ECON910 Assignment: Factors Influencing AUD Depreciation in 2018

This assignment analyzes the depreciation of the Australian Dollar (AUD) against the US Dollar (USD) in 2018, examining the economic factors contributing to this trend. The analysis identifies key drivers, including the slowdown in the Eurozone and China, which have increased demand for the USD as a safe haven, while simultaneously decreasing demand for the AUD. The assignment explores the impact of these factors on the AUD-USD exchange rate, illustrating how supply and demand dynamics influence currency valuation. It presents a graph depicting the historical exchange rate and discusses the effects of interest rate changes by the Federal Reserve and the Reserve Bank of Australia (RBA). Furthermore, it delves into the impact of AUD depreciation on exporters and importers, providing examples of how currency fluctuations affect revenue and competitiveness. Finally, the assignment addresses the RBA's potential strategies to appreciate the AUD, including increasing the cash rate, and discusses the associated economic consequences, such as potential impacts on domestic growth, consumer spending, and investment.

ECONOMICS FOR PROFESSIONALS
ECON910
STUDENT ID:
[Pick the date]

(a)The given article highlights that the AUD has witnessed depreciation to the tune of 10% in
2018 and has therefore reached the lowest level with regards to USD. The article also
indicates the various factors which are responsible for this trend. One of the key issues that
has been indicated in the article is the slowdown which has been witnessed in the Euro
region. This is apparent from the falling new orders coupled with the falling
manufacturing PMI. On account of growth concerns globally, the USD is emerging as a
safe haven to park funds to preserve value while earning some nominal returns. This is one
of the key factors which is fuelling the demand for USD and leading to its appreciation
against various currencies including AUD (Moore, 2019).
Another factor that is significant in the Australian context is the current slowdown being
witnessed in the Chinese economy (Moore, 2019). This is expected to have significant
implications for the Australian economy considering that China is the largest export
destination for Australia especially with regards to various mining commodities. A slowdown
in China would have significant adverse impact on the mining exports which are responsible
for about 40% exports from Australia. The prices of key exports such as coal, iron ore have
already started correcting in the expectation of weak demand from China going forward
(Chau, 2019). The collective impact for Australia would be lowering trade surplus or
potentially increasing trade deficit. A negative movement with regards to current account
would lower the demand of AUD and lead to depreciation against the USD (Mankiw, 2014).
The above factors tend to impact the AUD-USD exchange rate through the demand and
supply forces. Typically a given currency tends to appreciate when there is an increase in
demand of that current relative to the foreign currency under consideration. For instance, if
there is an increase in the AUD against the USD, then there would be an appreciation of
AUD. However, when there would be lower demand of a currency relative to the foreign
currency, then this would lead to depreciation of the currency (Arnold, 2015). For instance, if
there is an increase in the USD against the AUD, then there would be an appreciation of USD
leading to AUD depreciation. The supply factors also can influence the exchange rate. For
instance, if there is excess USD printing by the Federal Reserve, then the supply of USD
would increase leading to depreciation to USD and appreciation of AUD (Barro, 2015).
(b)The requisite graph for the nominal exchange rate for AUD in terms of USD has been
drawn using Excel based on the historical data obtained from RBA. This is indicated
below (RBA, 2019a).

From the above graph, it is apparent that the AUD has been stable and appreciating against
the USD in 2016 and 2017. This is apparent from the fact that the exchange rate moved from
USD 0.76 to USD 0.81 for one AUD. This may be attributed to the recovery in the Australian
economy witnessed during 2016 and 2017. Also, during this period, the Chinese economy
was also quite robust. The improvement in economic growth for Australia during this period
can be indicated from the fact that there were expectations that RBA would increase the cash
rate in the first half of 2018. However, during the last year i.e. 2018, there has been
significant depreciation in the AUD against the USD.
One of the factors responsible for this depreciation in AUD is the increased demand for USD
on account of slowdown in the Eurozone, Japan and UK. On the other hand, US economy in
the first half of 2018 showed significant signs of improvement which led the Federal Reserve
to increase the interest rates in US along with policy stance (RBA, 2019b). In this scenario,
US government bonds tend to serve as a attractive investment owing to the risk free status.
Further, situation for Australia has worsened from the middle of 2018 as there have been
news about slowdown in China in the backdrop of US –China tariff war. These fears have
been confirmed in the recent months when China has unleashed the biggest economic
stimulus package since 2008 (Laursen, 2019). Further, the domestic macroeconomic
indicators in Australia have also worsened resulting in pessimistic future outlook. The recent
RBA minutes are testimony to this as it recognises the various risks to Australian economy
(RBA, 2019b). As a result, many economists are expecting that interest rates would not be
increased by the RBA in the near future. This has led to further drop in AUD against the
USD.

