This article follows the one presenting the macroeconomic situation related to the COVID-19 pandemic [1]. It offers business leaders and decision-makers a framework for reflecting on currency risk for SMEs.Managing this risk is part of the broader strategic planning process triggered by the pandemic (or any other crisis), to ensure a clear alignment between profitability goals and the risks involved in achieving them.
COVID-19 and Currency Risk Management Policy for SMEs: Impacts on Businesses
In the months ahead, COVID-19 and its impact on currency volatility will be one of the major challenges for businesses. Geopolitical risks—reflected in major macroeconomic issues—and market volatility will be front and center for any business revisiting its strategic planning.
Major Currencies – Context
The Japanese yen and, to some extent, the Hong Kong dollar, have remained relatively strong despite economic exposure to China. These two currencies are considered safe havens in Asia during market disruptions—unlike the Australian dollar. Likewise, currencies of net commodity-exporting countries like Canada have depreciated significantly.
The Chinese yuan’s losses were contained thanks to its growing status as a reserve currency—but more so due to massive intervention by the country’s monetary authorities. While the yuan weakened against the U.S. dollar, it appreciated against most other currencies. The euro has experienced a roller-coaster first quarter, as has the British pound.
The U.S. dollar, bolstered by its status as the ultimate reserve currency and massive monetary and fiscal interventions, remains stable. Such volatility in major currencies does not bode well for peripheral currencies. Every country is facing a deep recession and growing financing needs.
Currencies of countries with already high debt levels, foreign-denominated debt, or high exposure to commodities (especially energy) are expected to be highly volatile in the months—or even years—ahead.
Businesses in Transition and Currency Risk Policy
Macroeconomic risks stemming from geopolitical events are hard to quantify but cannot be ignored in strategic planning. They affect how we do business, and their impact on currencies is swift, significant, and hard to predict over time.
These risks will remain prominent over the coming months and even years. They are likely to sustain high volatility in foreign exchange markets and may generate excessive uncertainty, whether you are an exporter or importer. Such extreme volatility complicates both strategic planning and the resumption of operations.
Clear market trends have vanished—or at least become more uncertain—and the range of possible fluctuations has grown. Every forecast must now account for heightened uncertainty and short- to medium-term currency swings.
Emerging Stronger from the Crisis
While today’s difficulties deserve our full attention, history shows that crises often bring new opportunities, even amid profound disruption. It’s essential to manage financial market volatility today to make confident decisions tomorrow.
Once you’ve weathered these difficult times, what strategic opportunities might arise? It’s important to recognize that every effort made now will strengthen your business for the future. Taking a step back to assess potential opportunities amid crisis can be highly valuable.
A company with a strong balance sheet may be able to acquire or invest in businesses that are less resilient. This could be a chance to diversify your product line, enter new markets, vertically integrate, or move into a new sector.
Scenario Planning as an Early Warning System
As they emerge from the pandemic, businesses are reassessing their game plans and examining risks related to their products/services, supply chains, and the exchange rates they’ll face.
Cash flow and market risk management have never been more important. Through detailed analysis of the operating cycle and proper use of hedging instruments [1], companies can protect cash flow, stabilize liquidity, and enable decision-makers to act confidently at the right moment. These are the hallmarks of an effective currency and interest rate risk management policy.
Key Elements of Your Scenarios
It starts with people. Do those who understand your cash position, liquidity, and FX hedging also have a backup? Who can quickly step in if your treasurer or controller is unavailable?
Your company’s risk tolerance should be reassessed in light of recent events. Based on your post-pandemic resources, re-evaluate your capacity to take on risk. Update your tolerance thresholds accordingly.
For instance, would your business be financially impacted by a 5% or 10% adverse exchange rate movement? Do you know this trigger rate and how it’s evolving? Your risk mapping must be adjusted accordingly.
Is this threshold consistent across all product lines? Which revenue or cost lines are most exposed? Should these be prioritized for ramp-up? Are your profit margins high enough to justify the associated risk?
When reviewing your product or service offering and its entire logistics chain, just as you would apply a risk premium to clients (or suppliers) in high-COVID zones or regions with weaker public health infrastructure, you should also require higher margins to justify revenue (or expense) lines exposed to currency (and/or commodity or interest rate) risk.
Ultimately, at what exchange rate (break-even point) can buyers still afford your product? And for your suppliers, how far can you stretch payment without eroding profitability?
Do you know your alert levels? What’s your Plan B? If production is outsourced abroad, is there a local backup supplier? If you sell internationally, can you diversify your customer base?
