How low will the Aussie Dollar go?
3 September 2015
As the Australian economy continues its transition from the mining and construction boom, Suncorp Bank Senior Economist, Darryl Conroy has provided an insight into the movements of the Australian dollar and outlined three reasons why small business owners exposed to currency movements should consider the impacts of the Australian dollar falling to around US50c over the next few years.
Reason 1 - The US Dollar (USD)
The USD is the reserve currency of the world, and as such a significant driver of exchange rates. Currencies are priced in terms of one currency relative to another, and as a result the USD is the yardstick against which all other currencies are measured and the benchmark currency for foreign exchange markets.
This century has seen the USD weaken as a result of growing debts and large trade imbalances, and a zero interest rate policy following the GFC. Recently, the US economy appears to have responded to this stimulus, which in turn has led to a strengthened USD. This new-found strength now depends upon the USD interest rate cycle, whereby many expect the first interest rate hike in nearly 10 years to occur before the end of the year.
Economists widely forecast the US economy to outperform a slowing Australian economy, hence the forecast for the US dollar to rise and the Australian dollar to fall. In fact, the last time the USD index sustained itself above 100 was back in 2001, and at that time the AUD briefly traded below US50c.
Reason 2 – The Chinese Economy
In contrast to the US economy, China has spent the better part of the last two decades becoming one of the world’s fastest growing, and now biggest economies. This position was achieved through investment in industrial production and the urbanisation of its population. In doing so, China became the world’s largest consumer of raw resources, including minerals, metals and energy.
Having largely completed a process of urbanisation and construction, the Chinese economy is now slowing to a more sustainable rate of economic growth, with Chinese officials stating their intentions to transform their economy from an investment and construction led economy to one based around internal demand and consumption. The challenge and opportunity for Australia will be to meet the growing demand from China for Australian services and high quality produce.
However, the fact remains that China is slowing and likely to demand fewer raw resources over the coming years. The previous economic decline saw Chinese GDP slip to 6.2 per cent before rebounding back above 10 per cent growth. However, this time around we expect less investment in construction and infrastructure as the economy is encouraged to transition towards a more consumption based model.
At the time of the last downturn, the AUD devalued at an alarming rate to US60.1c. Next time around the AUD may fall further without the backstop of enormous Chinese stimulus spending.
Reason 3 - The Commodity Cycle
The third big driver of the Australian dollar is the commodity cycle, whereby our currency tends to track rising and falling commodity prices quite closely. Glen Stevens has long argued that a higher exchange rate was a natural consequence of the mining boom, but now that the boom is deflating, so too should the AUD.
The broad consensus forecast commodity prices to fall further from current levels largely due to slowing world growth. The key reason why commodity prices have such a powerful impact upon the AUD is that commodities affect both the national income as a whole, and the economic sectors individually. Business investment has fallen off a metaphoric cliff (noting, investment/capital flows are a driver of currencies), households are constrained by record low wages and rising unemployment and underemployment, and Government budgets have been impacted by the decrease in royalty revenue.
Implications for the Australian economy
Large currency price swings experienced over the past 15 years (from a low of US47.7c to US110.8c) are a reflection of the changes sweeping through the global and domestic economies. The AUD is trending downward as the mining boom subsides. This unwinds some of the boom-time excesses, but also creates a renewed period of change, and new opportunities for different types of businesses and industries.
- Tourism has already seen a lift in activity, with increase in international visitors and also local visitors. Increased tourism influences a large sector of the economy including retail trade, accommodation and hospitality.
- Education is a major component of the Australians services sector, with overseas students’ consumers of food, services and specialised accommodation.
- Agriculture is a large part of the Australian economy, whereby overseas markets have a growing appetite for quality Australian produce including meat, sugar, wheat, seafood, dairy and horticulture.
- Business providers who specialise in services to the agriculture sector including finance, real estate, legal, tax and consultancy service providers.
- Local manufacturers are a significant employer and generator of activity. A lower AUD means local manufacturers are far more price competitive which enables them to engage more successfully in export markets and compete with imports.
- Local technology and software becomes more price competitive to the local and overseas market.
Australia is facing a tricky transition from a mining and housing construction led economy to a services and agriculture based economy. Historically, such periods introduce much change and volatility in exchange rates, whereby currencies tend to over-shoot. As such, we may revisit currency levels we have not seen for many years. Whist this generates a number of opportunities and challenges for businesses, the key for small businesses is to have a strong business plan now.
About Suncorp: Suncorp Group includes leading general insurance, banking, life insurance and superannuation brands in Australia and New Zealand. The Group has 14,500 employees and relationships with nine million customers. Suncorp Group Limited is a Top 20 ASX-listed company with $94 billion in assets. Suncorp Bank is Australia’s leading regional bank servicing more than one million personal, SME and agribusiness customers.