Currency Wars: BRICS and Euro-Zone have U.S. businesses readying for the worst

As the global recession sinks in, investors have been forced once again to buy dollars as a safe haven – The Dollar index is up roughly 13% since the relative lows a little over a year ago in April/May of last year.

The Fed had its chance to combat the rising dollar last week with further monetary easing (QE3), but hesitated opting only to extend Operation Twist through the end of the year.

Meanwhile, the rest of the world (either through policy and/or capital outflows) is seeing their respective currencies depreciating at a rapid pace:

  • Brazil’s real lost 12% this quarter through June 22.
  • The 11.5% depreciation in the ruble and 10% drop in the rupee were almost twice the retreat in the euro (which is down more than 12% over the last 3 years).
  • China’s yuan (which was kept unchanged during the global financial crisis in 2008 and 2009) fell 1.2% since March after the government widened the amount the currency is allowed to fluctuate each day.
  • On the heels of no QE here by the Fed, the Ruble sank 2.4% last week, while the rupee fell 2.9% to a record low against the dollar and the real dropped 0.8%.

These developing economies are weakening their respective currencies to combat slowing growth – and for the first time in 13 years, the real, ruble and rupee are weakening the most among developing-nation currencies. These companies are looking for an export boost because a bulk of their sales are in dollars.

Meanwhile, here in the U.S. – weaker currencies abroad are hurting companies that rely on developing-nation revenue to offset slower growth in the U.S., Europe and Japan. Article below cites P&G, Philip Morris, Coca-Cola, and Citigroup.

Currency devaluation, however, is not a panacea for slow to anemic growth, as inflation is really beginning to take hold and demand for local-currency debt is crumbling. After spending most of last year introducing policies to weaken their currencies, emerging-market governments are now working to limit the slide amid capital outflows.

Bloomberg: BRICs Biggest Currency Depreciation Since 1998 to Worsen

By Ye Xie and Michael Patterson  Jun 25, 2012

The largest emerging markets, whose economies grew more than four-fold in the past decade, are making losers out of everyone from central bankers to Procter & Gamble Co. (PG) as their currencies post the biggest declines since at least 1998.

For the first time in 13 years, the real, ruble and rupee are weakening the most among developing-nation currencies, while the yuan has depreciated more than in any other period since its 1994 devaluation. P&G, the world’s largest consumer-goods maker, cut its profit forecast for the second time in two months last week in part because of currency losses. Brazil’s Fibria Celulose SA (FIBR3), the biggest pulp producer, asked banks to loosen restrictions on dollar loans as the real hit a three-year low.

Investors are fleeing the four biggest emerging markets, known as the BRICs, after Brazil’s consumer default rate rose to the highest level since 2009, prices for Russian oil exports fell to an 18-month low, India’s budget deficit widened and Chinese home prices slumped. Investors are bracing for more losses as economic growth slows.

“I am quite bearish,” Stephen Jen, a managing partner at hedge fund SLJ Macro Partners LLP and a former economist at the International Monetary Fund, said in a phone interview from London. “When the global economy and capital flow slow down, it’s going to expose a lot of problems in these countries and make people stop and ask questions. A run on the currency could be particularly ugly.”

Ruble’s Retreat

Currencies from Brazil, Russia and India will probably decline at least 15 percent further by year-end, said Jen, the former head of global currency research at Morgan Stanley.

Brazil’s real lost 12 percent this quarter through June 22, the biggest drop among the 31 most-actively traded currencies tracked by Bloomberg. The 11.5 percent depreciation in the ruble and 10 percent drop in the rupee were almost twice the retreat in the euro. China’s yuan, which was kept unchanged during the global financial crisis in 2008 and 2009, fell 1.2 percent since March after the government widened the amount the currency is allowed to fluctuate each day.

The ruble sank 2.4 percent last week, while the rupee fell 2.9 percent to a record low against the dollar and the real dropped 0.8 percent.

Foreign Reserves

India’s currency rebounded 0.4 percent at 11:06 a.m. in London as the government said it increased the amount of rupee- denominated debt overseas investors can own, one of several measures unveiled to support the currency. The yuan fell as much as 0.3 percent to 6.3827 per dollar, the weakest level since Nov. 29, before closing little changed. The ruble strengthened 0.1 percent.

A decade after Goldman Sachs Group Inc. (GS)’s Jim O’Neill coined the term BRIC, China has become the second-largest economy while Brazil, India and Russia are among the 11 biggest worldwide. Their combined gross domestic product rose to $13.3 trillion last year from $2.8 trillion in 2002 as their share of the global economy increased to 19 percent from 8 percent, according to IMF data. Together, they control $4.4 trillion in foreign-exchange reserves, about 40 percent of the total.

