Asia Business

Australian dollar's rise creates dilemma for economy

From the Pacific peso to parity with the greenback and now beyond: the Australian dollar goes not so much from strength to strength but from historic new high to historic new high.

In the past week it reached $1.07 against the US dollar, and there is talk of it crossing the psychologically important threshold of $1.10 over the next six months.

Since the currency floated in December 1983, it has never reached such heights.

"Up and up the Aussie dollar goes,' says Stephen Long, the ABC's economics correspondent, "where it stops, nobody knows."

It has been a remarkable turnaround. At the time of the Sydney Olympics in 2000, a US dollar was buying two of its Australian equivalent. In the past year alone, it has gained 15% against the US dollar.

Needless to say, the rise of the Australian dollar partly reflects the slump in the value of the greenback - what might be called a push factor.

Driving forces

But there are pull factors as well, which are heightening investor appetite to the point of drooling salivation. Australia has comparatively high interest rates - 4.75% compared with 0% in America.

The 10-year government bond yield is at 5.5%. There is low sovereign debt and a tightly regulated banking system.

Overall, the economy is strong, with unemployment just under 5%, the level that economists refer to as full employment.

Australia has not experienced a recession since the early 1990s, and managed to avoid a downturn after the global financial crisis.

Above all perhaps, it is the surge in commodity prices that is fuelling the resources-linked currency.

In just 24 hours in the past week, the price of copper rose by 2.5%. Gold has reached a record high and the Australian dollar has been basking in the glow.

Investors want a slice of China's growth, and the Australian dollar has not only come to reflect the strength and stability of the local economy but the enormous growth potential in China.

Purchasing power

Australia currency notes
A strengthening currency has brought many tertiary benefits to the Australian consumers

Aside from global bragging rights, Australians are enjoying a number of economic benefits from their high-flying currency.

First, it is helping to dampen inflation pressures, a major concern of the Reserve Bank of Australia that has pursued a policy of raising the cost of borrowing from the emergencies levels set in the aftermath of the global financial crisis.

Though oil prices have surged over the first quarter, rising by 14%, import prices overall have risen by just 1.4%, which is acting as a drag on inflation.

The cost of computers and imported cars actually fell during the first quarter.

All this means that the Reserve Bank of Australia might defer further hikes in interest rates, which is obviously good for home owners with mortgages.

Australian international travellers are also massive beneficiaries. Getting much more bang for their Aussie buck, America has now become a relatively cheap destination, and many Australians are enjoying their shopping sprees in New York and Los Angeles.

Flip side

However, there are some drawbacks. The high Australian dollar is hammering the local tourism industry.

After her high profile visit in December, which was largely financed by the sector, the Australian tourism industry hoped to cash in on the Oprah effect.

Beach in Australia
Tourism has been one of the hardest hit sectors due to the strong currency

But the dollar effect is more profound. At both the luxury and backpacker ends of the market, operators are being hit hard.

Some cruise companies are reporting that business is 60% down, and that the massive discounts they are having to offer is hitting the bottom line.

The same is true of hostel owners, because backpackers are either tightening their belts or are being put off coming.

For the tourism industry, it is a double whammy, since so many Australians who might normally holiday at home are looking to travel abroad.

For Australian exporters as well, the soaring dollar is undermining their competitiveness, and eating into their margins.

The exception is the resources sector. There are two broad reasons for this. First, the seemingly insatiable global demand for iron ore and coal, especially from China. Second, many of Australia's commodity exports are priced in US dollars.

Future course

Will the Reserve Bank of Australia stage an intervention?

Its policy is to favour a free float, which is shorthand for letting the market set the value of the Australian dollar.

In an interview with Bloomberg Television, Kevin Rudd, the foreign affairs minister and former Prime Minister, also came out strongly in favour of a lassez-faire approach.

'We don't intend to drift back to anything which seeks to manipulate our exchange rate,' he said.

'And those countries that do I think ultimately pay a price," he added.

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