The downside to a lower Australian dollar

The Reserve Bank's focus on a lower Australian dollar to reinvigorate manufacturing hurts companies reliant on imported raw materials, and may prove futile.

The RBA has made a lot of noise about the economic benefits of a lower Australian dollar recently and most businesses involved in the local tourism sector, and exporters in general, agree a lower currency would help them remain competitive.

Some manufacturers might beg to differ however. In theory a lower Aussie dollar can help make locally-manufactured goods more competitively priced compared to imported goods. In reality, things aren’t so simple.

A 10 per cent drop in the Aussie dollar will, eventually, make imported goods more expensive. Crucially though, this will not necessarily translate to a 10 per cent increase in business for the manufacturer. What it can do is actually increase costs by 10 per cent without a noticeable rise on the other side of the ledger.

Some OzForex clients are expressing a preference for a higher Aussie dollar given they import many raw materials that go into the manufacturing process.

Let’s take for example a clothing manufacturer that proudly states its clothes are "Made in Australia". Remember that certification trade mark with the outline of a yellow Kangaroo in a green triangle? Launched by Hawke in the mid-1980s, it has become somewhat of a rare commodity nowadays, especially when it comes to clothing.

If I am a clothing manufacturer, then as an importer of fabric I want a higher not lower Aussie dollar. The benefit from a reduction in costs can be much more valuable than a more competitive price. A cost saving goes straight to the bottom line and can have a more immediate impact. A more competitive price will only be of benefit if I can attract more customers and sell more clothes. In businesses it is generally easier to cut costs by 10 per cent than grow revenue by the same amount.

The same can be said of many other Australian manufacturing industries that rely on imported raw materials.

It is interesting to see the latest Australian Industry Group (AIG) manufacturing index survey, used to monitor sentiment around the sector, showing a decline to 46.7, from from 47.6, to the lowest level since September. This is a survey of manufacturers in relation to general business conditions and includes things such as new orders and prices – two things that one assumes would be heavily related to the level of the currency. But the index isn't on the way up, it is in decline.


Graph for The downside to a lower Australian dollar

Manufacturers might have been feeling better late last year when the RBA appeared to be “helping” them but it appears the euphoria and general expectations of improvement have begun to wear thin. In fact the February 2014 AIG survey reading shows a lower reading than March 2012 (49.4), even though the Aussie dollar at around 0.89 cents is 20 per cent below its March 2012 levels of around 1.07.

So despite a lower Aussie dollar, manufacturers still don’t feel better about their future prospects. The RBA has placed a lot of emphasis on the manufacturing sector - rightly so given it does employ a lot of people - but targeting a lower currency to help may just prove to be futile.

Jim Vrondas is Chief Currency strategist, Asia-Pacific at OzForex, a global provider of online international payment services and a key provider of Forex news. OzForex Group Limited, is a publicly listed entity with shares traded on the Australian Securities Exchange under the code "OFX".