Deutsche Bank’s Phil O’Donahoe believes China’s economic measures will reduce Australia’s budget deficit as rising iron ore prices boost tax revenues.

China, which consumes over 76 percent of the world’s seaborne iron ore, has a direct impact on Australia’s economy as the world’s largest exporter of the commodity – Australia accounts for 56 percent of total global seaborne exports in 2023, 82 percent of which are imported from
China.

O’Donaghoe predicted iron ore would rise from US$106 to US$130 a tonne next year, driven by the GDP stimulus recently announced by Chinese authorities.

In a recent market note, the economist pointed to historical data showing that iron ore prices typically rise following announcements of Chinese stimulus, with the rule of thumb showing that for every 1 percent of GDP in Chinese stimulus, the average iron ore price increases by 3. 5 percent in the following year.

"Applying this metric to the 6 percent of GDP stimulus (DB estimate) announced by the Chinese authorities a few weeks ago suggests an average iron ore price of US$130/ton in 2025, up from the current price of US$106 /ton," said O'Donahoe.

While US$130 may be the upper limit, he remains confident that prices will continue to rise as iron ore prices have never fallen after major Chinese stimulus.

For Australia, the main impact will be an increase in national income, higher than expected tax revenue for the federal government and thus a higher than expected final budget bill, he said.

“Achieving a third consecutive budget surplus in 2024-25. will be challenging, but a smaller deficit than the budget estimate of $28.3 billion (1 percent of GDP) looks very doable,” O'Donoghue said.

Treasurer Jim Chalmers recently announced that Australia posted an underlying cash surplus of $15.8 billion, or 0.6 percent of GDP, in the 12 months ending June 30, instead of the previously forecast deficit of $13.9 billion dollar, with economists attributing this positive fiscal outcome in part to fluctuations in iron ore prices.

Namely, at the time of Chalmers' announcement, AMP chief economist Shane Oliver said the government had been able to use the unexpected rise in iron ore prices to strengthen its economic management credentials.

Looking ahead, the government expects a likely deficit of $28 billion this financial year and $43 billion next year, accounting for a fall in iron ore prices in its budget planning.

Speaking to InvestorDaily, Oliver stressed that the government needed a turnaround similar to 2023-24 to secure a budget surplus.

While he remains bullish on China's upcoming stimulus, unlike O'Donoghue he expects it to mainly stabilize iron ore prices rather than push them significantly higher.

That expectation, he said, stems from the likelihood that the stimulus will only support current levels of growth, rather than sparking a robust recovery, with a greater focus on consumer spending that is less dependent on commodities.

"I'm optimistic that China will iron out the details of significant stimulus, but I think it's more likely to keep iron ore in a range around current levels than to push it much higher," Oliver said.

"However, the stimulus should help keep the iron ore price tracking above the federal government's budget projections, despite the budget increase [via stronger mining profits] it will not be as strong as it was in the last two financial years”

"This likely means a smaller deficit than the May budget forecast of $28.3 billion, rather than another surplus."