Finance: The CFO's Guide to Managing in the Euroera

The world's youngest currency may be its most powerful. From risk-management to globalisation, CFOs will have to quickly learn to adapt to the new world of euro-finance.

Euroeka! The world's youngest currency hasn't just united 11 countries--Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, Portugal, and Spain--into one fiscal superpower and megamarket. It hasn't just created a potential challenger to the hegemony of the US dollar over foreign exchange transactions of every kind. It hasn't just given birth to a financial system that accounts for a fifth of the global economy and world trade, not to mention the planet's largest reserves of gold and other currencies. It has shifted the frame of reference--probably, unalterably--for India Inc.'s deals and dealings with the rest of the world.

And the enormity of the changes is only beginning to be sensed. For, the impact of the euro on your company will be much deeper than you imagine. It will remap your export markets, restructure your global operations, re-organise your financing plans. Issued and administered by the European System of Central Banks--comprising the European Central Bank, headquartered in Frankfurt, and the 11 National Central Banks of the member-countries--the euro will need new strategies to manage your foreign exchange exposure, to hedge your financial risks, and to re-allocate your resources. In short, the euro will transform your corporate finances. BT presents the CFO's Guide To Managing Money in the post-euro environment.

A common currency equals, for many--if not all--intents and purposes, a common market for India Inc.'s trading businesses. The 11 euro-countries are the collective destination of 24 per cent of India's exports, and the source for 27 per cent of its imports. Thus, the single-largest proportion of trade for corporates will, obviously, be conducted in the euro. In fact, CFOs can now expect to have virtually all of their companies' trade with Europe denominated in the euro instead of the US dollar. And a well-established euro could mean trade with other countries--in Central and East Asia, in North Africa, and Turkey--being managed in the currency.

THE EURO IMPACT

With the lion's share of global GDP and trade, the euro will attract increasing investment and transactions.

The euro will convert Europe into a single market for exports and a single sourcing-point for imports.

A single currency will lead to a uniformity of prices for products and services across the continent.

Hedging and risk-management will become less complicated as only the euro will have to be considered.

The substitution of 11 currencies with one will lower foreign exchange transaction costs considerably.

Agrees P.B. Desai, 52, Vice-President, United Phosphorus: "While invoicing in the euro will commence immediately, a shift from the US dollar to the euro can also happen in trade with non-European countries, depending on the future strength of the currency." Crucially, the euro is likely to bring stability to many locally volatile or relatively untraded currencies--such as the Italian lira or the French franc. Earlier, such volatility made trade with those countries dangerous for India Inc., but that barrier will now disappear.

But while the financial impact will be powerful, the deeper change, interestingly, will be at the strategic level. For, as the 11 markets become one, their internal dynamics will change greatly, thus affecting both the nature and the volume of India Inc.'s exports to, and imports from, them. For instance, if the euro leads to greater economic growth in the region, there will, obviously, be greater demand for products and services, spelling an opportunity for globally-minded companies from India. On the other hand, a common currency will also mean greater trade between the European countries, which will pose stronger competition than before to India's exporters.

The use of a common currency will also iron out cross-country imbalances in the prices of products, sooner rather than later. Only local variances in transportation, labour, and services costs may contribute to marginal differences in prices although the free flow of products will, probably, eliminate those as well. Importantly, this will almost inevitably lead to lower prices. The obvious implication for India Inc.: it must be prepared to sell its products at lower prices in the European markets, hurting realisations and margins for exporters. But shopping in Europe will be cheaper as a result. Explains Suresh Kumar, 36, General Manager, Ruchi Soya Industries: "Importers will benefit from price-rationalisation across Europe since products will be available at lower prices."

But then, the emergence of a common European market will also offer globalisation opportunities to India Inc.. For, companies can now set up their offices anywhere within the region and service all of euroland without the additional costs of crossing borders. CEOs planning subsidiaries in Europe, but thwarted by the high cost of operating in the leading economies, can now set up operations in the lower-cost countries--and still access the entire market.

Managing foreign exchange exposure to maximise gains--or minimise losses--will, obviously, become simpler. Eleven times simpler, in fact, for companies and banks that had dealings in all 11 of the currencies. Instead of juggling with the complexities of currency movements in different directions--a falling deutsche mark with a climbing franc, for instance--CFOs will only have to predict the movement of the euro. How much does that uncomplicate the process? Both exporters and importers, for instance, will now only have to worry whether the euro will strengthen or weaken against the US dollar, and pick their currency of payment or remittance accordingly.

THE EURO STRATEGIES

Switch receivables between the US dollar and the euro, depending on your outlook on the currencies.

Combine earnings streams from both the US dollar and the euro to just one currency to minimise fluctuation risks.

Swap floating rate loans in other currencies to fixed rate loans in the euro to cash in on lower interest rates.

