Managing Payments in Volatile Markets
The political unrest and economic instability rumbling across pockets of northern Africa and the Middle East symbolise the challenges that are simultaneously new and yet strikingly familiar to multinational businesses with long-standing interests in dynamic markets around the world. For cash managers, such events highlight the importance of both vigilantly monitoring political, social and economic trends that can trigger payment and exchange rate risks, and establishing a solid strategy for mitigating those risks.
A look at past political and economic disruptions provides valuable insights into the potential impact of geopolitical events on payment flows and risks.
In the early 1990s, the UK withdrew from the Exchange Rate Mechanism (ERM) because of diametrically opposed economic conditions in the UK and Germany. The UK, like all countries in the ERM, had pegged its currency to the Deutsche mark (DM) and, by extension, its monetary policies to Germany’s. When Germany raised its interest rates to attract foreign capital after the reunification of east and west Germany, the UK, which was battling a recession, was caught between a rock and a hard place.
Market speculators realised the UK’s dilemma and began selling the pound (GBP) short. When the GBP began to slide, the Bank of England (BoE) intervened by raising interest rates from 10% to 15% on ‘Black Wednesday’, and buying GBP in the market, thus shrinking foreign currency reserves. The manoeuvres were unsuccessful and the UK abandoned the ERM. Within weeks, the pound fell 15% against the DM and 25% against the US dollar.
Throughout the crisis, the UK government had to weigh up liquidity risks related to depleting its foreign currency reserves, and companies managing cross-border payments and cash flows had to juggle market risks tied to geopolitical events.
Also during the 1990s, a series of events unfolded in Asia as economic downturns and financial policy shifts in the west challenged Asia’s fast-growing economies.
Many developing markets in Asia attracted foreign investment with high interest rates, leading to an inflow of cash and also driving up the cost of assets and speculative borrowing. To buffer their currencies from exchange rate volatilities, countries such as Korea, Thailand and Indonesia pegged their currencies to the US dollar.
At the same time and in an effort to preserve capital at home, the US and other western countries raised their interest rates, effectively stemming the flow of investments to Asia.
Korea, Thailand and Indonesia all increased their interest rates and intervened in the markets to support their pegged currencies. Eventually, however, they were forced to abandon their pegs and allow their currencies to float on the market. Subsequently, in the year that followed, the Thai baht depreciated 36%, the Korean won was devalued over 30% and the Indonesian rupee plummeted 80%. Once the panic subsided, however, asset prices and foreign exchange (FX) rates found their natural market-driven levels and all three countries resumed impressive growth trends.
Malaysia, whose currency was only partially pegged to the US dollar, responded differently. When the Malaysian government perceived speculative trading on the ringgit, it set up currency controls that included resetting the currency’s peg and prohibiting offshore trading in it. With trading limited to licensed onshore banks, most global FX banks suspended trading, complicating cash and payment activities for their corporate clients, since payments in the country could only be made through an onshore bank. Only recently have these restrictions been relaxed.
Earlier this year, a different set of drivers created payment risks in parts of northern Africa and the Middle East. Social and political forces, rather than weaknesses in the financial sector, rocked financial markets in Tunisia, Egypt, the Ivory Coast, Libya and a number of other nations where civil unrest has accompanied calls for regime changes.
In Tunisia and Egypt, protesters fed up with government corruption and high unemployment quickly ousted leaders who had been in place for decades. Unlike Malaysia, the governments did not intervene in financial markets, except to close them temporarily because of demonstrations in the streets. As events unfolded there was a sense that the financial markets would eventually return to normal.
In the Ivory Coast, events took a different turn. Incumbent President Gbagbo refused to step down after being defeated in an election last November, opening up a new chapter in regional instability.
In an attempt to eject the unlawful regime, the Central Bank of the West African States, which services the Ivory Coast and seven other countries that share a common currency (XOF), suspended all transactions with the Ivory Coast.
The action essentially prohibited the Ivory Coast from participating in the XOF and precluded payments being made into the country. In response, the Gbagbo administration ordered all banks to revert to manual clearing. Rather than submit, foreign banks closed down and the government nationalised all banks. As a result, force majeure (superior force) was declared and financial assets were frozen.
Across emerging and developed markets alike, political and economic tremors are extremely significant from a payment flow perspective. What’s more, as history demonstrates, situations can deteriorate rapidly and payments systems can be materially impacted.
When it comes to making payments in volatile markets, the best defence is a good offence. This includes a three-pronged attack that covers situational, legal and processing-related factors:
The bottom line is that the best strategy for making payments in dynamic and stable markets alike is to align your payments activities with an experienced cross-border provider.
That provider should have on-the-ground experts who are attuned to what is happening locally, have the breadth and depth of experience to stay one step ahead of you and can provide the solid insights you need to manage cash flows most effectively during extraordinary situations.
Risks Associated with Dynamic Markets
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