How the dollar returned as king

When operating in the emerging markets, it seems the dollar is king again. Marc Barber reports

When operating in the emerging markets, it seems the dollar is king again. Marc Barber reports

When operating in the emerging markets, it seems the dollar is king again. Marc Barber reports

Not so long ago, clued-in companies operating in the emerging markets were making additional profits on foreign exchange transactions. Recent volatility in the currency markets has seen an end to all that and, for the foreseeable future, CEOs should be looking for a safety-first approach.

It’s easy to get caught out. Over the past few months, the exchange rate between sterling and the US dollar has swung by 15 per cent and back again. There will be businesses that have agreed a price with a supplier or client and are now struggling as they get a lot less dollar for their pound.

Mark O’Sullivan, director of dealing at foreign exchange specialist Currencies Direct, says in the emerging markets of Brazil, Russia, India and China (BRIC), the dollar has returned as the currency of choice as it’s seen as relatively secure.

‘When the proverbial hits the fan and everyone is trying to get out [of a country], trying to trade in the local currencies is not the most liquid thing you want to be doing. It’s quite easy to sell $50 million to buy euros or sterling, but you’re going to struggle selling currencies like the Brazilian real.

‘For four or five years it’s been okay [to buy local currencies] as the US dollar has got structurally weaker and the economies of these emerging markets boomed.

‘But now we’re in – or on the brink of – a global recession and you have to wonder if these economies are going to push forward. I doubt they will.’

Paul Graydon, head of HSBC’s treasury business development team, agrees that an alternative strategy is required. ‘Whatever sector you operate in, if you’re trading internationally it’s unwise to take big risks on making extra money in unpredictable markets. You’re better off putting that effort into protecting yourself against volatility and concentrating on profits. Make sure the emphasis is on guarding competitiveness.’

While currencies can be bought on the day – known as spot buying, there are other ways to try and gain greater protection in the markets. Forward contracts allow you to set a fixed rate for currency exchange transactions. ‘This, at least, removes the danger in one direction,’ observes Graydon. ‘But if rates become more favourable, you’re still locked in.’

O’Sullivan says he’s seeing greater demand for forward contracts. ‘We’re finding that when companies win business in those regions, they do not want the effect of exposure. Previously, they were quite happy to trade on the day as they were pretty much on to a sure thing all round, but now they’re getting set rates so they’re not caught out.’

A higher degree of protection can be gained through currency options. Graydon explains: ‘This gives you the best of both worlds. The client will set their protection level – say the dollar at is at 1.75, they may want protection at 1.73 to the pound as the worst possible rate. In three months time, if they’re buying and the rate has gone down to 1.60 when they make their payment, they can still buy their dollars at 1.73. By the same measure, if it goes up to 1.90, they can buy their dollars at 1.90.’

The price for this type of hedging varies, says Graydon. ‘It depends on where the client chooses to protect themselves. It’s also linked to the volatility of a particular currency and the time period. So there’s no set fee, it’s a market rate.’

Focus on bric

Mike Norfield is the group managing director at communications and networks specialist Team Telecom. The company operates in Brazil, India, China and sells online to Russia, and the company trades in sterling, euros or dollars. ‘Most of our price points are geared around working in those currencies,’ Norfield comments.

Based in the UK, the company manufactures a lot of its products in other parts of the world, such as Korea, Taiwan or Eastern Europe. ‘We actually buy and sell stuff in a lot of currencies, so when we’re manufacturing, we may be paying for our manufacturing in Taiwan in dollars, or we may buy stuff in euros – we’re constantly tracking what is best for the business within those currencies.’

Mark Whiteling, CFO at electrical components specialist Premier Farnell, says that, when operating in foreign markets, it’s essential to keep a close eye on currency rates and the wider economy. He observes that in India, where the company recently made an acquisition, ‘you do need to be careful around inflation and the exchange rate. You have to monitor that and we revisit pricing on a frequent basis.’

There are other ways to minimise risk. Whiteling says that the company keeps its stock in India down to essential items. ‘Products are imported specifically for an order, so we are minimising our exposure on a balance receivable,’ he says.