(c)There are various factors which are leading to the depreciation of AUD against the USD.
Some of the main factors have been outlined in the given article. One of these is the falling
manufacturing PMI in almost all major economies including Eurozone, China. The global
manufacturing PMI has been dropping for the last eight months and has touched the
lowest level in two years. This clearly highlights towards a slowing manufacturing sector
globally which is an indicator of tepid growth. Amidst this tepid growth, there are
concerns of global slowdown (Moore, 2019). In such an uncertain scenario, there is a
tendency on the part of investors to put their money in safe investments such as US
Treasuries. As more people want to buy US treasury bonds, there is increased demand for
USD leading to its appreciation which is not limited to only AUD but practically all other
currencies (Mankiw, 2014).
Another relevant factor that has been outlined in the article is the sharp drop in commodity
prices such as copper and aluminium. This does not auger well for the Australian economy as
it is a major exporter of various mineral commodities (Moore, 2019).=. The amount of
exports besides volume is contingent on the price of these commodities which tends to
fluctuate depending on the underlying demand supply scenario. With China witnessing a
slowdown, the demand for various mining commodities is expected to slowdown which
would lead to an adverse impact on the Australian economy thereby contributing to the fall of
the AUD (Arnold, 2015). Yet another factor that is relevant as per the article is the
probability of an increase in the cash rate by the RBA in the current year has become highly
unlikely (Moore, 2019). This is also leading to the AUD depreciation against USD. A higher
interest rate would have meant better returns for the domestic and foreign investors. This
would have resulted in some incremental foreign funds flow into Australia besides retaining
domestic funds which may have gone abroad. The above impact would have led to higher
demand of AUD thereby enabling appreciation of AUD (Barro, 2015).
On one hand, there is a general global slowdown owing to which USD is in high demand
since it is widely seen as a risk free asset meant for capital preservation. On the other, the
Australian exports are reducing which is expected to reduce the net exports which would
imply lowering demand for the AUD. Considering that USD is in high demand while demand
of AUD is comparatively low, it is not surprising to note that there has been a depreciation in
the AUD with regards to USD. Clearly, USD is appreciating against the AUD on account of
higher demand (Mankiw, 2014).

(d)The impact of the depreciating AUD against the USD needs to be outlined from the
purview of an exporter. The current decline in the AUD would auger well for the software
business which is exporting to US. This is because the revenue for this company would be
derived in USD. Even though the revenue in USD would remain constant but owing to the
AUD depreciation, the amount in AUD would increase (Arnold, 2015). This has been
explained through the following example.
For instance, consider the conversion rate of 0.8USD = 1 AUD. At this rate, USD $80,000
payment by the customer would imply AUD $ 100,000 for the Australia based software
company. However, now consider that there has been depreciation in the AUD against the
USD. As a result, the new conversion rate is 0.7USD = 1 AUD. At the new conversion rate,
the earlier payment of USD 80,000 would imply (80000/0.7) or AUD 114,286. Thus, it is
evident that as an exporter, the software firm is benefitted owing to incremental revenue that
would contribute to higher earnings. Also, the depreciation of currency would make the
exports more competitive as Australian exporters can reduce their prices owing to a
favourable currency exchange rate (Barro, 2015).
It is imperative to note that while the AUD depreciation would be positive for the exporters,
it would have adverse implications for the importers. This is because the importers would
need to pay a higher amount in terms of AUD to pay for their USD dominated imports. Also,
it is possible that these higher cost imports may lead to inflation owing to increased cost of
production especially if the final product would be used domestically. In the Australian
context, considering that there is a trade surplus, depreciation of currency would be beneficial
and could potentially lead to increased trade surplus in the short run. The exporters on
account of higher exports would provide greater revenue to the government in the form of
taxes which to an extent might be adjusted against the higher costs of imports. However, the
overall impact is still expected to be positive on the economy and in the long run would exert
an upward pressure on the AUD (Mankiw, 2014).
(e)It is known that there is stabilisation of interest rate at USD 70c per AUD. The Reserve
Bank of Australia wants to bring the exchange rate to USD 73c per AUD. This implies
that the AUD should appreciate against the USD. In order to achieve the same, RBA
should increase the cash rate by 25 bps points immediately. Owing to an increase in the
cash rate, the interest rates would increase. The higher interest rates would imply that the
yields on government bonds and other corporate bonds would improve. This would attract

