As the peak UK holiday season comes to an end, many travel businesses are facing the daunting task of setting prices for 2019, after a summer of significant volatility in foreign exchange rates.
Over the past month, JCRA has seen an increase in travel companies that are looking to review their foreign exchange exposures and either start hedging, or add to it as a result of the looming Brexit uncertainty and events in emerging markets.
Increased volatility - Emerging Markets a hot topic
While experienced FD’s and CFO’s in the travel industry are accustomed to the increased volatility that comes with the territory of travel to exotic or smaller countries, it’s fair to say that 2018 has been an extreme one. In particular for the Turkish Lira and Argentinian Peso, which experienced significant volatility and fell to record lows. So far this year, the Sterling has doubled in value versus the Argentinian Peso, and almost 70% versus the Turkish Lira.
Politics is normally key to these types of dramatic depreciations. However in Argentina, it is more a case of economic mismanagement, with inflation above 30% and the economy heading towards its second recession in three years, it has been forced to borrow $50 billion from the IMF. In Turkey, there are concerns that President Erdogan’s power grab will soon ensnare the country’s central bank, removing its ability to make independent monetary policy decisions based on economics, and forcing it to make politically motivated, high risk decisions such as cutting interest rates.
Neither of the issues facing these countries are likely to be resolved in the near-term and there are signs of contagion spreading to other emerging markets. Meanwhile, the Federal Reserve continues to raise interest rates as the US economy enjoys the tailwinds from the Trump administration’s tax cuts; raising the risk of further volatility in emerging markets that rely on US Dollar debt.
Fortunately, due to the volatile nature of many emerging market currencies, the majority of local contracts are priced in Dollars or Euros, predominantly to protect the local business from domestic currency depreciation. However, it is not possible to completely eliminate the local currency risk, and there is still the FX risk from either the Euro or US Dollar price.
Better safe than sorry
So how should travel businesses tackle the growing FX risks from increased demand to visit far flung places, as well as the potential for a large rise or fall in the value of Sterling depending on Brexit negotiations?
Don’t leave it to chance. Unless your business has complete flexibility to adapt pricing monthly, has large enough profit margins to absorb negative currency fluctuations, or has perfect flows of currency that naturally offset themselves, you should be hedging against FX risk.
The first step is to understand and quantify the risk, so that you can clearly identify where the risks lie, and which have the biggest impact on your P&L. The latter is crucial, as the largest exposure in terms of volume, isn’t necessarily the biggest risk when you factor in annual volatility.
The second step is to decide on a strategy and implement it, based on your hedging objectives and ensuring that you have adequate counterparties to meet your hedging needs at the most competitive price. If you don’t have an FX policy, you should consider one, as it defines the parameters to meet the agreed strategy. If you do have one, review it at least once a year to make sure that it is adhered to, that it remains relevant to the FX risks the business faces, along with the strategy that was set out.
While it’s almost impossible to eliminate FX risk entirely and the prospect of attempting to hedge can seem either too time consuming or too complex, the impact on your business’s P&L of not hedging can be devastating. Engaging an independent advisor can save you time, simplify the process and ensure your business is not left having to explain large foreign exchange losses due to inappropriate, or inadequate foreign exchange risk management.
Simply put, you wouldn’t suggest your customers go on holiday without taking out travel insurance, so why leave your business unprotected from foreign exchange risk?
To discuss any of the issues raised in this article, please contact Andy Scott or call on +44 (0)207 493 3310.