EXTERNAL STABILITY & THE EXCHANGE RATE Peter Kennedy Head Teacher Teaching & Learning CHHS HSC Senior Marker Economics Tutor Macquarie University 1
Australia s External Stability Let s start with some past HSC questions 2016 HSC analyse the influence of different factors on Australia s trade and financial flows. HSC Topic 2 Examine Economic Issues assess the impact of recent changes in the global economy on Australia s trade and financial flows HSC Topic 3 Examine Economic Issues assess the key problems and issues facing the Australian economy. Australia s External Stability / Balance of Payments Another past HSC question 2012 HSC analyse the impact of changes in the global economy on Australia s Balance of Payments. Examine economic issues: HSC Topic 1 examine the effects of globalisation on economic growth and the quality of life, levels of unemployment, rates of inflation and external stability Examine economic issues: - HSC Topic 2 assess the impact of recent changes in the global economy on Australia s trade and financial flows 2
Australia s External Stability More past HSC questions: 2010 HSC Analyse the causes and effects of fluctuations in Australia s external stability. 2009 HSC Analyse the impact of changes in the global economy on Australia s economic growth and external stability. HSC Topic 1 - Examine economic issues: examine the effects of globalisation on economic growth and the quality of life, levels of unemployment, rates of inflation and external stability From the HSC Syllabus. Examine Economic Issues (Topic 2): assess the impact of recent changes in the global economy on Australia s trade and financial flows examine the effects of changes in trade and financial flows on Australia s economic performance analyse the impact of changes in the components of the balance of payments on the value of the Australian dollar 3
Apply economic skills (Topic 3).. assess the key problems and issues facing theaustralian economy. External stability measurement Current Account Deficit (CAD) as a percentage of Gross Domestic Product net foreign debt as a percentage of Gross Domestic Product net foreign liabilities as a percentage of Gross Domestic Product terms of trade exchange rate international competitiveness trends positive and negative causes and effects 4
Australia s exports comprise: o Rural 13% o Mining 49% o Manufacturing 19% o Services 19% Australia s capital inflows comprise: Foreign Direct Investment (FDI) 24% Foreign Portfolio Investment 54% Financial Derivatives 6% Other investment (e.g trade credits) 16% Need to look through the prism of external stability 5
(Page 2) External stability can be defined as the ability of a country to meet its financial obligations arising out of international transactions. External stability is achieved when a country such as Australia is able to finance its import expenditure with its export income. 6
(Page 2) There is no one index of external stability, but a number of indicators are used to gauge the state of the external sector, and monitor whether external stability is being achieved. It is necessary to look at: The level and stability of the exchange rate ($AUD) in the FOREX market. The TWI is an important indicator here. The size of the Current Account Deficit (CAD). The general aim is to keep the CAD below- 5% of GDP The level of foreign debt (as a percentage of GDP) and the outflow of interest payments to service this debt Economic Environment The 3 Speed Economy (2005 11) Mining Boom /Terms of Trade Boom ( Terms of Trade grew by 45% between 2005 and 2011) The Booming Sector = mining sector Rebalancing the Australian Economy (2012 Present) Mining boom fades out : Terms of Trade start to deteriorate (fell by 10.2% in 2014-15). The TOT rose again by 15.6% in the year to December 2016. 7
Australian Dollar The 3 Speed Economy (2005 11) Strong $AUD reaching US $1.10(TWI 78.8)in July 2011 and averaging US 83.5c between 2005 and 2011. Rebalancing the Australian Economy (2012 Present) $AUD depreciates but still at US92.6c (TWI 71.3) in Jan 2013. It reaches US71c (TWI 61.3) by Sept 2015. Around US76.6c/TWI 63.9 by Oct 2016 Reached $80.66 / TWI 67.4 in early August 2017 The 3 Speed Economy(2005 11) Rebalancing the Australian Economy (2012 Present) Australian Dollar Effect on Export Competitiveness: Loss of export competit,iveness (services +manufactured exports) The Lagging Sectors Effect on Export Competitiveness: Renewed competitiveness of Australian Exports; eg tourism & education Effect on Import Competitiveness Effect on Import Competitiveness Cheaper Imports =capital goods +consumer goods import competing sector suffers Improved competitiveness of import competing sector 8
CAD declines ( 2.4% of GDP in 2010-11) During the 2001-2011 period Australia s CAD tended to vary between -2.5% and -6.3% GDP CAD stabilises (around -3% of GDP in 2013-14) then rises to over -5% of GDP in 2015-16. Balance of Goods and Services deficit declines: 2008-09 = BOGS Surplus of $7.6bn 2010-11 = BOGS Surplus of $21.3bn Net Primary Income Deficit rises : 2008-09 = NPI deficit of - $45.4 bn 2010-11 = NPI deficit of - $54.1 bn Mining Boom (2005 11) Balance of Goods and Services moves back into deficit: 2014-15 = BOGS deficit of -$21 bn Net Primary Income Deficit falls: 2014-15 = NPI deficit -$34 bn 2016-17 = BOGS back into surplus = CAD falling again??? Rebalancing the Australian Economy (2012 present) Net Foreign Debt The 3 Speed Economy (2005 11) Slow rise in Net Foreign Debt 2005-06 : $494.9 bn (51.8% of GDP) 2010-11 : $ 685.8 bn (49.4% of GDP) Rebalancing the Australian Economy (2012 Present) Slow rise in Net Foreign Debtreaches $1 trillion in 2016 (61% of GDP) 9
