Australian Dollar Boom Essay

The Australian dollar gains its highest level in more than five years. In April 2001, the Aussie dollar began the climb from a low of US Dollars 0.479. In July this year, it peaked at US Dollars 0.687. This climb that the Aussie dollar is in is happening due to many factors, some of these factors are internal that happened due internal causes such as: Government policies, Strong Housing cycle.

Or due to external factors which are factors that are caused by policies of countries that are directly related to the Australian economy or global or regional markets

The RBA “Reserve Bank Board” major responsibilities are to determine the banks monetary and banking policies. However, since banks are considered a key player in money exchange within the economy that is due to the facts that majority of businesses and people deposit at banks and so with those deposits, the banks overall behavior can influence the quantity of deposits in the economy and there for the money supply. So the RBA major job is to determine monetary policy for the banks and the overall banking sector.

What monetary policy means is the management by the central bank of liquidity conditions in the economy. That is the price and availability of funding for the economy’s expenditure. The objectives of monetary policies are to contribute stability of the currency, the maintenance of full employment, and the economic prosperity and welfare of the people of Australia.

The long-run objective of monetary policy is to influence the rate of growth in the economy and the level of prices. When the overall economic growth is too fast, this put pressure on prices so the RBA will implement a tightening of monetary policy to slow the economy. But when the economy is experiencing slow growth, the RBA will implement expansionary monetary policy.

However, the RBA influence the liquidity or the amount of cash in the economy by buying and selling government securities. If the RBA decides to change the amount of cash in the economy, it can either purchase government securities from financial institutions or sell them to financial institutions in the nation’s bond market.

Such policies like monetary policy the RBA conducts within the economy, this is considered an important cause to the strength of the overall dollar power within the economy and overseas markets. When the RBA control the liquidity of money within the economy, that for sure would increase the credibility of the overall Australian market and so that would attract overseas investments that is due to the stability within the economy and the country currency.

Fiscal policy is the use of government taxing and spending powers to affect the behavior of the economy. The economy’s total output, income and employment levels are directly related to total private and public spending or aggregate demand. Private pending consists of purchases of goods and services by consumers, by businesses for investment, and net exports (exports minus imports). For their part, governments raise revenues from taxes such as the income tax, sales taxes and payroll taxes, and from other sources to spend on such things as health care, education, pensions, social assistance, and defense. So when any government implements such policy like the fiscal policy, the overall market will keep on being managed to maintain stability.

Australia’s continuing growth is considered a good sign of overall growth within the Australian economy. A strong housing cycle which is caused by the Australian government first home owners’ scheme whereby first home owners were awarded grants between AUD 7,000 -14,000 to purchase homes.

The current explosive expansion of house building and buying is happening because of the fact that any person can borrow as much as he like – provided that he can afford to pay the interest rates. However, over the last decade, the ratio of household debt to household annual disposable income has gone from 56 per cent to 125 per cent.

What did most to faster the remarkably extended boom in lending for housing and house prices was the return to low inflation. This permitted Australians households roughly to double their borrowing without mortgage payments getting more burdensome.

For decades Australians had wanted to borrow more for housing, but couldn’t do so because of the limits on bank lending and because nominal interest rates were too high. And so with such a boom in borrowing or lending money from banks and financial institutions, the building industry will boom too and exporters for products that are needed will benefit and most important this will reflect how the over all domestic growth within the economy is high and so that would attract overseas investments and so that would help to give the dollar a push.

One aspect of Australia’s recent economic performance that has received favorable comment is the behavior of the exchange rate. When the American crisis erupted, the exchange rate fell so that at its low it had fallen by a very significant amount. Unlike a number of countries in the region, interest rates were not raised to defend the exchange rate.

The Australian dollar is strengthening against most currencies, but the most watched currency is the US dollar. The Australian dollar hasn’t been so much out performing; rather the US dollar has been under performing, which is consistent with the US domestic economy.

The Australian economy has outperformed the US economy, but with the Australian economy being so small, there are other factors at play.

The major factor is the yield differential between the two countries. Australia’s official interest rate is 4.75 per cent, whereas in the US it is 1 per cent. That is a 3.25 per cent interest rate difference, which creates demand for the Australian dollar.

The fact the Australian Reserve Bank did not cut interest rates increased the demand for Australian dollars. Investors are choosing to invest in Australian fixed income securities as they are giving a higher return than their US counterpart. Also Australia offers economic and political stability, which should support the Australian dollar at this level.

