Extra measures for volatile times
Amid the volatility of the current FX market, multinational corporates (MNCs) operating in sub-Saharan Africa (SSA) and offering payment terms to their local clients in SSA face a double whammy of cash flow and currency risk. Gerald Katsenga, Head of Corporate Sales, Absa Regional Operations (ARO) Markets (ex. SA) at Absa, offers an innovative solution.
SSA local currencies have not been immune to the COVID-19 pandemic and its disastrous economic side effects. Throughout 2020, SSA currencies have seen their US dollar exchange rates spike and drop like an emergency room doctor’s heartbeat chart. And those are the lucky ones. Other African currencies have seen their value against the dollar steadily fall, month on month, with no cure in sight.
These really are volatile and uncertain times. Take the Ugandan shilling: after crashes in 2016 and 2018 it was fairly stable through 2017 and 2019, yet it spent 2020 bouncing from UGX3670/$ (in January) to UGX3900/$ (March) to UGX3700/$ (September). The South African rand has also been yo-yoing between ZAR14/$ (in January) and ZAR19/$ (April), while Mozambique’s metical (flat around MZN60/$ to the greenback since 2017) has spent the year steadily losing value, dropping to MZN72/$ by October, with no signs of recovery.
Risk for exporters
“We’ve seen extreme volatility and extreme depreciation this year,” says Gerald Katsenga, Head of Corporate Sales, ARO Markets at Absa. “That creates an opportunity for exporting companies, which can convert their dollars or hard currency at a much weaker rate and generate extra cash flows. Importing companies, on the other hand, are now not able to meet their budget rates because when those budgets were set, SSA local currencies were relatively stronger (say, ZAR13.25/$ to the dollar in January 2019), but you’re now spending, say, ZAR17 for a single dollar.”
At times like these, businesses and central banks tend to hold on to what they have. “Very limited hard currency was coming into the market, so local regulators in countries like Nigeria, Tanzania, Kenya and elsewhere responded by changing their regulations on foreign exchange,” says Katsenga. “In Zambia, for example, mining companies that are exporting were given a directive that they needed to pay tax in USD instead of in kwacha (the local unit). In addition, the government passed another circular restricting government ministries from dealing directly with commercial banks.”
That, of course, drained the liquidity from the interbank market, keeping dollars stuck in central banks and leaving businesses with volatile (and weakening) kwachas, cedis, shillings and rands in their corporate pockets.
Cash flow and currency fluctuations
Pandemic or no pandemic, regulation or no regulation, business in SSA had to continue. But businesses that trade internationally were left with an unexpected problem. “When I’m importing, I want to keep the value of my assets and my liabilities close together in terms of the currency,” says Katsenga. “I’ve got my imports, which I pay for in dollars, and my sales, which I’m paid for in local currency. I want to create some certainty in my cash flows, so I’ll lock in a rate so that I know exactly how much I’m going to pay – both now and in a few months’ time – for my dollars. But in a market like Mozambique, which has banned the use of derivatives (including forwards and swaps), I can’t do that now.”
If you’re an MNC exporting into Mozambique, where the metical faced persistent depreciation, that means that when you give your in-country clients 90-day payment terms on their invoices, when they eventually pay you after three months, you’ve lost on the value you were expecting to get in dollar terms.
There’s another complication: “The pandemic has also seen central banks across SSA aggressively lower their interest rates in line with the global trend of rate cuts, which means, in addition to flight to safe haven dollar assets, local assets lost their high yield appeal to foreign investors,” Katsenga says. To create certainty for our clients in an environment with sharp weakness in SSA currencies and to alleviate that foreign exchange risk, Absa’s FX teams innovated – using those historically low interest rates as their secret weapon.
Avoiding the double whammy
“When local interest rates were high it didn’t make sense, in this context, for clients to borrow in their local currency,” says Katsenga. “But with local interest rates coming down, Absa has explored opportunities of invoice discounting for MNCs, extending a line of credit to those local clients who are earning in, for example, metical and paying in metical. Instead of an MNC waiting for the 90-day terms that they extended to their local clients, we as the bank can absorb the 90-day waiting period from the MNC. We buy your invoice and take on that risk. We’ll pay you now, so that you can buy your dollars at spot and know what you need to pay back to us in three months’ time.”
In markets where FX hedging instruments are absent or restricted, clients are unable to take out forward cover on their currency exchange. By selling your invoice and realising immediate cash for spot currency purchase, in other words letting the bank extend a loan to local clients for the 90-day payment term period given current extremely low interest rates, you are minimising your exposure to currency exchange volatility.
“Every business has payment terms,” says Katsenga. “And if you’re working on 90-day payment terms, what you’re actually doing is loaning that money to your client for 90 days.” MNCs face the double whammy of a cash flow gap (while you’re waiting for the invoice to be paid) and a currency risk (while you’re watching your local currency lose value to the dollar).