In this edition, we consider the implications of the recent announcement of the ability to directly convert the Chinese Yuan (renminbi, or RMB) into Australian dollars, and examine recent market movements.
Australian Dollars and Chinese Yuan
Earlier this month the Chinese and Australian governments reached agreement to allow direct conversion (trading) of the RMB and the Australian dollar as of the 10th of April 2013. Officially, Australia became the third country to have a currency trading agreement with China, after USA (the USD) and Japan (the Yen).
The overall significance of the deal lies in three areas.
Firstly, Australian and Chinese businesses potentially no longer need to purchase USD to settle transactions, which should lower transaction costs. Given that China is Australia’s largest export destination (26% of Australian export value in the most recent year), and Australia’s largest source of imports (15% of our imports in the most recent year), the potential transaction cost savings may eventually be substantial. To this end, the prospects for growth in use of the RMB as the settlement currency looks bright, given a recent survey by the Reserve Bank of Australia’s indicated many Australian businesses are interested in using the RMB for trade settlement.
The second area of potential impact lies in currency risk management – although this will largely depend on the extent to which the Yuan remains pegged to the USD. At present, the Yuan is only allowed to trade within a small range daily range against a basket of currencies (dominated by the USD), effectively limiting the scope of currency risk management benefit. However, the Chinese central government has indicated it intends to progressively increase the flexibility of the RMB, and so long-term benefit may accrue.
However, perhaps the most significant aspect of the deal is that it represents a further significant step in the opening of China’s financial markets and the emergence of the Yuan as another global reserve currency – taking our already strong bilateral relationship to a new level. Australia’s Reserve Bank has already taken a number of steps in this direction; opening in March 2012 a AUS30 billion currency swap facility with the Bank of China, and more recently, deciding to invest 5% of Australia’s foreign currency assets in China.
While there is no doubt that the financial arrangement will prove a positive step for Australian wool, there is little expectations that this development will have an immediate impact on wool trade between Australia and China, since established practice is to denominate export contracts in USD, and manage currency risks by hedging.
Nonetheless, since around 70% of our wool is exported to China, direct convertibility of the currency will potentially make financial transactions more convenient, and possibly reduce financial costs and risks to both parties. The newly redeveloped model China:Australia wool contract allows for the RMB to be used as the basis for settlement, provided both parties agree beforehand.
Over the past month we have seen some large price movements within the wool market, and we felt it timely to provide a benchmark of normal variability.
The following chart shows the historical pattern of variation in average monthly wool prices, using the AWEX Eastern Market Indicator as a proxy – prices are expressed in US and AU dollars. Four periods are shown – the stockpile era (March ’91 – June ’01), the current era (July ’01 – end-March ’13), two recent subsets of the current era: the Global Financial Crisis (GFC) period (April ’08 – March ’11), and the most recent two years (April ‘11 – end March ’13).
Since the market has trended upwards significantly across these periods, we have expressed the average monthly variation in nominal units (AU or US dollars) and also as percentage of the prior month value. For the statistically minded among you, the average monthly variation is calculated using the standard deviation of monthly mean price: two-thirds of all months will fall within this range.
The data shows that, normally, the average EMI for any month differs from the preceding month by around 5 - 6%: it rose during the period of the GFC in US dollar terms, but has fallen more recently.