Demystifying the China free trade agreement

Mark Ganz explains why more Australian businesses must take advantage of the opportunities presented by the recent pact with our largest two-way trading partner.

Nineteen per cent. That is the percentage of Australian businesses that take advantage of free trade agreements (FTAs). It is an underwhelming number, which is exacerbated by the fact that for those that do, 75 per cent achieve export growth. If FTAs help create growth for businesses then why are Australian businesses not participating? Lack of awareness, complexity, limited internal resources and a perception of unattractive markets are the primary reasons stated by businesses for either not understanding or harnessing these agreements.

But if ever there was a time for change, that time is now. In November 2014, Australia and China signed a historic FTA, which can be traced back to a feasibility study in 2005 and preliminary discussions well before that.

The significance of this agreement for Australia is that unlike other FTAs, the China-Australia free trade agreement (ChAFTA) is with our largest two-way trading partner. Australia also receives a high share of China’s outbound investment flows, a total of 800,000 Chinese visitors now come to Australia annually (up from 280,000 in 2005) and 95,000 Chinese students are enrolled to study in Australia, representing 25 per cent of all international students in the country.

It is an agreement that plays to our strengths and provides meaningful benefits to key parts of Australian agriculture, reduces tariffs for resource exports, and delivers preferential access to China for many service-based industries, including but not limited to healthcare, tourism, legal services, various financial services and education. Over time, 95 per cent of Australian exports to China will be tariff-free.

Potential markets

Healthcare is one area where the opportunity for Australian businesses could be substantial. The evolving demographic profile of the Chinese population will provide a material tailwind until at least 2030 when the population is expected to peak at around 1.46 billion people. An ageing population and a wealthier middle class has led to Chinese healthcare expenditure increasing at double-digit rates and further upside exists given that overall healthcare spending is just six per cent of GDP compared with much higher rates in developed Western economies.

Servicing this growing need will require significant private investment and the ChAFTA provides Australian businesses with the opportunity to own or buy wholly-owned hospitals and aged-care service providers in China. At present, this can be considered “best-ever access.”

Similar concessions will be provided to hotel, tourism operators and other service providers. But this window of opportunity is unlikely to remain exclusive indefinitely. It is highly probable that China will continue to liberalise its economy and provide similar access to businesses from other countries.

As such, for businesses with the right scale, capability and resources, China could be an attractive growth market – notwithstanding that capturing the opportunity also comes with increased risk and complexity.

Other areas where Australia and New Zealand Banking Group (ANZ) believes Australian businesses should do well include dairy, wine, education, funds management, insurance and vitamin exports. Small businesses also have a tremendous but less publicised opportunity. This is not an FTA for big business; it’s an FTA for all business.

Many niche industries could be major beneficiaries if they execute correctly. There will a number of products including honey, nuts, rock lobster, pearls and fruit juices that will exhibit tariff reductions of 15 per cent or more.

These sizeable tariff reductions could be just enough incentive to establish a Chinese trading relationship, or grow an existing customer base and should be explored by all businesses.

For businesses, understanding the changes and implications of the ChAFTA is important, but it should be in the context of the overall market. For instance, Australia is China’s largest source of beef, and the 12-25 per cent tariff reductions over nine years will provide a meaningful advantage to Australian producers.

However, Australian exports have benefited from food safety related bans from major beef competitors, including the US, Brazil and India. In time, these trade relationships are expected to re-open, which will provide an added dynamic to contend with, offsetting the positives associated with lower tariffs for beef exports. These dynamics should be carefully considered, particularly in the context of business investment and management focus across every industry.

Benefits to China 

China is also a major winner from this FTA. The reduction in tariffs for Chinese exports to Australia will provide a benefit to both Chinese businesses and Australian businesses that directly source from Chinese manufacturers.

In turn, Australian consumers should also benefit with many major Chinese imports including clothing, footwear and electronic goods, which will become cheaper.

However, retail prices are ultimately governed by local market conditions, the timing of tariff changes and the currency hedging strategies of importers.

Chinese investment into Australian property (residential, office and other commercial assets) and infrastructure will continue to increase, providing a capital tailwind that will be further favoured by a lower Australian dollar. It would also not be surprising to see increased Chinese investment in Australian industries favoured by ChAFTA, with a view to securing supply and exporting goods and/or services back to China.

Currency

Businesses should also understand the growing importance of renminbi (RMB) as a payment currency. At present, global trade is still primarily denominated by the US dollar, however RMB is rapidly accelerating as a key payment currency.

Trading in RMB can potentially lead to higher prices for Australian exports, or lower prices for Chinese imports given that the Chinese counter-party does not need to account for foreign exchange risk in prices and margins. This can provide an opportunity for Australian businesses to renegotiate contracts and/or sales terms for bearing this foreign exchange risk.

When trading in RMB it is critical that businesses utilise a bank that has direct RMB conversion, otherwise payments will be converted to US dollars first and then into RMB, leading to increased transaction costs. 

Managing liquidity and profit repatriation is another common focus of doing business in and with China. Like all successful business relationships, it’s important to find the right partner for all key services and not just banking. ANZ has been operating in China since 1986 and has a deep understanding of the local banking market.

To take advantage of the substantial ChAFTA opportunity, businesses should plan and prepare now. Tariff changes will commence later in 2015 and in a lower Australian dollar environment, the export opportunity window will be wide open for businesses that take on the challenge to participate.

Key considerations

Timeline: ChAFTA negotiations were concluded in November 2014 but the agreement will not enter into force until late 2015. For some products and services, tariffs will be immediately eliminated, while for others there will be a step down over time. Planning to capitalise on this opportunity should commence now.

Information: Benefits to Australian businesses will vary by industry. The full ChAFTA text is approximately 1,500 pages long, contains more than 8,000 product codes and is a legal document. It is this complexity that has been a deterrent for businesses taking advantage of FTAs and their lack of understanding of potential benefits. ANZ recommends businesses leverage their own industry specific associations, visit government websites like the Department of Foreign Affairs and Trade, and familiarise themselves with various external publications including ANZ opportunity China: the ChAFTA and implications for Australian businesses.

Participation: For Australian trading businesses there are two ways to participate in the ChAFTA: (1) Develop a trade relationship with Chinese businesses and/or consumers, or (2) Establish a local presence in China via a joint venture, or for those industry segments permissible, via a wholly-owned subsidiary. A trade relationship can take time, may require licences and should involve management building Chinese networks on the ground to capitalise on this opportunity. An on the ground presence requires an understanding of local regulations and should include involving the right legal and banking partner to help navigate the challenges associated with establishing and operating a business in China.

Understand the Chinese market: For businesses considering taking advantage of the ChAFTA, it is important to understand the Chinese market. This includes, but will not be limited to, understanding cultural considerations, customs, business dynamics, regulation and regional differences within China.

Navigating the banking market: Exporting to, or operating in China will require an understanding of the banking market. Key considerations will include risk management, liquidity and profit repatriation.