Uncommon Currencies (Part 1)

Planning and implementing - not to mention maintaining - operations offshore is hardly the world’s easiest task at the best of times. During a period of economic and financial upheaval, with uncertainty and concern around every corner, it becomes altogether trickier (as many SSON members can ruefully testify): pressures to cut costs and increase margins can send even the most granular business plan into the blender. The last thing, then, that those looking for offshore solutions want to rise up before them is extra uncertainty in the form of currency fluctuations impacting upon the most critical numbers in the ledger - but in accordance with Murphy’s infamous law, that’s precisely what the shared services and outsourcing space has had to cope with during (and partly as a consequence of) the most serious financial crisis in living memory.

In a nutshell, currency fluctuations are a nightmare for those organizations with offshore infrastructure (most relevantly, captive SSCs) since they render budgetary planning immeasurably harder (and can lead to significant extra costs in a comparatively rapid timeframe). If a US-based company sets up a center in, say, the Philippines, with wages, utility bills etc all payable in Filipino pesos - but, crucially, with the parent company’s income still overwhelmingly dollar-denominated - and the peso then appreciates against the dollar by ten percent over twelve months, at the end of the year that center has become ten percent more expensive in real terms for the parent organization. This kind of situation, obviously, can take a serious bite out of the cost savings which the centre has been set up to generate.

Fluctuations of ten percent per annum are by no means too outlandish to consider - indeed, especially over the last year or so, relative values for a wide range of currencies have oscillated by significantly more than that. The value of sterling against the dollar, for example, grew by over 20 cents per pound in a little over three months from the end of April this year. Meanwhile the crucial rupee-dollar rate - of critical interest for all those firms operating centers in India - while behaving slightly less aggressively, has fluctuated towards a stronger rupee by approximately 7.5 percent since April 29. This means that firms earning in dollars but paying for their Indian centers in rupees have seen real costs rise significantly through no fault of their own - while firms with outsourcing deals with Indian providers, with contracts typically dollar-denominated, have transferred this burden onto the unfortunate providers whose bills remain payable in rupees. (This cuts both ways, however: during 2008 the notoriously volatile rupee dropped from a monthly average 39.27 to 48.48 to the dollar, resulting in comparative gains for those operating captive centers on the subcontinent despite a degree of inflation.)

A major factor in the general volatility witnessed in the currency markets over recent times has been the performance of the dollar - still effectively the world’s reserve currency. The greenback has fallen by over 10 per cent against the euro since the beginning of May, taking with it a host of other currencies pegged either officially or de facto against the dollar. However, as Chris Towner, Head of FX Advisory at HiFX, points out, "it’s never going to be one-way traffic": at the onset of the main phase of the financial crisis with the fall of Lehman Bros the dollar soared as anxious investors sought a safe haven (particularly affecting sterling: the dollar-sterling rate saw a dramatic range of 60 cents last year, while in comparison the range between 1993 and 2002 was effectively between $1.40 and $1.70 to the pound). Now, with the dollar having weakened - and further weakness likely into 2010, according to Towner - investors are turning once again to other currencies including the euro (nearing the psychologically significant $1.50 mark) and beyond cash to commodities (hence the current record-breaking value of gold, and strengthening the so-called "commodity currencies" such as the Australian, Canadian and New Zealand dollars whose values are greatly affected by commodity prices due to the importance of commodity exports to their respective national economies).

So what does all this mean going forward for offshore SSOs? Clearly, one major issue is the impact of currency fluctuations for the wider organization ("If a company is importing or exporting even a small movement in the currency rate can have a large impact on profit margins," says Christina Weisz, Director, Currency Solutions): the cost-savings for which the shared services model is renowned might become even more valuable for organizations feeling the squeeze thanks to unfavorable developments on the currency markets, driving firms which might hitherto have been insufficiently interested in the model towards embracing shared services. As a result, and somewhat ironically, in some circumstances the offshore option might prove more attractive now despite the relevant exchange rate being less favorable than it was only a short while ago.

However, for many companies with existing offshore shared services infrastructure the situation is less satisfactory. Essentially, the safest course of action is to allow a significant safety net within annual budgets to provide for the impact of fluctuations - so if operating costs are expected to be X over 12 months, firms will allocate X plus an agreed percentage to cater for the possibility of fluctuation-induced extra costs. However, the big drawback inherent in this approach is that it ties up precious capital which might be required elsewhere within the company. Of course, this can be mitigated to a certain extent by arranging to borrow the extra cash should it be required - but then, they don’t call it a credit crunch for nothing, and extra borrowing might well be impossible or at least prohibitively expensive, especially for smaller organizations.

Another option - particularly of interest for companies which haven’t yet set up offshore centers, or those looking to expand their footprints, but also a worst-case option for firms operating centers in countries whose currencies become insupportably erratic - is to look for suitable locations within currency areas less subject to dramatic fluctuations. Of course, there are many other factors to consider than just a location’s currency attributes: but it might well be that the stability or lack thereof of a country’s currency could prove critical in the eventual decision as to where to site a center.

One important currency which has thus far retained a good degree of stability - as a result of its effectively being pegged against the dollar, despite officially weighing against a basket of currencies led by the dollar, the yen and the South Korean won - is the Chinese renminbi. As the Chinese government ramps up its attempts to lure overseas firms into setting up SSCs on Chinese soil, the solidity of the country’s currency is likely to prove an increasingly significant draw.

"The outlook for the renminbi is pretty much stable," says Towner. "Over the last 18 months the currency has been kept at more or less between 6.81 and 6.87, looking as though it’s been managed pretty heavily by the Chinese government. China with growth of 10 per cent is obviously outperforming most economies; the Chinese are heavily reliant on exports (fighting with Germany for the position of the world’s largest exporter). Given the credit crisis [the Chinese] want to ensure that the currency remains stable against the dollar. When they start to recover they might look at freeing their currency a little but a very high level of their reserves are dollar-denominated and held in US Treasury bonds; they have to act very carefully."

(Continued next week)