Use tools to tame kiwi, firms told

Murray Fenton, managing director of Adept, said the company had never tried to manage its exchange rate risks by investing in derivatives. Photo / Supplied

New Zealand exporters and importers could make better use of the financial tools available to manage risks posed by volatility in the kiwi dollar, bank economists say.

ASB chief economist Nick Tuffley said smaller businesses were less likely than larger ones to invest in foreign exchange protection, even though it had the potential to smooth out the impact caused by movements in the exchange rate.

Various tools, essentially derivatives, are available to businesses for managing exchange rate risks. A commonly used tool is a forward exchange rate contract, where a business locks itself into a future foreign exchange transaction at a predetermined rate.

"That rate is essentially determined by where the current exchange rate is and the interest rate differential between the two countries for the next 12 months," said Tuffley.

However, this tool can backfire if the actual exchange rate at the time of the transaction turns out to be lower than the predetermined rate.

Option structures are also available, which provide protection against the exchange rate moving in an undesirable direction, but also give businesses the flexibility to benefit from the exchange rate becoming more desirable, said Tuffley.

"An option is a right, not an obligation, so that's where it differs [from a forward exchange rate contract] - you don't have to exercise the option."

As part of a specified Treasury policy, large organisations often hedged a percentage of their expected sales over the next year or two, he said.

"Smaller companies may not have the same sort of discipline."

Bruce Goldsworthy, manager of the Employers and Manufacturers Association's advocacy and manufacturers' divisions, said that while larger businesses had an obligation to invest in protection against foreign exchange shifts, smaller companies might see it as a time-consuming luxury.

"[Protection] eliminates the downside risk, but it also eliminates your upside risk, so if the currency moved the other way you don't get the bonus.

"It gives businesses an element of certainty, I think that's the key to it, but for smaller companies it's just another thing to do."

BNZ senior economist Craig Ebert said some businesses may avoid investing in foreign exchange protection because it was viewed as a cost.

"When you buy cover it certainly minimises your risk, but it costs you money to get rid of your risk, so that's the trade-off," he said.

Ebert said there were an increasing number of tailor-made options available to companies, but it was possible some firms were not aware of the benefits.

Murray Fenton, managing director of Adept, an Auckland plastics manufacturer, said the company had never tried to manage its exchange rate risks by investing in derivatives.

"I've felt I've been justified [in making that decision] ... we've never taken out exchange rate contracts because half the time we've won and half the time we've lost and I think it's been pretty even.

"Also, we're buying raw materials in foreign currency, and selling mostly in US dollars overseas, so what we lose is partly offset by what we buy.

"I felt paying a few more per cent for the cover hasn't been worth it."

Ebert said derivatives markets had got a bad name in the past, mostly because of their connection with the US housing crises.

"A kitchen fork is a lethal weapon in the wrong hands but generally a fork's a good thing because it helps us eat ... it's sort of the same with derivatives, it's how you use them and in a large respect they are very helpful."