One of the key constraints to a pick-up in the economy has been the strong AUD. Clearly some industries would be quite happy if the AUD were to depreciate somewhat from its current level.
It is worth keeping in mind, however, that the AUD has now been steady for more than two years, at an average of just over parity against the USD (1.03). Without appreciating further we expect that the drag the AUD has had on growth in various sectors of the economy will start to wear off.
While it has had a dampening effect on some sectors and has been a key catalyst of the structural change in the economy, we expect that the effect on growth will not be permanent.
Indeed, there are some early signs that the depressing effect of the AUD appreciation on growth is already starting to wane, particularly in the tourism industry.
One way the AUD has had its impact of dampening some sectors of the Australian economy has been by making it more attractive for Australian residents to travel abroad. While abroad, Australians spend not just on travel and hotels, but also on retail goods. This has seen significant demand leakage, which has had a tangible impact on the Australian local tourism industry and the retail industry.
While estimates of the size of the tourism industry are not made as a regular part of the quarterly national accounts framework, there are special accounts calculated infrequently suggesting that consumption by tourists probably accounts for around 7% of the value of GDP and employs around 500,000 people.
In 2011, the net flow of tourists into Australia (overseas arrivals less domestic departures) was 1.8 million people. This compared with a net flow of 1.2 million in 2010. Between those two years there was a very large swing. If we assume that the average tourist spends $A3,000 on a two-week holiday on retail sales – as the statistics bureau’s survey suggests – this amounts to $A1.8 billion, which is around 0.7% of retail sales. That is, the AUD appreciation and swing in tourist numbers had a noticeable dampening effect on local retail sales.
More recently, however, we have seen a significant slowdown in growth in international departures. This has come despite the AUD remaining high. This is what you would expect to happen, as the AUD has not continued to appreciate it has not continued to provide increasing incentive for more international travel.
The biggest impact of the AUD on tourism and associated spending occurred when the AUD appreciated in 2009. In that year, the 25% AUD appreciation saw 15% growth in international departures of Australian residents. Over the past year, these departures have only grown by 4%. So while the increase in the net flow of tourists in 2011 was a massive 600,000 people, it is only expected to be 150,000 people in 2012.
The effect of the AUD on arrivals from offshore should also diminish, particularly on arrivals from Asia, as their incomes rise every year which is boosting purchasing power over Australian recreational activities, even without AUD depreciation.
Increased demand for recreation by Asian consumers is already having an effect on the Australian tourism industry. In the past two years the number of short-term visitors to Australia from China has risen from 1.4 million to 2.1 million. Growth in Chinese visits to Australia is by far the strongest amongst the range of countries in that period.
This trend is set to continue. HSBC estimates that 60 million people left mainland China to visit other parts of the world in 2011 and expects this to rise to 130 million by 2015. If Australia only gets a constant share of that increase, then the Chinese will be the most prolific visitors to Australia in three years’ time (second only to New Zealand).
Manufacturers in Australia have been very vocal about the impact of the exchange rate. This is understandable, as it directly affects their competitiveness.
However, the extent of weakness needs to be assessed keeping in mind that there has been a secular downward trend in the manufacturing industry in Australia since the mid-1950s as has been the case in many developed world economies. The downward trend in manufacturing in the West has been mostly driven by global wage differentials rather than currencies per se.
Indeed, despite the high level of the Australian dollar, manufactured exports have continued to rise in recent years.
There has, however, been a faster than usual fall in employment in the manufacturing industry in the past couple of years. This probably reflects the impact of the currency, through a number of different channels.
First, the high AUD makes Australian manufacturing less competitive in price terms, which means local manufacturers’ profits have been under pressure, forcing them to reduce costs. Second, the high AUD encourages local manufacturers to shift their operations offshore, as the strong AUD lowers the cost of production elsewhere in local currency terms. Third, the high AUD puts downward pressure on the prices of imported capital goods encouraging firms to substitute capital for labour.
All of these effects are strongest when the currency is appreciating. The effect of these forces on local growth should start to reduce as firms have spent the past two years making adjustments in the face of the high AUD. In this way we do not expect the high AUD to be a persistent drag on growth in the manufacturing industry.
One area of the Australian economy that has been weak recently, but has medium-term prospects is education exports. Expanding middle classes will drive increased demand for education. Being a developed economy with geographic proximity to Asia should help Australia to take advantage of demand for education services. While education exports have been hampered in recent years by the strong AUD and student visa cutbacks, this area should remain a medium-term focus for policymakers, as it will offer opportunities to Australia in the future.
But there are clearly risks to this outlook.
Paul Bloxham is chief economist for the Australia and New Zealand region for HSBC.
