Until recently, the Australian dollar (AUD) had been breaking multi-decade records by staying above parity with the US dollar. However, in recent months the AUD has started to slide, and businesses should expect it to fall further from here. Currency experts generally agree that in the short- to medium-term, the AUD is unlikely to rise again against the US dollar (USD), or even to stay at similar levels.
As a result, many businesses must now respond to the difficulties created by this (comparatively) lower AUD.
A moving AUD can create havoc for businesses attempting to manage costs and achieve profitability. Most businesses in the fashion and retail industries purchase goods from overseas, and many will have done so in USD. Unfortunately, they are now having to sell those same goods in a lower AUD environment and, in the lead-up to the Christmas season, the impact on profitability could be significant.
For instance, many businesses value inventory using a set exchange rate – usually one they have set themselves – rather than a ‘spot’ rate which reflects that day’s exchange rate. A standard rate makes valuing inventory easier; however significant movements in exchange rates result in the recorded value of the inventory not being a true representation of the amount paid, nor its true value.
Another problem may be that goods were purchased at the ‘spot’ rate on the day of the transaction; however foreign exchange amounts may be translated at the rate on balance date, which can be quite different.
Understanding the reasons for exchange rate movements can help in developing strategies to protect businesses from such movements.
There are many reasons for movements in foreign exchange rates. In recent years, the main reasons have been:
Supply and demand
Until a few months ago, the AUD was seen as a ‘safe haven’ by overseas investors. They therefore increased their holdings of AUD, which increased the demand for our currency and drove up its value.
In addition, the US Federal Reserve’s quantitative easing strategy resulted in an increased supply of the USD, meaning the AUD appreciated against the USD.
With the US economy showing signs of strength, and the Federal Reserve indicating that it will start to ‘taper’ its quantitative easing, demand for the AUD has declined, which is one of the primary reasons for its fall against the USD.
Interest rates
As official interest rates decrease, the usual impact is that the AUD depreciates, given there is a lower return for investments in AUD. Interest rates have fallen over the last few months, and some believe are likely to come down further.
Commodity prices
Higher commodity prices also contributed to the appreciation of the AUD since 2003, and helped it remain above parity with the USD since early 2011. With commodity prices coming down, the AUD has followed.
Strategies to manage
The two most common strategies for protecting against foreign exchange rate movements are:
Hedges
Hedges ‘lock in’ a foreign exchange rate. However this strategy may result in significant losses if exchange rates drop further. Businesses are taking a punt on the future direction of the currency, so they need to be confident of their forecast.
Options
Options also lock in a foreign exchange rate, but the risk of loss is limited to the premium paid. Option premiums are determined by the current market rate: the more favourable the exchange rate, the more expensive the option premium.
With most experts predicting the AUD has further to fall, choosing to hedge may be a sensible strategy, and options may also be appropriate, despite the premium.
However, almost certainly the most risky and costly strategy at the moment is doing nothing, and business owners should talk to their adviser or accountant to help come up with a strategy to manage any further movements in the AUD.
Unfortunately, for those who have already ordered the goods and now have to pay for them at a higher rate, there is little they can now do to offset this increased cost except increase sales prices to maintain margins.
It will be interesting to see how customers react to increasing prices. Those businesses that hedged currency through this recent fall will have a competitive price advantage in the run up to Christmas.
There is one advantage for retailers of the falling AUD: on-line purchases from the US now appear to be 15 per cent more expensive than four months ago.
Simon James is a partner with accountants and business and tax advisers HLB Mann Judd Sydney. www.hlb.com.au