The Impact of Exchange Rate Fluctuations On The Australian Economy
Expert reviewed • 21 July 2024 • 8 minute read
What are the Impacts of Exchange Rates on International Trade?
Exchange rate fluctuations significantly impact the Australian economy through the channel of international trade. They have the effect on the following:
- Exports: When the Australian dollar depreciates, Australian exports become more competitive in international markets, as they become cheaper for foreign buyers. This can lead to an increase in export demand, stimulating growth in export-oriented sectors such as mining, agriculture, and manufacturing. Conversely, appreciations in AUD will have the opposite effect.
- Imports: A weaker Australian dollar makes imports more expensive for Australian consumers and businesses. This can lead to a decrease in import demand, as households and firms switch to domestically produced alternatives or reduce their overall consumption. On the other hand, increases in AUD will result in greater import buying power for the domestic economy.
- Trade balance: The net effect of exchange rate fluctuations on the trade balance depends on the relative elasticities of export and import demand. If the Marshall-Lerner condition is satisfied, meaning that the sum of the absolute values of export and import demand elasticities is greater than one, a depreciation of the Australian dollar will lead to an improvement in the trade balance over time.
What are the Impacts of Exchange Rates on Investment?
Exchange rate fluctuations can also impact investment decisions in the Australian economy, both in terms of foreign direct investment (FDI) and portfolio investment.
- Foreign direct investment (FDI): A depreciation of the Australian dollar can make Australian assets more attractive to foreign investors, as they become relatively cheaper in foreign currency terms. This can lead to an increase in FDI inflows, stimulating investment and economic growth in the targeted sectors.
- Portfolio investment: Exchange rate changes can affect the returns on Australian financial assets for foreign investors. A depreciation of the Australian dollar can reduce the returns on Australian assets in foreign currency terms, potentially leading to a decrease in portfolio investment inflows.
Sectoral Impacts and Trends of Exchange Rate Fluctuations:
Exchange rate fluctuations can have varying impacts on different sectors of the Australian economy, depending on their exposure to international trade and their sensitivity to currency movements.
- Mining and resources: As a major exporter of commodities, the mining and resources sector is particularly sensitive to exchange rate fluctuations. A depreciation of the Australian dollar can boost the competitiveness of Australian commodity exports, while an appreciation can reduce their profitability and investment attractiveness.
- Agriculture: The agricultural sector is also export-oriented and can benefit from a weaker Australian dollar, as it makes Australian agricultural products more competitive in international markets.
- Manufacturing: The manufacturing sector in Australia has been in a state of long-term decline, in part due to the challenges posed by a high exchange rate during the mining boom. A depreciation of the Australian dollar can provide some relief to the sector by making Australian manufactured goods more competitive, but the sector also faces structural challenges such as high labour costs and limited economies of scale. Additionally, even though lower exchange rates may help the manufacturing sector, it is still hard to compete internationally, due to manufacturing superpowers like China dominating the market.
- Services: The services sector, particularly tourism and education, can benefit from a weaker Australian dollar, as it makes Australia a more attractive destination for foreign visitors and students. However, the sector is also sensitive to global economic conditions and geopolitical risks.