THE IMPACT OF EXCHANGE RATES

ON EXPORT BUSINESS

FILIPE FERREIRA DA COSTA | GIL LOUREIRO | NUNO FERREIRA | PATRÍCIA BOAVIDA

Agenda

What is exchange rate

How does it impact on economy (macro level)?

How does it impact on export business (micro level)?

What exactly is exchange rate?

Is the rate at which two currencies are exchanged;

Reflects the demand and supply of one currency

relative to the demand and supply of another;

The demand and supply of currencies is fueled by

the demand and supply of goods and services

and capital.

Key factors influencing exchange rates

Inflation Countries with consistently high inflation tend to have a lower currency value as its purchasing power decreases relative to other currencies.

Interest rates Lower interest rates compared with other countries discourage investors which causes a country´s currency to depreciate.

Trade Balance Countries with a deficit in balance of trade tend to see their currencies depreciate as demand for their currency decreases.

Public Debt Countries with high level of public debt are less attractive to foreign investors, due to fears of high inflation and the chance of defaulting. This will decrease the currency´s value.

Political Stability & Performance Political or economical risk in one country might encourage investors to invest in a more stable country.

Government intervention Central banks influence exchange rates by buying or selling the domestic currency to stabilize it.

THE IMPACT OF EXCHANGE RATES

ON ECONOMY

Economic effects of currency depreciation

Devaluation of domestic currency

Effects on Imports

Imports of intermediate inputs Prices RISE

Import Prices RISE

(finished goods | services)

Production costs RISE

Effects on Exports

Export Prices FALL INCREASE in Exports

GDP

Employment

Exporting Industries Profits and Incomes

Domestic Prices (imported goods and services, consumption composition will change)

Net Exports INCREASE

Aggregate Demand

INCREASE

Y=C+I+G+(X-M)

1Assuming that the export stimulus effect and the volume effect on imports together outweigh the import-cost effect

Inflation

Impact in key economic indicators1

DECREASE in Imports

Foreign demand or domestic supply

of export goods is inelastic

Global economy in recession

Business activities located in domestic market

Higher costs passed on to customers to maintain margin

Low Effect

Foreign demand or domestic supply

of export goods is elastic

Substantial demand from overseas visitors

Business overseas operations and investment

Higher costs to be absorbed via lower margin

High Effect

The effect of a depreciation depends on:

THE IMPACT OF EXCHANGE RATES

AT COMPANY LEVEL

The Portuguese Trade Account Exports for goods and services (2015)

USA 5%

Brazil 2%

Spain 21%

France 13%

Others 26%

UK 9%

China 1%

Angola 5%

Italy 3%

Netherlands 4%

Germany 11%

+189% (1996-2015)

PT Exports vs. Exchange Rates

0,2

0,3

0,4

0,5

0,6

0,7

0,8

0,9

1

2000

4500

7000

9500

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

EXPORTS (M€) FX (€/£)

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

1000

2000

3000

4000

5000

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

EXPORTS (M€) FX (€/$)

0

20

40

60

80

100

120

140

160

0

1000

2000

3000

4000

5000

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

EXPORTS (M€) FX (€/AOA)

€ appreciation (more € for £)

Financial crises hits

Bank of England cuts interest rates

9/11

Financial crises hits

Unemployment rate peaks

End of civil war

Oil prices fall

Reduction in oil production and Pub.+Priv. consumption

Angola economic crisis

UK US AO

Regression Model - the impact of FX in PT exports

export

s st

andard

devia

tions

FX Population Gov. Revenue Gov. Expenditure

UK US AOA

Example PT to UK: a 0,09 decrease in € (or increase in £) results in a 0,54 standard deviation increase in Exports, in value +483 € Millions (0,54x892)

Model versus Real

Exports (PT) = -11244,6 -919,8 FX (€/$) +51,05 Population +0,74 Gov. Revenue -0,72 Gov. Expenditure

Illustrative Example – The Navigator Company: Impact of €/$ in exports to the U.S.

Model

1,327

3.586,95

Exports 2014 (€ millions)

186,81

3.782,21

Exports 2015 (€ millions)

200,231

% (var.)

