Imagine yourself as a Thai exporter of coconut water. Given the trend towards healthier living, your product is selling very well in overseas markets and you are earning tonnes of money. Then one day, Britain decides to leave the European Union. The next day, the United States lowers its interest rates. The day after that, North Korea launches a missile, sparking a war.
During this week of imagined global financial mayhem, volatile exchange-rate movements have completely wiped out your coconut water profits.
Who is to blame? The British? The Fed? North Korea? The Bank of Thailand for not taking better care of the baht? Surely there is enough blame to go around, but if you had taken the precautionary steps to protect your business from foreign-exchange risks in the first place, then you could have been saved from doom.
In a more realistic setting where such market-shaking events do not happen all at once, exchange rates are still very sensitive to even minor news developments. And as our world becomes increasingly borderless and propelled by technology, with capital pouring out of one country and into another at the click of a button, the global economy will also become increasingly unpredictable.
Uncertainty and volatility are here to stay -- and the same applies to exchange rates.
Since the beginning of 2017, the baht has appreciated to its strongest level in two years in response to uncertainty about Donald Trump and the Fed's policy tightening plans. Businesses operating under these unstable conditions must learn to utilise risk-management products, otherwise they could face heavy losses.
In Thailand, there are many products you can utilise to protect yourself against or hedge against foreign-exchange risks. Banks offer forward contracts that allow you to buy or sell foreign currencies in the future at a rate agreed upon today, regardless of what the actual exchange rate will be in future. This essentially locks in the amount you have to pay or receive.
For example, if you are exporting coconut water and will receive a US$10,000 payment from your counterparty in three months' time, you can enter into a forward contract to sell your proceeds three months from now at an agreed exchange rate -- let's say 34.00. This means you have just locked in your income at 340,000 baht. You will receive this fixed amount no matter how high or low the baht swings in the next three months.
A similar product is available on the Thailand Futures Exchange (TFEX), called a futures contract. The main differences between forward and futures contracts are that forwards are available through banks and can be tailor-made in terms of the amount and term to better suit the needs of each business, whereas futures on the TFEX are pre-set to a specific size and term.
Since futures can be traded online just like stocks, they are a great alternative for small and medium-sized enterprises (SMEs) that have difficulty accessing bank funding or meeting credit requirements. The current size of one futures contract on the TFEX is fixed at $1,000, and the maximum number of contracts that one investor can hold at any one time is 10,000 (equivalent to $10 million), which is optimal for covering the smaller forex exposure of SMEs.
Another way to protect your business against exchange-rate fluctuations is to open a foreign currency deposit (FCD) account with your local bank. The money kept in this account must be in foreign currency. If you are an importer, you can purchase foreign currencies to deposit into the account to pay for the goods you import. If you are an exporter and receive foreign currency proceeds on a regular basis, you can deposit those proceeds in the account and withdraw them to pay for imported goods, or just keep the money to withdraw at a later date when the exchange rate is more favourable.
Last but not least, not all transactions need to be made in foreign currencies. You can simply choose to receive or pay for goods in baht, to avoid forex risk altogether. By doing so, you will be shifting all exchange risks to your counterparty, which will need to hedge those risks. This method, however, is subject to agreement between both parties.
If you still believe that hedging foreign-exchange risks is either too burdensome or not necessary for your business, then please be aware that exchange-rate movements are the result of collective thinking. Market participants collectively drive these movements. It is just not possible for one firm, whether it be a small exporter or a big investment bank, to beat the market.
The time spent second-guessing or trying to outsmart exchange-rate movements could be better put towards developing core business operations, such as investing in new projects and expanding product lines.
Protecting yourself against foreign-exchange risk is like buying insurance: it does not mean that your business will make more money, but rather ensures that you will not lose any, so that you can sit back and carry on with other things.
Tunyathon Koonprasert is a senior analyst with the Financial Markets Operations Group at the Bank of Thailand. The opinions expressed are the author's own.