Corporates in Kenya are at crossroads regarding how to protect their profits from a relentless rally in the US dollar, shining the spotlight on foreign exchange hedging.
The dollar was trading at a mean of Sh122.50 on Thursday last week compared to a mean of Sh113.17 at the start of the year, a rise of 8.2 per cent owing to increased demand especially from importers making it more expensive to purchase the greenback.
Firms rely on forex to settle external transactions such as making imports, paying workers, and settling foreign currency-denominated loans.
But amid the recent sharp fluctuations in the cost of purchasing dollars, pounds, and euros, companies are increasingly being hit with a tough dilemma on whether or not to hedge forex risks to lower their future forex costs.
Hedging with forex is a strategy used to protect one's position in a currency pair from an adverse move. It is typically a form of short-term protection when a trader is concerned about news or an event triggering volatility in currency markets
A decision to hedge is, however, always a complex one because the strategy is a double-edged sword that is great insurance should prices go up as expected but a major cost should the prices dip unexpectedly.
For instance, the national carrier Kenya Airways (KQ) has this year rued its decision last year not to hedge fuel before prices rose sharply following the outbreak of war between Russia and Ukraine that affected supplies.
The airline posted a pre-tax loss of Sh9.86 billion for the first half of the ongoing fiscal year but said the loss would have been a narrower Sh3.32 billion at last year’s fuel prices.
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Banks are now using the chance to promote FX forward contracts among corporates, promising them stable forex rates to mitigate the costs they would otherwise spend on purchasing forex should the rates continue to rise.
“Equity understands that there are certain risks that arise from fluctuating foreign currencies exchange rates, and therefore offers risk management solutions such as FX forward contracts, FX options, and FX swaps, to enable businesses to operate more efficiently and with a certainty of rates applied upon maturity,” Equity Bank told companies in an advert this week.
“To execute this, customers can enter into contractual agreements to transact at a future date, and at an agreed exchange rate and amount.”
Top banks are making handsome returns from forex trading with the shortage of foreign currency helping them to increase their earnings sharply in the nine months to September.
For instance, Equity Bank grew its forex income by 57.5 percent to Sh8.89 billion, Co-operative Bank’s forex revenue rose by 71.5 percent to Sh3.28 billion while that of Standard Chartered grew by 66 percent to Sh4.20 billion.
Further, Absa’s forex trading income went up by 59 percent to Sh4.98 billion, that of KCB grew by 86 percent to Sh8.40 billion and that of Stanbic Bank climbed 69 percent to Sh6.90 billion.
Others include I&M whose forex trading income rose to Sh3.78 billion from Sh1.81 billion, NCBA which expanded forex earnings by 162 percent to Sh9.21 billion, and Diamond Trust Bank (DTB) whose forex income went up by 80.59 percent to Sh4.98 billion.
Analysts, however, contend that hedging is not the only solution for firms to deal with their mounting foreign exchange fluctuation costs.
Experts say companies can adopt strategies to transact more in the local currency unless where it is necessary such as when settling foreign transactions. Kenya Power, which is one of the most heavily affected companies annually by forex see-saw costs is for instance moving towards denominating future power purchase agreements in Kenya shillings.
Currently, independent power producers are paid in foreign currency with the forex costs passed on to consumers through a rate that is adjusted monthly.
Further, experts say firms can include the forex fluctuation risk in the contract and transfer it to the other party.
For instance, an exporter of flowers to the Netherlands can raise the cost of flowers to recoup the forex costs up to a point that does not affect his produce’s competitiveness in the market.
As such, businesses can adopt singular or combine different methods of dealing with forex rate fluctuations to not only lower their cost of doing business but also alleviate the burden of the costs from consumers who shoulder it through higher prices of goods and services.