The MSCI BRIC Index (MXBRIC) of shares has surged 281 percent during the past decade, compared with 34 percent for the Standard & Poor’s 500 Index (SPX) as the real and the yuan strengthened more than 30 percent. Local-currency debt in the BRIC nations returned an average 86 percent in dollar terms since data for JPMorgan Chase & Co. indexes on all four countries began in October 2005, versus a 48 percent increase in U.S. Treasuries.

Export Boost

The countries are still strong enough to account for 80 percent of growth at New York-based Goldman Sachs, the fifth- biggest U.S. bank by assets, Chief Executive Officer Lloyd Blankfein said at the St. Petersburg International Economic Forum in Russia’s second-largest city on June 21.

Weaker currencies will stimulate economic expansion by making exports more competitive, said Warren Hyland, an emerging-market money manager at Schroder Investment Management, which oversees about $319 billion worldwide. He’s been buying ruble bonds of Russian companies.

Earnings at the nation’s commodity producers, including OAO GMK Norilsk Nickel (GMKN) and Polyus Gold International Ltd. (PGIL), will get a boost because their sales are in dollars while the bulk of their costs are in rubles, New York-based Morgan Stanley said in a report this month.

Weaker currencies are hurting U.S. companies that rely on developing-nation revenue to offset slower growth in the U.S., Europe and Japan.

Lower Forecasts

P&G, led by Chief Executive Officer Bob McDonald, said in a June 20 presentation at the Deutsche Bank Global Consumer Conference in Paris that foreign-currency fluctuations will cut 2013 earnings growth for the maker of Tide washing detergent and Bounty paper towels by about 4 percentage points. China is the Cincinnati-based company’s second-largest market and some of the firm’s biggest businesses are in Russia and Brazil, P&G said.

Philip Morris International Inc. (PM), the world’s largest listed tobacco company, reduced its 2012 earnings forecast the next day because of currency swings. The New York-based maker of Marlboro cigarettes gets more than 40 percent of its operating profit from Asia and Latin America, according to data compiled by Bloomberg.

Pandit’s Expansion

A weaker real and lower interest rates in Brazil may reduce Coca-Cola Co. (KO)’s second-quarter profit by $30 million, according to JPMorgan. The Atlanta-based company left about $3 billion in cash in Brazil at the end of 2011 to take advantage of the country’s higher interest rates, Chief Financial Officer Gary Fayard said in a conference call in February. Half of the positions were left unhedged, he said.

Brazil’s central bank President Alexandre Tombini has cut the benchmark Selic rate by 2.5 percentage points this year to 8.5 percent, while the real has depreciated 9.7 percent.

“We continue to be concerned by Coke’s reliance on this income source,” JPMorgan analysts led by John Faucher wrote in a note to clients on June 7, reducing their 2012 profit estimate to $4 a share from $4.06.

Kent Landers, a spokesman for Coca-Cola, declined to comment.

Fibria Loans

Citigroup Inc. (C), which has been expanding in Latin America and Asia under Chief Executive Officer Vikram Pandit, may take a $3 billion to $5 billion “hit” this quarter related to foreign exchange losses, Charles Peabody, a New York-based analyst at Portales Partners LLC, said in an interview with Bloomberg Television on June 20. The losses may reduce Citigroup’s book value, or assets minus liabilities, he said.

Peabody, whose recommendations on shares of New York-based Citigroup during the past year produced the highest total return among 31 forecasters tracked by Bloomberg, cut his rating on the stock to the equivalent of sell from buy in March.

“Citi’s unique global footprint and exposure to the higher economic growth regions of the world will drive above-average book value growth over time,” Jon Diat, a Citigroup spokesman, said in an e-mail. “The suggestion that having non-U.S. exposure is somehow detrimental to Citi’s ability to continue to grow value over time is simply wrong.”

Local companies in the BRIC countries are also being hurt. Sao Paulo-based Fibria said on June 11 that it renegotiated loan covenants after the real’s decline increased the cost of servicing foreign obligations. About 90 percent of the company’s net debt is in dollars, according to company filings.

Yuan Debt

The rupee’s drop has hurt Indian companies by fueling inflation and reducing the scope for lower borrowing costs, said V. Ashok, the chief financial officer of Essar Group, the utility and shipping company owned by billionaire brothers Shashi and Ravi Ruia. India’s central bank unexpectedly left interest rates unchanged on June 18.