The anemic outlook for the global economy likely to lead to slower growth for commodity prices Evidence that globalization is reversing as trade and capital flows are sluggish and migration is increasingly being restricted Despite the proliferation of Bilateral Trade Agreements - global protectionism is on the rise. The unorthodox monetary stimulus policies adopted by central banks post GFC have failed to stimulate sustainable economic growth, instead their main impact has been to inflate asset prices The post GFC explosion in global debt (a record high of US$152 trillion )- is a threat to global financial stability. 10
Australia remains an attractive destination for foreign investment - AAA rated government debt combined with a relatively high official cash rate (1.5%) The Australian economy is transitioning from the recent mining boom phase to a restructured economy with greater emphasis on service exports (e.g. tourism and education) and an emerging high tech manufacturing export sector Service sector productivity Improved computing power and software sophistication in areas such as health and education will enable access to larger overseas markets. Australia also maintains an advantage in the production of clean and safe agricultural and processed food products. 11
EXCHANGE RATES BACKGROUND INFO. o What is an Exchange Rate? o Difference between bilateral exchange rates and the TWI o Exchange rate systems (floating, fixed & hybrid) o Factors leading to appreciation o Effects of appreciation / depreciation o Page 16 W From the HSC Economics Syllabus Students learn to : o Examine Economic Issues : analyse the effects of changes in the value of the Australian dollar on the Australian economy. o Apply economic skills analyse the impact of changes in the components of the balance of payments on the value of the Australian dollar. 12
Past HSC Questions.. o 2013 Explain how movements in the Australian Dollar can affect the performance of the Australian economy. HSC Topic 2 - Examine Economic Issues : analyse the effects of changes in the value of the Australian dollar on the Australian economy. Past HSC Questions.. o 2011 Discuss the impact of changes in the domestic and global economy on Australia s exchange rate. o HSC Topic 2 - Apply economic skills analyse the impact of changes in the components of the balance of payments on the value of the Australian dollar. 13
What s been happening with the Aussie dollar? The Recent Trend.. The Australian Dollar was trading at around $US 0.74 (TWI 64.7) in early December 2016 and by mid March 2017 it had reached $US0.76 (TWI 66.8). It then pushed through the US 80c mark($us80.66/ TWI 67.4) in early August 2017. This meant that the Australian Dollar had risen by more than 11 per cent since the start of 2017. Page 21 Back in early February 2015, the Australian dollar was trading at $US 0.77 (TWI of 63.6) which was a five and a half year low. This slow weakening of the currency followed the pattern set in 2014 where the dollar finished the year at around $US0.82 after hovering around $US 0.93 in June (TWI of 71.1). - The Australian Dollar averaged $US 0.77 from 1993 until 2014, reaching an all time high of $US 1.10 in July of 2011 and a record low of $US 0.48 in April of 2001. 14
The Australian Dollar is one of the more volatile currencies of the developed world. Against the US Dollar, over the past 10 years to December 16, the AUD experienced 14.5% volatility while the Japanese Yen, Euro, Great Britain Pound & Canadian Dollar experienced around 10% volatility. Appreciating $AUD (2009 12) Depreciating $AUD (2013 16) Rising world commodity prices/ Stronger economic growth rates of Australia s main trading partners Australia s favourable terms of trade following strong global commodity prices Sustained PPa direct (FDI) and portfolio investment into the Australian economy Relatively high interest rates on offer in Australian financial markets Slowing global economic growth rates and declining commodity prices Declining terms of trade /declining global commodity prices Lower foreign investment into Australia s resource sector Lower Australian interest rates and rising US interest rates Foreign investors purchasing Australian Government bonds (AAA rated) Table 3: Recent Factors Influencing the Australian Dollar Page 24 15
The outlook for the Australian currency over the next year is once again clouded by global influences, most notably, the monetary tightening expected to be undertaken by the US Federal Reserve and the uncertainty surrounding the growth prospects for the Chinese economy. WHY? Most currency market analysts expect the Australian Dollar to head back to around $US0.70 during 2017 (TWI < 60) due to low commodity prices and the lifting by the US Federal Reserve (the US central bank usually just referred to as the fed ) the Federal Funds Rate by a quarter point into the 0.5 to 0.75 per cent range in December (2016) and again into the 0.75% to 1% range in mid March 2017. 16
