How SMEs can manage risks by learning how to spot the perfect storm caused by currency volatility
SMEs are often very specialised in a particular product or region. They also tend to generally have fewer capital reserves than their more sizable counterparts. They are also much less likely to have the benefit of in-house expertise. This makes them more exposed to currency changes and less able to weather the storm when they occur, especially if the change is sustained over a long period.
For example, in late September, when governor of Reserve Bank (RBNZ) Graham Wheeler made public comments on the Kiwi dollar and confirmed the central bank’s market intervention, we saw a stark movement in the NZ dollar, with a 2-cent downward move within a day. Prior to this, there were a number of prior comments by the RBNZ in the preceding months that pointed to the likelihood of a downward move . SMEs that took advantage of this with hedging might be still reaping the rewards.
Here is the good news. While there are no infallible guides to predicting exchange rates, it is entirely possible to – based on lessons from the past and keeping close watch – to spot currency-led threats to your business.
This is because foreign exchange markets are driven by momentum and move in one direction while the market has a certain expectation about what’s going to happen.
When monitoring patterns in exchange rates, there are a few important points to note.
Firstly, exchange rates reflect the relative differences between two economies – not just what’s happening here in NZ for example – so insight into the future value of currencies can often be gleaned from the expectations around changes in the interest rate difference between those two economies.
Foreign exchange rates in general don’t really have a natural long-term uptrend like a share or the property market might. Instead they are cyclical. This is because they are not driven by the economic growth of one nation but by the performance of two countries and the strength of their economic management, relative to each other.
This means while it is difficult to pick a value – like you can with a share for example – it is possible to recognise signs that momentum might be about to slow. If a country’s interest rate is getting close to historically high or low levels of its range along with inflation readings, this is a sign that momentum might be flagging, indicating the value of its currency could be close to a turning point.
So it’s not quite as black and white as when to buy and when to sell, but instead business owners would do well to think in terms of varying levels of risk created by certain factors aligning to create a perfect storm.
In my experience, businesses who succeed and thrive in the long term are those that acknowledge currency fluctuations as an inevitable part of international trade and focus their efforts on putting measures in place that minimise exchange change risks.
Practical ways to minimise risks
Here are five practical ways importers and exporters can minimise the risk of profit loss due to shifting foreign exchange market shifts:
- Diversification – product and regional diversification can significantly reduce exposure to specific currency risk.
- Plan ahead – create a budget that takes into consideration the number and likely timings of transactions, against a realistic assumption of currency fluctuations. This will help you build the financial capacity to weather a storm should it arise and ensure you don’t find yourself on the back foot in a crisis situation when rate changes occur that impact your business.
- Currency matching – where possible it is good to match cash flows. Paying for costs or borrowing money in the same currency that you are trading in will minimise exposure.
- Lock in costs – if your approach is trading regardless of the dollar value, think about locking in costs with suppliers and purchasers in advance to protect against fluctuations. This could be done with option, forward contracts and CFDs.
- Stay informed – being well informed enables you to take advantage of the positive movements and to guard against the negative shifts. Utilising the expertise of experienced market traders and forecasters for guidance can be useful.
Predicting exact currency movements can be a difficult feat. However SMEs that understand the indicators of a potentially fluctuating currency, and put in place practical ways to minimise risk, are far more likely to succeed and reap the rewards of movements in the dollar.
Chris Smith is the general manager of CMC Markets NZ