Protect your business against exchange rate uncertainty in the closing weeks of 2016.
Along with the latest sports scores and the weather report, the exchange rate has become a day-to-day topic of conversation for many South Africans. 2016 has been a rollercoaster year for the rand and our financial markets. Thanks to the aftermath of Nenegate, the UK’s Brexit decision, Donald Trump winning the US election, and so much more, we’ve had a great deal rock our economy.
And it’s not over. Historically, December is the most volatile month for the Rand, so now is the time to batten down the hatches and be prepared for any eventuality. And if you are involved in any import/export activities you need to pay particular attention to buffering yourself against foreign exchange fluctuations.
ForexPeople CEO, Richard Beddow shares insight and tips on how to protect your business at this unpredictable time of year.
Why is December a precarious time of year for forex?
“The liquidity, or volume of forex traded, is thin during the holiday slow-down, which makes the rand even more volatile. Because there are fewer, smaller trades, even relatively minor transactions and shifts in sentiment can move the market dramatically. It’s a bit like if you drop a large boulder into a dam, there’ll be ripples, but generally things will calm down quite quickly. Drop that same boulder into a tiny fish pond, and the impact is greatly intensified for a longer period.”
What causes the rand to fluctuate?
“The rand is an emerging market and commodity currency at the same time. So when global risk appetite shifts in favour of or against either (or both) of these asset groups the rand is significantly influenced. Very often it is not a local cause but something international that pushes the rand one way or another.”
What effect will Donald Trump’s election have on the South African economy?“The key to understanding the impact the US economy will have on South Africa is to understand the concept of ‘carry trade’. This refers to borrowing money in a country with a very low interest rate – such as the US, Europe or Japan and investing it in countries such as South Africa, that have higher interest rates. The goal is to profit from the difference between the interest you pay on the loan, and the interest you earn on your investment.
“Trump’s policy seems to be to drive domestic expenditure up. This will inevitably push US inflation up and result in a more aggressive interest rate hiking cycle. As this rises, the attraction of investing money in South Africa will decrease and existing carry trade will be diminished. What’s more, the US is a big export market for us and other emerging economies, but if Trump pushes local US industry, demand for South African goods will drop.
“This is why the upcoming credit re-rating in South Africa is so important. As long as South Africa’s rating is at an investment grade, foreigners will buy Rand. But if we are downgraded then a huge bulk of our investment will vanish, along with the ability to balance our deficit.”
Where is the rand at the moment?
“We are sitting on a knife-edge situation right now with a potential credit rating downgrade literally around the corner, a 90% probability of a US rate hike in December and an uncertain local political landscape. We may not be through the thick of it yet. The rand took a dive earlier on in the year, recently recovered to the year’s best levels and merely a few days later is under pressure again. This volatility means forex hedging is an absolute must – for importers and exporters.”
Who should be hedging/taking forward cover?
“An Importer (e.g. a business importing chairs from Italy)who has a foreign payment due in the future but wants to lock down the exchange rate now to ensure that their profit margin is secure. This is especially important if you are being held to a Rand price for your product. Don’t risk losing your profit to the vagaries of international markets and other things you can’t control.
“On the flipside, an exporter (e.g. a business exporting flowers to the Europe) should also be taking forward cover i.e. locking in the rate now for future receipts of forex to possibly increase their profit margin, but more importantly, to offer some certainty around what exchange rate you are going to achieve when your forex actually arrives.
“Either way, whether you are buying or selling forex, taking forward cover brings predictability and peace of mind in a volatile market. And can make the difference between a profitable holiday season, and a disastrous one. I am sure that any importers that did not have forward cover in the early part of 2016 can identify with this.”
Why are people nervous of hedging?
“Unfortunately, thanks to poor advice and the lack of tailored hedging strategies, Companies, especially SME’s, have not had great results from hedging forex in the past.”
How can poor hedges be avoided?
“The key is to remove a speculative mindset and emotion entirely. Then once your strategy has been established and implemented - you need to stick to it. This way you will have certainty and be able to sleep at night. Nobody can second guess this market – it’s like going to the casino with your business and it’s just not good business practice.”
Why should clients seek advice when hedging?
“You know your business, and after more than a decade in the FX game, we know ours. And we know the optimum strategies to use to navigate these tricky times, especially toward year-end. It is essential that you get good advice and get a solid strategy in place, one that is designed for your business requirements. The good news is that it’s actually more straightforward than you think, but it starts with understanding your business’s risk profile, agreeing to a specific strategy – and sticking to it.”
What are three last minute things that businesses should be doing to protect themselves?
1. Understand what outstanding forex exposure you have – right now!
2. Understand what the implications will be on your business if the rand were to go to 18 to the dollar, tomorrow and not recover for 6 months.
3. Hedge out your remaining foreign exchange commitments and remove the risk.
“And finally, remember, you can never predict what the rand is going to do, but you can protect yourself, and your business,” concludes Richard Beddow, CEO, ForexPeople.