We have tended to exaggerate the size of the fall in the Australian dollar by looking only at the Australian dollar/US dollar rate. At least half of the story was that the US dollar strength rather than Australian dollar weakness.

What has been the impact on the Australian economy and which industry sector have been affected most and why?

Australia’s economic performance is expected to keep as one of the strongest economies of the developed world in 2003 and 2004.

Despite a very weak and uncertain international economy, the Australian economy is expected to grow by a 3 per cent in 2003.With such high expectations compared to other advanced economies such as the US the European Union and Japan, the over all performance of the economy would appear in a good form. First quarter figures from the Australian Bureau of Statistics shows how the Australian economy performed well during the first quarter of this year despite the weak economic conditions worldwide.

Figures show that the economy expanded by 0.7 per cent compared to 0.4 per cent in 4th quarter of 2002. However, annual growth slowed to 2.9 per cent from 3.0 per cent
Australian GDP grew by up to 3.0 per cent over the year 2002. However when comparing GDP between Australia and the US would show how the Australian economy is as strong as the US whose GDP is currently at 2.9 per cent.

However, there are many factors that affect the overall GDP result. In Australia, the net exports have affected the over all economic growth within the country that is exporters have suffered from a weak world economy and the rise of the Australian dollar exchange rate. Meanwhile Australian imports have grown quickly due to the strong domestic economy

The Australian economy has attracted a fair bit of favorable attention because it has performed so well during the global financial crises. This is because the good performance of the Australian economy is not just a recent event, but something that has been unfolding over the past decade.

Companies and businesses that are highly dependable on their exports are most affected. The cheap Australian dollar has been an important contributor to most of Australians exporters. The value of exports rose 21% in 2000-01, to 152.4billion. Exports of primary products rose 29%, exports for manufactures rose 16% and exports for services rose 16%.

With such high currency of the Aussie dollar, exporters expect less income and local companies expects higher competition from importers.

Australia is a major exporter of agricultural products, minerals, metals, and fossil fuels. Commodities account for 57% of the value of total exports, so that a downturn in world commodity prices can have a big impact on the economy. The government is pushing for increased exports of manufactured goods, but competition in international markets continues to be severe. And so local manufacturers that exports their good are expected to gain less market share overseas due to the high exchange rate of the Australian dollar and so that will for sure affect the way these companies explore the international markets which would be different than when the dollar was week.

The effect of big exporters is hard to assess. Big exporters are operating on long term contracts and use currency hedging would be highly affected with any fluctuation of the dollar currency so their earnings. With the higher value of Australia’s dollar, exporters will suffer more because major commodities’ prices are set in US dollars.

A strong Australian dollar is considered a real threat for the overall tourism industry. While many industries will be affected adversely by the strong Aussie dollar others will gain more profits from such high dollar like companies that export their products overseas.

Tourism plays a key role in the Australian economy, employing six percent of Australia’s workforce and accounting for $21 billion or 4.5 percent of Australia’s gross domestic product (GDP) in 2001-02.

In 2002, the number of international visitors to Australia totaled 4.8 million, representing a 0.3 percent decrease compared to 2001.

For people coming to Australia a weak Australian dollar presents a real opportunity for the overall truism industry that is international visitors can get better value fro their dollar. But with such strong dollar with a high exchange rate, international visitors are less likely to come to Australia due to the low value there local currency can be changed with the Aussie dollar.

In 2003, international travel to Australia is forecast to fall by 5.3 percent to approximately 4.6 million visitors, the lowest since 1999. A number of factors have caused the decrease in international travel demand to Australia, including the terrorism events of September 11, high aussie dollar, the October 2002 terrorist bombing in Bali ,the Iraq war and SARS.

What effects has a strengthening dollar had on the ways in which public companies market their products overseas?

For an exporter a weak dollar means that the price of the Australian products is more competitive. On the other side a strong dollar means that the exports became more expensive and thus impact on a country’s competitiveness and profitability. Exporters in different industry sectors have been impacted by the recent strengthening of the Australian dollar. Parker says that “whatever the cause (of the strengthening of the dollar), the currency’s relative strength is bad news for exporters. Anecdotal evidence, however, indicates that few exporters depended on weak dollar for a profit margin; it was seen as bonus rather than a prerequisite. Nevertheless, exporters will begin to suffer if the climb continues.” Australia Industry Group adds that “for over one in three exporters (36%) the dollar appreciation has contributed to a lowering of competitiveness. As a consequence, many of these firms have suffered deterioration in export volumes, with 27% of exporters experiencing a decline. The fall reflects on the combined impact of weaker global demand and appreciating currency”. This has forced many of the companies to change the way they market the products overseas in the way they promote their products, price, and have even expanded the places they sell. We are going to look at comments made by different market leaders in different industries regarding their marketing strategies.

