After a long period of relative calm, foreign exchange markets were hit by some severe turbulence in 2015 as markets reacted to a series of surprise moves by major central banks. Natasha Lala, Managing Director at OANDA Solutions for Business explains why she believes high volatility is here to stay in 2016, before isolating five currencies she says treasurers will need to keep an eye on over the next few months.
Corporate treasurers are no strangers to restless currency markets and the problems they can create for cash management and accounting. But few treasurers could have anticipated the turbulence that 2015 brought to the table.
The jolts began early in the calendar year, with the Swiss National Bank’s surprise decision on 15th January to unpeg the franc from an artificial cap against the euro, unleashing waves of volatility into global currency markets. As 2015 progressed, former emerging market darlings became the epicenter for currency market tumult. China unveiled its own surprise devaluation of the once tightly-controlled yuan in August. A depressed economic outlook coupled with sinking commodity prices and political troubles sank the Brazilian real. Other currencies tied to commodities followed.
With economic prospects remaining flat for many emerging markets and reactive monetary policies on the horizon, high volatility will likely continue to plague currency markets in early 2016. And that’s bad news for corporate finance departments.
Beyond the impact on revenues, volatility compromises the integrity of currency rates that treasury professionals rely on for accounting, forecasting, reconciling balance sheets and so on. The accuracy of these rates is already challenged by the over-the-counter nature of foreign exchange (FX), which means that rate providers offer data based on their own estimates, not what’s actually happening in the wider marketplace. Volatility further increases the likelihood that rates are obsolete by the time they hit the treasurer’s desk.
Based on these factors – namely economic outlook, volatility and difficulty in sourcing accurate rates – we have identified five currencies that may prove to be particularly tricky for corporate finance departments in 1Q2016.
Turkey’s currency (and economy) has suffered from the dampening enthusiasm for emerging markets as well as the anticipation of the ever-impending, yet oft-delayed US interest rate increase. Awaiting a decision from the Fed, the Turkish Central Bank held its own interest rates for most of 2015, sending the Lira to its weakest-ever level against the US dollar. Political instability also raised questions about the government’s ability to drive economic growth.
Despite a tough 2015, the Lira’s prospects in the quarter ahead are improving. Elections in November delivered a decisive outcome for the ruling party, surprising most observers. The promise of a stable administration has shored up confidence in Turkey’s political system, leading to a near instantaneous lift in the value of the lira. Finally, the falling price of oil has been a boon for the country’s businesses, as Turkey has to import most of its fuel – lower oil prices equal a lower cost of doing business.
For corporate treasurers, the challenge in dealing with the Turkish Lira may lie in geopolitical instability – namely tensions with Russia – which may drive volatility higher and make accurate lira/dollar and lira/euro rates difficult to source. Likewise, the Lira’s plummet versus the dollar has been a challenge for corporates with business operations in the region.
On top of the deflated interest in the emerging markets, the Russian ruble also suffered from falling commodity prices in 2015. With Russia’s economy dependent on oil exports, lower prices have had the opposite effect to Turkey, hurting businesses.
Looking ahead, many observers feel that the Fed’s interest rate decision may have a negative effect on the ruble if the rate hikes (or discussion thereof) intensify. Oil prices could also see knock-on effects.
However, prospects for the country’s business sector seem to be levelling out – the impact of the currency’s weakness on consumer prices appears to be subsiding. The Central Bank of Russia has stopped cutting interest rates for now, but if inflation expectations slow, rates may be cut further, which may boost economic growth. The Russian banking sector has been largely cut off from accessing capital from other countries, but it has sufficient liquidity – namely USD and EUR liquidity – to function well, further instilling confidence.
The rate of the ruble has been a tricky one for international corporates to deal with in 2015, but the outlook for the first half of 2016 is pointing to a more predictable rate. The catch is for corporates to understand when and where to source ruble rates and how they’re affected by non-economic events. For example, it’s known that the ruble tends to strengthen towards the end of the month as companies convert overseas earnings into rubles to pay taxes.
That said, companies that rely on Russia for raw materials and commodities – especially European companies – will continue to be affected by the currency’s volatility.
The Brazilian real has seen a spectacular fall from grace. In 2015 the real has depreciated 40% versus the dollar, as lower demand for commodities further put the squeeze on Brazil’s economy which, like Russia, relies heavily on commodity exports. This further hurt Brazilian businesses, who were already feeling the pinch of a stubborn recession and tough austerity measures.
With major politicians continuing to be investigated for corruption or exiting office altogether, there is little confidence that the currency’s decline and economic growth will stabilize in the near future. As we write this, impeachment proceedings for President Rousseff have begun, putting proposed economic reforms in further doubt.
