As one of the most liquid foreign exchange markets in the world and the gateway to the African continent, South African businesses need to understand developments in the global foreign exchange (FX) markets to plan for the future.
South African corporates felt the unforgiving effects of the coronavirus several weeks prior to the official lockdown on 26 March 20, as disruptions in business activity emerged worldwide at the onset of global markets lockdown. At a time when the market had all eyes on US-China trade war, Covid-19 lockdown restrictions were enforced setting off global supply-chain disruptions.
Global supply chain disruptions in the form of shipment delays, logistics hurdles, and an unquenchable demand for resources necessary to complete certain production cycles had dire effects on revenue and growth for corporates.
The price action in the wake of Covid-19 saw the oil price plunge to historical lows, with the US Crude Oil Benchmark trading below zero.
Emerging market equities and FX markets felt the worst sting as global investors flocked to safe haven assets as trade shocks took hold. The Rand plunged to new historical levels against the dollar to only find some solace around R19.35/$ from opening the year around R13.93.
Winners and losers
Given this backdrop, most corporates have been stuck in-between a rock and hard place as the initial wave of Covid-19 triggered liquidity constraints and the ability to raise short-term funding has become a serious hurdle. Predicting and managing cash flows efficiently has become nearly impossible for treasurers due to shipment delays and disruptions in the production cycle.
It goes without saying that businesses or sectors that are classified as providing essential goods and services, would have performed better.
According to Absa research, top performing sectors where productivity levels have been slightly up included the agriculture, communication and water. Mining, manufacturing, construction, retail and tourism have been hit the hardest.
The shift to alternative hedging instruments
In an effort to manage FX exposure, local importers seem to have shifted their focus away from longer term hedging instruments to trading mostly in the spot market. The accelerated pace at which the Rand initially plunged made it impossible for corporates to formulate a strong medium-long term view on the direction of the currency. Following the South African Reserve Bank's (SARB) decision to increase dynamic FX hedging tenor from six months to 12 months, a large number of importers were seen taking advantage of the new regulation amendment and were able to lock-in attractive forward rates towards the end of 2019.
While the importer hedges in place may have attracted significantly positive mark to market as the Rand weakened, most corporates were unable to fully utilise the contracts due to shipment delays during the global lockdown.
Importers who had entered into medium-long term FX contracts prior to lockdown at fairly attractive rates have faced a number of operational challenges and some had to close-out at prevailing market rates, taking profit and boosted cash-flows because of the inability to utilise the contracts due to shipment delays. This may provide short-term relief but as lockdown restrictions begin to loosen up and activity picks up, the corporates have had to purchase currency at prevailing [expensive] market exchange rates.
Where clients did not close-out unutilised maturing contracts, they entered into expensive FX swaps which allowed them to extend the contract to a later date. Traditionally, where corporates encountered shipment delays, exchange control regulations permit for funds to be kept in a customer foreign currency (CFC) account for only up to 30 days in order to preserve the value of the funds without encouraging foreign currency hoarding.
Macro policy response
In response to the Covid-19 pandemic, a number of economic initiatives have been implemented across the globe by central banks, financial institutions and other regulatory bodies. In South Africa the government injected a R500 billion stimulus package with R200 billion of this package allocated as a loan guarantee scheme to assist businesses remain afloat.
On the back of this local banks were able to offer loan repayment holidays to struggling businesses.
The SARB so far has cut interest rates to historical lows in order to support growth and give some relief to consumers from interest loan repayments.
In addition to this, the SARB embarked on a Government Bond Purchasing program via the secondary market in order to reduce excessive volatility.
Across the African continent, Central Banks have illustrated a strong commitment and are doing as much as possible through tax relief and growth incentives.
So, what has worked well?
Covid-19 has changed the way that the world works and highlighted the importance of adopting technology in order for business to survive.
Digital trade execution and payment platforms will continue to be relevant and complementary to our clients businesses.
In terms of future themes, I expect the global economic environment to remain relatively weak for some time and businesses funded mostly in foreign currency denominated debt to remain vulnerable to currency fluctuations. Managing cash flows will take precedence more than ever as global supply chain disruptions and uncertainty continue to dominate.
As the world economy sails through this clouded period, corporates will look for FX hedging instruments that offer guaranteed protection against adverse movements in the currency while giving them the flexibility to take advantage and participate in favorable market movements.