Dealing with foreign exchange

Economy July 31, 2017 01:00


IMAGINE yourself as a Thai exporter of coconut water. Due to recent health trends, your product is selling very well in overseas markets and you are reaping huge amounts of money.

Then one day, Britain decides to leave the European Union. The next day, the US lowers its interest rates. The day after, North Korea launches a larger-than-ever missile, sparking a war. During this week of imaginary global financial mayhem, your profits from sale of coconut water are completely wiped out due to volatile exchange rate movements. 

The question is: “Who is to blame?” The British? The US Fed? Kim Jong-un? The Bank of Thailand for not taking better care of the baht? 

Coming back to a more realistic setting, exchange rates are still very sensitive to even the smallest of developments around the world. And as our world becomes increasingly borderless and propelled by technology, with capital flows pouring out of one country into another at the click of a button, uncertainty and volatility across markets are here to stay. The same applies to exchange rates.

Since the beginning of 2017,the baht has appreciated to its strongest level in two years due to uncertainty about the Trump campaign and the Fed’s plans to tighten fiscal policy. 

Firms operating under these unstable conditions must learn to utilise risk management products, otherwise they could be faced with heavy losses. 

In Thailand, there are many products you can utilise to prevent or “hedge” foreign exchange risks. Banks offer “forward” contracts, which allow you to buy or sell foreign currencies in the future at a rate agreed upon today, regardless of how much the actual exchange rate will be in the future. This essentially locks in the amount you have to pay or receive. For example, if you are exporting coconut water and will receive a US$10,000 (Bt340,000) payment from your counter-party in three months’ time, you can enter a forward contract to sell your proceeds three months from now at today’s exchange rate – let’s say Bt34. This means you have just locked in your income at Bt340,000 ($10,000 x 34.00). You can be rest assured that you will receive this fixed amount of money no matter how high or low the baht swings to in the next three months.

A similar product is also available on Thailand’s Futures Exchange Market (TFEX), called a “futures” contract. The main differences between forwards and futures contracts are that forwards are available through banks and can be tailor-made in terms of amount and tenor to better suit each firms’ needs, whereas futures are available only through TFEX and are pre-set to a specific size and tenor. 

The current size of one futures contract is fixed at $1,000, which is optimal for covering the smaller foreign exchange exposures of SMEs. 

Another way to protect your business against exchange rate fluctuations is to open a Foreign Currency Deposit (FCD) account with your local bank. The money kept in this account has to be of foreign currency. If you are an importer, you can purchase foreign currencies to deposit into the account to pay for the goods you import. Or, if you are an exporter and receive foreign currency proceeds from your overseas counterparties on a regular basis, then you can deposit those proceeds into the FCD account and withdraw them to pay for imported goods, or just keep the money to withdraw at a later date when the exchange rate is more favourable. 

Last, but not least, not all transactions need to be done in foreign currencies. You can simply choose to receive or pay for goods in baht, to avoid foreign exchange risk altogether. 

By doing so, you will be shifting all foreign exchange risks to your counterparty instead. They will be the one who need to hedge the risks, instead of you. This method, however, is subject to agreement between both parties.

TUNYATHON KOONPRASERT is senior analyst at Bank of Thailand’s Financial Markets Operations Group