2001 Special Article - Measuring Australia's Foreign Exchange Exposure
This article was published in Finance, Australia 2000-01 on 25/10/2001.
In the light of recent financial crises in a number of countries, international authorities have urged all countries to monitor and assess the vulnerabilities of their own economies by, for example, compiling balance sheets where these currently do not exist and by obtaining details of foreign exchange exposures. Such data assist in identifying weaknesses in the structure of external assets and liabilities. Accordingly, there is special interest in the extent to which Australia as a whole or particular sectors are vulnerable to unfavourable movements in the exchange rate.
While Australia is a net foreign currency denominated asset holder, this position is determined by the predominance of Australia's equity positions. The situation is quite different if we look at specific sectors of the Australian economy or look at debt assets and liabilities alone. For example, as at 31 March 2001, 64 per cent ($324 billion) of Australia's foreign debt liabilities of $508 billion were denominated in foreign currencies, most notably $US. At the same time, 65 per cent ($97 billion) of Australia's foreign debt assets (excluding reserve assets) of $148 billion were foreign currency denominated.
Although data appear to show that some sectors of the Australian economy, such as depository corporations, have significant net exposure to exchange rate changes, many Australian enterprises, including depository corporations, engage in hedging activities which are designed to minimise or eliminate the risks associated with such exposures. The mitigating impact of these hedging activities does not show up directly in the statistics on foreign currency assets and liabilities.
One of the most common means that enterprises use to minimise risk from exposures - whether such exposures are connected to exchange rates, interest rates, commodity prices, or other factors - are derivative contracts. Derivative contracts are secondary instruments linked to, but separate from, specific financial instruments or indicators, and through which specific financial risk can be traded in its own right. Anecdotal evidence suggests that the most common types of derivative contracts used by Australian enterprises to hedge against foreign currency exposures are cross-currency interest rate swaps and forward foreign exchange contracts.
The Reserve Bank of Australia (RBA) recently undertook some preliminary investigations in this area by collecting appropriate data from the four major banks. The results of their investigation indicated that the four major banks "are not taking foreign exchange exposure". The results were included in an article "Foreign Exchange Exposures of Australian Banks" which was published in the Reserve Bank Bulletin of August 2000. This article is reproduced in full below.
To obtain a more complete picture, the RBA and the ABS are collaborating on the conduct of a survey which will cover a wider range of enterprises, both financial and non-financial. The aim of the survey is to obtain a picture of foreign exchange exposure for the Australian economy as a whole, as well as for individual sectors within the economy.
Data being collected include:
- Total foreign currency denominated assets and liabilities at a point in time;
This information is being collected from those entities with significant foreign currency denominated foreign assets and liabilities and/or significant foreign currency denominated payments or revenue from trade in goods or services.
Qualitative information on the broad hedging policies of enterprises, particularly in relation to changing economic conditions and variations in time horizons, is also being sought.
Results of the survey will be released at the end of this year by both the RBA and the ABS, along with analysis of the results.
The article‘ Foreign Exchange Exposures of Australian Banks’, which was published in the Reserve Bank Bulletin of August 2000, is reproduced on the following pages with the permission of the Reserve Bank of Australia.
- the principal value of outstanding derivative contracts which have a bought (positive) or sold (negative) foreign currency component (or ‘leg’); and
- expected foreign currency denominated payments and receipts for a 12 month period, arising from trade in goods and services.