Just about all forecasts are for a lower Australian dollar in 2014, but we’re still seeing the AUD hold around 90 US cents. This uncertainty makes it hard for many businesses reliant on international trade to predict costs for the year ahead. Even worse, when the currency doesn’t move for a while it can lead to apathy and complacency.
While we know currency prediction is an extremely difficult exercise we also know that currencies must move eventually. A sudden move either way can be devastating for businesses, particularly those with longer payment cycles and predominantly one-way exposure.
One company saw a creditors book of $2 million blow out to $2.5 million when the Aussie dollar dropped sharply in the aftermath of the GFC. Like this company, if you’re an importer who has ordered stock and already sold it you can’t raise your prices to cover its increased cost.
That’s why any business exposed to foreign exchange rates should consider a hedging strategy. There are various tools that can be employed for this:
Forward Exchange Contract (FEC) allows the purchaser to secure an exchange rate today for a future dated transfer. An FEC can be booked for up to 12 months in advance and provides certainty.
Foreign Exchange Option, unlike an FEC where both parties are obliged to deal at a certain rate, this gives the buyer the right but not the obligation to settle at maturity. Protection against adverse moves is provided but there is the opportunity to take advantage of a better rate at maturity. In some cases a premium is paid upfront at time of purchase.
Limit Order allows you to nominate a target rate. A dealer that monitors the market 24/5 can lock in your nominated rate should it be achieved, without you having to be in front of a computer at all times.
A year ago, importers were enjoying a sustained period of the Aussie dollar above parity, which led to some complacency on the hedging front. However, when the tide turned and the AUD lost 15% of its value between May and August 2013, there was renewed interest in risk management.
The problem is that you can’t apply a Band Aid in retrospect. Hedging won’t fix past problems and it can’t protect you against what you’ve already lost, but it can cap losses so they don’t get any worse. It can also protect against future ones.
It really is important to have a plan when it comes to managing international money transfers for your business. Continually review it on a regular basis regardless of what the market is doing or what you think it will do because you can’t ever know with any certainty.
Economic factors can change very quickly and whether the sun is shining or not it always makes sense to actively manage at least a portion of known exposures.