the interest of foreign investors who would want to increase their investment in the
Australian debt instruments. As a result, there would an increased demand of AUD since
foreign money would play into Australia. Additionally, it is possible that the domestic
investors who might be investing in foreign debt may also start investing in Australian
debt markets after the increase in cash rate (Froyen, 2013). This would result in lowering
the demand for USD to some extent and hence provide upwards support to the AUD. The
net result of the above measure would be visible in the form of appreciation for the AUD
against the USD which would lead to achievement of the desired exchange rate (Krugman
and Wells, 2016).
However, the above action would have side effects. The most prominent of these would be
visible in the form of slowing domestic economy. The current macroeconomic indicators for
the Australian economy are not quite encouraging. Further, the concerns regarding the China
slowdown have further accentuated which spell greater trouble for the domestic economy
considering that China is the largest trade partner for Australia (Barro, 2015) Also, higher
interest rate would imply lower credit offtake which would have an adverse impact on
consumer spending. Further, the private investment would also be dampened on account of
higher finance costs and lower consumer demand. Considering that private investment and
consumer spending are two vital components of GDP, hence lacklustre performance on these
counts would have an adverse impact on GDP growth. As a result, the RBA would need to
be cautious with taking such a step (Koutsoyiannis, 2014).

References
Arnold, A.R. (2015). Macroeconomics, 9thed. Sydney: Cengage Learning, pp. 123-126
Barro, J.R. (2015) Macroeconomics.2nd ed. New York: MIT Press, pp. 56-58
Chau, D. (2019) Australia's fortunes are linked to China's economy — for better or worse,
[Online] Available at https://www.abc.net.au/news/2019-01-15/china-economy-slowdown-
will-affect-australia/10716240 [Accessed 3 April 2019]
Froyen, A. (2013) Macroeconomics. 3rd ed. New Delhi: Pearson Education, pp. 89
Koutsoyiannis, A. (2014) Modern Macroeconomics. 4th ed. London: Palgrave McMillan, pp.
78
Krugman, P. and Wells, R. (2016) Macroeconomics.3rd ed. London: Worth Publishers, pp.
101-102
Laursen, L. (2019) Why China Just Injected $83 Billion into Its Economy, [Online] Available
at http://fortune.com/2019/01/16/china-economy-83-billion-stimulus/ [Accessed 3 April
2019]
Mankiw, G. (2014) Macroeconomics, 6thed. London: Worth Publishers, pp. 110-113
Moore, T. (2019) Australian dollar tumbles to ten-year low, [Online] Available at
https://www.smh.com.au/business/markets/australian-dollar-slides-below-us70c-20190103-
p50pbq.html [Accessed 3 April 2019]
RBA (2019a) Historical Data, [Online] Available at
https://www.rba.gov.au/statistics/historical-data.html [Accessed 3 April 2019]
RBA (2019b) Minutes of the Monetary Policy Meeting of the Reserve Bank Board, [Online]
Available at https://www.rba.gov.au/monetary-policy/rba-board-minutes/2019/2019-03-
05.html [Accessed 3 April 2019]