For multinational companies that manage cash flows across emerging markets, an imminent rise in US interest rates stands to reverse the momentum of some of those currencies. We examine how a hike could affect FX transfers involving a few select emerging markets currencies.
Few things are predictable in finance. Yet almost no one would be surprised by a US interest rate hike in December, especially after the Federal Reserve noted recently that inflation expectations and economic growth were finally in the right place.
Such a move would cap a year’s worth of indecision, which has greatly influenced the appetite for global currencies. Indeed, as the year progressed and the odds of multiple increases from the Fed fell, emerging market currencies like the Brazilian Real and South African Rand benefitted from a higher risk appetite among investors.
Now that a rate hike seems a more plausible near-term scenario, especially since the US presidential election of Donald J. Trump, emerging markets could see their high-flying currencies come crashing down to earth. The reason is that higher interest rates typically attract investors seeking bigger yields; to accommodate this, money flows away from riskier currencies like those in emerging markets.
How would an interest rate hike affect corporate cash flows and payments?
There are upsides and downsides for US companies. A stronger Dollar means that goods and services procured abroad will cost less. Depending on the global footprint, supply chain costs could decrease and provide a minor increase to the profitability of goods produced at the end of the chain.
However, companies that are headquartered in the US and reliant on emerging markets may feel an even tighter squeeze. Corporations that produce consumer goods, like Procter & Gamble and Pepsi, have reported revenue losses due to FX rate fluctuations for the last few years. Some of these firms are already factoring in the impacts of a rate hike into future revenue forecasting.
For companies based outside the US, the news is just as mixed. Those companies that export to the US can expect greater revenues (after repatriation into their local currencies) and a higher appetite for their products. Companies that purchase US goods as part of their supply chain, however, are likely to see their costs go up.
It’s also worth noting that an interest rate hike may make it difficult for US companies to issue bonds. The cost of currency hedging against the Dollar has grown expensive in recent months. Per analysis from Bloomberg, this growing cost coupled with a an increased interest rate would make US corporate bonds less appealing for the foreign investors who have been the biggest buyers of such assets in 2016.
Which emerging currencies should corporations be keeping an eye on?
After the last hike in December 2015, macroeconomic expert Eswar Prasad stated that the move would leave many emerging markets with little choice for an appropriate economic response other than “[pushing] through essential reforms.” The countries that have stalled on improving their economic fundamentals stand to be the most sensitive to a rate increase.
Two currencies stand out in particular:
- Brazilian Real – In spite of its appreciation YTD, the Real is still in a precarious place. Companies that purchase Brazilian commodity exports, like soybeans and sugar, stand to benefit. Many international companies have sizable operations in Brazil, despite a retreat of sorts in 2016. Because a rate rise would make it more difficult for Brazilians to buy domestic goods using credit, some companies could expect further impact to revenues.
- Russian Ruble – The currency has strengthened over the past year in spite of falling oil prices and two rate cuts from the Bank of Russia. As is the case with many other nations, Russia is keen to devalue its currency further in the year ahead. Falling rates, a dampened appetite for risk and a US rate increase could pull some of the flow of money away from Russia and make the currency much weaker against the Dollar.
A 0.25 percent increase to interest rates may not seem like a spectacular one, yet such a move will have a notable effect on the buying and selling of goods. For international companies, supply chain financing, revenue forecasting, payments and profitability expectations will all need to be adjusted in some fashion.