Manufacturers are particularly vulnerable to exchange rate fluctuations, thanks to the global nature of the production and distribution process. In the latest installment of an ongoing series looking at FX volatility, Natasha Lala, Managing Director at OANDA Solutions for Business examines how corporate treasury teams in manufacturing are managing their FX exposure.
Multinationals of all types are feeling the pressures of this year’s volatility in global FX markets. None more so, perhaps, than manufacturers, whose sprawling supply and distribution networks expose them to exchange rate risk at all steps of the production process. In today’s global marketplace, it is extremely rare for a manufactured good to go through its entire life cycle within a single set of borders. A tablet destined for sale in the U.K., for example, may be assembled in China for a U.S. company with parts from Korea and Japan.
For those in charge of managing and forecasting cash flows at these companies, the process is indeed as complicated as it sounds. In addition to ensuring that liquidity is available to support operations at each stage of the manufacturing and distribution cycle, financial professionals must also keep a close eye on costs. This is especially critical as the sector traces an uneasy comeback. The April ISM index, a U.S. measure that tracks manufacturing health, dipped slightly in April to 50.8, just barely on the good side of expansion vs. contraction.
Under such circumstances, a sudden swing in exchange rates can make the difference between profit and loss. That’s why, in light of the current volatility, any financial professional needs to keep a vigilant eye on FX markets. One way that companies in—and beyond—manufacturing can do this is to equip their corporate treasury teams with automatic data feeds that display the latest, most accurate FX rates. Such platforms can also offer customized analysis and decision support in the event markets take an unexpected in turn, allowing financial professionals to react swiftly and appropriately.
Still, manufacturers have a complex set of circumstances to consider when it comes to managing their currency risk. For one thing, the cost of materials can fluctuate wildly based on swings in the price steel, oil, and other basic inputs. Companies often offset these risks using futures and forward contracts, which allow them to negotiate pre-established prices for assets in advance—sheltering them from the impact of currency volatility.
Interest rates are another area that manufactures watch closely in volatile FX markets. Borrowing costs are priced in local terms and typically rise or fall with the value of the underlying currency. A large capital expenditure may be delayed or put off altogether if conditions are unfavorable. One way that corporates manage this is to borrow in areas where interest and exchange rates are low then convert the funds into the desired currency at the time of expenditure. Of course, this is a complex hedging process that requires experience, expertise and advanced knowledge of exchange rate movements.