A strong dollar and a drop in coal exports are affecting Australia’s competitiveness, but the country’s economic health remains solid. Melodie Michel reports.
Australia’s gross domestic product (GDP) grew by 3.2% in 2012, marking its 21st consecutive year of economic growth. It would be wrong to say that the country has not been affected by the global financial crisis of 2008, or the ongoing financial uncertainty in the eurozone, but compared to other developed economies, Australia seems to be playing its cards right in these challenging times.
In 2011/12, the country’s goods and services exports increased by 6.2% to A$315.8bn, with export volumes up 4.6% while prices rose by 1.6%. This was mainly driven by commodities (62.8%), particularly minerals and fuels.
Asian proximity
The principal reason behind Australia’s resilience is its geographical proximity to ever-growing Asia – with 55.2% of exports going to China, Japan, South Korea and India.
Michael Reidy, head of trade and working capital finance at Commonwealth Bank of Australia (CBA), tells GTR: “Asia has been a major support for export, as 70% of Australia’s overall export volumes go to the Asia Pacific countries. The proximity to Asia as a major growth market has been beneficial for us, especially with the very tough environment in Europe.”
But while beneficial to the commodities industry, the proximity to Asian markets has a flip side for other sectors. Australian exporters are having to compete with the low costs of manufacturing in the region, made worse by an Australian dollar that has increased by over 15% over the past three years. “Whilst the commodity sector has remained robust, and was for some time masking the impact of the high dollar via stronger commodity prices, other parts of the Australian export market have found conditions challenging, particularly smaller to medium-sized businesses,” says Alan Huse, head of transaction banking for Australia and New Zealand at ANZ.
While primary product exports rose by 9.2% in the past year, manufactured product exports only grew by 1.1%. Matthew Durban, senior economist at the Australian Trade Commission (Austrade), explains that the appreciation of the exchange rate is a side effect of the commodities boom induced by strong growth in Asia. And while the negative impact of a strong dollar is being curbed by substantial investment in productive capacity in the natural resources segment, other export sectors are struggling.
“Certainly the non-mining sector has been under increased competitive pressure from the strong Australian dollar. Exports of manufactured products from Australia remain well below their 2008 peak, even though the volume of global trade has surpassed its 2008 level. In particular, some of Australia’s more traditional manufacturing export sectors, such as construction materials and road vehicles, are well down on their earlier levels,” says Durban.
As a result of these tight market conditions, companies in all sectors are putting a larger focus on improving their cost competitiveness through better working capital management. This has led to an interest in more efficient management of their supply chains, including through financing options allowing them to extend or accelerate payment terms. “More generally, there has been an overlaying trend of shifting to more financing of trade on an open account arrangement as opposed to using documentary instruments. This can take some costs out of the arrangement, but it also alters the risk profile and so it needs to be well understood and the balances traded off,” says ANZ’s Huse.
Even the better-placed mining firms are looking in more detail at costs of extraction relative to commodity prices in order to determine the viability of a project. “A number of large Australian exporters have reduced their investment
in projects to focus on treasury level and go back to more aggressive activities around managing their working capital. We’re trying to help them with financing, but also to better manage their inventories and post-shipment export financing. When companies are hit by a higher Australian dollar, their costs are effectively rising and we have to find ways to improve their competitiveness through a range of working capital initiatives,” says Reidy at CBA.
But exporters having to readjust their business models can at least count on the wide availability of financing, as the return of French banks, combined with a push from Asian, American and Australian banks to fill the market gap left during the French hiatus, has increased competition in the commodity financing sector.
Coal uncertainty
While demand for Australian coal is undeniably there, the country’s ability to fill orders has been affected by extreme weather conditions in 2012. Flooding is not an unusual occurrence in Eastern Australian mines, but last year’s events had a big impact on the logistics chain. Gordon Sparrow, head of trade sales at Westpac, comments: “The majority of our coal mines are in areas that are majorly food-affected, and flooding of the mines themselves is not a major issue, but we’ve had two or three exceptional rainfall seasons in areas where the rail routes run, and that has affected our ability to move our products to harbour. We have a lot of vessels waiting to load along the Australian coasts at the moment.”
According to him, the impact on volumes is already starting to show, and the risk of buyers switching to alternative markets is an issue, but the sector remains confident due to continued robust demand from China and a strong value proposition around Australian products.
