AUD – Too Strong for Its Own Good?
By Daniel Fink
The trend is posing new challenges for the economy, with Reserve Bank of Australia (RBA) Governor Glenn Stevens saying “the high exchange rate is exerting a powerful force for structural change.”
The results of the June National Australian Bank (NAB) Business Confidence Survey Index again showed that trade-exposed sectors not associated with Australia’s natural resources boom are struggling as a consequence of the currency strength. For another month, business confidence and overall orders were weakest among the retail, manufacturing, wholesale and construction sectors, with the robust AUD blamed for weakening business sentiment.
To help non-mining sectors adapt to this new reality, the 2011/12 budget includes initiatives to increase productivity through education, infrastructure and skills training to expose a greater proportion of Australians to the mining boom’s benefits and the changing structure of the economy. The following examines the three main drivers behind AUD strength.
The Commodity Story
Australia’s resource boom has been the main driver behind AUD appreciation. High commodity prices—terms of trade are at record levels—and increased investment are raising national incomes and putting upward pressure on the AUD. The mining industry is planning to invest AUD76 billion in 2011‑12. Moreover, large liquefied natural gas projects such as the Gorgon, Queensland Curtis and Pluto projects are also attracting high levels of foreign investment-associated capital inflows. Continued demand from India and China for Australia’s commodities will further contribute to higher export prices—the RBA Index of Commodity Prices was up by 12% y/y in June 2011— and AUD strength.
Source: Australian Bureau of Statistics
The Debt Woe Story
As the eurozone confronts its debt woes, the AUD and AUD bonds are increasingly seen as a safe haven for investors. Australia’s sovereign bonds are top-rated by S&P and Moody’s and the government is forecasting a return to surplus in 2013. According to the Australian Bureau of Statistics and the RBA, the amount of Australian government debt held overseas has risen to 73% from 63% in 2009. With the U.S. facing its own fiscal challenges and the prospect of a ratings downgrade, the AUD will continue to be seen as a safer bet. According to Bloomberg, trading of Australian interest-rate futures reached record levels in June while Australian government debt rose by 2.5%, the most among 20 developed markets tracked by Bank of America Merrill Lynch indexes.
Figure 2: Total Outstanding Central Government Debt (US$ millions, 2006-10)
Japan data as of FY2010 (ending March 31, 2011)
Source: OECD, Japan Ministry of Finance
The Diversification Story
Global central banks are increasing their holdings of AUD and AUD bonds as they seek to diversify their reserves. According to the BIS, the AUD was the fifth-most traded currency in 2010 and accounted for 7.6% of average daily turnover in the FX market, an increase from 4.3% in 2001, 6.0% in 2004 and 6.6% in 2007. Most recently, on June 20, Russia’s central bank announced that it would spend up to US$5 billion (AUD4.7 billion) of its US$528 billion in reserves to purchase Australian dollars, beginning in September. Similar trends among central banks seeking to diversify away from euro- and USD-denominated assets could exert additional upward pressure on the AUD.
Figure 3: Currency Composition of Official Foreign Exchange Reserves 2006-11
Note: The IMF Currency Composition of Official Foreign Exchange Reserves (COFER) data does not provide a breakdown of the currencies in the “Other” category, though they are assumed to be composed mainly of AUD and CAD, the two most liquid currencies not specified in the COFER data, according to the BIS. Specified currencies: USD, EUR, JPY, GBP, CHF