By Roger J Kerr
Amidst the heated political debate and intense media scrutiny of exchange rate and related economic policies over recent weeks in New Zealand the most important aspects of how to handle the “strong” NZ dollar are seemingly completely overlooked.
The high Kiwi dollar (actually a weak US dollar) is widely blamed for the spate of recent job losses and factory closures with the Government and the Reserve Bank coping most of the flack for the blame.
It is quite revealing that many political and economic commentators in New Zealand really think someone can wave a magic wand of alternative economic policies and instantaneously negate the adverse impact of an 80 cent NZ dollar exchange rate.
At the end of the day, it is the Board of Directors of individual exporting companies that are ultimately responsible for ensuring adverse currency market movements does not whack profitability to such an extent that mines and manufacturing plants are forced to close and workers laid-off.
Any company that fails to adequately manage its financial risks, such as exchange rates, is of course ultimately accountable to its shareholders and with stock exchange listed companies the adverse impact on profitability is immediately seen in a falling share price - that is, shareholders who don’t like the currency management practice/policy can vote with their feet and sell the shares
It is more difficult when the company is Government owned.
Many local exporters of commodities whose commodity prices are supposedly closely linked to the NZD/USD exchange rate movements do not hedge too far forward at all.
The practice of relying on the commodity/currency correlation always holding true has been found to be wanting.
The risk-offset policy has been blindly copied from listed Australian mining/resources exporters who do not hedge forward either the mining/metal price or the AUD/USD exchange rate risk. These companies say that their shareholders expect and want the exchange rate risk to come through the share price and thus do not want company management disrupting that risk profile by hedging forward.
It all works well when the two prices (commodity and currency) move in tandem, one off-setting the other.
However, over recent years the convenient and reliable correlations have broken down as the European debt problems/crises from time to time have seen global money managers seek out the NZD and AUD currencies as safe haven investment destinations at a time when commodity prices have been falling due to weaker Chinese economic date.
Net result is a divergence of a rising currency value and falling commodity prices.
Those companies solely relying on the correlations holding and thus the natural hedge always working have been badly found out with their swimming trunks around their ankles as the tide goes out.
Risking profits, shareholder’s funds and worker’s jobs on a bet that prices always stay nicely correlated is just poor management and governance.
Good risk management/hedging policies should be stress-tested for event risks such as the very price divergence we have just seen in both Australian and New Zealand in recent times. Unfortunately, for the skilled worked made redundant from the Bluff Aluminium smelter because the parent company Rio Tinto does not hedge the USD/NZD exchange rate risk, there is just nowhere to shed home the accountability.
Most New Zealand manufacturing exporters do operate disciplined and well-formulated exchange rate hedging policies that do not rely on market price correlations always holding.
The critical element that determines what percentage and how far forward an exporter hedges USD receipts forward is the ability to change the USD selling price of the product being sold.
Fisher and Paykel Healthcare hedge export receipts up to five years forward as they have limited ability to change their USD and EUR product selling prices. They compete against local manufacturers in their export markets, thus currency management is key to maintaining cost competitiveness in the marketplace from a NZ manufacturing base.
Other exporting industries such as forestry, horticulture and seafood operate similar and sensible medium-term hedging regimes.
Fonterra just reported a revenue-weighted average NZD/USD conversion rate below 0.7700 for the year-ended 31 July, benefiting from their 18 month forward hedge regime.
There is plenty of evidence that major exporters in New Zealand do manage their financial risks to a weak US dollar very well and jobs and profits are not always threatened every time the NZD appreciates to above 0.8000.
Those protagonists demanding ill-advised economic policy changes from the Government or Reserve Bank as a response to the weak USD should take a look at how the well-governed exporters manage their way through such periods.
Relief may just be around the corner for those USD exporters running short of hedging; the Reserve Bank of Australia should see the light on Tuesday 2 October and cut their official interest rates, pushing the AUD down against the USD and thus the Kiwi inevitably following the Aussie down.