Cover the dollar-euro leg of euro-rupee transactions to guard against international currency risks.

Strike short-term deals in the euro, watching the direction of the currency before making long-term deals.

A stronger euro will, obviously, lead exporters to prefer it to the US dollar. The typical strategy: take an option for converting from the US dollar to the euro if the value of the latter climbs above a certain point. That's just what Geetanjali Gems, one of India Inc.'s euro-pioneers, did. With export inflows of between $20 million and $25 million from euroland, the company entered into a swap option with Standard Chartered Bank. The terms? With a maturity of 1 month, the (0.50-million deal was struck at a rate of $1.18 against the euro, with the buy option at $1.22. So, if the euro hardens to over $1.22, Geetanjali Gems will buy $0.50 million of it from Stanchart at $1.18 per euro within the option period of 1 month.

How does this help the company? Well, its export proceeds are receivable in US dollars. Should the euro harden against the US dollar, it will, obviously, miss out on the potential gains--which it will compensate for by being able to buy its euros cheaper than the market rate. To be sure, the same hedging mechanism was available to the company--and to all exporters--even in the pre-euro era. Only, with 11 currencies to choose from, predicting movements and making derivative deals was much more complex. Not any more. Says P.H. Ravikumar, 45, Executive Vice-President, icici Bank: "Exporters who have invoiced in the US dollar should convert their holdings to the euro since, in the short run, the euro is expected to be strong against the US dollar."

The importer's euro-strategy will necessarily be more complicated, however. The importing firm's focus will, obviously, be on lowering its outgo. So, it will want to pay in the weaker of the 2 currencies: the rupee or the US dollar. However, the value of the euro vis-à-vis the rupee will be determined by 2 factors: the rupee-dollar rate, as well as the dollar-euro rate. And that makes prediction difficult. The smart strategy, then? Either shift all payments to the US dollar. Or, as Hari Mundra, 48, CFO, RPG Group, advises: "Cover the euro-dollar leg of the exposure." Because of the complications, it might be easier to operate in only one currency--either the US dollar or the euro--instead of both. Which one you choose, of course, will depend on your outlook on the currency--and whether it is your earnings or your expenditure that's in foreign exchange.

On the administrative plane, of course, the replacement of 11 currencies with one will dramatically simplify the arithmetical complications of doing deals with different countries. Agrees T.N. Balasubramanian, 49, Executive Director (Finance), KEC International: "Earlier, factoring in the price-differential and currency differential was a cumbersome task, and the euro-countries would generally quote a price higher than normal." But with the rationalisation of the currency, the exchange rate differentials will disappear.

So will the costs of conducting transactions, paying charges, and commissions, hiring people, and hedging that the multiple currencies demanded. How high were these expenses? Far from small: they are reckoned to have accounted for between 0.50 and 1 per cent of the total Gross Domestic Product of eurozone. Mapped to India's trade with the region, that amounts to 0.50 billion for India's companies--80 per cent of which should now vaporise. Admits Felix Fernandes, 47, Senior Vice-President, Kodak India: "Life will be much simpler for the corporate treasurer." Adds D.N. Vaze, 41, Executive Director (Finance), Dharamsi Morarji Chemicals: "The transactional cost will drop dramatically. It used to place a burden on corporates, squeezing margins."

Fretting about the future of your existing contracts in the ex-euro currencies? Don't forget, all these currencies will continue to be in operation till December 31, 2001. And their rates vis-à-vis the euro are unlikely to fluctuate significantly from the bilateral conversion rates fixed on January 1, 1999. However, it is still a good idea to migrate to the euro. Says Venugopal Dhoot, 47, ceo, Videocon International: "We have already converted 20 per cent of our total foreign exposure of $100 million into the euro. And we plan to convert at least one-third by the end of this year."

India's bankers must wake up to the new euro-reality too. Their largest loss may stem from the lack of arbitrage opportunities, with the global estimate of the disappearance of this business being pegged at between $30 billion and $50 billion. But their strategic response to the shift in clients' business to the euro will be important too. For instance, banks will no longer need to maintain several vostro accounts for making local payments in each of the European countries--which explains why the Bank of Baroda and the Bank of India have already announced their intention to reduce the number of such accounts in Europe. Of course, the consolidation of all accounts into one will not be possible either. For instance, no one account can be used to offer unlimited intra-day or other forms of credit, which will make multiple accounts essential. But the primary deciding factor for the banks will actually be the business plans of their clients.

The biggest boon from the birth of the euro for India Inc.? Almost certainly the lowering of interest rates on euro-debt. While US dollar loans cost between 6 and 6.50 per cent for AAA-rated Indian companies, the corresponding rate for the euro is already down to between 3.25 and 3.50 per cent. Says Ashwani Sindhwani, 37, Head (Corporate Forex), Banque Nationale de Paris: "Corporates looking to borrow overseas could save substantial sums by opting for the euro."

