Hedging Foreign Exchange Risks |
By Sam Vaknin |
|
The exchange rate of the Macedonian Denar against the major hard
currencies of the world has remained stable in the last few
years. Because of the IMF restrictions, the local Narodna
(Central) Bank does not print money and there are no physical
Denars in the economy and in the local banks.
Thus, even
if people want to buy Foreign Exchange in the black market, or
directly from the banks - they do not have the Denars to do it
with.
The total amount of Denars (M1, in professional
financing lingo) in the economy is around 200,000,000 USD,
according to official figures. This translates into 100 USD per
capita. Thus, even if each and every citizen of Macedonia were
to decide to convert ALL their Denars to Deutsch Marks - they
would still be able to buy only 150 DM each, on average. These
tiny amounts are not sufficient to raise the rate at which DMs
are exchanged for Denars (=the price of DMs in Denars).
But will this situation last forever?
According to
economic theory scarcity raises the price of the scarce
commodity. If Denars are rare - their price will remain high in
DM terms, i.e. they will not be devalued against the stronger
currency. The longer the Central Bank does not print Denars -
the longer the exchange rate will be preserved.
But a
strong currency (the Denar, in this case) is not always a
positive thing.
The Denar is not strong because Macedonia
is rich. The country is in a problematic economic situation. The
banking system is perilous and unstable. The reserves of foreign
exchange are minimal - less than 30 million USD.
The
currency is stable because of externally imposed constraints and
an artificial manipulation of the money supply.
Moreover,
a strong currency makes goods produced in Macedonia relatively
expensive in outside, export markets. Thus, it is difficult for
Macedonian growers and manufacturers to export. When they sell
their goods in Germany, they get DM for them and when they
convert these receipts into Denars - they get less then they
should have if the Denar reflected the true relative strengths
of the two economies: the German one and the Macedonian one.
They pay expenses (e.g.: salaries to their workers, rent,
utilities) in Denars. These expenses grow all the time as true
inflation grows (as opposed to the official rate of inflation
which is suspiciously low) - but they keep getting the same
amount of Denars for their produce and products when they
convert the DMs which they got for them.
On the other
hand, imports to Macedonia become relatively cheaper: it takes
less Denars to buy goods in DM in Germany, for instance.
Thus, the end result is a growing preference for imports and a
decline in exports. In the long term, this increases
unemployment. Export is the biggest driving force in creating
jobs in modern economies. In its absence, economies stagnate and
dwindle and people lose their jobs.
But an unrealistic
exchange rate has at least two additional adverse effects:
One - as a rule, various sectors of the economy borrow money to
survive and to expand.
If they expect the local currency
to be devalued - they will refrain from taking long term credits
denominated in hard currencies. They will prefer credits in
local currency or short term credits in hard currencies. They
will be afraid of a sudden, massive devaluation (such as the one
which happened in Mexico overnight).
Their lenders will
also be afraid to lend them money, because these lenders cannot
be sure that the borrowers will have the necessary additional
Denars to pay back the credits in case of such a devaluation.
Naturally, a devaluation increases the amounts of Denars needed
to pay back a loan in foreign currency.
This is bad from
both the macro-economic vantage point (that of the economy as a
whole) - and from the micro-economic point of view (that of the
single firm).
From the micro-economic point of view short
term credits have to be returned long before the businesses
which borrowed them have matured to the point of being able to
pay them back. These short term obligations burden them, alter
their financial statements for the worse and sometimes put their
very viability at risk.
From the macro-economic point of
view, it is always better to have longer debt maturities with
less to pay every year. The longer the credits a country (single
firms are part of a country) has to pay back - the better its
credit standing with the financial community.
Another
aspect: foreign credits are a competition to credits provided by
the local banking system. If firms and individuals do not take
credits from the outside because they fear a devaluation - they
help to create a monopoly of the local banks. Monopolies have a
way of fixing the highest possible prices (=interest rates) for
their merchandise (=the money they lend).
Access to
foreign credits reduces domestic interest rates through
competition with the local credit providers (=banks).
It
would be easy to conclude, therefore, that it is an important
interest of a country to be open to foreign financial markets
and to provide its firms and citizens with access to sources of
foreign credits.
One important way of encouraging people
(and firms are made of people) to do things - is to allay their
fears. If people fear devaluation - a responsible government can
never promise not to devalue its currency. Devaluation is a very
important policy tool. But the government can INSURE against a
devaluation.
In many countries of the West, one can buy
and sell insurance contracts called forwards. They promise the
buyer a given rate of exchange in a given date.
But many
countries do not have access to these highly sophisticated
markets.
Not all the currencies can be insured in these
markets. The Macedonian Denar, for instance, is not freely
convertible, because it is not liquid: there are not enough
Denars to respond to the needs of a free marketplace. So, it
cannot be insured using these contracts.
These less
privileged countries establish special agencies which provide
(mainly export) firms with insurance against changes in the
exchange rates in a prescribed period of time.
Let us
examine an example:
The firm MAK buys combines and
tractors from Germany. It has to pay in DMs.
An
international development bank offered to MAK a loan to be paid
back in 7 years time in DM.
Today, MAK would be so afraid
of devaluation, that it would rather pay the supplier of the
equipment as soon as it has cash. This creates cash flow
problems at MAK: salaries are not paid on time, raw materials
cannot be bought, production stops, MAK loses its traditional
markets - and all in order to avoid the risks of devaluation.
But - what if the right government agency existed?
If
governmental insurance against devaluation existed - MAK would
surely take the 7 year loan. It would take, let's say, 10
million DM.
MAK would apply to the governmental agency
with its business.
It would pay the government agency a
yearly insurance fee of 2.5% of the remaining balances of the
loan (as it is amortized and reduced with each monthly payment).
This would be considered a proper financing expenditure and the
firm will be allowed to deduct it from its taxable income.
The government will provide MAK with an insurance policy. An
exchange rate (let us say, 30 Denars to the DM) will be stated
in the policy.
If - at the time that MAK had to make a
payment - the rate has gone above 30 Denars to the DM - the
government will pay the difference to MAK in DM. This will
enable MAK to meet its obligations to its creditors.
MAK
will be able to cancel this insurance at any time. If, for
instance, it suddenly signs a major contract with a German buyer
of its products - it will have income in DM which it will be
able to use to pay the loan back. Then, the government insurance
will no longer be needed.
This very simple government
assistance will have the following effects:
- It
will encourage firms to obtain foreign credits.
- It
will create competition to the local banks, reduce interest
rates and encourage a wider and better range of services offered
to the public.
- It will encourage foreign financial
institutions to give loans to local firms once the risk of
re-payment problems due to a devaluation is minimised.
-
It will place Macedonia in the ranks of the more developed and
export oriented countries of the world.
- It will
facilitate activities with longer term credits (such as
modernization of plants for which longer terms of payments are
required).
As time goes by, the private sector may
step in and supply its own insurance against devaluation .
Insurance firms the world over do it - why not in Macedonia
which needs it more than many other countries? |
|
|
|
|
|