+5,4%

+6,7%

1,112

€/$ 2014 €/$ 2015

Impact of FX on EBITDA (sensitivity analysis)

-12% -8% -4% 0% 4% 8%

% of EBITDA

+7,1% (+6,3 M€)

-8,6% (-7,7 M€)

+9,0% (+7,4 M€)

-11,0% (-9,1 M€)

+1,8% (+7,2 M€)

-2,2% (-8,8 M€)

-2,3% (-7,5 M€)

+1,6% (+5,2 M€)

2015

2014

2015

2014

FX change

+10% -10%

Translation Exposure Changes in reported owners' equity in

consolidated financial statements caused by change in exchange rates

Operating Exposure Change in expected future cash flows arising

from an unexpected change in exchange rates

Transaction Exposure Impact of settling outstanding obligations entered into before

change in exchange rates but to be settled after change in exchange rates (impact on cash flow)

Changes in exchange rate can affect firm value through:

Types of Currency Exposure

Moment in time when exchange rate changes

Risk Mitigation

Diversify markets and/or production sites

Sourcing / Purchasing Flexibility

OPERATIONAL TOOLS

Currency risk-sharing agreements

Usage of derivatives: swaps and forwards - hedging policies

SHORT TERM TOOLS

Match cash flows: natural hedge

Intercompany back to back loans

Financing: Diversification of markets and currencies

LONG TERM TOOLS

In sum…

Several factors influence exchange rates, some related with demand and supply of goods

and services and some with capital/investment

Also, when there is a depreciation, the exports of a country will be cheaper and imports

more expensive. This may improve trade balance and therefore lead to economic growth

Evidence based on a model shows that exporting firms are vulnerable to exchange rate

movements. Nevertheless, there are other variables that impact the outcome

There are different types of currency exposure and the associated business risks are a fact

of life for multinational firms

APPENDIX

Exchange Rates and Net Exports

• If export products are predominantly priced and invoiced in domestic currency, and imports are predominantly priced and invoiced in foreign currency, a sudden devaluation of the domestic currency can possibly result – initially – in a deterioration of the balance on trade (x-y). After exchange rate changes are passed-through to product prices, and markets have time to respond to price changes by altering market demands, the trade balance will improve (y-z). The currency contract period may last from three to six months, with pass-through and quality adjustment following for an additional three to six months.

Currency impact on European Corporate Earnings

Fireapps quarterly study on how currency affects corporations. The companies included in this data set are large multinational firms with at least 15% international revenues in at least two currencies.

Goods & Services

Demand

Currencies

Gov. Expenditure

Population

Economic Growth

Gov. Revenue

Exports

FX

Variable to Explain: Exports - consolidated Goods and Services exports from Portugal to country ‘x’ in € million. Independent variables: FX – nominal exchange rate of €/x Gov. Expenditure - consists of total government expense and the net acquisition of nonfinancial assets, in Billions national currency. Population - comprise either all usual residents of the country or all persons present in the country at the time of the census, in Millions persons. Gov. Revenue - consists of taxes, social contributions, grants receivable, and other revenue, in Billions national currency

Regression model – variables that explain PT exports

Standard Deviations Standardized Coefficients

Variables UK US AO UK US AO

FX 0.09 0.17 53.80 -0.54 -0.26 -0.13

Population (Per. M) 2.25 16.15 3.36 0.75 1.39 0.26

Gov. Revenue (€B) 117.26 774.12 1,876.42 1.02 0.97 0.04

Gov. Expenditure (€B) 161.12 1,157.24 1,881.47 -0.64 -1.41 0.82

Exports from PT (€M) 892 594 1,512

Example: a 0.09 increase in FX(€/£) results in a 0.54 standard deviation decrease in Exports from PT to the UK, in value -483 € Millions (0.54x892)

0.00

0.00 Variable with more than 90% of probability of being correct that it have some effect;

Variable with less than 90% of probability of being correct that it have some effect;

Regression model – standardized coefficients

Regression model – outputs for US

SUMMARY RESULTS

Regression statistics

R multiple 0.99

R square 0.97

Adjusted R square 0.96

Standard error 113.24

n 20.00

Exports Standar Deviation 594.21

ANOVA

GL SQ MQ (F) F of

significance

Regression 4.00 6,516,390.46 1,629,097.61 127.05 0.00

Residual 15.00 192,339.68 12,822.65

Total 19.00 6,708,730.13

Coefficients Standard error Stat t P value 95% lower

than 95% higher

than Less than

95.0% More than

95.0% Standard Deviation Standardized Coefs

Intercept -11,244.60 1,701.82 -6.61 0.000 -14,871.95 -7,617.25 -14,871.95 -7,617.25

FX (€/$) -919.84 249.30 -3.69 0.002 -1,451.22 -388.46 -1,451.22 -388.46 0.17 -0.26

Population (Millions Per.) 51.06 6.94 7.36 0.000 36.27 65.84 36.27 65.84 16.15 1.39

