BUSI2025 - International Business - Aussie dollar Case Study - Assessment Answer

Assessment Task: 

In July 2019 the Australian dollar (AUD) was trading at just below 71 US cents, much lower than the 80 US cents where the currency was trading around eighteen months before. It has already fallen below the expectations of investment bank Goldman Sachs, which in April predicted the AUD would fall to 72 US cents by the end of the year. For many years the Australian dollar remained stubbornly high defying the wishes of the Reserve Bank of Australia (RBA), which wanted to see the currency lower. Traditionally, the Australian dollar has been a proxy for the performance of the Australian economy – when the economy was strong the dollar was strong because international traders bought the freely convertible currency. A survey by The Economist magazine, the Big Mac Index, conducted in July 2018, reached the conclusion that the Australian dollar was undervalued by 18 per cent against the US dollar, suggesting the AUD might rise. During most of the past two decades, the Australian dollar has been 30 per cent above its average value, particularly during the 2010-2014 mining boom. It has been a wild ride over the past decade or so with the Australian dollar falling to about 55 US cents back in 2001 before rising to 110 US cents in 2011. Yet most analysts now believe the Australian dollar has much further to fall and well below its long-term average, which in the past was typically in the US 70 cents to 80 cents range.

During the past decade, the AUD’s value has been closely tied to the demand for Australian iron ore, coal, and gas. For example, its rise from a low of US 68 cents in January 2016 to the high-70s in April 2016 coincided with a significant lift in the price of iron ore from $US40 a tonne to about $US90 a tonne. Although iron-ore prices have climbed about 6 per cent from this year’s low to trade at around $66 a metric ton last month, prices are only about half the level seen in early 2014. In September, the Department of Industry, Innovation and Science slashed its forecasts for the commodity, predicting it will drop to $51.10 next year as China begins to cut back its purchases. With iron ore remaining as Australia’s most important export, the expected decline in the iron ore price is likely to put further downward pressure on the Australian dollar. Furthermore, the threat of a growing trade war between the US and China will inevitably harm Australia’s export performance and make global traders nervous about holding Aussie dollars.

A second major reason the Australian dollar has sunk to its lowest level in two years is that the Australian economy is starting to struggle. Major economic indicators show reason for concern – retail spending remains weak, house prices are falling in the major cities, wage growth remains relatively flat, weaker jobs growth – with global traders becoming more reluctant to hold the currency. However, even with these ominous signs, the Australian economy has continued to defy the expectations of many economists with unemployment remaining steady, no significant change in consumer debt defaults (yet), Australia continuing to maintain its AAA credit rating, and its record run of recession-free economic growth since 1991.

But there’s a third reason that the AUD may fall further. In the past, Australia offered better returns on bank interest rates than in American banks and a better yield on 10-year Australian government bonds. If interest rates in Australia are higher than the rest of the world, then investors in London and New York will want to put money here to get the best returns. To invest in Australia, they need Aussie dollars. When they buy Australian dollars, the extra demand forces up the price of an Australian dollar. But at the moment, fewer traders are eager to buy the AUD. Australian interest rates are low and staying low, at least for the medium term, while interest rates keep rising in America as its economy booms. So smart investors are moving their money stateside in search of better returns. They’re selling Aussie dollars for US dollars, and pushing the AUD exchange rate down.

For Australian exporters, a fall in the dollar from historical highs is welcome news. A lower dollar helps both farmers and miners to offset the effects of lower commodity prices. For example, beef exporter Richard Rains explains that “every cent in movement in the A$ is worth the equivalent of $45 million to cattle producers”. Although global beef prices have been high for several years the benefit back to producers has been eroded by the high dollar. But a falling dollar and earlier record production of commodities such as beef, wool, grains, and sugar would inject more money through Australian supply chains.

However, not all Australians are happy to see a lower currency. Importers, shoppers, and Australians travelling overseas will all feel the pain if the Australian dollar slides further. Some importers, for example, have come under severe pressure in recent years, according to one retail expert. Greg Keith, a director at accounting firm Grant Thornton, was appointed as an insolvency administrator at Aquarium Industries, Australia’s biggest importer and wholesaler of ornamental fish. The company supplied around 60 per cent of the Australian market, including around 1000 retailers, and was hurt badly by the sharp fall in the Australian dollar in 2014, and the sharp drop off in consumer spending compounded its problems. Furthermore, a fall in the currency results in a rise in Australian inflation, given that 40 per cent of the Consumer Price Index, a key measure of inflation, includes tradeable goods. Another place where Australian consumers will feel the pain is at the petrol pump. Global forces have pushed oil prices up to about US$85 this week, and with oil traded globally in US dollars, the falling AUD has pushed the price of a litre of petrol to record levels.

Questions

1. If you were an Australian exporter explain how a falling Australian dollar would affect your firm’s sales revenues and profits.

2. What strategies should Australian importers adopt to manage the risk of a falling Australian dollar?

3. For MNCs with assets in Australia and overseas, what strategies would you recommend for maximising the value of your investments if the dollar continues to fall?

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