Finding Stability in 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.

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