Influence of Rising in Australian Dollar on Foreign Trade - Essay Example

INFLUENCE OF RISE IN AUSTRALIAN DOLLAR ON FOREIGN TRADE Executive Summary The purpose of the essay is to analyse the impact of rising value of Australian dollar on its foreign trade. This essay provides clear insights into various factors that have been driving the value of Australian currency just after the Global Financial Crisis (GFC). The study also helps to uncover range of factors that influences the Australian economy both in short and long run. The essay found that, the increase in the value of Australian dollar has both short term and long term impacts on various sectors, for instance, unemployment rate, economic stability, manufacturing and tourism. Even if it becomes difficult to overcome these issues in the short run, Australian economy can be stabilized by providing better education training, tightening the fiscal policy, job opportunity and better standard of living. TABLE OF CONTENTS TABLE OF CONTENTS 3 Introduction: 4 Short term economic impacts ~ 4 Long term economic impacts~ 6 Policies that can be implemented to combat trade deficit~ 7 Conclusion: 9 Reference List 10 Appendix: 12 Introduction: Over the last few decades, the rise in value of Australian dollar has become a subject of discussion among the economists. The appreciation in real exchange rate refers to the increase in the price of the average domestic goods or services relative to the price of average foreign goods and services. It leads to increase in current account deficits and rising in foreign debt (Henry, 2010). The rise in Australian dollar has both positive and negative impacts on foreign money market and its transactions. Since the value of Australian dollar is high, domestic people have the advantage of buying more products with fewer dollars while travelling in the foreign countries. However, dollar appreciation makes export more expensive in comparison to the other countries and at the same time, value of foreign investment goes up. Though Australia is a large and wealthy country, the value of goods and services produced within the country is not sufficient to meet the demand for its local customers. Thus, foreign trade to exchange of goods and services has become an inevitable part for Australia to survive in the present scenario. However, fluctuation in dollar value has been one of the important factors in deciding the volume of foreign trade and in effect is an indirect indicator of balance of payment and monetary & fiscal policy of the Australian government. The current essay seeks to analyse the extensive implication of currency appreciation of Australian economy over its foreign trade. Short term economic impacts ~ As per the economic theory, appreciation in the real exchange rate has both positive and negative impacts on an economy. In most of the cases, the impacts are diverse and extensive. In short run, major implication for increase in Australian dollar is improvement in terms of trade (Gittins, 2009). Improvement in terms of trade causes trade deficits as export become more expensive and import becomes cheaper. The increase in terms of trade allows larger volume of import and thereby, raises the purchasing power of the domestic production. With the change in relative price, there is likely to be decrease in demand for export in foreign countries and higher domestic spending on imports. Thus, the current account deficit may get worsen in short-run. From the starting of 2008, the value of Australian dollar has risen significantly against US dollar and some other currencies, such as euro and pound. For an economy like Australia, successful export business and industries is the key to future development. Some economists like Frankel and Froot (1987) and Tease (1988) argued that, rise in dollar helps Australian economy to control its inflation rate as strong exchange rate is effective to decrease money supply in the domestic market. A rise in exchange rate makes export product more expensive in foreign market, while import products cheaper (Reserve Bank of Australia, 2005). It signifies that the range of outflow of money is very high in comparison to the money inflow into the economy. Thus, there will be less money into the economy for circulation and up to some extent it is overall money supply will be in control. However, if the Australian dollar continues to raise, in short run it may affect the export trade negatively (for graphical representation refer to the Appendix). As export is getting expensive; the local exporting companies are facing tough competition in the global markets. Except the mining industry, the other industry sectors like, manufacturing and tourism industries also get highly affected. The tourism sector in Australia is made up with foreign as well as domestic tourists. Domestic travellers consider that overseas tours to be cheaper in comparison to the domestic travelling. Most of them prefer to go outside the Australian nation to spend their holidays. For example, when Australian dollar shot up to 93% of the US dollar, 18% of the people moved from Australia to spend their holidays (Lowe, 2009). At the same time, for foreign tourists, the cost of travelling to the Australian country seems to be higher in comparison to the other nations and thereby, they reconsider their tourist destination. For instance, in the beginning of 2008, when Australian dollar increased from 80% of US cents to 92% US cents, the number of visitors has declined to 0.7% (Economics Online. 2014). Based on all these statistics, it can be said that, appreciation of dollar has damaged the Australian tourism industry through weakening its inbound arrivals. Further, increase in exchange rate decreases effectiveness of the domestic firms to compete in the foreign markets. Consequently, due to the contraction of various industries, there will be an obvious increase in the unemployment rate. Long term economic impacts~ In long run, the main implication of currency appreciation is structural change within the Australian economy. Since an increase in dollar indicates exports to be more expensive, export industries become less competitive in the global market. Industries, those are unable to face high competition will contract (Lowe, 2009). This results in release of capital and labour which were previously being used in nonperforming businesses and thereby will be reallocated to mining industry. The mining industry in Australia is very developed and is a major contributor to the economy, reallocation of resources in this area will result in higher productivity and economic growth. This will in turn improve standard of living of Australian people. Further, structural change within the economy causes opportunities of higher unemployment in expanding sectors, for instance mining sector. The subsequent increase in the employment opportunities will cause decrease in unemployment rate. Although, some economists like Tease (1988) argued