Another aspect potentially threatening the future of the Australian coal industry is the development of mega mines in Mongolia, particularly Tavan Tolgoi. But again, experts believe the insatiable Chinese demand and proven reliability of Australian coal exporters will help them maintain their competitiveness, even against potentially cheaper Mongolian coal. In fact, Mongolia’s coal mines could even create export opportunities for Australian equipment manufacturers. “Given Australia’s strength in the mining sector, we see increased opportunities for advanced manufactured products to support the expansion of other mining sectors, such as Indonesia, China, Mongolia, and even in the long term, India,” says Reidy.
The Rmb option
With China as their biggest market, Australian exporters are bound to pay particular attention to the country’s currency liberalisation efforts. Last year, the two countries signed a three-year, A$30bn currency swap agreement, through which the Reserve Bank of Australia and the People’s Bank of China are to make funds available for business via commercial banks, and discussions are continuing on direct convertibility. As this issue went to press, Australian prime minister Julia Gillard was expected to discuss direct conversion with the Chinese authorities during her visit to the country in April.
But despite obvious interest, renminbi (Rmb) trade is still very low in Australia. “We do have customers talking to us about Rmb letters of credit and financing and deposit structures as well, but it’s fair to say that the major impacts around Rmb financing are more heavily felt in the Asian markets,” says Reidy.
According to Austrade, about two thirds of Australia’s export trade is in US dollars at present, and although the major commodity exporters are already moving towards Rmb, convertibility is still beyond most small and medium-sized businesses.
“There has been some interest in transacting in Rmb but take-up has generally been slow, which we put down
to a combination of uncertainty as to the rules and regulations, as well as an inability to reach a compelling economic arrangement between buyer and seller. There is clearly a strong push from the authorities to see this market grow so we expect to see this level of activity increase, initially in areas where there is either a logical currency alignment or the economics become more compelling. As the economy continues to grow in China and the Chinese government deals with some of the challenges of inflation, currency liberalisation etc, we expect to see greater interest in exploring Rmb as a viable currency of trade,” adds ANZ’s Huse.
Steeled for competition
While many bankers around the world are losing sleep over the impending implementation of Basel III rules, in Australia it is seen as a positive development. Banks are working through the regulations with the Australia Prudential Regulation Authority (Apra) and expect to be early adopters of the Basel III framework, along with Singapore, Hong Kong and Canada.
“Part of the reason why we have such a strong banking system here, is that we have worked very hard to achieve compliance with the requirements of Basel I, II and III all the way down the line, so we’ve moved very quickly and effectively to achieve that,” says Gordon Sparrow, head of trade sales at Westpac.
“Our industry is subject to far more stringent capital regimes and treatments than the majority of our competitors on the global market. It places a lot of pressure on the Australian banks, and we have a disadvantage when it comes to our cost structure as a result of Basel III. But on the flip side, both our customers and the banks that we do business with are very appreciative of our ratings and the standing that we have from a security perspective, and that plays in our favour and often is sufficient to almost mitigate the higher cost offering that we bring to market.”
In a way, Australian banks are eager for decisions to be made around global Basel III implementation: If the rest of the banks come up to their standards, it will level the playing field; if they don’t, it will give Australia an opportunity to relax these standards. Moreover, banks in Australia are now in a stronger position than they were before the crisis, as the withdrawal of European banks from the market allowed them to reinforce existing relationships and find new clients. “One of the things that treasurers have learned is that banks are not always there when you need them, so we’ve been able to leverage our very strong relationships and reinforce them through the fact that we’re still able to support when traditional banks have had to reduce their limits,” says Sparrow.
Michael Reidy, head of trade and working capital finance at Commonwealth Bank of Australia (CBA), adds: “The lesson that’s been learned from the global financial crisis is that you need to have a better understanding of the businesses in which you operate, your customers and their trade flows. This has prompted a review and a re-understanding of core markets and capabilities.”
Both CBA and Westpac have experienced growth in their trade finance businesses since the crisis, and are playing on the trust factor to maintain their market share now that European and international banks are back with a vengeance.
Reidy adds: “There has been a re-entry of institutions that initially pulled out of the market, and they have decided to re-apply their capital elsewhere. They all realised they needed to have exposure to the Asian market, and some of them opted to open businesses in Australia; others are exposed to it through their Asian offices. There is a huge focus on this part of the world due to growth in Asia, the cost of extraction out of the Australian mining sector and relatively low logistics costs in terms of shipment.”
