and uncertainties generated by the pandemic.