Overvalued AUD

27 August 2012

he past week has been rather interesting in relation to the Australian economy.

It started in a major way when BHP Billiton announced the decline of their annual profit by about a third followed by postponement of major resources projects to the tune of $30 billion.

From then on, political entities reacted in various ways. The Opposition certainly did not miss the window of opportunity to blast the government policies on the resources sector. This in turn was flamed when the BHP Billiton Chief issued statements that echoed such sentiment that Australia would be considered a high cost mining destination.

It did not help the sentiment when the Resources Minister came out to say that the mining boom was over.

Only later towards the end of last week that further analysis by other houses appeared to indicate that some more investments would still be coming in and perhaps the actual peak could still be two years away, i.e. 2014. And despite of declining inflows of mining investments, the actual export receipts of the produce would still be flowing healthily in the years to come.

Nevertheless, against the backdrop of never ending situation in Eurozone, uncertainty in the US economic rebound, China’s confirmed economic slowdown, all of which seem to be already affecting other BRIC nations and even countries usually insulated such as Indonesia which is beginning to register trade deficits, things do not look good globally.

When we combine all these factors that to date have resulted in decline of Australia’s terms of trade, they are negative for the AUD.
It is nonetheless interesting to see how the AUD has been relatively resilient this time around in the face of so much negativity, which leads one to wonder what other positive influences are at play. We could still see that Australia is one of now very few AAA rated nations and that its interest rate is comparatively high. Perhaps these are the remaining supporting factors for the AUD.

Considering all the above, the near term outlook for the AUD is neutral whereas the long-term outlook is beginning to dim. In the longer haul, we might see AUD drop below parity against USD, though not as far as its Purchasing Power Parity level of 0.74 or so. Instead, it might be plausible to suggest that 0.90 or even 0.85 is a genuine possibility, which in turn could help bolster other sectors in the Australian economy as the mining sector growth finally moderates.