Bilateral relations between China and Australia are deteriorating rapidly, and a recent focus has been an incident in the Twittersphere. China's Foreign Ministry spokesperson Zhao Lijian condemned the killing of innocent people by Australian soldiers in Afghanistan on Twitter, alongside a computer-generated image appearing to show an Australian soldier with a knife at the throat of an Afghan child, whose head was wrapped in Australian flag. The incident drew the ire of Australian Prime Minister Scott Morrison, who demanded an apology from the Chinese government, saying the Chinese government "should be totally ashamed of this and this incident has diminished China's status in the world's eyes". Nevertheless, China's Foreign Ministry spokesperson responded with a series of retorts. This incident remains unresolved to this day.

This incident was not the first to trigger for the deterioration of China-Australia relations, which had begun much earlier and there were a number of "incidents” prior this. From China's perspective, Australia follows closely the U.S. in exerting geopolitical pressure on China, including over the issues of Hong Kong and the South Sea, actively takes part in the Indo-Pacific strategy to counterbalance China, bans Huawei by non-market means, and proposes to hold China accountable in the COVID-19 outbreak. The two countries have built up quite a bit of "frictional momentum" over these issues.

The deterioration in geopolitical relations certainly will have economic impact on either country. China and Australia, now locked in acrimony, actually have very important and close trade relations. According to statistics, the trade volume between China and Australia in 2019 was about USD 158 billion, while Australia's trade surplus with China was close to USD 50 billion, and its export to China was USD 103.90 billion, accounting for 38.2% of Australia's total export. Australia imported USD 55.07 billion from China, accounting for 25.8% of Australia's total imports, an increase of 1.4 percentage points. Australia's trade surplus with China was USD 48.83 billion, up 51.1%. China remains Australia's largest trading partner, largest export destination, and the largest source of imports.

To a considerable extent, the Australian economy needs the Chinese market, hence it puzzles many ordinary Chinese that Australia takes tough stand on China politically. Many Chinese would wonder since Australia is not a global hegemon like the United States, what makes Australia act in this way? This perception, which is prevalent in Chinese society, will shape public opinion that would influence Chinese policy to a considerable extent. There is no absolute "separation of politics and economics" in state-to-state relations, especially at a time when China is being "contained" by the West, and friction between Australia and China is bound to provoke a backlash from China. In fact, the deterioration of bilateral relations has already begun to hit the economic and trade relations between the two countries.

The trade conflict between Australia and China has intensified this year as relations between the two sides deteriorated. In May this year, China imposed an anti-dumping duty of 73.6% and an anti-subsidy duty of 6.9% on Australian barley following investigations under WTO rules and domestic laws. In addition to tariffs, relevant trade restrictions have also been introduced. In October, foreign media reported that four Chinese state-owned utilities received verbal notice from China's customs to immediately halt Australian coking and thermal coal imports on October 9. Since then, Chinese imports of Australian coal have indeed fallen sharply from 9.44 million tons in May to 5.17 million tons in October and to a low of 1.79 million tons in November. In early November, Bloomberg reported that China would formally launch a crackdown on seven categories of Australian goods, including coal, barley, copper ore and copper concentrate, sugar, wood, wine, and lobster, with an effective date of November 6. On November 27, China's Ministry of Commerce announced that some Australian wines had been dumped in China, causing substantial damage to China’s wine industry, so it imposed duties of between 107% and 212% on the dumped Australian wines. This measure, which has shocked Australia, is undoubtedly a further blow to the economic and trade relations between China and Australia.

In terms of the China-Australia trade, the deterioration of geopolitical relations has led to the escalation of trade conflicts. China's restrictions on Australian barley and wine imports have taken place, and there are obvious signs that the coal trade has been banned. The news that "53 Australian coal-carrying ships are stranded in Chinese ports" has gone viral on the internet. According to Bloomberg, these coal-carrying ships had been stranded in Chinese ports for about four weeks or more. These ships were carrying about 5.7 million tons of coal worth AUD 700 million, a data Intelligence company said. A few days ago, China signed a three-year coal agreement with Indonesia to import about USD 1.5 billion worth of coal from the country. This is seen as China's first step in the replacement of coal imports from Australia.

The deterioration of China-Australia economic and trade relations is a fait accompli. Researchers at ANBOUND predict a further blow to China-Australia economic ties as the conflict intensifies. Will China and Australia sever economic and trade ties? In our view, in the extreme scenario where Australia cuts off its geopolitical relationship with China, then the possibility of a break in China-Australia trade relations cannot be ruled out. In this case, the short-term impact on the Australian economy would be significant, because the bilateral trade between China and Australia accounts for 11% of Australia's GDP. Considering that the annual growth rate of the Australian economy is about 2-3%, a break in China-Australia trade relations would wipe out the economic growth of Australia.

However, geopolitical games do not usually go to extremes, and the two countries are not yet completely torn apart. The more likely scenario is that the two sides ratchet up to a point where the pain of economic losses balances out with the geopolitical gains, the two sides may stop the conflict and begin to seek a shift in strategy. But even so, China-Australia relations will be hit hard. In our view, the China-Australia trade relationship faces the possibility of a "reset" of trade after a series of trade "sanctions" and suspensions, but it will not return to the levels of the past. We expect structural changes in some commodity trade between Australia and China (e.g., wine, coal), and a certain degree of trade substitution is certain to occur. Australian manufacturers and traders will also learn the lesson that excessive dependence on the Chinese market is a significant risk.

There are also some trades that will not be significantly affected, most notably the iron ore trade. Minerals exports, mainly the metal ores exports, have been the mainstay of Australia's exports to China, reaching USD 71.39 billion in 2019, an increase of 29.0% and accounting for 68.7% of Australia's total exports to China. The two main exporters of minerals in Australia are BHP and Rio Tinto Group. Therefore, if mineral exports are affected, the impact is large in terms of the trade amount but limited in terms of the number of companies affected. In contrast, disruptions to Australian iron ore exports would have a greater impact on Chinese companies, as China imported 665 million tons of iron ore from Australia in 2019, accounting for 67% of the country's total iron ore imports for the year. If iron ore imports were disrupted, a number of Chinese steel mills could be hit with a supply cut, which could have a significant impact on the domestic steel industry. A disruption to iron ore trade would cause substantial damage to China-Australia trade and is unlikely to be triggered by either country.

Final analysis conclusion:

The deteriorating geopolitical relationship between China and Australia is having a serious impact on the trade relationship between the two countries, which we expect to be structurally damaged and "reset" to some extent. A "reset" does not mean a complete zeroing out of trade, and the subsequent reset will not restore relations to its previous state.