Exchange Rate Fluctuations and
SMEs
Dr. Cathy L. Jabara
U.S. International Trade Commission*
*This presentation represents solely the views of the author and is not meant
to represent the views of the U.S. International Trade Commission or any of its
Commissioners.
Exchange Rate Uncertainty
• Fluctuation in the exchange rate is one of the
uncertainties associated with international trade.
• Foreign exchange risk is the probability that the
exchange rate will change unfavorably and adversely
affect the financial situation of exporters and
importers.
• Exchange rate fluctuations affect both large and
small businesses.
How do Exchange Rate Changes Affect Businesses?
Short and Long Run Effects
• Fluctuations can impact positively or negatively on a
firm’s profits or receipts.
• Assume most companies are risk averse—then it is the
possibility of financial losses due to an adverse exchange
rate change that is of concern.
• Exchange rate changes have short- and long-run effects on
businesses:
Short run:
Long run:
Unanticipated changes in
exchange rates affect
profits/revenues from
specific transactions.
Sustained long term changes in
exchange rates affect the demand for
imports and exports by changing the
prices of traded goods.
Exchange Rate Fluctuations and Trade:
Estimated Impacts?
• Economic studies have generally not found
significant adverse impacts on trade flows from
fluctuating exchange rates (IMF, 2004).
– The exchange rate is just one of many factors that affect
the success of companies in international trade;
– Firms have options to mitigate exchange rate volatility,
which are reflected in the aggregate trade statistics.
• Studies based on firms, rather than aggregate trade
data, have found larger effects (Dekle and Ryoo,
2007).
Anecdotal Evidence
• Japan—large company:
– A Wall Street Journal article from last May noted that Toyota has been
struggling with a sustained increase in the value of the yen, which has eroded
the value of its dollar-denominated earnings and made its Japanese exports
less competitive in foreign markets.
• United States—SMEs:
– In a 2011 survey of 300 small U.S. exporting firms, businesses cited such
factors as shipping, logistics, storage costs, insufficient margins of profitability
as well as fluctuating exchange rates as top trade barriers.
• Vietnam—SMEs:
– Vietnamese businesses importing panels from Malaysia cited financial losses
in 2011 due to a depreciation of the Vietnamese dong relative to the U.S.
dollar, the invoicing currency for their imports.
• UK—SMEs:
– Over a third (36%) of UK SMEs state currency fluctuations as their top
concern when trading internationally (American Express FX).
Impacts on SMEs
• Few if, any, studies have quantitatively examined
the impact of exchange rate volatility on SMEs;
• To understand its potential impact, there is a
need for information on:
– Nature of exchange rate fluctuations; why
exchange rates are uncertain;
– How businesses, large and small, cope with ER
fluctuations;
– Special characteristics of SMEs.
Nature and Extent of Exchange Rate
Fluctuations
• Exchange rate changes are a source of uncertainty
depending on the degree they are unforeseen.
• Unfortunately, economists have not had a lot of
success in predicting exchange rates.
• Again we look at the short-run and long-run
exchange rate changes:
