Dollar Doldrums

Multinationals are hedging currency risk, but they may need to do more.


Finance executives can't say they weren't warned. After more than a year of dire announcements that the United States was living beyond its means—and that budget and trade deficits could mean an eventual, sudden decline of the dollar against the currencies of the country's major trading partners—Federal Reserve chairmanReserve chairman Alan Greenspan set the wheels in motion for a dollar devaluation last November. That's when he predicted to members of the European Banking Congress in Frankfurt that international investors would eventually tire of financing the burgeoning U.S. budget deficit and trade imbalance.

Deutsche Bank Group chief economist Norbert Walter, who says he was "one of the lucky guys" who heard that Greenspan speech, agrees that "the development of the external debt of the United States over the past three years is unsustainable." Among the bleaker predictions is that central banks, particularly Asian banks that hold more than two-thirds of the funds invested in U.S. Treasury debt, may wind up pulling the plug at some point during the next several years.

"It's not something that's very imminent," says Walter. "[The central bankers] are not anxious to see their biggest investment downgraded." But Walter says it may be inevitable, particularly if China, which has its yuan (also known as the renminbi) pegged at roughly 8.3 to the dollar and is judged by forward contract markets to be undervalued by about 4 percent, sees its economy start to overheat. Walter sees that happening "if they get very close to 10 percent annual gross domestic product growth." China's GDP is currently running at 9.5 percent.

Despite such predictions, treasury executives of companies doing business in multiple markets are confident that their financial results are relatively immune. Most are hedged against the risk of a falling dollar through financial instruments or other offsetting measures, if they aren't poised to benefit. Some also consider the risk not nearly as great as pessimists contend. But experts caution that such efforts could fall short if the dollar's fall is particularly dramatic, and they decline to rule out that possibility.

Consider Honda Motor Co.'s approach. "Honda's basic policy hasn't changed," says Yoichi Hojo, general manager of the finance division of the Japanese carmaker. Hojo expresses confidence in the company's hedging strategy, if only because it is decidedly conservative. "The objective of the hedging is to secure ourselves but not to profit from the hedging," he says. "We don't do any speculative things."

Observers say Honda's approach is typical. "The basic philosophy [of multinationals in general] really hasn't changed" as a result of the dollar's decline, explains James Hodge, senior consultant for Chicago-based Treasury Strategies Inc. The "better companies," says Hodge, already have extensive programs in place to limit currency risks, whether through natural hedging such as diversification of markets and suppliers or by means of financial instruments. The two basic alternatives among the latter are forward contracts and currency options, both of which carry a not-insignificant cost for many companies.

Shorting The Greenback

To avoid such costs, and to meet the requirement under FAS 133 that such instruments be marked to market regularly, the most logical hedge for all but the largest or most highly leveraged companies would be to borrow money in the currency under siege. "Actual [financial] hedging would be very expensive," says University of Michigan economist Nejat Seyhun. Were he a finance executive of a smaller company concerned about a dollar downturn, he "might reduce my liabilities, reduce the foreign-currency debt, and increase my U.S. borrowings," in effect shorting the dollar. To be sure, massive new corporate borrowing in dollar terms could put upward pressure on U.S. interest rates, sending the dollar higher and undermining such a hedging strategy, but Seyhun says that scenario is highly unlikely.

Even some of the largest companies are doing what he recommends. Consider Wal-Mart, arguably the U.S. company most heavily exposed to a run on the dollar. China is the discount retailer's largest source of products, supplying some $20 billion in goods last year, according to analysts. The company plans to increase U.S. borrowings in 2005, says Jay Fitzsimmons, Wal-Mart's treasurer and senior vice president of finance, though he contends it's not for purposes of hedging, since the Chinese currency is linked to the dollar.

In any case, says Fitzsimmons, "we try to do as much as we can naturally." Natural hedges include setting aside cash and borrowing in local currencies such as sterling, yen, and Canadian dollars. But Fitzsimmons says the company will probably borrow about $5.5 billion to $6 billion by year's end, up from about $1 billion so far this year. Its total debt portfolio currently weighs in at around $30 billion, including everything from public bond issues to commercial paper.

