Impacts Of Rising Australian Dollar On Foreign Trade Economics Essay

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The purpose of this report was to study and analyse the impact of rising Australian dollar on Foreign Trade. This research report analyses various factors that have been driving the value of Australian dollar during and after the Global Financial Crisis (GFC). The study also helps to uncover a range of components which influences the Australian dollars in the short run as well as in the long run.

The policy makers will have to take necessary steps to either minimize or control the short run after effects of a rise in Australian dollar such as incompetent domestic market, Shut down of local manufacturing units, Less Tourism and Unemployment, increase in demand for Australian resources, high commodity prices, high Interest rates and investment by overseas investors are four major reasons behind the rise in value of Australian dollars. The report also found out that a rise in value of Australian dollar has both short as well as long term impacts on various sectors such as domestic exports, tourism, manufacturing and unemployment. But it is certain that in the long run, it helps in stabilizing the Australian economy by creating high income and thus by providing better standard of living and job opportunities. The report also shows that export increases as it becomes cheaper and profitable while import decreases as it becomes costly and unfavourable.

While it is clear that rise in the value of Australian dollar benefits the economy in a significant manner, the report recommends that The policy makers will have to take necessary steps to either minimize or control the short run after effects of a rise in Australian dollar such as incompetent domestic market, Shut down of local manufacturing units, Less Tourism and Unemployment. The report also recommends reducing the dependency on Chinese economy, and trade more with other upcoming economies like Brazil, Russia, and India in order to sustain in the future.

Introduction

The Australian dollar was introduced on 14th February 1966 as a replacement for Australian pound, which was officially introduced in the year 1910. Conversely, the dollar was poised against the British pound than American dollars. After almost two decades, the Australian dollar was drifted to the floating system, which allows its value to rise and fall as a result of change in demand and supply around globe.

It was not too long ago when Australian dollar touched proportional with the American dollar for the first time. Ever since that time, Australian dollar has been traded above parity with American dollars. However, the rising Australian dollars have had both positive and negative impacts on both foreign money market and transactions. The negatives are; export has become very expensive to remaining countries and the value of foreign investments has dipped deeply as each cent gone up against other countries currencies. On the other hand, since the Australian dollars are worth more the domestic public have the advantage of buying more products with fewer dollars while travelling in foreign nations.

Though Australia is very large and wealthy country, the goods and services produced in the country is not sufficient to efficiently meet the demand of the Australian customers. This is because of the modest domestic market we have in this country when compared to other countries. Thus, foreign trade, the exchange of goods and services between the countries, has become an inevitable part of Australia to survive in the present. But, fluctuating dollar rates has been a deciding factor in amount of foreign trade that is being carried out each year. In effect, the amount of import and export decides the Balance of Payment and other monetary and fiscal policy of the Australian government.

The trade weight Index (TWI) determines the value of Australian dollar against other major trading currencies in the world. The following chart shows the fluctuations in the Australian dollar in terms of US dollars and gives a brief idea whether Australian dollar is rising or falling on average (Ravimohan, 2010).

History of Australian Dollar

The Australian dollar was introduced on 14th February 1966 as a replacement for Australian pound, which was officially introduced in the year 1910. Conversely, the dollar was poised against the British pound than American dollars. After almost two decades, the Australian dollar was drifted to the floating system, which allows its value to rise and fall as a result of change in demand and supply around globe.

During the past two decades, the highest value of the Australian dollar proportional to the US dollar was 103.043 cents on 28March 2011. On the other hand, Australian dollar managed to be the 5th most traded currency in the International money market. The Australian dollar had been fluctuating heavily since 2011, but gradually it started to steady down and hit above 96 cents in 2008.

Resource Boom (Import and Export )

According to RBA source, resources consist of more than 50% of the total export (RBA, 2011). In fact, that is the reason why Australia have been doing reasonably well even in the Global Financial Crisis (GFC). On the other hand, the commodity prices have been started growing robustly due to the high demand (Appendix 1). During the past ten years, the commodity prices had hit high twice because of an increase in the exporting of Australian commodities and minerals to other countries (Lowe, 2009). The following chart shows the annual share of total exports to various countries from Australia.

The figure clearly shows the exporting to countries like India and China have increased significantly years. And, the sudden increase in the export to China has certainly helped Australia to attain a favourable Balance of Payment (BoP).

Rise in Commodity Prices

The rise in the Australian dollar has got a lot to do with emergence of the Asian giants such as China and India. Over the past two decades, the GDP of India has tripled and in China's case it has increased more than six times than the base year (Appendix 2). The governments of these Asian countries wanted to renovate and develop their infrastructure in order to boost their economy (Ravimohan, 2010). As a result, Australia, a country which is gifted with ample minerals and proficient production system, had become a large resource provide to the Asian economy over the past twenty years or so (Lowe, 2009).

One of the main reasons for the rising Australian dollar was the higher commodity export prices. The resource boom has started blooming in the year 2004, as the demand increased the price of commodities have also increased, which in turn caused foreign countries to buy more Australian dollars inorder to carry on the trade. In the long run, this resulted in a high demand for Australian dollar hence led to an increase in price of Australian dollar (Gittins, 2009). But as the GFC started affecting the demand of commodities by the foreign countries, the price started declining and brought down the exchange rates. Unexpectedly, the whole scenario started shifting to a favourable side when China recovered from the GFC and initiated trading again with Australia more than they used to trade before (Ravimohan, 2010).

