Foreign Exchange Management: A Key Concern as Turbulence Hits European Currency Markets
Many of our readers involved in international business have asked us how the recent turbulence in the European currency markets will impact their company's ability to export products. Peter Wadkins, a senior vice president at MTB Bank in New York, discusses how these events will affect international business.
Peter Wadkins: It will be more difficult for companies to price their products. The recent widening of the currency bands within the European Rate Mechanism (ERM) has increased the potential for greater currency volatility, as the currencies will now be allowed to fluctuate by 15 percent within the ERM bands, rather than the 2.25 percent that was in place. Economic dislocations amongst member countries and the realignment of the currency bands means that the unified market approach has been postponed. U.S. companies will have to continue to manage exposures against individual currencies for a longer period of time than had been originally planned.
Business Credit: Since the European currencies (other than the Dutch guilder) have widened their bands, do you have any specific forecasts for these currencies?
PW: As the French franc is the strongest of the ERM currencies (other than the German deutsche mark) we tend to focus our attention on how that currency will fare against the Deutsche mark (DM).
Presently, the French franc has weakened about 4 percent since the realignment. The franc is currently around 3.51 per DM, and a gradual weakening to around 3.60 against the DM over the next six months, or an additional 2 percent is expected. The other currencies should fare similarly (the width of the bands makes it hard to speculate against them), but in general, we should see the Spanish peseta and Danish krone get hit the hardest, with perhaps a further 5 percent depreciation from current levels against the DM.
BC: And against the U.S. dollar?
PW: We are bullish on the U.S. dollar, despite the difficult time that the current Administration has experienced pushing its economic programs through. U.S. exporters are extremely competitive at these levels of exchange rates, and as Latin America seems to be drawing closer to the U.S., our exports are booming in that part of the world. It is our belief that the dollar is on a cyclical upswing which started in September 1992, and that although it may see bouts of weakness, it presents buying opportunities. Exporters should look for the dips in the exchange rate to cover their currency receivables.
BC: Some U.S. companies avoid getting involved in currency billing because they feel it is safer to conduct business in dollars. They feel that they can still compete with the Europeans without indulging in what they view as currency speculation. How do you feel about this?
PW: This strategy was somewhat successful while the dollar was falling between 1985 and 1992. Companies billed in dollars, and the dollar fell against the European currencies, so products dropped in price against local competition. The dollar has since reached a cyclical bottom (September 1992) and then strengthened between 20-40 percent against various European currencies. U.S. goods have increased in cost to the overseas buyers without any benefit to the U.S. exporters' bottom line.
BC: So the strength of the dollar should be impacting the sales volumes of our exporters?
PW: Exactly. Just because you bill in dollars your goods are not isolated from currency movements. When billing in dollars, the onus is on your overseas customer to manage the exchange risk. At best, the overseas customer will demand some sort of discount (around 10 percent) compared with his other suppliers to offset the additional business risks. At worst, dollar billing will cause overpricing compared with local suppliers (or other European suppliers) and business will be lost. By billing in local currency, you can take control of your products' costs and factor in the cost of currency hedging when providing costs to your clients. …