Industry Exposure to the Rising Exchange Rate – Study

(Statistics Canada)

Construction profits the most of any industry from the rising loonie, as it reaps the benefit of lower prices for imported inputs while selling its output almost entirely in Canada, according to a new study published today in the Canadian Economic Observer.

Services oriented to domestic demand also stand to benefit from lower import prices. Most resource-based industries have much larger exports than imported inputs, but have been insulated from the negative impact of the rising loonie by stronger commodity prices.

Comparing exports of outputs and imports of inputs by industry yields a measure of the net exposure each industry has to the exchange rate. Industries most vulnerable to a rising dollar are those with a large export dependency but little offset from imported inputs. The best-positioned industries are those that use large amounts of imported inputs and sell mostly in domestic, not export, markets.

This study showed that the net exposure of exported outputs and imported inputs is an important, but not dominant, determinant of industry fortunes. For nearly half the economy, exports are almost irrelevant to demand. Others that have suffered the most, notably forestry products and clothing, have been victims of events specific to those industries.

Overall, Canadian industry earned 20% of its income directly from exports in 2004. Industries vary greatly in their dependence on exports, with manufacturers and commodity producers being the leading exporters. Manufacturers of transportation equipment relied directly on exports for 73% of their output, the most of any industry in 2006.

Several other manufacturers rely on exports for nearly half their output, including machinery and equipment, chemicals, metals, wood and paper, and clothing. Mining and oil and gas directly export about half their output.

But large swathes of the service sector have little dependence on export markets. Together with construction, industries with almost no exposure to exports account for nearly half (48%) of gross domestic product.

Canadian industries imported 10.6% of all their inputs in 2006. Broadly speaking, what emerges for import use by industry is a sharp split between manufacturers and the rest of the economy — most manufacturers import inputs extensively, while other sectors essentially do not.

Comparing exports in output with imports in inputs reveals that among manufacturers, the wood and paper industries had the largest net exposure, with a gap of 36 points between the shares of exported outputs and imported inputs. This helps explain the woeful financial condition of these industries.

However, a large reliance on exports relative to imported inputs does not always imply hard times for an industry as the dollar rises. Oil and gas and mining have the largest net exposure to fluctuations in the dollar, at 46 and 43 points. These industries overall have done well recently, as the US dollar prices of their commodities have risen faster than the loonie has depressed export revenues.

Many manufacturers have a built-in hedge in their cost structure that helps compensate for the depressing effect on revenues of a rising exchange rate. While the soaring loonie has slowed export earnings, this has been partly offset by lower prices for inputs they import. This helps explain how manufacturers have adapted to the stronger exchange rate, maintaining steady output since 2003 while stepping up investment plans into 2008.

Construction stands out as the goods industry with the most to gain from a higher dollar, with a 10-point gap between the share of imported inputs and exported outputs.

Governments import a larger share of inputs than their exported outputs, notably health and education. Most commercial services have a slight excess of imports over exports. This includes business services, finance and recreation.

The study is included in the March 2008 internet edition of Canadian Economic Observer.