FX International Payments
By Frances Coppola
Global trade became more difficult as protectionist impulses increased in many nations of the world, particularly in developed countries. The oil price remains low and unstable, causing deflationary tendencies in developed countries and putting at risk the fiscal finances of many oil-producing developing countries. Populism is gaining power in developed as well as developing countries.
Traditional “safe haven” currencies such as the Japanese yen and the Swiss franc were strong for much of 2016, as investors fled from currencies perceived as becoming riskier due to economic shocks and rising uncertainty. The U.S. dollar, too, was strong against most currencies, reflecting a generally positive outlook for the U.S. economy. In contrast, many developing countries saw sharp declines in their currency exchange rates versus the dollar – and so did some developed countries.
U.K. trading partners that are oil-producing countries saw significant decreases in their currency exchange rates in 2016. Oil prices have been falling since 2014; because oil is priced in U.S. dollars, this reduces the dollar income of oil-producing countries, causing terms of trade1 (TOT) deterioration reflected in a lower exchange rate versus the dollar. Countries whose currencies float versus the dollar, such as Kazakhstan, often find that although inflation may rise in the short-term, allowing the dollar foreign exchange rate to fall helps to buffer the economy from the negative economic shock of oil price declines, enabling a fast recovery.2
In contrast, countries which peg their currencies to the U.S. dollar can have difficulty maintaining their fixed exchange rate. Nigeria pegged its currency, the naira, to the dollar for over a year, but was forced to abandon the peg in July 2016. The naira depreciated rapidly, falling 14.2 percent in one month. It will finish 2016 over 60 percent lower in dollar terms than in December 2015. The naira’s depreciation caused very high inflation in Nigeria’s import-dependent economy, forcing the central bank to raise interest rates sharply despite a deep recession. Floating a currency abruptly to avoid running out of FX reserves can be painful.3
But rationing foreign exchange to preserve a peg can be even worse. Venezuela is experiencing a severe foreign exchange crisis, largely due to its fixed exchange rate and price controls. Reduced dollar income due to the low oil price, coupled with high U.S. dollar debts, means that the country lacks the dollars to pay for essential imports. This is resulting in widespread shortages, famine and civil unrest.4 The extreme scarcity of dollars has caused the unofficial foreign exchange rate of Venezuela’s own currency, the bolivar, to collapse.5 As most goods in Venezuela are only available at unofficial rates, the result is hyperinflation. The International Monetary Fund (IMF) estimates Venezuela’s average inflation rate for 2016 at around 480 percent, and predicts that in 2017 it will rise to 1,700 percent.6
But not all of 2016’s foreign exchange rate declines were due to economic factors. Two of the most challenged currencies in 2016 were the British pound and the Mexican peso. For them, the story was one of political shocks.
On June 23, 2016, the U.K. held a referendum on European Union membership. The referendum campaign was hard-fought, and as the vote drew closer, the outcome became less certain. But the day before the vote, opinion polls were predicting a victory for those who wanted to Remain. Sterling rose in anticipation. However, as the results came in overnight from the U.K.’s voting districts, it quickly became apparent that the vote was not going as expected. The pound’s foreign exchange rates started to fall when Sunderland declared for Leave: and as more and more districts rejected the EU, the pound continued its slide. By the end of the night, the pound’s FX rate versus the U.S. dollar had fallen by 10 percent.7
Following the vote, U.K. Prime Minister David Cameron resigned and the opposition Labour party collapsed. Despite the political turbulence, however, the pound’s FX rate stabilised during the summer, largely due to the calming effect of Bank of England (BoE) interventions. But in October sterling fell by another 6 percent after the new Prime Minister, Theresa May, appeared to suggest that the U.K. would leave the EU with no deal and the Bank of England would come under political control.8 The pound recovered slightly in November and December, but it finished 2016 some 15 percent down from its December 2015 value.9
The election of Donald Trump as president of the U.S. caused foreign exchange rates to fall in many developing countries, as investors anticipated a tougher international trading environment in the future.10 For example, the Turkish lira has fallen rapidly since the U.S. election, though this is also in part due to growing political tension between Turkey and the European Union.11 Some developed country currencies experienced falling foreign exchange rates, too: for example, the Australian dollar’s exchange rate versus the U.S. dollar fell from $.775 on election day to $0.740 two weeks later.12
The Chinese yuan, the value of which is set every day by the People’s Bank of China, had been gently depreciating against a basket of international currencies for much of 2016, in parallel with China’s slowing economic growth. But after the U.S. election, its value fell sharply to a six-year low against the dollar.13 For businesses in China’s key trading partners, such as the U.S., the yuan’s weakness is likely to mean higher costs in 2017.
