MENA and Pakistan: Have a cross-border business? Time to consider currency hedging
Deciding whether or not to hedge against foreign exchange risks is a lot like deciding about insurance: by the time you realise you need it, it might be too late, too expensive, or both.
The good news is that opportunities for affordable hedging occur frequently. That’s one reason why we encourage clients to use it to mitigate their risk. This is as true for firms operating in the Middle East, North Africa and Pakistan (MENAP) region – an area of both pegged and floating exchange rates – as elsewhere.
Of course, hedging isn’t for every firm. Those engaged solely in local trade, for example, likely don’t need it. But an increasingly globalized economy means many firms are exposed to FX risks, yet don’t address this aspect of their business.
They should. Being under-hedged is a risk, and one that seems to rise in times of low currency volatility - such as this year, during which some gauges of volatility in G7 currencies have fallen to lows not seen since 1992. Low volatility can bring complacency, and that is dangerous. In 2017, for example, more than 50 European-based multinationals were caught out by currency moves, with 26 reporting a collective loss of €3.6 billion.
A more recent study of the results of 1,200 listed European and North American firms found FX losses totalled $15.61 billion in the third quarter of 2018 alone. Over a two-year period, quarterly losses ranged from $5.28 billion to $22.93 billion.
Firms in the MENAP region might suffer from such FX swings too. Consider a hypothetical regional electronics distribution firm based in the United Arab Emirates (UAE), whose currency, the dirham, is pegged to the US dollar. The firm makes payments to foreign suppliers in non-USD foreign currency and would typically need some time to collect payments from regional suppliers and clients. This time gap, coupled with the currency mismatch, exposes the firm’s profit margin depending on the dollar’s performance against the suppliers’ home currencies.
As we shall see, hedging the foreign exchange risk makes sound commercial sense, whether for a firm based in a pegged currency nation or one operating a floating exchange rate regime.
Pegged exchange rates
Most members of the Gulf Cooperation Council (GCC ) have pegged their currencies against the US dollar (Kuwait is an exception, pegging against an undisclosed basket of currencies). The peg makes sense, given that their main revenue source is energy commodities traded globally and commonly priced in US dollars.
The key benefit of a pegged rate is higher macro stability. However, the stability of the peg is driven mainly by that country’s ability to maintain an inflow of foreign currency and to have foreign currency reserves on hand to protect against any unexpected outflow of hard currency. The GCC states experienced just that during the 2014-2018 period of oil price swings. They incurred a combined $270 billion drop in foreign exchange reserves between 2015 and 2017, with the price crunch putting FX markets in some GCC states under pressure.
Adopting a pegged regime also means that the country is impacted by the performance of the base currency, which can cut both ways. On the one hand, for our UAE-based distribution firm, a weaker dollar post-supply purchase means shrinking profit margins. On the other hand, an export-led firm also based in the UAE would be better off with a weaker dollar as its products would be more competitive in global trade.
In other words, whether a peg poses an opportunity or a threat to a firm depends on how the base currency or currencies to which it is pegged perform, as well as the firm’s operating and funding profile and its payment/collection cycle.
Broadly speaking, the more stable a country’s currency peg regime, the lower the risks of currency shocks. In the case of the GCC nations, they tend to be well-funded and have sufficient FX reserves, so the chance of devaluation is very low. That makes forward currency hedging cheap. For example, a Saudi corporate that is required to pay a lender or supplier $100 million in one year’s time can hedge its currency mismatch at a cost of $135,000 (13.5 bps).
This, in turn, is why it makes financial sense for companies that have forward exposure to potential currency fluctuations and that are not FX specialists – like our hypothetical UAE-based distribution firm - to hedge that risk. Doing so allows them to focus on their core business without unnecessary exposure to currency risk. After all, why keep an FX risk on the books when you can hedge it cheaply?
Floating exchange rates
Operating in an environment in which floating rates are used – such as in Egypt or Pakistan – is significantly riskier when making decisions on investments, operations, divestments or other factors with implications on capital or returns.
The key risk is local currency volatility. Take Pakistan: after spending most of the first half of 2019 near the 140 mark, the rupee weakened sharply against the dollar – losing 15% in the six weeks to late June, when it closed at 162.80. Being unhedged in such a volatile environment can be extremely risky.
