With US interest rate rises suggested, CFOs may need to consider strategies to manage the impact of interest rate and currency movements on their operations.
Traditional risk mitigation tools such as options and futures are not the only way to reduce the risk of interest rate movements that adversely affect a company. CFOs may canvas other, less expensive ways to address this challenge.
But before CFOs begin thinking about how to manage the impact of interest rate movements on their operations, they might need to form a clear view about the outlook for central bank policies here and abroad.
In December 2016, the RBA left the cash rate unchanged at 1.5%.
AMP Capital Chief Economist Shane Oliver notes, the central bank's language in its post-meeting statement suggests rates are likely to remain where they are for some time.
“The RBA predicts economic growth will rise to about 3% or just higher over the next few years. The central bank is more bullish about the sustainability of the pick-up in non-mining investment. Higher infrastructure spending will also assist in boosting growth, as will continuing labour market strength which will prompt a subsequent pick up in wages growth and inflation," he says.
Central banks have historically tended to raise rates when there is a positive economic backdrop. But Oliver says for now, the RBA has decided to leave rates where they are, owing to a rocky outlook for consumer spending, slow wages growth and inflation in the near term.
“All the same, the RBA has suggested a stronger Australian dollar could dampen growth and maintain inflation at current rate. But concerns about an overheated Sydney and Melbourne residential property market have diminished with national home sales remaining flat over the second half of the year," Oliver notes.
He says that while some commentators expect the RBA to pursue a similar path of rate rises to the US Federal Reserve, Australia's central bank bases its decisions on local conditions, so rates don't necessarily move in tandem with other markets.
“With all this in mind, we believe the RBA will only start raising interest rates late next year at the earliest," Oliver adds.
Simon James, partner at HLB Mann Judd, says that in an environment of benign interest rates, CFOs have an opportunity to take advantage of the resultant low cost of borrowing.
“If the business has the right growth story in place, there's a real opportunity for CFOs to lower their cost of borrowing. Some of our clients have had success negotiating with banks and reducing the rate of interest they pay," he says.
According to James, with interest rates at record lows, now might be the time for finance chiefs to have refinancing conversations with lenders.
Any change in interest rates here or overseas could prompt movements in the Australian dollar and its currency pairs including the US dollar.
While there is little expectation of a change in the cash rate in Australia in the near term, that's not the case in the US.
If interest rates rise in the US, this could possibly reduce the value of the Australian dollar. This could affect many mid-market businesses in 2018.
Any reduction in the value of the Aussie dollar might reduce importers' purchasing power. Conversely, it could decrease the price of local goods and services, which could be good news for exporters.
“Most business, especially in the mid-market, shouldn't be playing the foreign currency game too much. In general, they should focus on providing goods and services, rather than building a sophisticated treasury function," James says.
“But it is important to be aware of the effect of currency movements on the business," he adds.
Find the natural hedges
According to James, businesses that are exposed to currency movements might first look for ways to develop natural hedges around their operations.
“Try to incur costs and income in the same currency to provide a natural hedge. That way, you don't have to convert the currency, which costs money and reduces profits," he adds.
Another way a business might reduce its exposure to currency fluctuations, without having to invest in hedging instruments such as options or futures, is to negotiate terms with suppliers and customers.
Says James: “Try to build terms into contracts to provide you with a hedge within the terms so that if the currency goes against you, the business has the ability to raise prices. It's not about trying to win on currency; it's about de-risking the business.”
“If you can manage the company without incurring the fees associated with derivative instruments, you'll be in a better position financially," he adds.
“Hedging instruments are still widely used, but I suggest seeking advice from experts if you absolutely have to go down that track. Don't hedge beyond where you need to, because it is expensive," he says.
Trends to watch
As for other trends to watch out for in 2018, James believes the right approach to technology will continue to occupy CFOs' minds.
“Technology is transforming the back office. So, CFOs should be constantly focused on identifying software systems that can improve efficiencies and deliver better information for the business. The idea is to find ways of automating as many tasks as possible, from those currently done by humans," says James.
- The Reserve Bank of Australia is expected to leave rates on hold for much of 2018.
- The US Federal Reserve is predicted to lift rates several times.
- To reduce the impact of rate rises and currency movements on their operations, CFOs could look for natural currency hedges and negotiate to transfer the risk.