Exporters need to devote more time to managing their currency risks
Exporter Magazine, Issue 6, March 2008
Brett Finnigan, Managing Director of currency exchange specialist HiFX, provides some comments on how Exporters can better manage their currency risks.
Whilst we know what time the sun will rise and set each day no one has any certainty as to where the NZD will be from one day to the next.
In January, the Kiwi appreciated against the US dollar by 7.25%, from 0.7380 to 0.7915. If your business budgets a 10% profit margin on exported goods, this move in the currency would wipe out 75% of your budgeted income in just one month! Since August 2007 the currency has appreciated 24% from a rate every exporter would bite your arm off for now of 0.6637 to a bitterly disappointing rate, from an exporter's perspective, of around 0.82 in February! This sort of volatility has not been seen for decades.
Many exporters might have thought their bank would have raced to the rescue, particularly as exporters have been hurting for years. The simple fact is that banks are merely a provider of a price and driven to ensure their own existence, not of their clients. Banks service levels vary dramatically with better service reserved for top-end clients.
Consequently, currency risk management is something that many exporters leave to chance at their peril. It is an area that has often been overlooked as exporters focus on driving sales or HR needs or simply put it in the too-hard-to-do basket.
Some exporters may believe they avoid currency risk by selling their products in NZD; however, this is not entirely true. As the NZD appreciates, the goods become more expensive to the customer in USD and may lead to the customers sourcing alternative suppliers from say Chona or a competitor who has hedged effectively.
Exporters should be effectively managing their FX risk. The following aspects of an exporter's business should be analysed.
1. The company structure. Are you exploiting all netting opportunities and cash management tools available? For example, is part of the exported product imported first in a foreign currency? Netting would avoid crossing the spread.
2. The market. Who are your competitors? Are they local or international competitors? How do the hedge? Is your margin sufficient to absorb a currency move or can it be passed on to your customer? Are you a price maker or price taker?
3. The product/service. Is it a seasonal product? What are your payment terms? Is the revenue stream predictable and or reliable? What percentage of your business is recieved in foreign currency?
4. Your risk profile. Are you prepared to take on risk or not? Can you afford to take on risk?
5. Your risk tolerance. At what rate would it become uneconomic for you to continue to export? Consider a worst case scenario - what would happen if the currency appreciated a further 10%. Youd you remain profitable?
6. Your expertise. Are you skilled in FX? Do you need help? If so consider someone apart from your banking partner, particularly someone who will spend time understanding your business and provide a bespoke solution.
The outcome of the above will go a long way towards developing an FX policy, the framework to make hedging decisions. This might, to some SME's, seem unnecessary but it has the main advantage of removing emotion from the decision making process of whether to hedge or not, the major cause, in my opninion, for exporters to "get it wrong". It gives clear direction as to what needs to be done and who is to do it. The FX policy is important and needs to be ratified by the board.
In short, it provides a disciplined approach and a framework for which to manage the risk of the company. This document need not be complex or inflexible. It can be as simple as hedging 100% of know sales using forward contracts or allowing management to hedge a portion as they see fit. The important thing to realise is that one size does not fit all. It will tick all the right boxes as far as good corporate governance is concerned and provide shareholders with the comfort of adopting best practice.
One thing seems certain; the volatility seen in global markets looks set to continue for the forseeable future. The interst rate in NZ may well remain high for some time yet and hence continues to be an attractive place to park money, further shoring up the currency. With some many unknown challenges influencing currency and cash markets, it is imperative that businesses that trade offshore have policies in place and seek expert providers to effectively manage and mitigate FX risk.