“One has no clue where it is going to end,” Ashok said in a June 22 phone interview from Mumbai. “The uncertainty and the volatility is the biggest concern.”

A weaker yuan is sapping demand for local-currency debt sold in Hong Kong, where international investors speculate on China’s foreign exchange rate. The average yield rose to a four- month high of 5.35 percent on June 5 from 4.82 percent at the end of March, according to data compiled by Bank of America Corp. Wang Changshun, chairman of Air China Ltd. (601111), told reporters this month that the company’s income from foreign-currency transactions will drop about 80 percent.

Bearish Bets

“All the BRIC looked ugly,” John Taylor, who oversees $3.5 billion as founder of currency hedge fund FX Concepts LLC in New York, said in an phone interview on June 19. The real and ruble will suffer “fairly decent” declines later this year as a global recession spurs investors to buy dollars as a haven, Taylor said.

After spending most of last year introducing policies to weaken their currencies, emerging-market governments are now working to limit the slide amid capital outflows.

Brazil’s government pared a tax on overseas loans on June 14 and has used swaps to add dollars to the market. Russia’s central bank sold U.S. currency this month to slow the ruble’s retreat, according to Chairman Sergey Ignatiev. India cut the amount of overseas income companies can hold in foreign exchange last month, spurring them to repatriate earnings. The ownership ceiling on government bonds was raised by $5 billion to $20 billion, the central bank said in an e-mailed statement today.

Investors withdrew $6.3 billion from Brazil’s stocks and bonds in May, the most since at least 2010, central bank data show. Russian capital outflows reached a net $46.5 billion in the first five months of the year, including $5.8 billion in May, which is “a lot” for the country, Ignatiev told reporters in St. Petersburg on June 6.

Consumer Defaults

Derivatives traders see no sign of a turnaround.

Wagers on a weaker real on Sao Paulo-based BM&FBovespa’s futures exchange rose to $4.7 billion on June 12, the most since February 2010, according to data compiled by Bloomberg.

Option traders are the most bearish on the ruble since October and they expect price swings in the rupee to be the biggest in Asia, the data show. Twelve-month forward contracts on the yuan are pricing in a further decline of 0.7 percent in 12 months.

A surge in bad loans in Brazil will weaken the real further, said Amit Rajpal, who manages global financial funds for London-based Marshall Wace LLP. The default rate on consumer debt rose to 7.6 percent in April, matching the highest level since December 2009, as lending growth slowed to 18 percent from a record 34 percent in September 2008, according to the central bank.

India Deficit

“What we’ll see now is basically a full-blown credit problem,” said Rajpal, who predicts rising defaults in Brazil will resemble the collapse of the U.S. subprime mortgage market five years ago.

In India, Prime Minister Manmohan Singh is grappling with trade and budget deficits, corruption scandals and fighting in the ruling coalition. The country may become the first among the BRIC nations to lose its investment-grade rating, Standard & Poor’s and Fitch Ratings said this month. India’s budget gap amounted to 5.8 percent of gross domestic product, compared with 4.2 percent in Portugal and 3.9 percent in Italy, according to data compiled by Bloomberg.

China has cut its growth target this year to 7.5 percent, from the 8 percent goal that had been in place since 2005. Home values fell in a record 54 of 70 cities tracked by the government in May, while industrial production growth slowed to a three-year low in April.

In Russia, the price of Urals crude, the country’s main export blend, sank 26 percent this quarter. Russia relies on oil and gas for about 50 percent of its budget revenue.

Investors are still too bullish on assets in the BRIC nations as Europe’s debt crisis weighs on emerging economies, said Eric Fine, a money manager at Van Eck Global.

“They will do poorly when the world is doing poorly,” Fine, whose firm oversees about $35 billion, said in a phone interview from New York. “I don’t believe in decoupling.”

Reuters: Euro risks have U.S. businesses readying for the worst

*Preparations beyond pure housekeeping

*U.S. corporates holding onto cash

*Majority of companies look to FX hedging

By Gertrude Chavez-Dreyfuss and Debra Sherman

NEW YORK, June 22 (Reuters) – Three years into the European debt crisis, with the likelihood of the euro’s demise still remote, U.S. multinationals are making preparations for a number of grim scenarios that include the worst: the collapse of the euro.

They have been actively looking to lower their hedging costs by taking advantage of the weak euro, while others have been moving money daily to other financial centers to reduce euro zone exposure, consulting firms and banks that hedge for large U.S. corporations say.

“Almost all companies have a committee in some shape or form to prepare to deal with the euro crisis,” said Martin Donovan, deputy policy and technical director of the London-based Association of Corporate Treasurers, which advises corporate finance departments.

