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Company News | BT CEO's e-Club : Topic 'The Art of hedging'

The Business Times,  8 November 2004

The Art of hedging
How would a sharp decline in the US dollar impact your business, your industry and the economy?
THE pressure on the US dollar is almost palpable. The US current account deficit keeps rising. Though off their peaks, oil prices remain at prohibitive levels and the security situation in the Middle-East is as grave as ever. How will a weakening dollar affect the Singapore economy and its companies? Over to BT's CEO e-club.
THE Bush re-election spells more trouble for the US dollar as he seems unconcerned about the twin deficits and mounting debt in America. In his first term, the US dollar declined about 21 per cent against a basket of currencies and there is no reason to suppose it won't decline by at least that amount again in President Bush's second term.
If people pull out of the dollar, where will they go? There are only two places that can cope with such a volume of money. They are Europe and the euro, and Japan and the yen. Whether they deserve it or not, both of these currencies seem set to strengthen further.

I am very optimistic about the Singapore economy and, in fact, Asia in general. Geopolitical incidents aside, I don't share the views of the gloom and doom merchants. I don't think oil will remain above US$50 per barrel. it will come down to manageable levels. The US economy will not crash and I think there are many opportunities out there to do good business for Singapore and Singapore companies. In my view, this is a good time for us to expand throughout the region and the world.

Amanda Foods operates in the global seafood business and trades in a variety of currencies. Therefore, the real question is: 'What will the US dollar do against currency x or y?' - as they will all differ. As a Singapore company, we obviously report in Singapore dollars. There will be ups and downs but I don't expect the Singapore dollar to strengthen dramatically against the US dollar. Overall, I believe we will have some negative effect on our bottom line on translation. But the global seafood industry will continue to grow dramatically as consumers around the world increasingly enjoy the pleasures of eating high-quality seafood.

Currency fluctuations are a normal part of international business. There is, frankly, little that management can do about it. Instead, we at Amanda Foods will remain focused on quality products, good execution and people and brand development. These things create a universal currency of high value.

Some business executives are very quick to point out the negative effects on their businesses when currencies move against them. They are, of course, usually silent when it goes the other way. I wonder why?

Graham M. Bell
Executive Chairman
Amanda Foods

VOLATILITY in exchange rates is not conducive to business because planning under such conditions is difficult.

As a global trader, almost all the commodities we trade in are denominated in US dollars and our earnings are all in US dollars. Freight and insurance costs and interest on bank borrowings are all denominated in US dollars. Our cost of operations translated into corresponding US dollar will go up since salaries, rents, utilities, telecom and travelling costs are all denominated in Singapore dollars and this should have some effect on us.

The same impact will be felt by other players in our industry, as most of us have global businesses with the transaction currency being the US dollar. This impact on the bottom line may be offset by a commensurate increase in trading volume.

There are, however, adverse factors:

1) The Chinese currency is pegged to the US dollar and the impact of a US dollar decline on China's imports will be neutral. There are strong concerns about overheating in the Chinese economy, with interest rates poised to go up further, which may affect business volume as China has been the engine of commodity demand.

2) For non-US suppliers, there may be an effective decline in realisation, and consequently they may tend to increase their US-dollar denominated prices to cover their costs of production.

3) Although buyers theoretically stand to gain, a rise in US-dollar denominated prices by suppliers will most likely offset these gains. Buyers' appetite for commodities will not go up significantly if there are no material decline in the prices of the commodities in their own domestic currencies.

As far as the economy goes, on the negative side:

1) A weak US dollar could hamper Singapore's exports, as major trading partners of Singapore have their currencies pegged to the US dollar (China, Malaysia and Hong Kong). Combined with the US, they comprise a significant portion of Singapore's exports.

3) If the US dollar declines, there may be some impact on investment decisions that US companies may make overseas, and this may include Singapore.

On the positive side:

1) Singapore companies with significant borrowings in US dollars will gain.

2) Singapore companies that plan to have a footprint in the US should benefit.