Pay in, ship out
At Team Telecom, Norfield says that orders can range from $100,000 to over $2 million. When operating in emerging markets on deals of this size, a handshake doesn’t quite cut it: ‘We have a bit of an unwritten rule and that is whenever we do business in emerging markets, or difficult economies, we ensure that when we take an order we get at least 30 per cent upfront.

‘Before we ship anything, we get the balance paid on shipment. We give credit in the UK and some places in Europe, but in most places it is a case of seeing the money upfront.’

Both Whiteling and Norfield have in-house teams that monitor the currency markets. For Carsten Brinkschulte, CEO of Synchronica, which specialises in affordable Blackberry-type services on mobile phones in emerging markets, it’s something that needs to be addressed as the company has suffered from currency fluctuations.

‘We are fully exposed to currency volatility and it is a big problem. Most of our customers are asking us to do deals in dollars, so we’re considering buying currency. It is very difficult to have a strategy against it. We are considering using a broker and hedging but, as it stands, we don’t do it.’

Ranjan Singh, CEO of travel experiences concern Isango!, recently set up an office in India near Delhi. He says the company also spot-buys currency, but attributes this to the size of the business. ‘What we do isn’t very sophisticated at the moment, but that’s ostensibly because our revenues are not that high. We transfer chunks of money in and try to get the best rate. When we grow to scale next year, that’s when we’ll need to do the hedging and start buying currency smartly.’

For entrepreneurs wanting to move into China, the closed currency keeps matters relatively straightforward. O’Sullivan states: ‘A lot of corporate clients would like to buy the Chinese yuan, but you can’t do it, so if you want to operate there you are looking at the dollar. If you get involved in the local currency, , you will need a licence and, normally, you’re at the mercy of the local banks as they decide what kind of exchange rate to give you.’

Although the yuan had appreciated against the dollar, the Chinese government still keeps a tight rein on how fast it’s allowed to strengthen. It’s expected to be some years before there is a move to a free-floating currency.

Says O’Sullivan: ‘With China, it’s political as well. They like to keep their currency weak to make their exports cheaper.’

For Russia, the dollar reigns supreme. ‘On a local business deal, you’ll probably get dragged into using the rouble, but for bigger deals it will be done in dollars,’ says O’Sullivan, who notes the actions of the authorities can make it a little unpredictable.

‘The rouble itself isn’t fully convertible as a currency. You can buy them but you’ll have trouble trying to sell them outside the country. One of the problems with Russia is they can change the rules overnight, as we saw recently when the stock market was closed.’

For India, the level of foreign direct investment has overheated the economy, strengthening the rupee. ‘The government started to play around with rates and changing regulations on what you can and can’t do,’ reflects O’Sullivan. ‘It is freely tradable but there are rules and regulations on how much money you can take out of India. The fallback will be the dollar or sterling.’

Whiteling comments that, in Brazil, ‘although you can only invoice in local currency, effectively pricing is done in dollars. So you need to be sensitive to what is happening to your price list at the dollar value.

‘If you’re buying in dollars and quoting a local currency price list, you must be able to fix your prices in the local currencies, otherwise you will be caught out.’

While the emerging markets may be slowing, Whiteling points out the GDP growth of the BRIC countries is going to outstrip countries in Europe and North America. Isango’s Singh states that the company’s growth, fuelled by $10 million VC backing, would not be possible if it had tried to set up in the UK.

‘By operating in India, we have achieved in one year what it has taken the competition ten years to do. We are now in 60 countries and have 8,000 product options. This wouldn’t have been possible in the UK due to the higher cost base.’

A smarter strategy is needed to operate in the emerging markets. ‘The rule of thumb seems to be that cash is king wherever you are,’ comments O’Sullivan. ‘In effect, as the economic panic spreads, everybody is throwing the baby out with the bath water; that will create lots of opportunities. You can pick up really good assets at cheap prices.’

The message is that the dollar is now the currency of choice and that opportunistic currency trading can hurt you badly. Says O’Sullivan: ‘Now we’re lurching from crisis to crisis every day, when a business wins a contract, many want to lock in the rates. They need to make their money in the contract, not the foreign exchange.’

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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