“The larger companies have been thinking about this for a long time. And it’s really gone beyond just a pure housekeeping exercise,” Donovan said.

Fireapps, a provider of FX hedging software in Arizona and an adviser to several Fortune 500 companies, did a poll of 800 corporations last month, most of which are U.S.-based. The survey revealed that 88 percent of the companies have or are developing plans to deal with the euro’s end.

Minnesota-based medical device maker Medtronic Inc <MDT.N> said its cash is actively being transferred out of countries to a central depository to minimize risk.

“We continue to work with every country in Europe to ensure our receivables are being paid. These are normal ongoing procedures to minimize risk, and we believe adequate in the circumstances,” said Medtronic spokeswoman Amy von Walter. The company generates about a quarter of its revenue from Europe.

St. Jude Medical <STJ.N>, which gets about 25 percent of sales from Europe, said it has cash concentration systems in place in order to minimize the amount of cash held in euros.

U.S. beverage maker PepsiCo <PEP.N> has also been doing daily euro sweeps, according to the Financial Times. Calls and e-mails seeking comment were not returned.

“Sweeping” cash is a normal strategy carried out by international companies with bank accounts in different countries. A company takes out cash in each euro-zone country where it has a subsidiary and deposits it nightly in a stable financial center. The company then returns the funds to each country the next day.

Medtronic’s and Pepsi’s strategy mirrors that of European companies, which have been sweeping euros on a daily basis in case of an overnight currency devaluation.

European companies such as British drugmaker GlaxoSmithKline

<GSK.L> and Diageo <DGE.L> have also been sweeping euros daily for the last several months, the companies said.

Fast-food giant McDonald’s <MCD.N> said it is closely “monitoring” these strategies, though it is not yet sweeping.

Other U.S. companies have opted to revise the currency denomination of their contracts from euros to dollars.

One U.S. electronic components distributor with annual revenues of $25 billion, for instance, has informed its vendors in the euro zone that it will pay for supplies in dollars instead of euros, according to Wolfgang Koester, president and chief executive officer of Fireapps.

Other U.S. businesses are opting to keep their cash in the United States and those with funds overseas are keeping the funds in liquid and very short-term instruments.


Many companies deriving sales from the euro zone have hedged against the decline in the euro, which is down more than 12 percent over the last three years.

Fireapps’ Koester, who advises corporations on hedging, said about 97 percent of U.S. companies have protected against currency volatility, having learned their lesson in 2008. “They are not risking any currency exposure at all,” he said.

Heavy equipment maker Caterpillar Inc <CAT.N> said it has protected itself against euro weakness, which is necessary as its dealers have reported a sharp slowdown in Europe for a three-month period ended in May. [see story].

“We have an even balance for worldwide currency exposure that limits and hedges our risks,” said Jim Dugan, Caterpillar’s chief corporate spokesperson.

Whitehouse Station, New Jersey-based drugmaker Merck & Co Inc. <MRK.N>, which derives about 30 percent of sales from Europe, has an active hedging program in place to protect against the euro’s weakness, although company spokesman Ron Rogers said it would be difficult to predict how exchange rates would impact its bottom line.

“At 2011 exchange rates, sales are expected to be at or near 2011 levels. Full-year 2012 sales may be unfavorably affected by foreign exchange, depending on the exact exchange rates,” said Rogers.

As more U.S. companies hedged, U.S. banks saw a surge in volume in May as the euro fell below the $1.30-$1.35 range.

Chris Fernandes, senior corporate adviser for Bank of the West in San Ramon, California, said last month’s FX hedging volume at his bank was the highest in five to six years.

“Many of our customers with euro payables had assumed an exchange rate of $1.30 per euro on their budgets at the beginning of the year, s o now they’ve locked in FX margins of five to six cents lower (through forward contracts)” than their previous hedges, Fernandes said. That’s a good thing for those clients.

Those with euro income, however, are partly hedged because they are hoping the euro will rebound, which would help profits.

“It’s just human nature to think that the euro is going to come back,” Fernandes said. “These customers are waiting for a rebound in the euro so they can hedge their euro receivables at a higher level.”

A major concern among corporate hedgers, Fernandes said, is what would happen to their euro hedges if the euro zone breaks up.

“Ultimately, both sides are obligated to honor the contract,” Fernandes said. “The customer is still obligated to deliver the U.S. dollars that they owe us for purchasing a forward contract whether it’s for three or six months. And obviously we’re obligated to deliver the euro.”

(Additional reporting by Lisa Baertlein; Editing by Dan Grebler)

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