Overall, in our view, a sharp decline in the US dollar could be a drag on the economy. But the magnitude of this drag will be determined by the speed at which the US dollar declines.

Vijay Iyengar
Agrocorp International

LIKE virtually all businesses, we prefer a stable exchange rate environment. That said, my personal view is that the US dollar will weaken over the next 2-3 years, and all businesses - including Bain & Company - need to think through the implications of this.

At Bain Singapore we have taken steps to minimise the impact of foreign exchange shifts on our business. First, we invoice our services in a range of currencies, including euros, US dollars and Singapore dollars, based on customer preference. We try to roughly match our payments to the same currencies. For example, we pay some of our compensation in Sing dollars and the rest in US dollars. By keeping revenue and expenditure roughly in balance - what I would term passive hedging - we neither benefit nor lose from currency shifts.

Consistent with this philosophy of passive hedging, most of our clients operate with relatively dispersed operations, allowing them a flexible response to changes in currencies and other input costs. For example, they may have assembly operations in Batam and southern China. If the yuan were to strengthen, as many expect, they would gradually shift some production (say, that destined for Australia) to Batam. One of the reasons contract manufacturers like Solectron and Flextronics have done so well is their ability to flexibly respond to changing market circumstances, including currency moves, in a fast and flexible manner.

If your firm is significantly hurt by a drop in the US dollar, the answer may be a change to your operating strategy - manufacturing and supply chain - rather then expensive hedging or across-the-board cost-cutting.

Charles M Ormiston
Bain & Company

OIL prices are almost always denominated in US dollars. Oil companies therefore have a natural long position in US dollars and are vulnerable to a weakening in that currency.

In China Aviation Oil's case, revenue and commissions for our procurement business are denominated in US dollars, while many operating expenses are in Singapore dollars. A fall in the US currency relative to the Singapore unit therefore raises costs. As well, China is our main customer, and with its pegged currency, a weaker dollar raises the cost of imports such as oil, and puts pressure on enterprises and consumers to use less.

It must be noted, however, that oil companies have been dealing with a weaker dollar for some time. The US dollar has been weakening against the euro and the yen since early 2002. Indeed, one of the major reasons oil prices have risen in dollar terms has been the weak currency. Because the US dollar is the currency of choice for oil transactions, this has had the effect of reducing effective costs to countries with currencies not pegged to the US dollar. This, in turn, has helped oil demand remain quite robust, to the extent that the benefits of volume growth have exceeded the costs of a weaker dollar. We see this most readily in the positive financial results being reported by most oil companies in Singapore and around the world.

So while there is a clear and direct concern facing oil companies from a weaker dollar, there is also a less obvious, but just as important, gain in the business's overall demand.

Chen Jiulin
Managing Director
China Aviation Oil

MOST advanced software products come from the US. A lower US dollar makes them more affordable in countries whose currency is not pegged to the US dollar. This is good for companies like NCS which build business solutions on advanced hardware and software. I hope the US dollar will fall in an orderly manner and stabilise soon. Volatility and uncertainty are bad for business.

Lee Kwok Cheong

THE currency for exchange in shipping, being an international business, is the US dollar. Revenue is earned and most expenses are incurred in US dollars. Hence, technically, a swing in the value of the US dollar will not materially affect our business. But the books of account - as the reporting currency is Sing $ - have to reflect any fluctuation and account for the loss if there is a sharp decline in US dollar. Recent amendments in the Singapore regulations allow companies to maintain their books in US dollars or any other currency. So, henceforth, if we keep our books of accounts in US dollars, this book loss will be eliminated.

With regard to vessel acquisitions, the transactions are again mostly done in US dollars. Therefore, in all, we do not see any appreciable impact on our business and our industry as a whole.

