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02 Dec 2013

Australia’s ties with Asia to rise

Paul Bloxham

by Paul Bloxham

Chief Economist, Australia and New Zealand, HSBC

Australia’s ties with Asia to rise (Getty Images/David Freund)

More than 70 per cent of Australia’s goods exports go to Asia

Australia’s strong trade and population links with Asia are growing rapidly, but its financial ties are still in their infancy. While Australia is seen by Western investors as a good way to get financial exposure to Asia (a proxy trade for Asia), direct financial flows into Australia from Asia are still only small. But the next stage of Australia’s integration into the Asian region could well be financial. This should offer the local finance industry many opportunities to build on the trade and population links that already exist.

No other economy part of the Organisation for Economic Cooperation and Development has a larger export exposure to the Asian economies than Australia. More than 70 per cent of Australia’s goods exports go to Asia and the recent investment boom in the resource sector should see this rise. We forecast that 80 per cent of Australia’s exports will go to Asia by 2020.

Since the mid-1980s, Australian immigration has been dominated by population flows from Asia. In the past couple of years the number of immigrants from China and India has overtaken those from the more traditional source of Great Britain. Of the more than five million foreign-born people living in Australia, two million were born in Asia. But it is not just permanent arrivals where the Asian population connections are growing rapidly. The majority of foreign student visas are taken up by students from Asia and tourist arrivals from China have skyrocketed, rising 85 per cent in the past three years alone.

Despite the strong trade and population flows, financial flows directly from Asia remain comparatively small

Despite the strong trade and population flows, financial flows directly from Asia remain comparatively small. Australia’s strongest financial links are still firmly with the Western economies. Foreign capital from the US and Europe combined accounts for around 60 per cent of total foreign investment in Australia.

Perhaps surprisingly, China represents only around 1 per cent of total foreign investment in Australia. Admittedly, China’s share has risen from almost nothing only five years ago, but it is still at a very low level. Japan is still the single largest Asian economy with foreign investment in Australia, accounting for around 6 per cent of all investment. Foreign investment from the rest of Asia combined accounts for about the same amount as Japan.

While Australia is seen by Western investors as a good way to get financial exposure to the Asian economies (a proxy trade for Asia), direct financial flows into Australia from Asia are still only a small part of the story. There is a similar pattern in Australian investment abroad. Western economies account for around 65 per cent of the total stock of our investment overseas. By comparison, Japan receives only around 3 per cent of Australia’s investment abroad, China takes around 2 per cent and the rest of Asia another 6 per cent.

The fact that trade and population links with Asia are so much stronger than the financial ties reflects historical and cultural connections, as well as the fact that Asian financial markets are still developing and opening up to the world. But as Asian financial markets liberalise, particularly those in China, Australia should see a large increase in these flows and benefit in a number of different ways.

First, Australia's own experience with liberalising its financial markets, together with the robust performance of the local financial system during the global financial crisis, could help guide choices made by Asian authorities in their financial reform programmes.

Second, Australia's economy offers stable, deep and liquid markets for the benchmarking of new securities. Much as the US dollar is used for benchmarking, the Australian dollar could play a larger role in the future, given its developed market status and the time zone in which it trades. The Australian dollar is already the fifth most-traded currency in the world.

Third, there is a clear opportunity in trade finance, particularly as the use of the renminbi becomes more prevalent. Given the already very strong trade relationship between China and Australia, it is somewhat surprising that most of this trade is still processed into a third currency: usually the US dollar. As the renminbi is internationalised, there should be greater opportunities for direct trading in the Australian dollar and the renminbi to facilitate trade.

Fourth, Asia has an enormous pool of savings looking for high-yielding investments. Australian infrastructure has a lot to offer in this area. Asian investors already have significant holdings of Australia government bonds, but the lack of depth of the local corporate bond market and almost non-existent infrastructure bond market make broader investment in Australian private sector debt more challenging. This is a key area where market development opportunities exist.

Finally, flows could also move in the other direction. Australia's superannuation system represents the world’s fourth largest pool of pension savings, despite being only the 12th biggest economy. Much of this money needs to be invested abroad for diversification reasons and Asia should increasingly be able to offer a home for these funds.

For Australia, the first decade of this century has been dominated by the mining boom story, which has significantly increased trade with Asia. The next stage of Australia's integration into the Asian region could well be financial, particularly as the Chinese financial system opens up to the world. This should offer the local financial services industry many opportunities to build on the trade and population links that are already in place.

This article first appeared in Australia’s InFinance magazine on 25 November 2013.