Of all the change that multinational executives face in their organizations and their markets, none has been as universally painful in 2015 than currency volatility. Emerging-markets currencies have become increasingly unstable as economic and monetary policy announcements have injected a new wave of currency volatility into the global financial system.
In fact, translation risk, or the impact of currency movements on multinational corporations (MNC) earnings, reached its highest point on record in Q1 2015. U.S. and European companies reported $31.7 billion in losses solely due to currency movements. The figure is nearly 50 percent higher than even the peak of the “taper tantrum” in 2013, during which the U.S. Federal Reserve’s announcement that it would begin to ease off or “taper” its quantitative easing program had a similar effect on corporate earnings.
How it works
The current bout of currency volatility is particularly acute because of the U.S. Federal Reserve’s intentions to raise interest rates, likely this year. Interest rate increases in the U.S. prompt flight of portfolio capital from shallow emerging-market investment pools, resulting in dramatic swings in currency valuation. In an environment of slower global economic growth, underperformance in many emerging markets due to falling oil prices, and historically low developed-market interest rates, even a 25-basis point increase results in a big difference in the risk-reward tradeoffs of financial market investors.
Impact on business environment
Currency volatility is always a concern for companies operating overseas. Changes in local currency values can erode earnings in USD or other hard currency even if in-market sales targets are met. However, these impacts rarely rise above US$4 billion per quarter, making the recent US$31.6 billion figure truly significant. The result is important for companies and shareholders, but also for the markets in which they do business:
- Lower hard-currency earnings for emerging markets: rapid currency depreciation can cause country managers to miss dollar or euro targets by a wide margin, even if in-market sales targets were met.
- Slower growth in emerging markets: For emerging markets, volatile currencies can result in massive downward revisions; Argentina’s 2014 GDP growth forecast tumbled to -2.6 percent in August 2014 from 2.0 percent in January 2014, as the currency depreciated 28 percent in eight months.
- Changes in consumer preferences and behavior: Emerging markets consumers are accustomed to higher inflation, but a large change in currency values makes imported goods relatively more expensive and renders local inflation even higher than expected. The result is a reduction in purchasing power that can change consumer preferences and behavior, risking both the brand value and market share of MNC products in local markets.
- Increases in oil supply, which in turn put downward pressure on prices: As local currencies depreciate, energy exporters have an incentive to increase their exports of oil and gas. This is because oil and gas contracts are priced in dollars; every barrel of oil exported brings in more local currency than before, even as oil and gas prices fall. This additional supply puts even more downward pressure on prices, reducing overall exports earnings and foreign exchange reserves for those countries, threatening their economic stability.
Actions to take
Many companies rely on their treasury department to consider a top-level financial hedging strategy to make up for changes in local currency values. However, this strategy ignores the operational effectiveness that emerging-markets executives can bring to the table to protect their earnings. FSG identifies two main goals by which executives can consider strategies for mitigating liquidity, credit and translation risk in emerging markets.
- Improve margin by securing short-term exposures and reducing volatility to create more certainty around cash flows. Actions to achieve this strategy include providing working capital in local currency, adjusting payment terms or factoring invoices from currency depreciation by selling receivables to a third party.
- Gain market share. In an environment where MNCs have access to very low-cost financing and a strong dollar, producing locally or expanding via acquisition can be a well-timed and powerful way to gain market share.
These strategies are not mutually exclusive. Executives often combine strategies to achieve their currency volatility management goals. Perhaps most importantly, these strategies can be implemented by international and regional leaders with limited support from treasury.
As companies begin their strategic planning sessions in the fall, and as the U.S. Federal Reserve is set to raise interest rates, executives should expect increasing currency volatility to impact multinational corporations in 2015 and 2016. The stakes for executives’ targets are too high to be left to chance, or treasury.