But no currency suffered more than the Mexican peso. During the campaign, the peso became something of a barometer of U.S. public opinion. Trump’s campaign promised a wall to curb immigration from Mexico and tough new rules to discourage companies from relocating production facilities to Mexico. When Trump appeared to be winning, the peso’s FX rate fell versus the dollar; when Hillary Clinton appeared to be winning, the peso’s FX rate rose.14
The day before the election, opinion polls were predicting a Clinton victory so the peso rose sharply – only to collapse even more sharply as the results came in overnight. By dawn on November 9, 2016, the peso’s dollar FX rate had fallen by over 13 percent, though it later rebounded slightly. The peso finished 2016 more than 15 percent lower than its December 2015 dollar value.15
Large abrupt swings in foreign exchange rates were a feature of 2016, as political and economic shocks roiled the global economy. Such risks remain elevated in 2017 due to rising nationalism: for example, elections in Eurozone countries may turn in surprise results like those seen in 2016. Economic risks are elevated too, because of the growing possibility of trade war. For businesses, navigating these choppy waters will be a challenge: but with foresight, nerve and sensible use of FX hedging techniques and tools, profit opportunities can still be found.
With 17 years experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “Terms of trade” represents the value of the exports of a country relative to the value of its imports. From: “Terms of Trade – TOT,”, Investopedia; http://www.investopedia.com/terms/t/terms-of-trade.asp
2. "How the transition to floating foreign exchange rates impacts businesses", American Express; https://www.americanexpress.com/us/foreign-exchange/articles/floating-foreign-exchange-rates/
3. "How falling oil prices caused foreign exchange rate movement in Nigeria", American Express; https://www.americanexpress.com/us/foreign-exchange/articles/falling-oil-prices-impact-foreign-exchange-rates-in-nigeria/
4. "Venezuela on the brink: a journey through a country in crisis", Guardian; https://www.theguardian.com/world/2016/oct/11/venezuela-on-the-brink-a-journey-through-a-country-in-crisis
5. "Venezuela’s currency is collapsing on the black market again", Bloomberg; https://www.bloomberg.com/news/articles/2016-11-01/venezuela-s-currency-is-collapsing-on-the-black-market-again
6. WEO database query for Venezuela inflation, IMF; https://www.imf.org/external/pubs/ft/weo/2016/01/weodata/weorept.aspx?pr.x=71&pr.y=8&sy=2014&ey=2021&ssd=1&sort=country&ds=.&br=1&c=299&s=PCPIPCH%2CPCPIEPCH&grp=0&a=
7. "Pound slumps to 31- year low following Brexit vote", The Guardian; https://www.theguardian.com/business/2016/jun/23/british-pound-given-boost-by-projected-remain-win-in-eu-referendum
8. "Pound falls under $1.21 as Brexit fears hit sterling", Guardian; https://www.theguardian.com/business/live/2016/oct/11/pound-pressure-city-fears-hard-brexit-bank-of-england-business-live
9. GBPUSD (interactive), Bloomberg; https://www.bloomberg.com/quote/GBPUSD:CUR
10. "Trump win sparks emerging market sell off", The Australian; http://www.theaustralian.com.au/business/markets/trump-win-sparks-emerging-market-selloff/news-story/7f04dcde552c359c81f58d574a03c77c
11. "How the Turkish lira entered freefall", Al-Monitor; http://www.al-monitor.com/pulse/originals/2016/11/turkey-how-government-contain-the-economic-crisis-blaze.html
12. "XE Currency Charts: AUD to USD", XE.com; http://www.xe.com/currencycharts/?from=AUD&to=USD&view=1M
13. "Donald Trump’s victory in US election sends China yuan to six-year low against dollar", CNBC; http://www.cnbc.com/2016/11/09/donald-trumps-win-in-us-presidential-election-sends-china-yuan-to-six-year-low-against-dollar.html
14. USDMXN (interactive), Bloomberg; https://www.bloomberg.com/quote/USDMXN:CUR