Navigating emerging market currency volatility
Unilever this week became the latest company to attribute slowing sales growth to turmoil in emerging market (EM) currencies.
A statement on the company’s website said third-quarter sales growth has been revised down to 3% to 3.5%, adding: “The emerging market slowdown has accelerated as a result of significant currency weakening.” In comparison, second-quarter sales growth was 5% and third-quarter growth had previously been predicted at around 4.5% to 5%.
The announcement echoes a similar statement made by sporting goods company Adidas last month, when the company announced that its full-year expectations were being updated “to account for recent negative market developments”, including the weakening of a number of currencies versus the euro.
In August, meanwhile, Wal-Mart said its second-quarter sales had taken a $680 million hit as a result of currency fluctuations.
The current wave of volatility experienced by EM currencies was triggered in May when Ben Bernanke, chairman of the Federal Reserve, suggested the US might begin to scale back its quantitative-easing programme this year. Coupled with expectations of rising interest rates around the world, this has prompted a shift of money away from EM currencies and back into the US, with substantial consequences.
The Indian rupee has dropped more than 15% of its value against the euro since May, while other currencies, including the Mexican peso, Brazilian real and Russian rouble, have also suffered substantial declines. This prompted global central banks to sell off 30% of their EM currency holdings in the second quarter of this year, according to data published by the IMF.
This follows a period in which corporations have been less inclined to hedge FX risk, according to the results of a triennial foreign exchange turnover survey published last month by the Bank for International Settlements. The survey found that FX transactions with non-financial customers dropped from $532 billion in 2010 to $465 billion in 2013 and now represents only 8.7% of global FX turnover – down from 13.4% in 2010.
These changes are significant for companies operating in EMs. With economic conditions remaining sluggish in western markets, many companies have looked to faster-growing EMs for growth opportunities in recent years.
However, the recent volatility in EM currencies has caught some unawares – and with corporations feeling the effects of the volatility, many are taking the opportunity to revisit their hedging policies in EMs. Indeed, Citi has reported a 12% to 13% increase in its business with companies hedging FX risk in EMs since June.
|Greg Edwards, at Deutsche Bank|
Greg Edwards, director, head of electronic FX corporate sales Europe at Deutsche Bank, says for most corporate treasurers the challenge in EMs is a lack of visibility over their FX exposures. “If you don’t know the size of the exposure, there can be awful surprises if a currency moves 15% over the course of a period of time and there is a realization that a certain revenue stream is not as strong as it was expected to see, or that the value of a subsidiary has suddenly shifted quite dramatically,” he says. Whereas companies in western Europe and the US tend to be very good at understanding their FX exposures, that understanding tends to be less extensive when dealing in EMs. “When you go further afield, and where you are looking at a joint venture or a subsidiary that is a little bit outside of the company’s day-to-day activity, companies don’t always have the tools available to understand the FX exposures they are running,” says Edwards.
These factors have meant that treasurers have had something of a wake-up call this year, prompting them to quantify and understand the risks they are running in EMs more thoroughly.
In some cases, companies have responded to this by moving FX execution away from EM locations and into their regional treasury centres. Companies are also keen to gain additional transparency on everything from the size of an FX exposure to the way in which a transaction is executed.
“They are looking for a comprehensive oversight of all of the trades that are being done and the associated workflow,” says Edwards.
As a result, companies are looking for banks to provide guidance on risks, liquidity, market dynamics and an overall FX strategy that will allow them to better manage their FX exposures, monitor what happens pre-deal and then successfully execute the transaction directly into the market.
While these changes might have been triggered by the recent EM volatility, it is likely that changing corporate practices in FX risk management are part of a longer-term trend.
For many companies, operating in EMs can be daunting at the best of times, and the recent fluctuations are likely to have underlined the importance of understanding exposures in these markets more thoroughly.
As companies look to take control of this area, they will likely lean on their banks – not only in terms of execution but also to gain a greater understanding of the challenges and opportunities in these markets.