The Australian dollar’s plunge to a seven-year low is turning out to be a blessing as China steers its slowing economy away from the heavy industries that helped fuel a mining boom Down Under.
It’s more than four years since a record-high Aussie threatened to destroy manufacturing and hamstring the economy. Instead, the currency’s steepest three-year slide since it was floated in 1983 is working its magic - a weaker local dollar has spurred record tourist arrivals and education income. And it’s tempered the drag from iron ore’s plunge to unprecedented lows while making the nation home to the world’s lowest-cost miners.
Australia stands out in getting the currency boost it needs at a time when economies the world over are grappling with exchange rates considered undesirable. The Aussie is in line with economic fundamentals, after being 25% or more overvalued in 2013. China is struggling to curb yuan declines and Saudi Arabia is burning through reserves to maintain its peg to a strengthening greenback. Policy makers in Europe and Japan have pushed interest rates below zero, risking accusations of competitive devaluations.
“The fall in the Australian dollar has helped support the recovery and restructure the economy, so it is a good example of how a floating exchange rate should act,” said Greg Gibbs, director of Amplifying Global FX Capital in Breckenridge, Colorado, who has spent over two decades in the currency markets including stints at the Reserve Bank of Australia and with lenders in Sydney, New York, London and Singapore.
RBA Governor Glenn Stevens stopped calling for a weaker currency in August and subsequent declines drove the Aussie closer to fair value than at any time since the global financial crisis, according to a measure of purchasing power parity based on producer prices.
Stevens pointed in December to new opportunities for growth as Asia’s middle class demands more services, energy and food, filling the economic vacuum left by a contraction in mining investment.
The impact of the Aussie’s decline has been particularly apparent in the “sizable contribution” of services exports to growth, the RBA said in November, acknowledging the labor-intensive sector’s role in helping to push unemployment to a two-year low.
The currency has also absorbed much of the impact of a more than 60% slide in prices for iron ore and coal from their 2011 highs. Earnings from goods shipments fell just 14% till November from a peak two years earlier, also aided by rising volumes of Australia’s main resources as the mining boom’s bounty comes on line.
“In many ways Australia has proven to be unbelievably lucky once again,” said Klaus Baader, chief Asia-Pacific economist at Societe Generale in Hong Kong. The Aussie was high when the country needed to import capital goods to build new mines and now it’s fallen “very significantly, which helps to contain production costs and it’s contributed to making Australia very competitive even at lower prices.”
Australia’s dollar fell in London on Monday, extending its 36% slide from a post-float record of $1.1081 reached in July 2011 at the height of the mining bonanza. The currency weakened as China’s official factory gauge signaled a sixth month of contraction in January, the longest such stretch on record.
It averaged more than $1 for three years to the middle of 2013, spurring Stevens to signal the need for currency depreciation - and to cut interest rates - to wean the economy off a dependence on resource-sector spending. Forecasters see it at 69 cents by year-end, according to estimates compiled by Bloomberg.
The Aussie is 1.2% overvalued according to the PPP measure. It reached about fair value at the end of September from being about 30% overvalued as recently as three years ago.
While the RBA’s battle with foreign-exchange traders appears to have ended, China’s has just begun.
The Asian nation has run down reserves, squeezed traders in Hong Kong with 67% overnight borrowing costs and used state media to warn speculators, including billionaire investor George Soros, to deter bets on rapid yuan depreciation. Saudi Arabia, the world’s largest oil exporter, used 16% of its currency stockpile last year to defend the riyal while Mexico’s shrank to a two-year low in November amid intervention to bolster the peso.
Central bankers in Europe and Japan are meanwhile wary of strengthening currencies as they struggle to spur inflation and economic activity. Japan’s central bank on Friday surprised markets by introducing negative rates, weakening the yen as much as 2.4%. European Central Bank President Mario Draghi, already using negative policy settings, on January 21 signaled a further expansion of unprecedented accommodation. The actions hint at the type of race to the bottom known as a currency war, said John Kanas, chief executive officer of Miami Lakes, Florida-based BankUnited, speaking on Bloomberg Television after the BoJ’s decision.
In Australia, the currency boost to activity will help the economy expand 2.6% this year, up from 2.3% in 2015, the fastest pace among 11 developed economies after Sweden. It will also help drive a 7.2% gain in exports, up from 6.3% last year, analysts forecast.
“Net trade is likely to remain a key growth driver over the next few years,” Rick Harrell, an analyst at Loomis, Sayles & Co in Boston, wrote in an e-mailed response to questions. “This also means the Australian economy has become increasingly fragile and hostage to demand from emerging Asia and the broader global economy.”
Harrell said he expects that dependence to keep the Aussie in a lower trading range given the weakness in Asian economies and in commodity prices, while also driving greater currency volatility.
As Australia’s export profile improves, at home it faces the risks of a slowing housing construction boom, record low wage growth and the potential for a slump in consumer spending.
That’s prompted markets to maintain pricing for the central bank to cut its record low 2% benchmark rate at least once this year.