In spite of these difficulties, major corporates find themselves unable to pare down local operations very much. As the German car-parts maker Continental AG noted, the Brazilian economy is “too large to abandon.” On the plus side, consumption of domestic goods is on the rise.
2016 promises to be an especially tricky year for corporate treasurers to work with the Brazilian real. For starters, the country has a tricky tax jurisdiction that requires corporates withdrawing capital from Brazil to justify why the money should leave the country. On top of this, the country’s proposed 2016 budget currently calls for a ‘financial transaction tax’ that would levy a 0.2% fee on things like currency exchanges and transfers.
Between surprise devaluations, bouncy stock markets, lukewarm economic indicators and a lift in retail sales, the Chinese yuan could have arguably been the currency that left investors and corporate treasurers doing the most head scratching in 2015.
The IMF’s designation of the yuan as an elite world currency (alongside the dollar, euro, pound and yen) in late November should bring some stability and predictability to the currency as China will relinquish some control to the financial markets. That said, the loosening of controls could also unleash uncertainty into the country’s economy.
In the near term, all signs seem to be pointing towards an economic slowdown, which would possibly entail further cuts to its interest rates and reserve requirement ratio (which dictates how much banks can hold in deposits and lend to consumers). That said, retail sales continue to rise at or near double-digit figures, which signals success in the government’s programme to steer their economy towards consumption.
An unexpected change to currency policy is never out of question with the yuan. How corporate treasurers deal with the currency in 1Q2016 is dependent on what type of goods their businesses deal with. Slowing industrial growth will continue to hurt companies that export commodities to China. International retailers could see some growth as Chinese consumption increases.
While Malaysia continues to offer promising economic growth prospects for specific industries, namely semi-conductors and other niche electronics, the currency remains one of the weakest in the world.
The ringgit hit a 17-year low against the dollar in 2015, hurt by the global slump in oil prices. As in Russia, the Malaysian economy relies quite heavily on oil exports – especially after the government’s push in 2013/14 to invest in developing a sustainable long-term oil sector. The ill-timed move continues to depress overall economic growth.
One upside to the weak currency, however, is the attractiveness of Malaysian exports. Demand for electrical and electronic products manufactured in Malaysia will be a centerpiece for the country’s trade balance growth in 2016. Domestically, sales may be crimped by the goods and services tax implemented last April.
With that all said, oil prices will likely continue to dictate the way for the currency. Any corporate treasurers that are using FX rates for forecasting, modelling, etc. will have to take oil prices into consideration. The Malaysian central bank may hold on doing anything with interest rates until later in the year, something for treasurers to consider.
Many corporate finance departments will continue to be challenged by the relatively rapid – and sometimes unexpected – fluctuations of emerging markets currencies in the first quarter of 2016. Beyond the reaction to the Fed’s interest rate decision (or indecision), there are a host of external developments that will continue to influence how these five currencies move: oil prices, geopolitical turmoil and unanticipated devaluations, to name a few.
Sourcing accurate rates for these five currencies already pose a challenge for treasury executives and others in corporate finance, as they are much less thinly exchanged in the financial markets, which translates into a bigger spread – and wider range of rates. Beyond having a deeper understanding of how/why these currencies fluctuate, there are a few steps that treasurers can take to enhance the accuracy of the rates they source:
Be selective, knowledgeable and consistent when deciding where to procure FX rates
Currency markets are over-the-counter and widely fragmented. There are many prices that can be valid at the same time. Discrepancies in rate providers across different divisions/business units/regions are a prime cause of errors in international corporate finance departments.
Automating the procurement of FX rates data
This sounds like a simple step, but surprisingly many major corporates we’ve talked to still collect FX data on an ad-hoc basis and plug it into a system. Best practice among the big-four accounting firms and major global corporates is to have an automated feed that plugs into an enterprise resource planning (ERP) or financial reporting interface.
Increase the frequency of FX rate procurement
Sourcing rates more frequently ensures that the currency values being used for key functions across the enterprise are as reflective of what’s happening in the market as possible. Many corporates we’ve spoken to still check rates at month-end or, at best, week-end. Daily rate sourcing is a must for corporates to ensure better decision making across the enterprise.
As the cost of hedging currency risk continues to rise and as corporates seek to limit the cross-border currency hemorrhaging affecting their balance sheets, treasurers are being pressed to heighten their knowledge and visibility of FX rates. Given the currently unstable and unpredictable nature of the former emerging market standouts, these five currencies are a natural place for treasurers in 1Q2016 to focus their energy.