By Kenneth Tan Forex manager at Phillip Futures
By Kenneth Tan Forex manager at Phillip Futures

Can Singapore Dollar sustain Parity Exchange Rate with the Australian Dollar?

First Published: e-Forex Magazine 62 / Currency Clips / October 2015

The sliding Aussie dollar fell to parity against the Singapore dollar last month, the weakest it has been since 2009 during the depths of the sub-prime financial crisis. The currency has been battered by slowing global demand for the country’s commodities exports and a string of disappointing economic data. 

So what does this all mean?

Singapore families funding their children’s education in Australia will enjoy stretching their dollar’s worth and tourists travelling to Down Under get to enjoy higher purchasing power as well. 

(Graph is only a pictorial representation and is not to scale)
(Graph is only a pictorial representation and is not to scale)

But local companies with big investments in Australia could take a big foreign exchange discount when repatriating earnings. 

But is it sustainable?

We take an interesting look at the Big Mac Index, a simplified indicator of a country’s individual purchasing power for a similar basket of goods and services. The relative purchasing power based on this index is then compared against the actual exchange rate. We see that in July 2012, the cost of a Big Mac in Australia is US$4.68 versus US$3.50 locally, giving an implied exchange rate of 1.3371. The actual rate then was pretty close at 1.3005. However, in the recent July survey, the implied exchange rate based on the Big Mac Index was 1.1395, when the actual rate dropped to 1.0385, a massive undervaluation of the weakening Australian Dollar. 

Interest differentials should drive foreign exchange rates to equilibrium levels in the long run. Australian overnight cash rates stands at 2% whilst the Singapore Overnight Interbank Interest Rate was last recorded at 0.23%. With foreign exchange rates at parity, this would encourage greater borrowings from domestic investors to place out in Australian deposits so as to earn on the interest differentials, thereby driving demand for Australian dollar. 

However, Australia’s mining and agricultural sectors make up a significant share of the country’s economy. The Reserve Bank of Australia continues to emphasize that the exchange rate is adjusting to significantly lower commodity prices. The slowdown in China’s growth and the tumult surrounding Greece’s debt crisis continues to create greater uncertainty for the economy.