speech fx markets around the turn of the year christopher kent [ * ] assistant governor ( financial markets ) australian corporate treasury association fx roundtable webinar – 17 february 2021 introduction today i will discuss some recent developments in the foreign exchange market, and provide some views on the role of the reserve bank's various policy measures. i will also briefly discuss a modest change to the way the bank will be using foreign exchange swaps to manage our foreign exchange needs. a novel development in the market for australian dollar swaps typically, australian banks pay a small premium to swap foreign currency into australian dollars. this premium is also referred to as the basis, which is the difference between the implied cost of obtaining australian dollars in the fx swap market and the cost of obtaining australian dollars onshore. most of the time the basis is positive, but over the course of 2020 the basis declined and became negative at shorter tenors, with a very noticeable decline around the turn of the year ( graph 1 ). i thought it was worth explaining what's happened in this market. graph 1 but first, it's helpful to understand why the australian banks have typically paid a premium in this market. they obtain foreign currency by issuing debt offshore – including via bonds denominated in us dollars. they do this to help diversify their funding sources. it allows them access to deep, liquid foreign capital markets. they then swap this foreign currency into australian dollars in order to fund their australian dollar assets, including the loans they make to households and businesses. the demand for australian dollars in the swap market by the australian banks is the flipside to the demand from other entities to swap australian dollars into us dollars, much of which relates to their own hedging needs. this includes foreign entities issuing kangaroo bonds in australian dollars to fund their assets offshore and australian investors who hedge their foreign currency assets. [ 1 ] while the flows are large in both directions, demand and supply are brought in balance in the swap market with those demanding australian dollars typically paying a small premium. however, over the past year there have been some sizeable changes in the market for australian dollar swaps. the reserve bank's policy actions have played a part here by providing plenty of australian dollar liquidity. for example, to date the reserve bank has provided australian banks with $ 86 billion of low - cost funding for terms of 3 years via the term funding facility. at the same time, the banks have seen strong growth in their deposits and slower growth

investment has resumed again in recent quarters. incidentally, inward direct investment continued at a relatively steady pace over recent years, and was largely unaffected by the tendency described above. in the past, it was inward direct investment that attracted unfavourable comment. foreign investment and multinational corporations were viewed with suspicion and accused of buying our best companies ( in some sense, the opposite of the “ we are off the radar screen ” argument ). now the interesting tendency is in the opposite direction - australian direct investment abroad is greater than foreign direct investment in australia. also, australian portfolio investment abroad has risen strongly. what does this mean? does it support another often - heard view that there are no good investment opportunities in australia, and firms and investors are forced to go abroad? the first thing to note is that australia is still an overall net importer of capital, i. e. more is invested in and lent to australia from abroad than we lend to or invest in other countries ( a necessary corollary of running a current account deficit ). since the government has little or no role in these investment flows, it is the world and australia ’ s private sector players that have chosen this outcome. notwithstanding this consideration, some people are still troubled by the amount of portfolio investment abroad by australian institutions and direct investment abroad by australian companies, accusing them of turning their backs on australia. i think the situation is a bit better than this. my guess is that the bulk of the portfolio investment abroad is just a sensible diversification of assets by australian investors and institutions. in 1983, before exchange controls were abolished, australian portfolios had zero international diversification, and in time we will reach a level that is appropriate to our circumstances. in the meantime, we will see outflows as we move from zero to the optimal level. in addition, we should not forget that other countries are also diversifying their portfolios, and in the process purchasing australian equities and bonds. world bank, “ globalisation, growth and poverty ”, 2002. on direct investment, we are going through the second phase of australian companies buying overseas assets. in the first phase in the late eighties, it was done rather indiscriminately with a lot of investment outside the investor ’ s normal area of expertise. the results were not very good. more recently, however, most of it has been done by successful australian firms that have reached their limit of expansion in their own industry locally, but are good enough to compete