Exchange Rate Determinants
The demand and supply of currencies is
constantly changing as banks,
businesses, and individuals enter the
markets.
Exchange rates change by the minute,
hour, and day.
Exchange rate changes are
correlated with macroeconomic
fundamentals:
Productivity, demand, monetary
policies.
Short run
Long run
Difficult to predict;
Exchange rates and prices move to
equalize “real exchange rates (RER).”
Much of the fluctuation is random noise;
Demand for international capital is
important.
The RER measures the cost of goods
in one country relative to another.
In practice, this adjustment takes a
long time.
So What is the Fluctuation Businesses are
Worried About?
• It depends on the time frame of business decisions.
• In the short run, businesses cannot react or adjust
prices, so the nominal exchange rate is the source of
ER fluctuations.
• In the long run, both prices and nominal exchange
rates adjust, affecting the cost of traded goods across
countries—so the real exchange rate is important.
• To the extent businesses recognize relationships
between prices and exchange rates, they will lessen
their uncertainty around ER fluctuations.
U.S. Dollar RER
U.S. Dollar ER
Source: Federal Reserve Board. Note: An increase is a dollar depreciation.
2011-02
2010-02
2009-02
2008-02
2007-02
2006-02
2005-02
2004-02
2003-02
2002-02
2001-02
2000-02
1999-02
1998-02
1997-02
1996-02
1995-02
1994-02
1993-02
1992-02
1991-02
1990-02
1989-02
1988-02
1987-02
1986-02
1985-02
1984-02
1983-02
1982-02
1981-02
1980-02
1979-02
1978-02
1977-02
1976-02
1975-02
1974-02
1973-02
Log first difference
Figure 1 Nominal (ER) and real (RER) dollar exchange
rates move together in the short run
0.08
0.06
0.04
0.02
0
-0.02
-0.04
-0.06
-0.08
-0.1
-0.12
RER
Source: Federal Reserve Board
ER
Linear (RER)
Linear (ER)
2011-01
2010-01
2009-01
2008-01
2007-01
2006-01
2005-01
2004-01
2003-01
2002-01
2001-01
60
2000-01
1999-01
1998-01
1997-01
1996-01
140
1995-01
1994-01
1993-01
1992-01
1991-01
1990-01
1989-01
1988-01
1987-01
1986-01
1985-01
1984-01
1983-01
1982-01
1981-01
1980-01
1979-01
1978-01
1977-01
1976-01
1975-01
1974-01
1973-01
Index March 1973=100
Figure 2 Nominal currencies are correlated with prices changes
over time (trend in the nominal (ER) and real (RER) dollar vs. major
currencies)
160
ER = 0.2181Time + 89.077
R² = 0.429
120
100
80
RER = 0.0679Time + 102.38
R² = 0.0705
40
20
0
ER Changes and Businesses: Focus on Exporters
• Start with a basic price equation:
Pf x Et = Ph where:
Pf is the selling price (importing country),
Et is the nominal exchange rate (per unit of foreign currency);
Ph is the domestic price or cost.
• If Pf is fixed, when the importer’s currency depreciates (Et↓),
actual revenue falls below the expectations of the exporter
when converting receipts :
Pf x ↓E t = ↓Ph
Exchange Rates and Exporters
• As new contract prices are negotiated, exporters may have
the option to factor in new exchange rates:
↑Ptf x ↓Et = Pth
or
Ptf x ↑ Et = ↑ Pth
or
↓ Ptf x ↑ Et = Pth
• If the importer’s currency depreciates (Et ↓), exporters might raise
prices to make up the difference,
• In the event of an appreciation (Et ↑), they might chose to lower
contract prices, or capture the difference themselves..
Table 1 Adapting to exchange rate fluctuations
Short run
Medium-to-long run
Hedging strategies:



