Mitigating Currency Risk
Mitigating Currency Risk in the Philippines
January 5, 2016
Primary Article Contributor – Nick Avis
Team Leader Following the Philippines – Cameron Torrens
Keywords: currency conversion, economic stability, Philippine peso, American dollar, Euro, Japanese yen, foreign investment
When markets closed for the last trading day of 2015, the Philippine peso registered its third straight annual loss. Over the course of the year, the peso was greatly influenced by an net exodus of US$1.2B from the Philippine stock market, the US Federal Reserves’ tightening of its monetary policy, and an overall slowdown in emerging markets. The weakening of the Philippine peso will have a significant impact on the flow of money in the country. MNCs operating in the Philippines need to have a plan outlining how they will convert currencies for operations in the Philippines.
Most MNCs operate using either the US dollar (USD) or the euro (EUR) as their home currency. This home currency is then exchanged to Philippine pesos (PHP) when MNCs invest in the Philippines, or conversely pesos are converted to the home currency when MNCs extract money from the country.
In the past year, the exchange rate favoured businesses that invested USD in the Philippines and extracted PHP to Europe. In raw numbers, the PHP:USD depreciated 7.3% compared to the PHP:EUR exchange which appreciated 12.8% during the same five-year period. What this means is that US companies benefited when sending money to the Philippines but had to pay more to convert PHP into USD. The euro is the opposite; remittances to Europe were worth more whereas euros bought less in the Philippines than they have in recent years.
Much of the PHP:EUR appreciation occurred since early 2014 and the PHP:USD depreciation began in mid-2013. Neither trend appears ready to stop; in particular, interest rates in the US are likely to continue rising, which will result in the USD gaining even more strength, and the EUR is likely to further falter as Europe continues to fight market disappointment.
Although European companies would benefit from extracting money from the Philippines and US companies benefit from sending money to the Philippines, businesses cannot necessarily change their strategy based on current exchange rates. This often results in companies having very limited options to combat ever-changing exchange rates. There are, however, a few steps that businesses can take to mitigate the risk of changing currency exchange rates. First, companies can buy futures contracts so that there is more stability and predictability when they convert cash. Companies that rely on raw materials can also use futures for further predictability. Second, companies should seek debt and equity financing in the US. Not only are the US markets more stable than elsewhere, but companies (whether American or not) would benefit when they convert the USD they raised into PHP. Third, companies should diversify where they sell their products or services. By not concentrating too heavily on the Philippines and instead operating in multiple countries, MNCs can use a favourable exchange rate in one country to compensate for an unfavourable exchange rate elsewhere. Finally, companies can try to conduct as many business transactions as they can in their home currency so that they do not need to worry about exchange rates. This will be easiest when dealing with other multi-national or foreign corporations operating in the Philippines.
Whenever a business operates in a foreign jurisdiction, it is subject to currency exchange risk. The Philippines is no different. There are limited options for mitigating the risk of fluctuating exchange rates, so investors need to carefully evaluate whether they are willing to accept the inherent risk before operating in the Philippines. It is worth noting investors are increasingly willing to accept the risks and invest in the Philippines. In 2015, foreign direct investment was at an all-time high, led by investors from the US and Japan (similar to the USD, the Japanese yen (JPY) has also appreciated compared to the PHP, meaning the JPY can buy more PHP than it could before). American and Japanese investors are wise to take advantage of the current exchange rate because over time it will change; likewise, European investors may be better off waiting to invest in the Philippines until they can benefit from a more favourable exchange rate.
