Dealing with Disruptive Dislocations

The third installment of pieces focusing on Coronavirus and its effects on international business, this piece compares currency risk sharing with Covid-19, offering a unique and interesting comparison to be found. Here we go:

The coronavirus disruption intensifies. Questions of human safety and business continuity reach far beyond lock-down orders. What can be done to manage the unexpected? Are there analogue situations of help, recourse and guidance? This commentary is based on some well-developed theories of international business, which might be usefully applied to COVID-19 transmissions. 

One virus comparison can come from currency risk management. COVID-19 is more deadly, but its frequency and strength vary at different times and locations. For currencies, companies share and trade off risk with their partners to reduce the effects of dislocations. A similar approach works for health care. Ventilators and testing capabilities may at one time be needed more in one region than in another. Together with hospital beds they can be shipped to hot spots. Even medical personnel can be transferred around the globe to cope with imbalances. When needs shift, return shipments can be administered fairly. 

Firms that continuously trade have ongoing economic currency exposure. Typically, such firms wish to maintain good relationships with their business partners. Good partners between suppliers and customers do not force all the currency risk of international transactions onto the business partner. Both currency and viral risks have a good portion of randomness to them. In the finance sector, risk-sharing agreements have proven to be useful under such conditions. 

Here is an example with companies A (American) and B (Israeli), both multinationals. If A continuously trades with B and pays in New Shekel, then major swings in currency values may cause one party to benefit at the expense of the other. Firms can address such a problem with currency management. 

Both companies could agree that all purchases by A will be made in Israeli New Shekel, as long as the currency value on the payment date (spot rate) remains between 0.25-0.3 New Shekel/$. Such range lets A agree to accept any currency exposure because it is paying in the foreign currency. If, however, the exchange rate falls outside of this range on the payment date, A and B will “share” the difference. If the spot rate is 0.35 New Shekel/$, then the Israeli currency would have depreciated. Because this rate would fall outside of the contractual range, a sharing arrangement would divide up the shift between the parties. Therefore, B loses 0.05 New Shekel/$, and A gains 0.05 New Shekel/$. Not ideal, but long-term preferable to each party absorbing its own full exchange rate impact. 

Such risk-sharing agreements have been in use for nearly 50 years in modern world markets. They became something of a rarity during the 1950s and 1960s when exchange rates were relatively stable under the Bretton-Woods Agreement. Firms with long term customer/supplier relationships across borders can now return to some old ways of keeping old friends. Since it synchronizes imbalances and eases adjustment intensities.

This article is featured in Voice of Vienna, Ovi Magazine, Sri Lanka Guardian, Korea Times, CEOWORLD Magazine, and New Straits Times.