AAP wrote in their finance news that out of “930 companies, including 560 exporters, surveyed about the impact on them by the Australian dollar’s gains against its United States counterpart. Companies most at risk of losing exports – and suffering lower profits as a consequence – were those exporting food, beverages and basic metals The report added that some of the exporters more prone to negative effects of the rising dollar were looking to source more of their supplies from overseas in order to maintain their profits”.

Sustainable farming economic news (2003), says that “during May, the only thing preventing a much larger fall in the Westpac-NFF rural commodity index was a 12% increase in wheat prices,” NFF Economics Committee chair Charles Burke said. The index fell by 0.4 % during May, as the strengthening Australian dollar continued to put prices under pressure. The higher dollar offset a large increase in wheat prices. Meanwhile, all other prices in the index (cotton, sugar, canola, beef and wool) fell in value. Mr Burke said the large increases in the Australian dollar over the past months had hit farmers hard. “The Australian dollar has increased by 27 % since September 2001, unwinding the benefit of the low dollar for farm incomes,” he said.

Wool prices”have fallen marginally due to the decreased demand from the Chinese and European buyers, the rising AUD and the increased supply (with more than 75,000 bales being offered for sale nationally) were identified as the reasons for the general slide in prices… The decline in sales has forced the government to open up to more trading contracts with different countries example Uruguay, Chinese food group.”

In the wine industry reduction in the price of the wine overseas has became a current trend to help the companies stay competitive at an international level “Australian vintners are selling more wine overseas but making less money from it, according to new figures from the Australian Wine & Brandy Corporation”. Australian wine producers are stepping up their marketing push in North America and Europe in a race to reach $3 billion in exports by December…The Australian Wine Export Council said growth in Britain was slowing and the focus was shifting toward the US.

The chief economist at the Australian Trade Commission, Tim Harcourt, suggests a higher-value dollar should not deter exporters from pursing offshore sales, at least in the medium term…“Exporting is a difficult process that relies on patience, trust, commitment and the building of relationships with suppliers and customers in overseas countries, Australia’s export success can’t depend on exchange rates alone” ” he said.

Phil Rosser, senior manager of Trade Development at Sydney Ports believes the growing imbalance between imports and exports will turn out to be more significant for Australia. “The economy is strong so we’re drawing in imports like crazy – and exports have dropped off,” he said. “This is more than just the effects of the drought. Some export lines have fallen because there has been a drop in demand from overseas, like cotton. Cotton plantings were being reduced even before the drought set in because there was a lack of demand.” It’s a welcome move away from simply exporting commodities and concentrating, instead, on processing food products and value-adding, from everything I’ve seen, that trend is holding up” he said.

Australian exporters could survive the higher exchange rate if they pursued quality and productivity, an economist said. Tim Harcourt, the chief economist with AusTrade, said the higher Australian dollar was certainly making life difficult for many exporters. “While it is tough for some at the moment, Australian exporters have shown their resilience through thick and through thin,” he said.” And their capacity to build export markets, nurture relationships and find new ways of creating value and improving productivity will continue even if it means living with a higher dollar.” But he said there were opportunities, particularly in countries with young populations such as China and Indonesia, for Australian exporters. Customer service standards, product quality, brand building, marketing, management ability, levels of education and training and the capacity to build long-term relationships with overseas clients, customers and business partners are all factors that have helped Australian businesses to achieve export success on a sustainable basis,” he said. “All of these factors require long-term commitment, whatever exchange rate fluctuations maybe occurring in the financial markets in any given day”.

In South Korea recently, after a visit to Japan, Meat and Livestock Australia (MLA) managing director Mark Spurr said ongoing promotions in both countries had been critical to positioning Australia as a supplier of quality beef. Over the past 12 months in Japan a major MLA promotion program (funded with support from the Australian Government, processors and industry) has involved more than 4,000 in-store demonstrations, trade seminars, retail promotions and consumer awareness campaigns. He said the strength of consumer demand in Japan was evident in the stronger export prices for our beef to Japan. In Korea, the Hoju Chungjungwoo brand launched last year – promoting the clean, natural and safe attributes of Australian beef – already enjoys 30 percent brand awareness.

