Foreign exchange reserves — our asset base
The value of foreign exchange reserve is reflective of a country’s economic status. Foreign exchange can be held in banknotes, deposits, bonds, treasury bills and other government securities. Past decade, AUD has been quite stable and the foreign exchange reserves have been fluctuating within tolerable limits. Australia’s top Foreign exchange earners are iron ore, coal, education, tourism and meat. Main imports are machinery, vehicles, medical equipment and pharmaceuticals.
We will try to understand the factors that affect currency of any country. We will be comparing Australian economic data with that of France and Canada to better understand our position.
Foreign Exchange Reserves
The Foreign exchange reserve and currency value are affected by four primary actions:
· Import — export (Good and services imported needs to be paid for)
· Foreign Capital / investments (All foreign investment results in inflow of foreign exchange)
· Remittances (Payments made by people to their family and relatives overseas)
· Borrowing / External debt (Foreign loans / repayments for development eg. IMF)
All the countries selected for our argument are developed and stable economies. We will be discussing only the first two points for our argument.
Import — export
Top five export earners for each country:
Overall figures and position looks very similar, however, there is a risk that has been overlooked by Australia and Canada. We have all heard the old saying “Don’t put all your eggs in one basket”.
Canada have put almost all eggs in the US basket (75%). But then Canada and US are close allies and the probability of its export being at risk, is practically zero. They got a safe market in US.
Australian portfolio looks a little bit more diversified, however, looking at the current situation globally, is facing a challenge. Australia exports 34.7% of its products to China. Right now, with the diplomatic /trade spat going on between Australia and China, our exports seems to be in danger. China has been actively rejecting Australian imports. Drop in exports will not only see our income deplete but will also affect our foreign exchange reserves and AUD will be under pressure. We have to actively look for newer markets and spread out the portfolio.
France’s portfolio is very diversified and balanced. EU is a big market for France. The current ongoing protests demanding ban of French products in certain countries will have minimal effect as the trade volume with those countries is very small.
Foreign Capital / Investments
FDI attracted by any country indicates two things. Firstly, it is an indication of a stable, resourceful country and secondly, improved Foreign exchange reserves of the country.
While a high value of FDI is a good indication, we should also be looking at the sectors attracting the investment. For France and Canada, the sector that got the highest investment is manufacturing whereas Australia’s main investment is in mining and quarrying.
Mining mainly involves extraction and transport of iron ore, coal etc. It means the investment doesn’t lead to a great deal of value addition or job creation. Mining activities do contribute a great deal towards exports though. A large part of our investment is in real estate and wholesale / retail, which probably doesn’t do much in terms of value added production or job creation.
On the other hand, France and Canada got 47% and 23% respectively of FDI in manufacturing (11% by Australia).
FDI in Finance and insurance in France and Canada are 42% and 15%. It improves liquidity and showing confidence in the French market. France also got reasonable amount of FDI for R&D and technology.
Remittance
Personal remittance values are fairly similar and doesn’t play much role in our argument today.
Borrowings / Repayments
All the countries generate healthy revenue and are in a position to service their debt comfortable.
Analysis
1. French revenue streams are very balanced and has lower risk component. (I define risk as the probability of loss of foreign revenue as a result of political or financial fallout).
2. Looking at the current global trading situation, Australia is at a high risk of losing foreign exchange revenue from China. It’s a big percentage of our income.
3. Australia must look for alternate markets quickly to compensate for loss of market in China. (China has openly stated that they will be retaliating on the economic front as Australia has demanded an enquiry in the coronavirus pandemic)
4. All the investment in the education and tourism sector is under threat in Australia. Students / tourists from Chinese comprise a large portion of the revenue.
5. Australia should attract more investment in manufacturing and value added production.
Economies with challenges
To make this blog more meaningful, let me also give you two examples (Venezuela and Pakistan) to show how mismanagement leads to disaster.
Pakistan has been consistently importing more that it can export, resulting in big pressure on its balance of payment, economy and currency. For e.g. in 2018 exported goods worth USD23.6 bill as opposed to import value of USD 60.1 bill. Over a span of 15 years exports have remained constant whereas imports have increase from US 11.9 bill to USD 60.1 bill in 2018.
Pakistan’s foreign exchange reserve is USD 13.6 bill.
Official FDI has been very weak, which effectively doubles up on the low export figures and support the argument of being a weak economy. Last five years, Pakistan has attracted total FDI worth USD 11.5 billion, averaging USD 2.3 bill (invest.gov.pk). With this kind of figure one would ask questions about all the media publicity about USD 60 bill CPEC investment. Where has all the investment gone?
The Pakistani Rupee has been losing its value. USD vs PKR was 105 in 2017 and today the USD vs PKR is sitting at 165. A loss of 60% value in less than 3 years. Pakistan is currently trying to raise money from various means (IMF, WB) to help them ease the balance of payment situation.
Venezuela has been in an economic turmoil for some time now. The country has also gone through a currency transformation in August 2018. The original currency bolívares Fuertes (VFF) was discontinued and a new currency was introduced bolívar soberano (VFS) with an exchange value of 100,000 : 1.
After the currency was floated, since 2018, the value of new currency has been going down. The USD / VFS rate was 60 in September 2018. It is currently trading at 500,000. I call that currency devaluation at the speed of light.
The situation is so bad that I couldn’t get any reliable Economic data to present here.
Did you know? — Venezuela has the largest petroleum reserves in the world? Now you must be wondering where have they gone wrong to get into such a disastrous situation…!!
