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Finding Stability in Volatility
Jonathan Rees, Western Union Business Solutions - 3 Sep 2013
Jittery markets and currencies under pressure present challenges for corporate treasury departments of all sizes, but small and medium-sized enterprises (SMEs) can be particularly vulnerable - especially those involved in importing or exporting. This article suggests ways in which smaller businesses can respond to what are likely to be further periods of volatility.

Since May this year, US Federal Reserve chairman Ben Bernanke has been indicating a ‘tapering’ of some of the Fed’s quantitative easing (QE) policies in the near future; assuming continued positive US economic data. This tapering is expected to begin towards the end of the year, with the Fed’s QE programme culminating in 2014.

Bernanke’s plans for the US central bank to end its asset purchase programme sparked widespread market volatility. Currency markets reacted as expected, as in theory reduced monetary easing will squeeze the supply and result in a stronger US dollar. However, currency investors quickly became jittery when news merged that Chinese banks are charging over 12% to lend to each other, despite being largely state-owned. This spike in interbank lending rates triggered fears of a ‘mini credit crunch’. It also raised concerns over the underlying health of the world’s second-largest economy at a time when the world’s largest is indicating that it will be weaning financial market ‘feral hogs’ off their supply of ready cash. The impact of these two factors on global markets was severe and is likely to be something we will see more of in the coming months as QE reaches its inevitable end.

Many small and medium-sized enterprises (SMEs) were caught by surprise at the markets’ reaction to this news. Since the real epicentre of the global financial crisis in 2008-09, currency markets have undergone a period of relatively low volatility and have largely been driven by fundamental economics in both established and developing economies. What we are seeing now, however, is a three-fold confluence of factors; development and financial prudence in key economies is clashing with conflicting government and fiscal policy, setting the stage for a dramatic and sustained return to volatility.

This point is reiterated in the latest annual report from the Bank of International Settlements (BIS), which calls on central banks to end the ‘whatever it takes’ approach. Page 11 of the report declares that “we are past the height of the crisis, and the goal of policy today is to return to strong and sustainable growth… Governments must redouble their efforts to ensure the sustainability of their finances”. The sentiment among central banks is that they cannot ‘hand out’ cash forever and at some point governments must do more to reform imbalanced national economies. These imbalances are the root cause behind the extreme currency volatility that we have seen in recent weeks and it is an imbalance that shows no signs of disappearing anytime soon.

Where then does this leave small businesses? Whilst volatility may be good news to currency investors, there is an obvious threat for SMEs; many of which are importers and exporters and therefore heavily exposed to currency markets.

Many SMEs began looking at global expansion as a means to escape the harshest depths of the financial crisis, but such sudden internationalisation may have left them under-prepared to face volatile foreign exchange (FX) conditions. While larger and more established multinational corporate (MNCs) tend to be more experienced and better resourced to cope with fluctuation in overseas markets, SMEs are often left needlessly exposed. In order to minimise the effect of the tapering of QE, companies of all sizes need to be as ‘financially-savvy’ as possible ahead of what looks to be a further turbulent period before 2013 closes.

Tightening Control over Cash Flow

In times of volatility, businesses often take a closer look at how to control their finances. Some tools that can help increase budget certainty are forward contracts and future payments. These enable businesses to lock in international payments at a fixed exchange rate, so as to manage their costs and avoid being subjected to currency fluctuations. By fixing the exchange rates of their international payments, businesses are in a better position to manage their outgoings, and will therefore be better equipped to cope with unforeseeable market disruption and other external variables.

Companies should look to exert as much certainty over their financial transactions as possible; managing exchange rates for incoming and outgoing global payments helps do this by reducing exposure to FX volatility and protecting profit margins from market fluctuations. Knowing budgets will not be affected, regardless of what the market does, enables corporates of all sizes to operate internationally with increased confidence and security.

Effective cash management strategies can be complemented by technology. Having a live online dashboard - which very often can be used on a mobile device via an app or mobile interface - can provide an immediate overview of payment exposures, allowing treasurers to react swiftly to market changes and maintain tighter books. Users are able to calculate their FX risk based on the amount of money and currencies that they are trading in at the current market prices, therefore giving subscribed companies a welcome advantage in the fast-moving world of international trade.

Options payments are another tool for managing international payment exposure to market volatility. Business owners and corporate treasurers are able to set a forward exchange rate at a specified date and then choose whether to use the pre-agreed amount or to reconsider given current market conditions. This gives SME owners the security of knowing what rate they will pay, but also gives them flexibility to reconsider should the market move in their favour.

Dealing with overseas suppliers and procurers presents challenges for both sides of the transaction. Where possible, paying in a local currency is a significant and worthwhile gesture; especially in countries such as China where remninbi (RMB) liberalisation is relatively recent. The additional effort can be worthwhile in avoiding additional administrative and conversion charges, aside from the advantages that come from stronger working relationships between businesses.

The Ones to Watch

The Bank of England’s (BoE) new governor, Mark Carney, successfully moved to quell market uncertainty toward sterling in his inaugural ‘Quarterly Inflation Report’ at the beginning of August. Carney set out clear parameters that need to be reached - namely the UK unemployment rate dropping below 7% - before any movement on the inflation rate will be considered. After some initial market trepidation that caused the pound plummet in value in the run-up to the press conference, sterling has since been on the rebound and performing well against many major currencies.

This strength, however, could be short-lived if positive economic news falters or, conversely, could increase if the UK economy continues to gain pace. The fact that the pound is currently difficult to forecast highlights the importance of offsetting the risk of price spikes for small businesses that often cannot afford to be hit with surprise expenses.

India’s rupee (INR) is another case in point. It has had a turbulent time as the Reserve Bank of India (RBI) has introduced further measures to stabilise their currency by implementing weekly sell-offs of government bonds. The market responded with scepticism to the latest RBI measures and the INR slid to record lows. India is an important trade partner for the UK and these swings in market mood can have dramatic impact on the profitability and working relationships between businesses. Being able to maintain a tight grip on finances will offer vital protection for SMEs while the INR attempts to weather the storm. Treasurers need to be extra vigilant about payments when trading with India as there could be some way to go before the INR stabilises.

Brazil’s real (BRL) and Indonesia’s rupiah (IDR) have been sliding too as both countries have seen a slow-down in their growth and faced questions about the health of their economies and widening current account deficits. Economists have reduced forecasts for further Brazilian expansion while worries about Indonesia’s dependence on raw material exports has led to an IDR sell-off.

Australia has also been affected by similar concerns and markets have reacted, sending the Australian dollar (AUD) through a period of rapid devaluation, particularly against the US dollar (USD). As these examples show, as one currency stabilises, another may falter. Managing international payments has traditionally been complex and time-consuming, but the tools to offset global volatility are maturing to provide savvy companies with the opportunity to get ahead of the competition and secure their finances with greater certainly, flexibility and efficiency.