FOREIGN CURRENCY FOR EXPORTS
It is becoming more popular for exporters to accept payment for their orders in the currency used by their overseas buyers. There are several reasons for this. Some goods are traded internationally in one particular currency e.g. oil sales in dollars. A buyer may traditionally prefer to price a contract in a particular currency e.g. Latin American importers usually wish to be invoiced in dollars. Buyers are aware of the fluctuating nature of rates of exchange for major trading currencies and may prescribe contracts priced in a currency that they expect to depreciate before final payment. By quoting in this currency, an exporter may be able to gain an advantage over competitors unwilling to do likewise. If an exporter uses credit finance, the cost of borrowing may be cheaper in a foreign currency than in sterling.
However, an exporter must consider carefully the consequences of any invoicing contract in a buyer's currency. Payment of a foreign currency leaves an exporter open to an exchange risk e.g. an exporter may not receive full domestic currency value for an order if a buyers currency has depredated during the contract period. Moreover it is unwise to accept payment in a currency that is not freely convertible on the foreign exchange market. The exporter may end up with blocked accounts or with funds saleable only at a considerable discount.
Forward exchange market. An exporter can protect against any loss caused by fluctuating currencies during the sales contract period by taking out a forward exchange contract with a UK bank.
The exporter, invoicing a buyer in a foreign currency for payment at an agreed future date, sells those expected receipts to a bank in advance (i.e. forward) of the due date of payment. The bank agrees to buy at a pre-determined forward rate of exchange which varies according to the time of future delivery e.g. one, three or six months, or even longer. No money is exchanged at the time the forward contract is made, but under its terms the exporter is guaranteed a certain amount of domestic currency in place of the foreign currency sales proceeds, whatever fluctuations in the exchange-rate may take place between invoicing and payment by the buyer.
The forward rate varies from the spot rate i.e. the rate the bank is prepared to pay for foreign currency at any moment of time. The forward rate for selling the foreign currency may be at a premium i.e. it exchanges for more domestic currency than the spot rate, or it may be at a discount if it exchanges for less. The difference between spot and forward rates is determined by market forces — the most important of which is the different in the prevailing interest rates being paid by hanks for fixed deposits of the two currencies concerned.
A fixed forward contract binds an exporter to delivering the required foreign currency to the bank on the date of maturity of the exchange contract. If the buyer defaults on payment or government controls are imposed on the currency payment, the exporter must still deliver the required foreign currency amount. The exporter must purchase the required amount of currency al the spot rate to close the forward contract. This could be expensive since the rate of exchange used will be that applicable at the time of the spot purchase. However, if the delivery of the currency is delayed beyond the maturity date then the forward exchange contract can be extended — but possibly at some extra cost, depending on the forward rate for this additional period.
An exporter may still use forward exchange even when the date of payment by a buyer is in doubt, by entering into an option contract. Under this contract the exporter delivers the required amount of currency at a fixed rate at any chosen time between two agreed dates.
Foreign currency borrowing. It is increasingly common for many exporters to raise finance in foreign currency. An exporter can eliminate exchange risk by taking a loan in the same currency as that to be paid by an overseas buyer, so that fluctuations in the exchange rate cannot affect the exporter's expected receipts from the buyer. Moreover borrowing in a foreign currency may be cheaper than borrowing in sterling, depending on the relative interest rates prevailing. Bills drawn in a foreign currency can usually be negotiated by a UK bank in a similar way to sterling bills. Foreign currency loans can help the exporter develop international business, whether for capital expenditure at home, overseas acquisition or for export credit, including front-end finance.
Various types of Eurocurrency loans are available to finance export business. They include fixed-rate loans where borrowing costs are predetermined or floating-rate loans where the rate varies periodically according to market rates. As mentioned previously ECGD can provide guarantees for foreign currency export contracts and large projects.
Currency accounts. If an exporter has a continual flow of international business it may be preferable to open accounts in the currencies of the sales proceeds, instead of converting all of them into domestic currency.
The various balances can then be used to meet any expenses incurred in those currencies, while reducing commission fees incurred from dealings in the foreign exchange market.