Foreign Exchange Risk of Firms in Asia-Pacific
Professor David Parsley of the Vanderbilt Owen Graduate School of Management and Helen Popper of Santa Clara University undertook a study that substantially clarifies the subject. They evaluated the extent of foreign exchange exposure among firms in Hong Kong and eight Asia-Pacific countries – Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand – and compared it to that of two benchmark countries, Australia and New Zealand. In addition, they researched whether there was a link between currency risk and the use of exchange rate “pegs.”
13-Year Regional Analysis
The study examined the exchange rate exposure of companies in Hong Kong and the eight Asia-Pacific countries from 1990 through 2002. An average of 80 of the largest publicly traded companies were selected in each of the locations. In some cases, the economies of these countries varied greatly from Western economies in terms of size, participation in international trade and borrowing, financial development and exchange rate arrangements – that is, the policies and practices by which they interacted economically with the rest of the world and by which they pursued domestic monetary policy.
The 13-year span of the study encompassed a host of major changes in the economic landscape of the selected countries. In addition to dramatic macroeconomic shifts of the 1990s, there were sweeping financial reforms in many of the countries, including a liberalization of regulation of foreign exchange derivatives, which can be used to hedge some exposures. To highlight how the changes may have influenced currency markets, Parsley and Popper split the full sample into four three-year periods: 1990-1992, 1993-1995, 1996-1998, and 1999-2002.
Much Greater Currency Risk
Their findings? As reported in the November 2006 issue of The Journal of International Money and Finance, they show that many Asia-Pacific companies have significant exposure to foreign exchange risk, and their vulnerability is much greater than that of companies in large, developed Western economies, including the benchmark countries of Australia and New Zealand. “The basic issue we highlight is that many Asia-Pacific businesses haven’t hedged their exposure and face significant risk of depreciation of their assets or severe increases in their debt obligations held in foreign currencies,” said Prof. Parsley.
The researchers also noted that the increased orientation of Asia-Pacific countries to reduce restrictions on capital flows could, in some cases, have magnified currency risk. They suggest that currency market liberalization proceed at a “gradual” pace accompanied by more intense oversight of how companies access foreign exchange markets.
Dollar Yields Highest Risk
The study found that many Asia-Pacific firms showed significant exposure to fluctuations in one or more of the world’s four major currencies: the U.S. dollar, the euro (deutschmark prior to 1999), the Japanese yen and the British pound. Some of the greatest vulnerabilities resulted from fluctuations in the dollar which, over the study period, impacted 76 percent of the studied companies in Korea, 61 percent in Malaysia, 58 percent in the Philippines, 54 percent in Indonesia and 47 percent in Singapore. Against the euro, Taiwan had the most exposed companies (27 percent), while the highest exposure to the Japanese yen occurred in Singapore (31 percent), and Hong Kong (30 percent). Relatively few companies in any of the nine markets were vulnerable to the British pound.
“These levels of exposure,” the study reported, “are in stark contrast to those in most Western economies, where individual companies are adept at hedging their exposures against individual currencies, or more able to shift operations in response to major changes in exchange rates.”
The researchers pointed out that “a potentially wide range of firms were exposed to rate movements regardless of their direct financial exposure.” As might be expected, currency fluctuations affected the profitability of companies whose financial assets and liabilities (most notably debt) were held in foreign currencies and that had foreign-based operations. However, possibly less obvious was the significant impact that exchange rates had on companies with no foreign currency exposures but who competed with companies that did. Such companies could increase their market share as a result of a favorable exchange rate movement to the detriment of the firm with no apparent foreign currency exposure.
Not surprisingly, the greatest period of vulnerability was the Asian financial crisis, which occurred during the third study segment (1996-1998). More than half of the studied companies in Indonesia, Korea, Malaysia and the Philippines, and about a third of those in Japan and Singapore, were exposed to the dollar, and about a quarter of the firms in Singapore were exposed to the yen.
The Verdict on Pegs
The researchers discovered that currency pegs – where a country fixes the exchange rate of its currency to that of another country – are an imperfect solution. “It is sometimes argued that a fixed exchange rate regime offers a hospitable environment for business by providing stability and removing the need for expensive hedging,” the study pointed out. However, the research showed statistically significant risk related to the dollar for a much greater number of companies with a peg in place than without one in Malaysia, the Philippines and Thailand. The results were even more pronounced with the yen. More than half the companies in Indonesia, Korea, Malaysia and the Philippines, and nearly a third of the companies in Taiwan and Thailand, showed significant exposure to fluctuations in the yen with a peg in place.
Even in the “rare case” of a stable exchange rate peg, the study found, the exchange rate cannot be fixed independently against more than one currency. “A firm’s value may be quite sensitive to exchange rate fluctuations in this setting,” the study warned. For example, if a currency is officially fixed against the U.S. dollar, say, it will still fluctuate freely against the yen and euro – and remain exposed to foreign exchange rate risk. “In contrast, firms in countries with freely floating currencies may be accustomed to hedging, and hedging may be less costly in such countries.”
Exposure Has Not Abated
Prof. Parsley believes that the extent of exposure in the Asia-Pacific region identified in the study almost certainly continues today since hedging practices there have changed little. With this in mind, Prof. Parsley noted that the study makes a strong case for a gradual approach to liberalizing restrictions on currency flows and that liberalization should be accompanied by closer government oversight of how individual firms access foreign currencies, particularly in countries that have pegged exchange rates.
“Simply abandoning capital controls is not the way to go for these emerging economies,” he contended. ”Despite a Western push for market liberalization, economies throughout the region would be well advised to maintain a slow-and-steady approach, encouraging more company-level hedging, moving away from single-currency pegs, and further developing bond markets in the Asia-Pacific region.”
Copyright 2007 Vanderbilt Owen Graduate School of Management