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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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7 Comments
Unfortunately, for the skilled worked made redundant from the Bluff Aluminium smelter because the parent company Rio Tinto does not hedge the USD/NZD exchange rate risk, there is just nowhere to shed home the accountability.
Aluminium prices have appreciated by around 15% in the last month.
Okay , so Government cannot " control" the exchange rate without fixing the rate ( which creates distortions and is dangerous), but they can influence the rate .
Companies can only manage their forex exposure through hedging for a limited period, these contracts are never open -ended , so they will hurt eventually ,
AND it is expensive to do this , buying forward cover or hedging does not come free
AND the smaller players cannot afford to do it , or dont have the internal skillsets to manage it .
While Government can't control the rate , it can "influence" the exchage rate.
It can be done through interest rates, the cash rate and/or mopping up excess currency,and / or increased long term borrowing for capital projecs ie : spending on infrastructure ,
Or simply creating new money through M1 to M3 money supply manipulation.
Traditional economists suggest these mechanisms are inflationary , but we seem to be in some sort of almost - deflationary environment right now , so as long as the process is managed , and we exit at the right time , it should work
Well said. Companies can only react to what the $ is doing, not control where it goes. Hedge or not, it is still too high and hard to compete. Government can choose to try and influence the rate, if they choose to. We see a lack of effort.
I would like JK to just stop saying nothing can be done and sinmply say 'we are looking into it' that would scare a few traders off an 'easy deal'.
As for Roger's article - I read it as blah, blah, blah I'm an economist and you should follow standard economist doctrice, blah, blah. Nothing in my book about doing it differently so it can't be done.
Roger , your final paragraph is where we could have a problem ....... we are not actually running in tandem with the Aus$
The NZ$ is consistently , albeit slowly strengthening against the Aus$ .
Australia remains our biggest trading partner , and this is where we are most likely to come unstuck when our agricultural / food exports which have a marginal advantagein the Aussie market , are uncompetitive .
All the waffle and excuses about whether or not the Government can do anything about the exchange rate does nothing to convince me that a Government, any Government, is powerless. It has been commented by many that there are a lot of decisions made that can influence the direction of rates. Sure, an immediate effect may not be measurable.
What we finally appear to be getting is hopefully getting under the skin of some of our leaders. It is not helpfull to leave it to the status quo.
Boatman gets my vote!
What to do about the exchange rate - First you need to know what's going on. In simple terms, the exchange rate is determined by buyers and sellers of NZD
Sellers of NZD can be categorised as
- Locals buying overseas assets
- Outbound tourists
- Local enterprises buying plant and equipment
- Government borrowing
Buyers of NZD can be categorised as
- Foreign buyers of NZ commodity exports
- Overseas investors buying NZ assets
- Inbound tourists
- Currency traders - carry trades
- Overseas buyers of NZ bonds
- Safe haven seekers
Ignoring tourism and focusing on the big buyers leaves
- buyers of NZ assets including govt bonds
- carry trades
- buyers of NZ exports
- safe haven seekers
The following numbers may not be precise .. from data available they're in the ball-park
Daily trade in NZD is $20 billion plus
- Exports $2 billion per day
- The rest $18+ billion
On the face of it, because of its size and volume, "The Rest" sets the price and overwhelms the export trade. That can be solved by imposing an FTT on all foreign currency movements, with all registered exporters who are registered for GST receipts are exempted. If the balance of 2/18 was the other way round at 18/2 you would look for another solution. You will notice that David Parker in his interview with Alex Tarrant discusses just about everything BUT the exchange rate, offering a few soothing words that one assumes will affect the exchange rate. According to Roger Kerr, companies can fix it. Trouble is they are minnows among sharks.
I agree with Iconoclast. FTT would be very useful in re establishing fundamentals are primary in setting exchange rates. And would cut out the pure currency traders whose activity distorts everything currently. Quite a small FTT would do the job, as the traders are speculating on very small margins. And as a small tax it would then not significantly affect currency transactions for actual business trade.
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