Exports Business Related Exchange Rate Risk

Exports is a cross border business. Exports deal with two different countries.

The risk associated with exports trade is the involvement of two different currencies and uncertainty of future exchange rates. The relative values of the two currencies could change between the time periods of goods forwarded to payment received. Once goods are shipped to another country, there must be certain period goods will travel via sea or air. Even after receipt of goods, as per agreement payment term, the importer will remit the cash in designated currency. Changes in the currency exchange rate (currency fluctuation) may affect the business profits, positively or negatively.

The risk involved in foreign currency fluctuation known as Currency Risk, Foreign Exchange Risk or Exchange Rate Risk.

Impacts of Exchange Rate Risks to Exporter

  • Today’s competitive global business environment has a substantial influence on currency volatility and changes in exchange rates to a greater scale. That indicates the company’s bottom line of profitability.
  • Foreign exchange volatility may be unprotected to transaction exposure and economic exposure. Transaction exposure occurs due to currency volatility between transaction period, which may create short and medium-term impacts. Economic exposure occurs due to affected macro-economic conditions of the country, which affects the future cash flows and market value of the company in the long-term.
  • Unanticipated currency changes carriers’ substantial impact on the company’s on-going business concepts. Example garments exporters of Sri Lanka closing the business, since LKR strengthen against GBP, which may cause a loss in sales. In another way, if exchange increased that will be a competitive advantage for garments exporters. Exchange risk adversely impacts the operations of an exporter.
  • Depends on the exchange rate, the exporter will budgets and forecasts on certain assumptions. Changes in the exchange rate may cause management to focus on accurate estimation and to engage in hedging tools, which may cost additional chargers.
  • The exchange rate is difficult to quantify precisely when exporter deals with multiple countries.
  • Exchange rate ultimately affects exporters’ rate of return. Exporter makes more profits when a currency falls in value in relation to other country currencies. At present LKR is depreciate in value while USD is appreciating in value. Therefore more profits to the exporter in Sri Lanka.
  • Gain or loss arising when converting the currencies may affect the future cash flows of the firm.

Precaution is better than cure

Mitigations to Exchange Rate Risk

1. Sri Lankan exporters can avoid risks associated with the disparities in currency exchange rates by quoting a price in local currency. To cadre same importer should tie up with exporter’s local bank or needs to establish his own subsidizers to carry out business. But very rarely foreign country importer will like the deal, which may lead to loss of entire business into another exporter or another country exporter.

2. The exporter may strict into only USD value only policy to avoid difficulties associated with currency convertibility since other currencies such as Indian Rupees, Norwegian krone, South Korean won are not freely or quickly converted in LKR. Internationally USD is widely accepted.

3. Banking products and credit lines support exporters to safeguard against future currency fluctuations.

  • Foreign Currency Accounts — Allow exporter to receipt of contract payments in a foreign currency and use of those funds to pay invoices in the same currency. This helps reduce currency risk by not having to convert funds to local currency immediately. Therefore exporter can hold foreign currency until price become favorable.
  • Foreign Bill Negotiations — Exporter can obtain foreign bill negotiations credit facility from a bank for the invoice to be received from an overseas buyer. This can help to manage foreign exchange risk and enhance cash flow.
  • Foreign Currency Exports Loans — Simple credit facility or bank loan in the same currency as the export contract. These allow exchange rate risk to be managed, by being able to use the funds as working capital to fulfill export orders before you receive payment. Repayment of loan take in designated foreign currency, therefore exporter avoids foreign currency fluctuations completely.

4. Hedging is a tool for exporters to manage or avoid exchange rate risks. The exporter can consult or negotiates their bank. Bank advise regarding the particular currency and risk associated with the same. And the bank may offer a range of products that can help manage exchange risk given below:

  • Forward Contracts –A forward contract allows the exporter to sell a set amount of foreign currency at a pre-agreed exchange rate with a delivery date from 3 days to 1 year into the future. In other words, the bank agrees to buy or sell a certain amount in a foreign currency at a fixed rate on a particular date. This allows Sri Lankan exporters to know the future exchange rate to foreign currency receivable from sales/exports proceeds. Therefore exporter can work peacefully and forecast accurate income. The exporter is 100% protected in a forward contract with the flexibility of benefitting for improvements in the FX market.
  • Par Forward Contracts — The exporter must be guaranteed series of future foreign exchange commitments over a fixed period of time. Applicable to the exporter who has a series of foreign currency inflows. The contract will book into a single foreign currency rate. A confirmation of the transaction has to be signed by both parties (bank & exporter). Forward contracts obliged to do the transaction at the agreed rate, irrespective of the fact that the prevailing market exchange rate is advantageous or disadvantageous for the client.
  • Foreign Currency Options — Its derivative financial instrument that gives the right, but not the obligation, to sell a nominated foreign currency to a bank at a fixed exchange rate, either on a particular date or during a defined period of time. If the strike price (price offered in a contract) is more favorable than the spot exchange rate on the date on which this option matures, the option expired “in-the-money” and the holder will exercise it. If the exchange rate on the expiry date is better than the strike price, the holder will not exercise his option and the same known as “out-of-the-money”. Due to speculation nature and Sri Lanka being a developing nation, Sri Lankan local bank not practiced this tool.

Mitigating the exchange risk is not only increasing the profit of exporter but also strengthening economy of country…

Being banker by profession, I personally believe, the partnership with right business banking is significance for the exporters to succeed in the trade. If you are an exporter, who intended to mitigate the risk associated with the exchange rate, please feel free to contact me through digital platforms and any advice in this regard.

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Leso Kumar

Leso Kumar

Banker by profession. Contribute to SME business development. Believer in life long learning and change.