Worried that lower rates will be translated into greater volatility, making mincemeat of your rupee allocations for interest payments? Don't be. Unlike the yen, whose low interest rate of 0.50 per cent is accompanied by yo-yoing rates--spanning jumps and falls of up to 50 per cent--the euro is a stable currency. And that spells an opportunity to shift from floating rates--where you expect interest rates to fall and don't want to lock yourself into a high rate--to fixed rates.

That's why Srei International Finance, for one, has swapped its 7-year dm 7.50-million floating rate loan--which currently works out to 3.85 per cent--for a fixed rate of 3.10 per cent on the euro. Of course, it is also hedging against a drop in the interest rate, in which case it would lose. How? By writing an option to cancel the contract should the interest rate fall beyond a pre-set level. Sure, it is just testing the waters, having effected the swap for 6 months only. As Sunil Kanoria, 33, Director, Srei International Finance, puts it: "We could have opted for a longer maturity period, but we wanted to study the market and the development of the euro." But as an early mover, it will also be an early winner if it has guessed right.

But will the euro-rates stay as low? The uncertainty is understandable. Cautions U.Y. Phadke, 48, Financial Controller, Mahindra & Mahindra: "I would not advise long-term borrowing in the euro since the future is unclear." The continuation of low rates depends, in part, on the outcome of the battle between the newly-christened euribor (European Inter-Bank Offered Rate) and the traditional libor (London Inter-Bank Offered Rate) for the status of the benchmark. The latter is the average of the rates offered by 16 banks in London while the former is the average of the rates offered by 56 banks in Frankfurt. Says C. Girish, 29, Senior Analyst, Mecklai Financial & Commercial Services: "The differential between the LIBOR and the euribor is marginal now."

In fact, it springs from the composition of the benchmark rather than from market forces. Explains A. Anchan, 43, Head (Treasury), Global Trust Bank: "The larger number of representative banks, including weaker banks, is bound to make the reference rate of the euro costlier." Moreover, a stronger euro will, obviously, add to the cost of borrowings in the currency.

India Inc. had better be prepared for a duel for dominance over the world's financial systems between the euro and the US dollar. After all, the banks in euroland collectively possess more gold and foreign exchange--mostly US dollars--than in any other economic entity. The region's 18.60 per cent share of world trade puts it 2 percentage points ahead of the US. Indeed, the 48 per cent of global currency use that the US dollar accounts for is disproportionate to the share of the US in world trade. So, the euro could well correct that skew.

One indication: the euro-based financial market has been both widening and deepening significantly. The eurobond market, for instance, was worth $46 billion in 1997, but, by the end of the first quarter of 1998, it had swelled to $56 billion. Says Anil Singhvi, 36, Treasurer, Gujarat Ambuja Cement: "Although, in the last 2 years, we have seen a heady run of the US dollar against all currencies, the collective strength of the euro might pose a challenge to the US dollar. However, the future of the euro itself is in doubt since there is little cohesiveness between Italy and Germany, and there is a lot of diversity within Europe itself."

Nevertheless, most Central and East European countries, which had been pegging their currencies to the deutsche mark, may shift forthwith to the euro. And the Asian currencies, which are now predominantly pegged to the US dollar, may diversify depending on whether their trade with euroland exceeds that with the US. So, a gradually strengthening euro--as the pros anticipate--will also lead global investors to shift their money from the US dollar. In fact, Japanese investors, with the world's largest supply of domestic savings at their disposal, may be the first to move away from the traditional US Treasury Bill to euro paper. The Bank of Japan held no reserves in any European currency before the dawn of the euro; that could change now. A portfolio shift away from the US dollar in the currency reserves of foreign banks in Asia will add momentum to that trend. Says Siddharth Kapur, 36, Vice-President, Petronet: "In terms of trade volumes, the euro will be bigger than the US dollar in the long run. In fact, it could eventually become the common trading currency."

Of course, the shifts will have to be tectonic before the US dollar's status as the de facto reserve currency of the world is in real jeopardy. It will need a migration of between $500 billion and $1,000 billion to the euro for it to account for somewhere between 25 and 30 per cent of global currency holdings, from which position it can launch an assault on the US dollar. The time-frame over which such a shift could take place? While many financial experts believe it can only be gradual, some analysts cite the rapid decline of the pound sterling from its pre-eminent position--following its devaluation in 1931--as evidence that, once the shift towards the euro begins, it will gather pace quickly.

With the value of the rupee being a vital factor in your business plans, the status of the euro on the global financial map will not just be a curiosity. For once, India Inc. has the opportunity to operate on a level playing field, without the handicap of being a late mover, in the manoeuvres to capitalise on the new currency. As the CFO of the globally-minded Indian corporation, you mustn't miss this chance to become eurocentric.