2012-13 Government Mid-year Financial Projections Statement

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2012-13 Government Mid-year Financial Projections StatementExchange Rate and Iron Ore Price Forecasting AssumptionsThe royalty income and North West Shelf grant estimates for this mid-year review arebased on a new method for projecting the $US/$A exchange rate and $US iron oreprices across the forecast period. The methodological revision is a result of thechanging dynamics within exchange rate and iron ore markets, the current state of theglobal economy, and Australia’s position in it.Volatility in the exchange rate and iron ore prices creates a high level of uncertainty forprojected royalty collections by the State. In the past, movements in the Australiandollar and $US commodity prices have often been highly correlated, with the revenueimpact of fluctuations often largely offsetting. However, there has been a sustaineddivergence from this historical relationship since the 2012-13 Budget was finalised inMay, as evident in the following figure. Iron ore spot prices fell in September 2012,reaching levels close to those observed during the global financial crisis, while theexchange rate remained high, hovering above US100 cents since June 2012 (see figurebelow). The iron ore spot price has recovered since September but remains well belowthe high levels witnessed in 2010 and 2011.IRON ORE PRICE AND EXCHANGE RATEFigure 21.20$US/$A$US/tonne2001.101751.000.901500.801250.701000.60750.50$US/$A exchange rate (LHS)Iron ore price (RHS)0.4050Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12Source: Datastream.$US/$A Exchange RateAt the time of the 2012-13 Budget, exchange rate projections were derived assumingthat the prevailing six-week-average at the cut-off date returns to the historicallong-run average (US75 cents) in a linear fashion by the final month of the forwardestimates period.58
The Western Australian EconomyAs of November 2012, Treasury has adopted a revised market-based approach, whichuses forward rates to derive the exchange rate assumptions over the budget forecastperiod. This approach is impartial and produces forecasts that are consistent withmarket expectations of the exchange rate and changes in interest rate differentialsbetween the United States and Australia.Under this new market-based approach, the exchange rate assumptions are derivedusing the 20-day (4-week) average of market quoted forward exchange rates (tosmooth out volatility inherent in the daily rates) for contract maturities ranging from1 month to 5 years, and interpolating values where monthly forward rates are notseparately available.Cause of Structural ChangeThe change in the relationship between commodity prices and the exchange ratereflects changes in the factors underpinning demand for the Australian dollar. Demandfor the Australian dollar has traditionally been influenced by the outlook forcommodity prices and exports, given Australia’s relatively high exposure to externaldemand. In recent years though, demand for the Australian dollar has increasinglybeen underpinned by foreign demand for Australia’s AAA-rated CommonwealthGovernment Bonds (see following figure). This reflects Australia’s comparativelyhigh interest rates, politically stable economy, liberal financial system, and exposure toemerging economies in Asia.80Figure 3FOREIGN INVESTMENT IN COMMONWEALTH GOVERNMENT SECURITIES%$US/$A1.10701.00600.90500.80400.70Share of Commonwealth Government Securities held by non-residents (LHS)30Exchange rate (RHS)0.60Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12Source: ABS Catalogue 5302.0.59
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