2016 has begun with a bang. Oil prices have continued to plunge, falling well below analyst downside predictions due to surprisingly resilient production levels and increasing concern over the pace of global growth, most notably that of China. Equities indices have reeled to the downside, marking the S&P’s worst start to a new year. Amidst this alarming activity, the most consistent financial markets trend has been the growing strength of the US dollar. Or put differently, increasing dollar strength implies the intense depreciation of most currencies across the world. These trends in global financial markets are in fact closely linked, as highlighted in FSG’s Global Outlook for 2016.

As a result, many of FSG’s clients have been racing to adjust their plans for sustained local currency depreciation, as input costs and prices change more quickly and to a larger extent than ever before. New data shows that US and European multinationals continue to experience heavy losses as a result of a strong dollar and depreciating local currencies. 2015 contains the two worst quarters for currency translation ever, Q1 and Q3, which marked the largest translation losses on record. US and European companies lost approximately US$24 billion in Q3 2015, which is six to 18 percent more than even the height of the eurozone crisis in 2012.

Impacts to emerging markets

Although the Federal Reserve has indicated a desire to conduct four rate increases in 2016, financial markets appear to be unconvinced and are pricing in only two additional rate rises. Despite this apparent incongruity in interest rate expectations, the dollar continues to climb. The result is that emerging markets’ currencies are weakening even further, with multiple consequences for multinational companies:

• US dollar profits will fall: As local currencies lose value relative to the dollar, repatriated profits are worth less when translated to US dollars. Companies with six-month hedging strategies have seen smart currency positions elapse, leaving most companies exposed to ever-increasing currency fluctuation.
• Some countries will ban profit repatriation: As local currencies come under pressure, governments are taking policy action to avoid capital flight. In some countries, this has meant a ban on imports, the purchase of which draws much-needed reserves out of the economy. In other cases, truly strained governments could even freeze profit repatriation for companies operating locally.
• Pegged currencies are becoming very expensive for their governments: As the dollar strengthens, some governments have maintained currency pegs in order to reduce their own currency’s depreciation. However, the gap between official and unofficial exchange rates has been widening in many countries, and reserves are dwindling. Even countries like Saudi Arabia and China, who have sizable foreign exchange reserve stockpiles, have drawn upon reserves significantly over the past year. While governments can maintain these policies for some time, exchange rate pegs soon come at the expense of other forms of social spending which may not be tenable forever. Some countries, such as Kazakhstan, Azerbaijan and Argentina have already released their currency pegs, resulting in a major shock to multinationals operating there. FSG identified this pressure – and the sheer expense of currency pegs – as a major trend to watch in 2016. Executives should use FSG’s 2016 Events to Watch report to identify currencies in their portfolio that may be most at risk of a rapid change in exchange rate policy.

Implications for action:

Given sustained and increasingly complex currency translation risk, FSG recommends that executives consider the following actions:

• Be wary of sudden changes: As we saw in 2015, beginning with Switzerland’s surprise de-pegging of the franc, currency policies can change overnight. Monitor where the gap between official and unofficial exchange rates are widening, where local companies or governments have substantial US dollar-denominated debt, commodity exporting countries with pegged exchange rates, and where new currency policies could be popular among local groups. These countries could be the most at risk for a rapid change in currency policy which would disrupt local business plans.
• Re-examine your product positioning, including price: Rapidly depreciating exchange rates make imported products more expensive and indicate relative weakness in the country’s domestic economy. FSG’s clients are experiencing changes in customer preferences toward cheaper, localized products. As a result, your competitive position and market share can change without any change to your product price or packaging. Re-examine your customer segmentation and product positioning to understand where you may have pricing power, or where marketing campaigns may be value-additive in maintaining or even gaining market share.
• Extend payment terms: In previous years, currency volatility has caused executives to tighten payment terms, ensuring that they receive as much revenue as they can. However, slowing global economic growth and depreciating local currencies mean that many partners and customers are struggling to make ends meet. Now is the time to work with your local team and consider extending payment terms.
• Go local: Particularly for companies reporting in US dollars, local assets have become cheaper. Where joint venture, merger, or acquisition is an effective corporate strategy, it is time to localize production.

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