How to stay in the money, internationally.

• Author: Fluck, Brian H.
• Position: Treasury Management

If you've been eyeing emerging markets but worry about foreign-currency risk, fear no more. Three executives explain how their companies cover their overseas exposures with countertrade, put options and a host of other ideas.

SOME ENTERPRISING SOLUTIONS

Since 1984, developing countries have grown at roughly twice the rate of industrialized countries and, in the last two years, have grown three times as fast. As domestic and traditional markets mature, corporations face both increasing competitive pressure and opportunities to enter emerging markets.

Of course, emerging-market countries vary in their economic conditions and policy approaches. The economic and the foreign-exchange hurdles are significant in most of these countries. Often they have greater swings in currency values, and the exchange controls are more severe. For example, China recently unified its currency. It merged the official rate and the swap-center rate, which substantially depreciated the official rate. The Mexican peso has depreciated more than 400 percent since 1986, and almost 300 percent of that change occurred between 1986 and 1988. Companies doing business in developing countries may need to use a great deal of creativity to overcome these barriers.

Still, markets that were once closed are now becoming more open, and they are welcoming and valuing foreign trade in a way they never did before. Some examples are Mexico, the Commonwealth of Independent States, China and Argentina. Governments around the world are privatizing state assets, and this trade liberalization is leading the capital inflows.

What is an "emerging market"? Its characteristics are average or low income per capita, plus widespread exchange or capital controls (particularly for nonresidents). These currency controls are frequently accompanied by wide-ranging import controls. Often domestic financial markets are in their infancy, and communication is poor. The economy tends to lack monetary discipline, causing high inflation rates and currency depreciation. Emerging markets include all of Latin America, the Caribbean, most of Asia (except Japan), all of Africa, most of the Middle East and all eastern European countries.

The range of economic policy and regulatory practice in emerging-market countries often includes currency controls, including currency-convertibility restrictions. Because the markets in some countries have been nearly nonexistent, some local currencies are extremely difficult to exchange for U.S. dollars or other hard currencies. Hard currency refers to any readily convertible, freely traded and relatively stable currency, such as the U.S. dollar, yen, deutsche mark, French franc or British pound.

Even if a currency is convertible in theory, the shortage of hard currency and the lack of effective markets may make it inconvertible in practice. This is especially true in countries with balance-of-payments problems or deficits that use up available foreign currency reserves, such as Honduras, Ukraine or Russia. Some governments require the exchange to be executed through a local bank. This is true for the Brazilian cruzeiro, Indian rupee and Philippine peso. Other currencies can be exchanged only through a U.S. bank. The government might permit a U.S. bank to exchange currency, in addition to some of the local banks, as in Malaysia and Thailand.

PUT YOUR MONEY WHERE YOUR MARKET IS Gross Domestic Annual Gross Product in Domestic Product 2001 ($ Billions) Growth Through 2001 China 1,132 10% India 524 6% Brazil 331 4% Mexico 314 5% Indonesia 239 7% Source: The WEFA Group In countries where the exchange must be handled locally, the U.S. company may need to get approval from some central authority. The government may permit currency exchanges only for certain kinds of transactions, such as imports or dividends, capital flows and interest payments. In Brazil, selling cruzeiros requires formal documentation and approval. However, the long-term trend toward greater currency convertibility is likely to continue as governments around the world recognize the benefits of opening up their economies and liberalizing trade.

WHEN IN ROME...

What can your company do to address currency risks in emerging markets? Some companies have shown a great deal of creativity in working with the limitations and conditions of their host countries. A U.S. company that is dollar-based can set its foreign prices in dollars. This transfers the foreign risk to the local importer. But the host country could still change its convertibility rules or, without any advance notice, impose other restrictions that would cut off hard currency for the importer.

Price indexing, the practice of indexing a foreign price to a U.S. dollar or other exchange rate, is another option. Or the buyer and seller can structure a formal risk-sharing agreement. Buy-back arrangements are also a possibility. This often involves longer-term repayment, and compensation frequently takes the form of industrial products. Offsets also may be necessary. That is, your company may agree to spend money in the host country in return for receiving hard currency as part of the sale. This could mean co-production or research and development, or it could mean purchasing some goods locally.

Counterpurchases are similar to offset arrangements. For instance, your company might agree to buy back products from the host country to partially repatriate the sales proceeds. Companies often sell products purchased through offset obligations...