Monday 4 September 2017

It Is Possible to Survive a Currency Depreciation

Since that fateful day when Britons voted for Brexit a year ago, the British Pound (GBP) has fallen by 11.8% against US Dollars. Worries about Singaporean companies' investments in UK were raised in the aftermath of the vote. However, the fall in GBP was small fry to one Singaporean company which faced much larger currency depreciation in the countries it invested in. The company is Food Empire, which derived 58% of its revenue from Russia and 13% from Ukraine in 2013. 

In Mar 2014, Russia annexed Crimea from Ukraine. International sanctions on Russia followed suit. Both the Russian Ruble (RUB) and Ukraine Hryvnia (UAH) fell against major currencies. Fig. 1 below shows the fall in RUB (blue line), UAH (red line) and GBP (orange line) against USD since Mar 2014. At the lowest point in Feb 2016, RUB fell by 60% while UAH fell by 70% against USD. In comparison, GBP's fall of 24% against USD over the same period appears mild. 

Fig. 1: Fall of RUB and UAH against USD

Food Empire, which derives the majority of its revenue from Russia and Ukraine, saw its earnings fell from a gain of USD11.3M in FY2013 to a loss of USD13.6M in FY2014. However, despite the continued depreciation of RUB and UAH, earnings began to recover for Food Empire. In FY2015, it narrowed the loss from USD13.6M to USD0.1M. By FY2016, it had recovered to a gain of USD13.8M, which was even more than in FY2013, even though neither RUB nor UAH had recovered to their previous values against USD.

Likewise, Food Empire's share price also followed its earnings. The share price fell from $0.535 in Dec 2013 to a low of $0.205 in Jan 2016 before staging a spectacular recovery to a high of $0.765 in May 2017. 

Fig. 2: Food Empire's Share Price Performance

When a currency depreciates in value relative to other currencies, there are usually 2 impacts -- accounting and economic. The accounting impact means that all assets, liabilities and cashflows denominated in that currency are worth less. However, such impact on assets and liabilities are usually one-off, unless the currency continues to depreciate.

The economic impact means that the real purchasing power of consumers in that country reduces and consumers are not able to afford as many as before the products that companies sell. However, such effects will also readjust themselves over time. When a currency depreciates, imports become more expensive and the real purchasing power of its consumers reduces. However, at the same time, exports also become cheaper and exporters can sell more products overseas and increase their earnings. The net effect of a currency depreciation is that imports will decrease while exports will increase, thus increasing the current account surplus of the country. Over time, a part of these surplus will be spent within the country, leading to a recovery of the real purchasing power of its consumers. Hence, eventually, the profits of companies selling products in the country will also recover.

Having said the above, not all companies will survive a currency depreciation. Those companies with large debts denominated in foreign currencies would have difficulties repaying the debts which have become much more expensive in local currencies. To avoid such situations, companies need to hedge their foreign currency exposure, either by entering into a currency swap, or by holding foreign assets denominated in the same currency. For example, if you take a GBP-denominated loan to buy a property in UK, the effect of the currency depreciation on the property and the loan will offset each other if the loan quantum matches the property price.

Thus, although a currency depreciation will lead to immediate losses for companies invested in a particular country, eventually, prices within the country will readjust and the companies could make normal profits again.

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  1. Great post as usual!

    In my humble opinion, it might be a worthwhile strategy to purchase local stocks with overseas exposure. They are at a better position to buy financial instruments / hire risk consultants to hedge risk rather than the individual taking on the full impact of forex risk. Assuming most of us are not sophisticated enough to do forex hedging.

    To forecast macro economic trends is too difficult. Rather buy stocks with good fundamentals and conduct due diligence on its risks and forex exposure.

    1. Thks for your compliments!

      Agree with you that companies are in a better position to hedge their forex risks. Most individuals cannot take a foreign loan to do natural hedging.

      Yes, easier to analyse risks than to forecast changes.