However, if the Australian dollar continues to rise, in the short run it will affect the export trade unconstructively. As each cent rises export becomes costly and import becomes cheaper. At least for a short period of time, the local exporting firms become incompetent in international markets. Except the mining industry, other industrial sectors like tourism and manufacturing will also be affected. Thus the declining exporting and other firms may produce a lot of unemployment in the short run (Ravimohan, 2010).

In the long run, the strengthening mining industry will cover up the unemployment and deficit created in the export but, the economy will be still vulnerable to external threats as other departments like tourism and manufacturing are weak. A strengthened economy results in a higher productivity and growth which in turn creates higher standard of living for the Australian residents.

Most importantly, a rising dollar will be a real test to the policy makers of Australia as the economy will take some time to stabilize and may struggle to efficiently meet the demand from various sources (Eslake, 2009). The domestic market will face huge pressure as import becomes cheaper and confront with cheaper imported products from other countries like India, China, Thailand and other Asian countries. The policy makers should make efficient use of Macro-economic policies to deal with issues such as unemployment.

Interest Rate and Foreign Investments in Australia

Another major reason for the rise of Australian dollar is that unlike some other trading nations, Australia has a unique policy which doesn't allow another currency to directly invest in Australia. That means all foreign currencies should be converted into Australian dollars inorder to make an investment in Australia (Ravimohan, 2010). Despite China doing well, global investors were not able to invest directly in Australia due to strict and stringent investment policies. But, investors saw the opportunity of indirectly investing in China by investing in Australian firms that are directly trading with China. This resulted in humongous buying of Australian dollars in International money market.

Due to the China effect, Australia came out of the GFC almost untouched compared to other developed nations. Owing to this reason, the interest rate did not fall as expected by the economists during the initial half of the GFC. Australia relatively higher interest rate fascinated the global investors, thus avoided the credit crunch pertained in the money market during the period from 2008-2009 (Eslake, 2009). The following chart shows the interest rates in Australia and other major developed counties before and after the GFC.

The above chart shows why Australia was considered as one of the most favourable countries to invest at the current times. As far as I'm considered, the favourability is likely to improve as the RBA is enduring further increase in interest rates (Sharecafe, 2010).

Conclusions

The main reasons of the rising Australian dollar over the past three years are the rapid increase in demand for Australian resources, high commodity prices, high interest rates and recent hike in investment. A rise in the value of an Australian dollar has many positive and negative effects in an economy. In short run, it dries up the economy and creates significant unemployment. But, in the long run it benefits the economy overall. The mining sector produces relatively higher income, which will eventually reach the household through various ways such as salaries and compensations. The higher income flow leads to high spending in the domestic economy which eventually leads to better economic growth in the Australian economy. Undoubtedly, Australia is doing exceptionally well, the financial and monetary policies had successfully endured the GFC and proved it's endurance. But, one of the most challenging problems that Australia is facing right now is; Australian economy is too much depended upon Chinese economy. If anything bad happens to China or its economy, then in all probability, Australia is likely to suffer. According to the economists, India will overpower China by 2025, hence it will also be good to the Australian economy to start trading with India in the same manner.

Findings

The four major reasons for rising Australian dollar are;

Rapid increase in demand for Australian resources

High commodity prices

High interest rates

Investment by overseas investors

Short- term effect of rise in Australian dollar

Incompetent domestic exporters

Shut down of local manufacturing units

Less Tourism

Unemployment

Lon-term effect of rise in Australian dollar

Stable Economy

High generation of Income

High spending

Increased Standard of living

More job opportunities

Export and Import

Export increases as it becomes more cheaper and profitable

Import decreases as it becomes costly

Recommendations

The policy makers will have to take necessary steps to either minimize or control the short run after effects of a rise in Australian dollar such as incompetent domestic market, Shut down of local manufacturing units, Less Tourism and Unemployment. To avoid these after effects the following actions could be implemented;

Provide stimulus packages to each sector prior to the rise.

Provide financial and planning assistance inorder to survive patch in the short run.

Provide training and develop the skills of unemployed to make them available for other jobs.

Reduce the dependency on Chinese economy, trade more with other upcoming economies like Brazil, Russia, and India in order to sustain in the future.

While importing, Deduct or reduce the surcharges and taxes on important and necessary goods that are insufficient in the market.

The government policy makers should ensure that the natural resources and minerals of Australia are not been over exploited for economic expansion.

Bibliography

Eslake, S. (2009, 11 03). The dollar race: edging closer to parity. Retrieved 04 03, 2011, from An online opinion website: http://www.onlineopinion.com.au/view.asp?article=9641

Gittins, R. (2009, 08 03). Australia sitting pretty - home on the boom's back. Retrieved 04 03, 2011, from The Sydney Morning Herald Website: http://www.smh.com.au/business/australia-sitting-pretty-x2013-home-on-the-boomx2019s-back-20090731-e4d3.html

Lowe, P. (2009, 10 19). The Growth of Asia and Some Implications for Australia. Talk to Citi Australia Inaugural Australian Investment Conference . Sydney, New South Wales, Australia: RBA.

Ravimohan, A. (2010). Appreciation of Australia's real exchange rate: causes and effect. Retrieved 03 30, 2011, from RBA website: http://www.rba.gov.au/econ-compet/2010/pdf/first-year.pdf

RBA. (2011, 03 02). Balance of Payments and External Position. Retrieved 04 03, 2011, from Reserve Bank of Australia: http://www.rba.gov.au/chart-pack/balance-payments.html

Sharecafe. (2010, 04 16). Parity For The Dollar: Pain Or Benefits? Retrieved 04 16, 2011, from Share Cafe: http://www.sharecafe.com.au/article_air.asp?a=AV&ai=16423

Appendices

Appendix 1

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