Roger Donnelly, Chief Economist
Cassandra Winzenried, Senior Economist
The Australian dollar has fallen 5c against the USD since 8 September, feeding expectations that it could fall further. What might be in store for the AUD? And how might exporters fare?
The recent falls in broader perspective
Recent Aussie dollar weakness (Chart 1) has attracted much attention, but in actual fact, the AUD has been undergoing depreciation since mid-2011. Against the USD, it has fallen 19% (or 20 cents) since peaking in July 2011. The depreciation against the broad basket of our trading partners’ currencies, or trade weighted index (TWI), has been less sharp — 12% since peaking in early 2012 (Chart 2).
Has recent AUD weakness boosted exports?
Yes. But resource export volumes have been the main growth driver — basically from the additional supply capacity built during the mining investment boom.
The solid growth in resource export volumes has not been adequate to offset price declines — resource export earnings have declined 13% since peaking in January 2014 (Chart 3).
Commodity prices have thus been a considerable drag — falling 36% since their peak in October 2008, and 15% over the year to date (in AUD terms) (Chart 4).
The price falls have been most severe for non-rural commodities — they are down 39% from their 2008 peak, and 17% over the year to date. Rural price declines have been less severe — prices are down 19% since peaking in February 2011, and only 2% over the year to date (Chart 5). The government’s agricultural research bureau ABARES expects rural export prices to remain largely unchanged in 2014-15, while its resources and energy forecaster BREE expects further price softness for key non-rural commodity exports.
Outisde resources, rural exports have been particarly strong — increasing 9% a year over the past three years. Key services exports like tourism and education have also expanded briskly. Services exports have increased 5% a year over the same period. Conversely, manufacturing exports have been stagnant, a position they have been in for the past decade (Chart 6).
Could the AUD weaken further?
Quite possibly, for two reasons. First, it is still above what might be regarded as its ‘fundamental’ or ‘equilibrium’ value. As the RBA’s September Board Minutes notes, the exchange rate remains ‘above most estimates of its fundamental value, particularly given the declines in key commodity prices’.
The RBA expects Australia’s terms of trade — the ratio of export to import prices — to remain broadly stable over the next several years (chart 7). If the exchange rate continues to decline reflecting the terms of trade adjustment to date, this would help the economy to rebalance towards non-resource exports now that the commodity supercycle is over. In particular, Australia’s services and rural exports will continue to benefit from a boost to international competitivenss.
Needless to say, considerable uncertainty besets the outlook for global growth and the exchange rate, but three broad scenarios seem possible.
1. Continuing global recovery with stabilising commodity prices. Probability 50%. Here the Chinese economy achieves a 'soft landing', the US economy continues to grow, and the eurozone avoids another crisis. Supply and demand come into better balance in most commodity markets. The US Federal Reserve starts to raise official interest rates in 2015. And as a result of a narrowing interest rate differential, the AUD depreciates to around 85c over the next year. With a weaker AUD, yet strengthening world growth, commodity and non-commodity exports alike achieve steady growth. The drag from commodity price weakness fades.
2. China hard landing and much weaker commodity prices. Probability 10%. Here Australia's No.1 trading partner sees its growth slow sharply, which causes both commodity prices and the AUD to fall sharply. But in this case, a cheaper AUD REFLECTS weaker exports, rather than DRIVES stronger exports. In this scenario, a weak AUD is not good news for Australian exporters.
3. Widening growth differential between China and advanced economies. Probability 40%. Here the Chinese economy revives, and the US and eurozone languish. Because of the commodity-intensive nature of the Chinese economy, commodity demand picks up and commodity prices stabilise. What's more, the Fed and European Central Bank keep interest rates ‘lower for longer’ to arrest flagging growth. But the RBA starts to raise official interest rates because the balance of payments remains strong and the wider economy is also strengthening. The combination of stabilising or even rallying commodity prices plus a widening interest differential in Australia's favour pushes the Australian dollar back up. In this scenario, commodity exporters probably do better than non-commodity exporters, because both their volumes and international prices are improving. Non-commodity exporters face buoyant trading partners in China and the rest of Asia, but are handicapped by the stronger AUD.
• How would you cope under each of these scenarios?
• What is your assessment of the probabilities of each?
• Do you see the world evolving in a different way?
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