To support this process, map the criticality of inputs to finished goods (based on margin size), and therefore to revenue sources.
Identify components and raw materials with the greatest impact on revenues. Measure and understand their exposure to various risks (including currency), and the resulting impact on profitability.
In an environment where production and distribution capacity is increasingly vulnerable to external shocks, prioritizing activities is key.
Review These Elements Regularly
In this context, it’s essential to review cash flow, working capital management, inventory forecasts, and supply-demand projections based on new risk-weighted assumptions.
Also, the relevance of pre-pandemic hedging positions [1] must be assessed.
It’s likely that pre-pandemic hedges by a Canadian importer now carry positive market value and could become a source of liquidity. In contrast, those held by exporters may carry negative value but can be adjusted to mitigate cash flow impact.
Ultimately, risk management happens within the operating cycle—where risks enter, transform, and exit the business. Currency risk is not the only threat, but it is one of the most disruptive, especially in a volatile macroeconomic environment. One of these macro-risks could very well become the next “black swan.”
Scenario Planning for Preparedness
Understanding and planning for how financial stability might be affected by business model risks is essential. Identify tipping points and intervention thresholds for each risk, and determine the right course of action. This is key to resilience.
Be as prepared as possible for various scenarios. Scenario analysis should become your alert system and Plan B development tool. You must anticipate—not just react. Make sure your tactical and strategic business planning accounts for the potential impact of each risk.
The goal isn’t to avoid all risks, but to define which ones are acceptable, to what extent, and which ones should be avoided altogether.
Special Attention to Hidden Risks
By evaluating your supply (or distribution) chain and the risk differential between global, regional, and local flows, you can allocate capacity more wisely according to your business’s risk tolerance. You’ll also strengthen the risk/reward balance inherent in your business model.
This pandemic has exposed dormant risks in globalization. As such, businesses should take steps to uncover any other hidden exposures in their models. Factoring in all risks is what ultimately strengthens business performance and resilience.
Choosing a strategy also means choosing which risks to accept.
Globalization Rebalanced
Globalization has led to vast integrated supply chains, justified by economies of scale through outsourcing to emerging economies. In exchange for productivity gains, the global economy accepted more (dormant) risk in the form of fragile supply chains. But the pandemic, geopolitical tensions, and emerging externalities like carbon pricing are forcing organizations to re-evaluate whether this is the right operating model.
Most companies cannot completely abandon this model due to the scale and quality of existing supplier ecosystems. It’s more a matter of rebalancing. New operating models favoring production closer to the point of purchase will emerge as businesses seek to diversify risk and secure their models. These supply chains, being closer to end users, may also be more resilient to pandemics and geopolitical shocks.
Currency Risk Management Policy as a Performance Anchor
Risks stemming from supply chains and macroeconomic issues—sovereign debt, tax changes, tariffs, trade quotas, and resulting trade tensions—will become increasingly relevant to the business environment. The impact of any of these risks on operations is rarely isolated or short-lived. Among other effects, they have an immediate and significant impact on the frequency and amplitude of currency fluctuations.
Trying to forecast FX markets is a losing game. Exchange rate projections for the next month, quarter, or year offer little value in strategic planning. Your currency risk management policy becomes your anchor. This policy must always lead you back to your profit margin.
A risk management policy built with D-Risk FX prepares you to withstand unfavorable currency movements while allowing you to benefit commercially from favorable ones. Adopt and maintain a clear risk mitigation strategy aligned with your business scenarios. Plan how to respond to a range of risks. The recovery will be faster after an adverse event.
The Lingering Question
China is the world’s second-largest economy and the main driver of industrial and manufacturing trends. It is preparing for a rebound. But what can it achieve without U.S., European, or other global consumers? The Eurozone has been hit hard by the COVID-19 pandemic, as have the United States. The European Central Bank will do what it can, but given weak 2019 economic results, high debt levels, and signs of a pre-pandemic recession, the outlook is grim.
Emerging economies have seen major capital outflows, with investors turning to safe havens. And considering how COVID-19 strained healthcare systems in developed nations, it’s clear that many emerging countries—some with only embryonic healthcare—are unprepared. The pandemic’s economic impact on these regions will be severe and long-lasting. So how long will this last? Much depends on the strength of global healthcare systems. Once restrictions are lifted, how long will it take for growth to return? It’s hard to say.
[1] Crisis and Currency Risk: Macroeconomic Perspectives on COVID-19
For more insights on currency risk for SMEs, see the following articles: Currency Risk for SMEs: From Forward Contracts to Options and Bank of Canada – Currency Risk Management.
International Markets: A World of Opportunities
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