Like other companies, Wal-Mart has natural alternatives to hedging with debt, including diversification, thanks to retail operations in 10 different countries. "On one level, our retail operations portfolio contains a mix of emerging markets and more-established markets," notes Fitzsimmons. Two of Wal-Mart's largest markets—Canada and Mexico—recently saw their currencies actually fall against the U.S. dollar. (The company's 37.8 percent interest in a Japanese retail outlet, Seiyu Ltd., is accounted for as an equity investment, and is not consolidated.)

Also, Wal-Mart tries to get what Fitzsimmons describes as the "lowest possible margin commensurate with the risk" in its purchasing and retailing arrangements. As a result, he says, "the actual impact of currency on the merchandise we buy is minimal." The company buys very little from Europe. As for the risk posed by the Chinese yuan, he contends it is undervalued versus the dollar by about 4 percent, noting that "5 percent is kind of the margin of error."

Because of this, Fitzsimmons dismissed dire predictions that the Chinese government will wreak havoc on his bottom line by abruptly jettisoning its currency's link to the greenback. "We buy everything in dollars," he says. "The Chinese aren't interested in getting more yuan. Their number-one priority is keeping people employed."

Where's The Impact?

Elsewhere, however, multinationals are clearly feeling the impact of a sliding dollar, and the impact isn't limited to earnings. From April to December 2004, the first three quarters of Honda's March 31 fiscal year, the company experienced a ¥54.5 billion drop in operating income, or 10 percent, due to the dollar's fall against the yen. Since currency fluctuation also affects the value of assets denominated in foreign currencies, Honda felt the decline in its cash balances and asset valuations as well. "If the yen appreciates, our balance sheet becomes smaller when it's converted to the yen," says Hojo.

Still, natural hedges such as local production facilities mitigate the impact on cash. "The basic policy of Honda is to produce the product where the demand exists," says Hojo. "By emphasizing local production, we can minimize currency risk."

Again, borrowing in the local currency also helps. "North American operations borrow dollars from North America, [so] there is no currency impact."

European companies are similarly hedged against the euro's appreciation. For them, the declining dollar leads to competitive disadvantages not only against U.S. products, but also against products from Asian countries like China, again, as their currencies are virtually pegged to the dollar.

Like Honda, however, many European companies are hedged naturally through their local operations. Some, like Siemens AG, not only produce and sell product in the dollar region, but also buy raw materials there. So despite Siemens's net foreign-exchange translation exposure, of which 73 percent is dollar-related, Hans-Peter Rupprecht, head of treasury and financing services at Siemens Financial Services, notes that "the positive effects [of its natural hedges] partly offset the negative effects of a declining dollar" (see "Acting Local").

Yet Siemens sees a need to hedge against the dollar's decline through financial products as well, so that the "net effect on income is limited," says Rupprecht. To limit the impact on cash flow, Siemens tries to offset currency risk by netting out daily transactional exposure. He says Siemens does that in every currency on a global basis, through intercompany financing or operating-unit investments. And Rupprecht notes that the company requires each local entity to monitor its foreign-currency transaction exposure and hedge at least 75 percent of the net exposure of their operating transactions.

Natural Limits

Without extensive hedging, companies face major risks from the dollar's continued decline, says Standard & Poor's managing director Tanya Azarchs. Companies that maintain a strategic emphasis on local production can manage to avoid a hit to cash flow if currencies move in the wrong direction, "as long as their operations are self-contained abroad," she says. "In dollar terms, they can be doing very well," she concedes. But if, for instance, they're buying steel from abroad with cheaper dollars, she points out, "they have to pay more for the steel."

Moreover, says Azarchs, the risk of a sudden, catastrophic change in currency relationships is real. To skeptics like Wal-Mart's Fitzsimmons, Azarchs notes that similar doubts preceded the financial crisis of the late 1990s in Argentina, which also pegged its currency to the dollar. And while she admits that the likelihood that China's dollar peg is going to fall apart may be relatively small, the potential magnitude is anything but. "When the dollar peg fails," says Azarchs, "it fails big." If that happens, the cost and regulatory burden of financial hedges might not seem so onerous after all.

Ed Zwirn, based in Bethel, New York, is a regular contributor to


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