Mahesh S Iyer
Managing Director
Orient Express Lines (S) Pte Ltd

WE have a fair amount of transactions in US dollars for our electronics and medical businesses, and therefore the weakening of the US dollar will affect us in terms of exchange losses. However, as we operate a hedging strategy within our group to lower the risks of exchange rate fluctuations, the adverse impact is mitigated to some extent. We also have operations in Malaysia and China, where a fixed US dollar exchange rate regime is in place, and these operations are shielded from the weakening of the US dollar. On the whole there is some adverse impact on us, but it is manageable.

A sharp decline in the US dollar could have wider implications for the economy, particularly if the US dollar weakens more against the Singapore dollar than the currencies of other Asian countries exporting to the US. Our exports to the US may be affected, as our goods would be relatively dearer. The more immediate impact on the economy would, however, be a fall in income as Singapore is a net exporter to the US and the weakening US dollar would translate into a net exchange loss for exports denominated in the US dollar.

In general, with the US being our major trading partner, any weakening of the US dollar could have a significant impact on our businesses and the economy as a whole. Businesses should therefore practise a prudent hedging strategy to keep the risks of exchange rate fluctuations in check so as to minimise any negative implications that may arise.

Lawrence Leow
Executive Chairman
Crescendas Group

THE impact on our industry of electronic components distribution is complex, in both micro and macro aspects. Depending on where a distribution company is headquartered, the affecting factors are the denominating currency used and what major currencies are used to transact sales and pay expenses and suppliers.

At company level, and headquartered in Singapore, we collect revenue from most customers in US currency to pay our suppliers in US dollars. A declining US exchange rate will put more pressure on the gross profit margins due to an artificial increase in product costs

If a credit term is extended for payment - a common practice in our industry - a savvy customer, for example, in India, may choose to drag the payment out with confidence that the same US dollar payment can be purchased with fewer rupees later.

Another undesirable effect is that US-dollar revenue collected from sales must now battle against salaries and other expenses paid in appreciating local currencies.

Luckily or not, being production-demand driven and with orders booked on average two to three months ahead, the distribution business is not likely to jitter violently with sudden US dollar movements. In the eight countries where we are located, most sales are transacted in US dollars. But some overseas subsidiaries trade in their own local currency and may, in fact, gain from a sharp decline in the US dollar due to a lower transfer cost of products. So you gain some here and lose some there. However, a prolonged period of a sliding US dollar will definitely give rise to an unpredictable chain reaction in our industry.

Markets like Singapore, Malaysia and the Philippines, where production is carried out for US-based, local currency-paying clients, may be seen as less competitive than factories in China, where the local currency is pegged to the US dollar. Production may ramp up there instead of here, affecting our business undesirably. No doubt for those already charging their clients in US currency, local expenses and costs will also appreciate against their income and put pressure on their margins.

Much cheaper US dollars will also have a dampening effect on many low-end electronics produced in Asia destined for the US consumer market, despite the lower cost of components used in these gadgets if we assume that most of the components used are exported by US companies. To what extent and which direction this scale will tilt is anybody's guess.

Jerry Hui,
BBS Electronics Pte Ltd

ONE thing about currency fluctuations is that no one can really predict to what extent the impact to the economy is going to be. There are just too many factors in play at the same time. While generally there will be a negative impact when the Sing dollar appreciates against the greenback, being an infrastructure operator, the impact of a US dollar declining is quite minimal to our business.

Joey Chang
AXS Infocomm

AS the US dollar depreciates, our business and bottomline profit (S$) continue to slide, as our sales are fixed and contracted in US dollars.

The semiconductor business sector has been projected to be slow in 2005. The weakening of the US dollar will affect it further and make it harder for companies like us to maintain profitability and remain competitive.

Most semiconductor and electronics manufacturers are in located in Asia. It means there is a lot of cost pressure.

A weaker US dollar would also have an immediate impact on companies that export their products/services to the US. This would hurt domestic exports to US markets.

Singapore is highly dependent on the global economy and the global growth cycle. A slowdown by a key market player like the US would affect the domestic business environment and foreign investors' confidence. It would also increase domestic economic volatility.

James GJ Jeong,
CEO & President
ComSOC Technology Pte Ltd

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