From all the above comments we see that exporters are doing their best not to be dragged out of market by the exchange rates movements. Emphasis is being paid to the products being distributed and the customers (building relationships).

What strategies are required during times of adverse currency movement to cushion volume/profit volatility?

Currency risks can affect the growth and profitability of a company. If a company is exporting as seen above the strengthening of a currency can mean low competitiveness, low profits and negative growth. If a company is exporting a weak currency means the same implications as above. It is therefore important to manage or cushion the risk associated with currency movements. This can be done though the use of several strategies which we shall discuss in depth. During this discussion we are going to assume the position of an Australian agricultural company that specialises in both imports and exports of agricultural commodities and equipments.

Strategies used:
Forward rate agreement: This is a contract to buy or sell currency at an agreed upon exchange rate at a specific date in the future. This allows the exporter or importer to contract with another party to assume the risk of adverse currency movements (Price, 2000). This is done by a financial institution mostly banks. The company gets contracted by an overseas market to export a certain bales of wool to a Chinese market at a set later date; the amount contracted may be in a Chinese currency. In this case the company can sell this currency at the present time to a bank or financial institution. These two negotiate a price and come to a standardized agreement. The negotiated amount maybe AUD 2 million. If the exchange rate has moved against the exporting company between the date of contract and the settlement date the company is thereby protected. On the other hand the company foregoes the potential windfall of favourable exchange rate movement. This kind of strategy protects the growth of the company by preventing the large gap between huge profits and huge loss at different times due to currency movements. The company is assured of what to expect in the future and can be able to make other growth decisions or facts basing on this.

Exchange-Based futures: In this strategy the company can “eliminate exchange risk (“hedge”) by using a futures contract to offset the risk involved in receiving foreign currency as payment for an overseas sale”. Currency futures contracts are used primarily as price-setting mechanisms rather than for the physical exchange of currencies. The contract is cash settled; that is, following the final trading session (on the last business day of the month prior to the futures contract month), one last mark-to-market and cash adjustment takes place.By taking this short position the exporter will make a profit if the value of the currency falls, which will offset the currency related loss of the product sale. An example of this can be illustrated in the import of agricultural equipments, our company makes a contract with Japan and the contracted amount (in Japanese Yen) is to be paid in a 30 day period, the rate specified is the exchange rate at the day that the contract is made. If we pay before the end of the 30 day period, we can buy the Yen in that day exchange rate to pay the amount it would cost in Japanese Yen. If the Aus dollar is higher we make profit if it is low, we might as well wait for the payment date.

Future hedging between companies: In this kind of hedging unlike the one mentioned above does not involve a financial institution. It is a contracted agreement between two trading partners. During the wheat of season our company might decide to enter into a contract promising to sell a certain amount of wheat for a certain price in Aus dollar to Saudi Arabia. At that particular time none of the parties know the exchange rate but a decision is reached when the two partners negotiate and reach an agreed rate. At the time the actual exchange occurs if the Aus dollar is high we make a loss if it is high we profit. This way we protect ourselves from unexpected huge losses.

Options: Financial Insurance: Foreign Currency Options can provide a fixed exchange rate for a future date if rates move adversely, but also provide the added flexibility of being able to use the prevailing spot rate if rates have moved favourably. If you buy a foreign currency option, you get the right to choose, on an agreed future date, whether you want to exercise the option and transact at the option’s exchange rate or not. If the spot rate is more favourable than the option’s exchange rate, then you will choose to transact at the spot rate. However, if the spot rate is less favourable you will use the option. This can be illustrated in a case where our company decides to sell dairy products to Japan at 5million Yen on a 60 days terms. If the value of the Aus dollar rises in this period, the value of sales falls and therefore our company makes a profit, if the value of the dollar falls, our company has the financial insurance (option).

One strategy that can be used to protest against surging in growth due to adverse currency movements is: when a country decided to open up companies in other country to serve the domestic market it important to invest with the countries currency rather than your own. For example for every country that our company has opened up a dairy produce outlet all the products are sold in the local currency. This way each country is given its own growth standards.

In an exports level however it is advisable to use one currency to make sales. Example: use of the Aus dollar regardless of the country of buyer. This buffers the risks associated with dealing with too many currency exchange rates.

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