General government revenue (Billions) 0.74 0.08 9.02 0.000 0.57 0.92 0.57 0.92 774.12 0.97

General Government Expenditure (Billions) -0.72 0.11 -6.62 0.000 -0.96 -0.49 -0.96 -0.49 1,157.24 -1.41

• Very high value of R Square • All independent variables are significant with a confidence

interval of 95%

Regression model – outputs for UK

• Very high value of R Square • Independent variable “Gov. Expenditure” not significant

with a confidence interval of 95%

SUMMARY RESULTS

Regression statistics

R multiple 0.98

R square 0.95

Adjusted R square 0.94

Standard error 217.55

n 20.00

Exports Standar Deviation 892.17

ANOVA

GL SQ MQ (F) F of

significance

Regression 4.00 14,413,337.55 3,603,334.39 76.14 0.00

Residual 15.00 709,918.79 47,327.92

Total 19.00 15,123,256.34

Coefficients Standard error Stat t P value 95% lower

than 95% higher

than Less than

95.0% More than

95.0% Standard Deviation Standardized Coefs

Intercept -11,049.90 4,742.37 -2.33 0.034 -21,158.03 -941.78 -21,158.03 -941.78

FX (€/£) -5,284.60 1,326.69 -3.98 0.001 -8,112.37 -2,456.82 -8,112.37 -2,456.82 0.09 -0.54

Population (Millions Per.) 295.90 94.67 3.13 0.007 94.11 497.68 94.11 497.68 2.25 0.75

General government revenue (Billions) 7.76 3.91 1.99 0.066 -0.56 16.09 -0.56 16.09 117.26 1.02

General Government Expenditure (Billions) -3.57 2.82 -1.26 0.225 -9.58 2.44 -9.58 2.44 161.12 -0.64

Regression model – outputs for AO

• Very high value of R Square • Independent variable “Gov. Revenue” and “FX” not

significant with a confidence interval of 95%

SUMMARY RESULTS

Regression statistics

R multiple 0.99538792

R square 0.990797111

Adjusted R square 0.988343008

Standard error 163.2353932

n 20

Exports Standar Deviation 1511.893068

ANOVA

GL SQ MQ (F) F of significance

Regression 4 43030905.4 10757726.35 403.7308 4.52178E-15

Residual 15 399686.9037 26645.79358

Total 19 43430592.31

Coefficients Standard

error Stat t P value 95% lower than 95% higher

than Less than

95.0%

More than

95.0% Standard Deviation Standardized Coefs

Intercept -1,245.93 831.81 -1.50 0.155 -3,018.90 527.04 -3,018.90 527.04

FX (€/AOA) -3.52 2.03 -1.73 0.103 -7.85 0.81 -7.85 0.81 53.80 -0.13

Population (Millions Per.) 116.24 54.73 2.12 0.051 -0.41 232.89 -0.41 232.89 3.36 0.26

General government revenue (Billions) 0.03 0.11 0.26 0.795 -0.21 0.27 -0.21 0.27 1,876.42 0.04

General Government Expenditure (Billions) 0.66 0.14 4.72 0.000 0.36 0.95 0.36 0.95 1,881.47 0.82

Sources:

• www.pordata.pt • stats.oecd.org/ • www.ine.pt • www.economicshelp.org/macroeconomics/exchangerate/effects-devaluation/ • www.economicshelp.org/macroeconomics/exchangerate/factors-influencing/ • www.pestana.com • www.thenavigatorcompany.com/ • www.xe.com/pt/currencycharts/?from=EUR&to=AOA&view=2Y • www.igcp.pt/fotos/editor2/2015/Taxa_de_Cambio/2015_10_30fim_de_mes_.pdf • www.bportugal.pt • www.portugalglobal.pt/pt/biblioteca/livrariadigital/portugalfichapais.pdf • How do large depreciation affect firm performance? – Forbes, Kristin J. IMF Staff Papers, 2002 • Análise das empresas do setor exportador em Portugal, Estudos da Central de Balanços, Banco de Portugal, Junho 2015 • Firm Performance in a Global Market, De Loecker, Jan et al., Princeton University, 2014 • The Impact of Financial Risks on the Firms’ Performance , Noor, Jamal A. Mohamed and Abdalla, Ali I., European Journal

of Business and Management, Vol. 6, No5., 2004 • Internacionalização – Países Lusófonos, Survey, AIP, Janeiro 2015 • International Monetary Fund, World Economic Outlook Database, April 2016

(https://www.imf.org/external/pubs/ft/weo/2016/01/weodata/index.aspx ) • Penn World Table, version 9.0 (www.ggdc.net/pwt)