This is in addition to the Fed s approval of a quarter-point increase in its target funds rate on December 16/ 2015 (after seven years of the most accommodative monetary policy in U.S. history). The new target rate went from 0 percent to 0.25 percent. Further rises in the Federal Funds Rate are expected over the next 12 months largely in response to promised increased budget spending driving up US interest rates as the Trump administration puts its economic stimulus agenda into effect. A) US Federal Reserve tightens MP B) US Fiscal Stimulus US interest rates rise Increased issue of US Treasury Bills US Dollar rises Yields on US securities rise / higher US interest rates Australian Dollar falls US Dollar rises Australian Dollar falls 17
a sustained fall in the Australian dollar tends to have a positive effect on our economic growth. As a rule of thumb, a 5-cent drop in the currency has a stimulative effect on the economy about equal to a quarter-point interest rate cut. It makes our exports easier to sell, and makes domestically produced goods more competitive with those from offshore. BT Financial Group Chief Economist, Chris Caton Who wins when the Aussie Dollar depreciates? Companies with majority of assets overseas Companies who export - (mining, manufacturers & services) Australian tourism and education sectors Manufacturers (import competing sector) Farmers (import competing sector) Companies with majority of assets overseas 18
Who loses when the Aussie Dollar depreciates? Overseas travellers Online shoppers buying from overseas Australian shoppers buying goods made overseas Companies who import (intermediate & final goods) Companies with overseas suppliers (eg. retailers) Very Sensitive to ER movements = mining, manufacturing & agriculture Also very sensitive to ER movements = personal services (accomodation, food, recreation &arts) and other business services (IT, media, scientific & technical services ) 19
Why business services? Many of these industries have considerable exposure to trade-exposed industries. For example, around a quarter of the output of administrative & support services is ultimately consumed by trade-exposed industries. Less sensitive to ER movements = Social Services (education &training, health care & social assistance) 20
WHY- business services? Many of these industries have considerable exposure to trade-exposed industries. For example, around a quarter of the output of administrative & support services is ultimately consumed by trade-exposed industries. Females are also amongst the unemployed, mainly due to pregnancies and raising a family- sometimes it is by choice. Full unemployment is when you are completely out of a job. People affected by seasonal unemployment might be ski instructors 21
These people suffer from the discouraged worker hypothesis At the last federal budget the government introduced a contemporary macroeconomic policy known as fiscal policy The horse and cart has now been replaced by the automobile. Another means of measurement is a head count at CES branches at a particular point in time. Eg bank tellers taking the place of a human. According to a local newspaper, name which cannot be revealed due to HSC regulations 22
e.g. fruit picking. As the fruit only needs to be picked during one part of the year, the rest of the year the fruit must find some other form of employment. THREE MAIN FACTORS RESPONSIBLE. The relative weakness in the AUD (2014-17) has been driven by multiple factors, such as: the weakness in both the Australian economy and its major trading partner (China) the differential outlook for interest rates between the US (raising rates) and Australia (falling rates) lower commodity prices largely due to falling demand for our resources from emerging markets (particularly iron ore and coal demand from China), (Page 7) 23
Australia s External Stability at a Glance... Economic Environment Australian Dollar The 3 Speed Economy (2005 11) Mining Boom / Terms of Trade Boom ( Terms of Trade grew by 45% between 2005 and 2011) The Booming Sector = mining sector Strong $AUD reaching US $1.10(TWI 78.8)in July 2011 and averaging US 83.5c between 2005 and 2011. Effect on Export Competitiveness: Loss of export competit,iveness (services +manufactured exports) The Lagging Sectors Note: third speed = non tradeable sector (between the booming and lagging sectors) Rebalancing the Australian Economy (2012 Present) Mining boom fades out : Terms of Trade start to deteriorate (fell by 10.2% in 2014 15). The TOT rose again by 15.6% in the year to December 2016. $AUD depreciates but still at US92.6c (TWI 71.3) in Jan 2013. It reaches US71c (TWI 61.3) by Sept 2015. Around US76.6c/TWI 63.9 by Oct 2016 Effect on Export Competitiveness: Renewed competitiveness of Australian Exports; = Services (e.g. Education &.Tourism}+Manufactures Effect on Import Competitiveness Cheaper Imports =capital goods + consumer goods import competing sector suffers Effect on Import Competitiveness Improved competitiveness of import competing sector Current Account CAD decli nes ( 2.4% of GDP in 2010 11) During the 2001 2011 period Australia s CAD tended to vary between 2.5% and 6.3% GDP Balance of Goods and Services deficit declines: 2008 09 = BOGS Surplus of $7.6bn 2010 11 = BOGS Surplus of $21.3bn Net Primary Income Deficit rises : 2008 09 = NPI deficit of $45.4 bn 2010 11 = NPI deficit of $54.1 bn CAD stabilises (around 3% of GDP in 2013 14) then rises to over 5% of GDP in 2015 16. Balance of Goods and Services moves back into deficit: 2014 15 = BOGS deficit of $21 bn Net Primary Income Deficit falls: 2014 15 = NPI deficit -$34 bn Net Foreign Debt Slow rise in Net Foreign Debt 2005 06 : $494.9 bn (51.8% of GDP) 2010 11 : $ 685.8 bn (49.4% of GDP) Slow rise in Net Foreign Debt reaches $1 trillion in 2016(54% of GDP) 24