Floating rates bring other risks that need to be considered. Specifically, in Egypt and Pakistan those include aspects such as repatriation of funds, and the difficulty of hedging in the local currency – both areas that Standard Chartered has experience in resolving.
Although a floating regime adds uncertainty, it can provide opportunities. For instance, the higher risk associated with a floating rate regime can offer higher returns, with Pakistan’s and Egypt’s 10-year government bonds yielding 11.4% and 14.325% respectively versus 1.79% on 10-year US treasuries. Standard Chartered can help clients who are comfortable with that local currency and credit risk by capturing these elevated yields.
Hedging in floating rate markets is a more complex decision largely because the increased uncertainty makes it more costly. Despite this, our advice, as a starting point, is that clients without a strong view on currency direction should hedge, particularly if the risk on an open position is material to their business.
"Why keep an FX risk on the books when you can hedge it cheaply?"
How to hedge
A key consideration when looking to smooth potential fluctuations is deciding how to hedge. The most common approaches are forwards and swaps.
How might this work in practice? Take the example of an international construction contractor that is appointed to a regional project. Its expenses are predominantly in foreign currency, whereas its revenues that are receivable from the project-owner are denominated in local currency. In addition, the payments schedule is based on the percentage of work completed, which puts the contractor at further risk of a currency value mismatch.
We would work with the contractor to quantify the currency risk they are running and put together a forward foreign currency purchase program to match the payments schedule, along with a timer option that incorporates some flexibility in the timing of exchange in the event there are some delays in revenue receipts.
This strategy gives the client peace of mind that the entire value of the receivable is hedged against any adverse movement. Conversely, they could decide how much of their forward receivable risk they are comfortable leaving unhedged and hedge the remainder.
Although this example is for hedging receivables, a range of products and strategies are available whenever there is exposure to multiple currencies.
A recent study of the results of 1,200 listed European and North American firms found FX losses totalled $15.61 billion in the third quarter of 2018 alone
Hedging with a client focus
Standard Chartered’s experience in the MENAP markets and our familiarity with the core risks, as well as second-level threats that are less visible – such as trading flows in the interbank market or between large market participants – allow us to offer targeted advice about when and how to hedge successfully.
More broadly, our role is to provide as much information as possible for clients operating in pegged or floating rate regimes so that they can make an informed decision.
Should they decide to hedge, we can provide multiple strategies that clients can assess to determine which suits their needs best. We also offer colour on liquidity, and optimal execution that makes use of seasonality, our franchise access and distribution – and even the possibility of taking advantage of opposite flows that could generate cost savings for clients.
Our capabilities and expertise have secured us a market-leading position in the MENAP region, allowing us to offer strategies and execution for the optimal hedge.
The fact is that hedging is often inexpensive and accessible – like insurance. And, like insurance, it’s something best to have in place before you may need it.
About the author
 “European corporates blindsided by FX volatility”, Euromoney (February 8, 2018), https://www.euromoney.com/article/b16v5swdcvnbnq/european-corporates-blindsided-by-fx-volatility
 Why FX Volatility Has Been Falling, And What To Do About It, Nasdaq (November 8, 2019), https://www.nasdaq.com/articles/why-fx-volatility-has-been-falling-and-what-to-do-about-it-2019-11-08
 “Corporates revisit options for reducing FX exposure”, Euromoney (November 1, 2019),
 “European corporates blindsided by FX volatility”, Euromoney, op cit.
 FiREapps Q3 2018 Currency Impact Report, FiREapps (2019). See:
 GCC members are the UAE, Saudi Arabia, Bahrain, Oman, Qatar and Kuwait.
 Sustaining the GCC currency pegs: The need for collaboration, Brookings Institution (2018), https://www.brookings.edu/wp-content/uploads/2018/02/sustaining-the-gcc-currency-pegs_english_web.pdf
 Accessed on November 25, 2019, https://tradingeconomics.com/pakistan/government-bond-yield
 Accessed on November 25, 2019, http://www.worldgovernmentbonds.com/country/egypt/
 Accessed on November 25, 2019, https://tradingeconomics.com/bonds
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