that, currency appreciation has caused rise in structural unemployment rate in Australian economy. According to him, major impact of increase in Australian dollar is the rise in structural unemployment. Labour contracted from inefficient businesses are getting enough chance to be employed in mining sector, but worker discovers that the skills of the worker were not appropriate with the emerging employment opportunities in mining industry (Meese and Rogoff, 1983). Thus, dollar appreciation might have long-term impact on unemployment rate in Australian economy. The continuous increase in the export rate and decrease in import may cause unstable economy in long-run. The strong dollar rate de-motivates domestic as well as foreign investors to make their investment in Australia. This decrease in investment will hinder development of the economy in long run. Furthermore, tourism and some other related service also suffer from increase in the exchange rate. Beside these, declining in tourism and other exported service drives down Australian GDP. All these can prove to be a sustainable negative impact for Australian economy. Moreover, persistently Australian economy has lower level of national savings, while development of mining sector requires huge investment and thereby needs to borrow from the overseas market and this leads to further deficit on current account. The widely rising foreign debt is a matter of concern for the economy. However, Bernanke et al. (2008) suggested that, rise in foreign debt is not an issue if the imported capital is being used productively. Policies that can be implemented to combat trade deficit~ Concern about negative impacts of a higher dollar rate led some noted arguments over allowing exchange rate to float freely and take some policy instruments to reduce. As noted from the earlier discussion, appreciation in real exchange reinforces the interest rate on economic activities, while also reducing import price and thereby strengthen the current account deficits. In this context, if the policy maker wants to target lower interest rate, it will be easier for RBA to implement monetary policy (Blundell-Wignall and Gregory, 1990). If the interest rate set to the level of target inflation rate, in respond to that, higher inflation would be incompatible to holding down the exchange rate. Thus, the only way to sustain a lower exchange rate is to shift the monetary policy away from the targeting exchange rate. Another way in which lower exchange rate can be achieved without sacrificing the macroeconomic stability is through tightening the fiscal policy (Economics Online, 2014). Increase in taxation or cutting down government spending has a significant impact on economic activities. It leads to decrease in disposable income of the people and thereby, spending less on imported goods. A sufficient large fiscal policy is effective to balance the exchange rate without causing inflationary pressure on the economy. Achieving substantially lower exchange rate by Australian economy, demands for larger fiscal contraction as it is appropriate to face current global economic environment. Apart from fiscal and monetary policy, acquiring foreign assets by Australian government can be another way to control trade deficits (Froot and Frankel, 1989). This is unlikely to have material impacts on the exchange rate. A strong Australian dollar leads to structural unemployment within the economy through contraction of non-resource sector of the economy. Some macroeconomic policies significant to address the problems can be invested in training and education program. This includes retaining employees who have lost their jobs due to structural change. This policy can be implemented by collecting additional tax revenue from the increasing profits of mining companies. Thus, in order to combat unemployment issue, policy makers needs to invest the tax revenue in more sustainable way. Conclusion: The current essay focused on analysing the implication of currency appreciation over foreign trade of Australian economy. The study revealed that the rise in the value of Australian dollar has both short run and long run within the economy. In short run, it leads to liquidity crisis in the economy and create unemployment problem, while in the long run it indicates lower level of savings and unstable economy. Fiscal and monetary policies have successfully entered into the economy and proved to be effective to balance the economy. However, Australias dependence on China is increasing and thus, if anything happens wrong with the Chinese economy, it will have simultaneous impact on Australia. Thus, it will be good for Australia to start trading with some other countries also in the same manner, so as to avoid the over dependence. Reference List Blundell-Wignall, A. and Gregory, R.G., 1990. Exchange Rate Policy in Advanced Commodity Exporting Countries: Australia and New Zealand, in V. Argy and P. de Grauwe (eds), Choosing an Exchange Rate Regime: The Challenge for Smaller Industrial Countries, International Monetary Fund, Washington, D.C., pp. 224-271. Meese, R.A. and Rogoff, K.. 1983. ‘Empirical Exchange Rate Models of theSeventies: Do They Fit Out of Sample?’, Journal of International Economics, 14(2), pp. 3-24. Frankel, J.A. and Froot, K.A. 1987. Using Exchange Rate Data to Test Standard Propositions Regarding Exchange Rate Expectations. American EconomicReview, 77(1), pp. 133-153. Bernanke, B.S., Olekalns, N., and Frank, R.H., 2008. Principles of Macroeconomics, 2nd ed. McGraw-Hill Australia, Sydney. Gittins, R. 2009. ‘Ignore cries of woe over soaring dollar’, Sydney Morning Herald, 17 October, pg 5. Lowe, P. 2009. ‘The Growth of Asia and Some Implications for Australia’, Address to Citi Australia Inaugural Australian Investment Conference, 19 October, Sydney. Reserve Bank of Australia 2005. ‘Commodity Prices and the Terms of Trade’, RBA Bulletin, April. Henry, K. 2010. ‘Fiscal Policy and the Current Environment’, Address to the Australian Business Economists forum, 18 May, Sydney. Froot, K.A. and Frankel, J.K. 1989, ‘Forward Discount Bias: Is It an ExchangeRisk Premium’, Quarterly. Journal of Economics, 104(1), pp. 139-161. Lowe, P., 2009. The Growth of Asia and Some Implications for Australia. Talk to Citi Australia Inaugural Australian Investment Conference . Sydney, New South Wales, Australia: RBA. Tease, W.J., 1988. Speculative Efficiency and the Exchange Rate: Some Evidence Since the Float. Economic Record, 64(189), pp. 2-13. Economics Online. 2014, Trade Problems and Policies. [online] Available at:< http://www.economicsonline.co.uk/Global_economics/Balance_of_payments_problems_and_policies.html> [Accessed 8 October 2014] International Economics. 2014, Factors which affect exchange rates. [online] Available at:< http://www.sanandres.esc.edu.ar/secondary/economics%20packs/international_economics/page_59.htm> [Accessed 8 October 2014] Appendix: (Source: International Economics. 2014) Read More