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A prolonged downturn in China’s housing market will have significant effects on the finances of the Australian government and the local steel industry, economists have warned.

The Asian superpower’s real estate sector has been seen as a pillar of economic growth until 2020, when China instituted some of the world’s toughest and longest COVID-19 lockdowns.

During that time, its president, Xi Jinping, introduced tough new rules to rein in the nation’s debt-ridden housing bubble, leading to the financial collapse of Evergrande, Country Garden and other major property developers.

Unlike Australia, property prices in China fell at the fastest pace in nearly a decade.

Construction activity has also slowed considerably, with figures for May showing they were about 80% lower than the same period four years ago.

“China’s real estate sector accounts for about 30% of its steel consumption,” Commonwealth Bank commodities analyst Vivek Dhar told the ABC.

“And with China importing about three-quarters of the world’s iron ore, what happens in the real estate sector has a massive impact when it comes to iron ore demand and steel consumption.”

Australia shipped $136 billion worth of iron ore overseas last year, most of it to the Chinese market, Department of Foreign Affairs and Trade (DFAT) data has revealed.

But the prosperity Australia has enjoyed as a result of China’s insatiable appetite for iron ore may be threatened if its prices fall significantly, according to Tim Harcourt, professor of economics at the University of Technology Sydney.

Why China’s housing market woes are impacting here

The Reserve Bank of Australia is among those closely watching developments in China’s economy.

RBA Governor Michele Bullock told the House Economic Committee in Canberra on Friday that China was “a risk that is very pertinent to us”.

While she noted that its economy was still “performing well”, reaching its growth target of around 5%, they still had a “very big hurdle because of the problems in the real estate sector there”.

“China is really important to us because of our trade relations… [it’s our] biggest trading partner and it is very important especially for the prices of the commodities we export, especially iron ore,” she said.

“So that’s something we’re watching quite closely because developments in China can have quite an impact on how our trade develops and therefore our growth.”

For many years, the sale of iron ore has provided a major boost to the Australian economy, but that could soon change as China’s steel industry struggles.

“All momentum is waning. If we look at the margins of the steel mills, we can see right now that the steel mills have very little incentive to buy iron ore given how much losses there are,” Mr. Dhar said.

“When we see steel demand in China very weak, as it is now, they look to the export market to fill the gap.

“And in that sense, we’re starting to see very cheap steel come into the market, and that naturally increases a lot of trade friction.

“This puts pressure on many domestic steel producers, not just in Australia but globally.”

Steel is “flying” out of China and into Southeast Asia

China appears to be offloading its excess steel stock onto other markets, causing price pressures to be felt in Australia.

“We are certainly seeing the impact of a large volume of steel flying out of China into the Southeast Asian markets,” Vassella told The Business.

“And what it’s done is it’s driven by price pressure, which then feeds back into our domestic market here in Australia.”

The price of iron ore – a key component of steel – has fallen by about 35% since the start of the year. The spot price is now around $90 per tonne ($133.78 per tonne).

Treasury analysis this week found falling prices could cost the federal government $3 billion in revenue, pushing the budget into deficit this financial year.

“We’ve had very high iron ore prices for 20 to 30 years,” Mr Harcourt said.

“We’ve really been a lucky country in terms of very high prices. So it had to go down.

“It’s just a question [of] How far will it go down and will that have a significant impact on our budgets?”

Australia’s biggest steelmaker BlueScope said its financial performance would be hurt by tight steel spreads in Asia.

The company said this would be driven by high regional steel production and exports, which affected both steel prices and raw material costs.

Earlier this week, BlueScope revealed that its full-year profit fell 20% to $806 million.

However, BlueScope Steel chief executive Mark Vassella described the result as “a solid performance against a background of macroeconomic and industry volatility”.

He also offered a more optimistic assessment of the future, seeing this as the bottom of the cycle.

“Steel companies, especially some of the less efficient steel companies, would lose money [at these prices]and you can’t do that forever,” he told The Business.

“So those are the kinds of adjustments that need to be made. And does that mean a structural adjustment to production levels and the ability in China to meet their domestic demand? I suspect that’s what we’re going to start to see.”

What does this mean for Australians?

Meanwhile, if iron ore prices continue to fall, Mr Harcourt warned the federal government would “have less revenue to spend”.

The Treasury analysis found that with iron ore prices falling faster than expected, Labor faces the prospect of less revenue and a bigger deficit as it heads into an election year in 2025.

“So the government either has to cut spending or raise taxes domestically,” Harcourt said.

“So it’s not good news for Australian taxpayers.”

While it is unclear how this will all play out, especially as Prime Minister Anthony Albanese prepares to enter an election cycle, Mr Harcourt says there are ways the government can cut back if necessary.

“They have ways to raise other parts of the income and cut education and health in a very careful way so they don’t hurt people, especially at the lower end of the spectrum,” he said.

“But they have to be very careful. It is much easier to have a surplus with higher oil prices than to have lower iron ore prices and a smaller surplus, or potentially a deficit.”

However, this may not be necessary if the price of iron ore stops falling.

In the last budget, the Treasury made its spending decisions on the conservative assumption that iron ore would be much lower at $65 a tonne.

“Basically, even if spot prices are maintained till the end of this financial year, even based on the federal budget estimate, we are talking about 21% more than what is budgeted for,” Mr. Dhar said.

“So you still have a lot of upside here from what was budgeted.”

Analysts such as Dhar believe that the price of iron ore will rebound in the coming months, given that the Chinese government is facing intense pressure to revive its economy through further cuts in interest rates.

“If we see a real estate sector and [Chinese] infrastructure going south, we will see the economic growth target of around 5% be at risk,” he said.

“This opens the door for additional incentives to enter the market by the end of the year.

“And that’s something that, in our view, could see iron ore prices return to $100 to $110 a tonne by the end of the year.”