Lock in future exchange rates through forward
contracts;
Purchase an option to exchange currency at a
specific rate.
Other hedging strategies.
Currency invoicing:


Set contracts in the currency of the exporter;
transfers risk to the buyer;
Set contracts in a currency that is perceived to
be more stable (vehicle currency).
Pricing-to-market:


Lower or raise export prices; but
Competitive pressures in specific markets may
limit pricing opportunities.
Adopt globalized strategies:


Purchase inputs from different foreign suppliers;
Restructure production to lower costs, including
moving to foreign countries.
Cross Subsidize:

Sell into various markets where exchange rate
changes tend to offset each other.
Specialized products:

Source: Compiled from industry and academic sources.
Export niche products with low price elasticity of
demand.
Challenges to Managing ER Fluctuations
• Hedging:
– Hedging leads to additional fixed contract costs.
– Prior experience and knowledge.
– Typically insufficient or too expensive to address large and long-term
exchange rate shifts.
• Currency-invoicing:
– Useful when the exporter’s currency is commonly accepted in
international trade.
– Trade between advanced countries is often invoiced in the exporter's
currency, while trade between advanced and developing countries is
generally invoiced in the advanced country’s currency .
• Price fluctuations are more easily managed when the firm is a
market leader with high-technology products—limits market
switching.
F ig u re 3 T h e d o lla r is a c o m m o n ve h icle cu rre n c y: D o lla r e xp o rt in v o ic in g , va rio u s c o u n t rie s,
2 0 0 3 - 2 0 0 7 a n d U .S . s h a r e o f e x p o rt s, 2 0 0 7
1 00
80
60
40
20
0
U n i te d S t a t e s
K ore a
C hina *
d o ll a r in v o ic e
* D a ta a re f or C h i ne s e e xp o rt s o f te x t i le s o nl y
S o urc e : J ab a ra, 2 01 0 .
T h ailan d
C an ad a
A us t ralia
U . S . e x p o r t s h a re
In d i a
J ap a n
ER Fluctuations and SMEs
• SMEs face specific constraints in foreign markets.
• The USITC (2010) identified such factors as:
–
–
–
–
Small size and lack of economies of scale;
Limited access to working capital and export finance,
Limited information on foreign markets,
Limited managerial time, skill, and knowledge.
• High fixed costs of exporting can have a significant impact on
the limited financial resources of small firms.
Figure 4 The majority of exports from the United States are by
large companies (percent of exports and number of exporters by
company size, United States, 2009 )
80
70
60
P
e
r
c
e
n
t
50
40
30
20
10
0
Unknown
Source: U.S. Census Bureau
Note: SME < 500 employees.
1-19
20-99
100-499
Company size (employees)
Known export value
No. exporters
500+
SMEs and Exports
• The results for the United States are illustrative of the
situation in many other countries.
• The USITC reported that, in various years, SMEs accounted
for:
–
–
–
–
–
Nearly 36 percent of total merchandise exports for Canada,
29 percent for Thailand,
18 percent for Indonesia,
17 percent for the Philippines, and
16 percent for Singapore.
• Additionally, SMEs (≤ 500 employees) accounted for 32
percent of U.S. imports in 2009.
Figure 5 The larger the firm, the more export markets (percent
U.S. exporters by number of markets and exporters/importers, 2009 )
Source: U.S. Census Bureau
SME Characteristics/ER Challenges
Characteristic
Challenge
Lack of access to
finance
Financial constraints:
• Limit opportunities to expand exports when the exchange
rate is favorable,
• SME’s vulnerable when the exchange rate is unfavorable.
• Hedging requires collateral/credit line with banks.
• Informal finance may limit hedging opportunities.
Lack of
knowledge, skills,
management
• Are SME’s aware of hedging opportunities ?
• SME’s may not have the resources to track exchange rates
and costs in different markets.
Small scale of
production
• Do SME’s have the flexibility to adjust costs and suppliers ?
• Selling in only a few markets limits ability to offset ER losses
in one market with gains in another.
• Opportunities for global ER strategies more limited.
• Exports of “commodity type” products increases
vulnerability to ER fluctuations.
Figure 6 Many SME exporters are wholesalers (percent of SME and
large company exports by company type, United States, 2009)
80
70
60
p
e 50
r
c 40
e
n 30
t
20
10
0
Unknown
1-19
20-99
100-499
Company size (no. employees)
Manufacturer
Source: Census Bureau
Wholesaler
Other
500+
Figure 7 Do SMEs export more “commodity” type products?
(percent of chemical manufacturing exports by company size, NAICS 325, and
chemical manufacturing as percent of total, United States, 2008)
50.0
45.0
40.0
Percent
35.0
Employees
30.0
25.0
0-19
20.0
20-99
15.0
100-499
10.0
500+
5.0
0.0
Source: Department of Commerce
Anecdotal Evidence: SMEs and Hedging
• Deutsche Bundesbank (2008):
– Most larger companies hedge exchange rate risks.
– Most medium-sized firms do not usually hedge due to lack of
experience.
• New Zealand (2008):
– The existence of fixed costs for hedging means that large firms are
more likely to hedge.
– Large firms hedge more than small firms, but small firms hedge more
than medium-sized firms.
• United States (2005):
– Survey of SME exporters in New Hampshire
– Most SME exporters did not hedge (dollar invoiced)
– Some U.S. importers billed in foreign currencies: most did not hedge.
Final note
• If small firms are entrepreneurial, and not risk
averse, exchange rate volatility could expand
trade and provide opportunities for profits
from risk taking (IMF, 2004).
Selected Studies
• U.S. International Trade Commission. Small and Medium-Sized
Enterprises: U.S. and EU Export Activities, and Barriers and
Opportunities Experienced by U.S. Firms, USITC Publication
4169. Washington, DC: USITC, 2010.
• Dekle, Robert, and Heajin H. Ryoo. “Exchange Rate
Fluctuations, Financing Constraints, Hedging, and Exports:
Evidence from Firm Level Data.” Journal of International
Financial Markets, Institutions & Money 17 (2007): 437-451.
• Clark, Peter B., Natalia Tamirisa, Shang-Jin Wei, Azim Sadikov
and Li Zeng. “A New Look at Exchange Rate Volatility and
Trade Flows.” International Monetary Fund, Occasional Paper
235, 2004.