Time for the Aussie Government to Step Up

By Ari Charney • October 25, 2013 • Pacific Digest

In recent weeks, we’ve noted that Australia has three factors in place that should help spur an eventual rebound in its economy: historically low interest rates, a weakening exchange rate, and a new, more business friendly government that’s likely to rescind both the carbon tax and the Minerals Resource Rent Tax (MRRT). However, the situation with the Australian dollar has now become more complex, while stronger-than-expected inflation data could cause the Reserve Bank of Australia (RBA) to stand pat on short-term rates.

Until earlier this year, the Australian dollar had enjoyed unusual strength relative to other developed-world currencies, thanks in part to the perception that it’s backed by a resource-based economy. Unfortunately, a strong Aussie made the country’s exports less competitive in global markets, while raising consumer demand for imports at the expense of domestic manufacturers.

Although one of the main goals of the RBA’s easing cycle has been to undercut the Aussie’s strength, the currency didn’t truly weaken until US Federal Reserve Chief Ben Bernanke indicated that the central bank was considering when to start withdrawing some of its extraordinary stimulus. The Aussie subsequently fell below parity with the US dollar, bottoming at USD0.89 in August.

But the Fed blinked when it came time for what many assumed would be a September taper, and the recent government shutdown along with a still sluggish US economy suggest a further delay in the central bank’s eventual curtailment of it’s so-called quantitative easing. That, in turn, has bolstered the Aussie, which is up 7.9 percent since early September and currently trades near USD0.96. Even at that level, the currency is still about 9.4 percent off its year-to-date high.

The currency’s resurgence prompted an intriguing analysis from the Australian Chamber of Commerce and Industry’s outgoing policy chief, Greg Evans, who expects the Aussie to once again reach parity with the US dollar in the coming months. “Relying on a depreciating exchange rate to deliver greater competitiveness may lead to disappointment; more enduring alleviation will come from government and policymakers delivering the big structural reforms, including having a sustainable budget approach, reducing regulatory burdens and removing other cost-bearing rigidities,” he said.

“There has been too much reliance on currency depreciation as some type of silver bullet, and not on reform, which is the crux of the issue.” That may be a spot-on critique, but its perhaps too much to hope for a government in a representative democracy to easily deliver on such structural reforms, even one that’s favorably disposed to the business community, such as the ascendant Liberal-National Coalition.

Policymaking at the federal level is an inherently messy process, so it’s easy to understand why so many would place their hope in a weakening currency as a quick panacea for the economy’s ills. Nevertheless, the onus may now be on the government, as the RBA’s monetary policy could be constrained by a rising real estate market, which we’ve written about previously, along with a sudden surge in inflation, both of which diminish its scope for further easing.

This week, the Australian Bureau of Statistics reported a sharp jump in inflation, with the consumer price index jumping 1.2 percent sequentially during the third quarter, which was four-tenths of a percentage point higher than the consensus forecast and triple the pace of the second quarter.

This result was partially due to a declining Aussie’s impact on the prices of key imports. Although this could cause the central bank to moderate its easing bias to a more neutral stance, the central bank’s cash rate remains at an all-time low of 2.5 percent.

Of course, currency markets are dynamic, and the sudden jump in inflation could prove fleeting. But for now, it’s up to the Australian government to shoulder more of the burden of boosting the country’s economy.

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Our analyses of Portfolio companies’ recent earnings reports are linked below.

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