The Zambian Kwacha has lost its value to unprecedented levels ever witnessed in this country. The swift and violent loss of value has brought about untold misery to both businesses as well as consumers.
Hot on its heels is inflation which has soured to 14.3% from 7.7%, a feat which was expected anyway. At the time of putting ink to paper, the exchange rate between the local currency and the US Dollar is K13.80 having traded earlier in the day at K13.10 to a dollar. Who knows, by the time the ink dries up, further devaluation could take place. This hair spinning state of affairs sends cold chills in the spines of business decision makers making it impossible for them to plan, and as you and I know, failing to plan is planning to fail.
In this discourse, I will bring to fore some of the proactive measures that business people and consumers at large may employ to avoid loss or erosion of their hard earned resources through depreciation of the Kwacha. I will explore the efficacy of the use of one of the financial instruments which businesses can use to plan. While Zambian companies may not be able to stop the volatility in the short-term, they are at least able to hedge using over the counter forward exchange contracts or indeed exchange traded currency contracts.
Forward exchange contracts (FEC) hedge against exposure by allowing the importer or exporter to arrange for a bank to sell or buy quantity of Dollars, Pounds or Rand at a future date, at a rate of exchange determined when the forward contract is made. The customer will know in advance either how much Kwacha he will receive (if he is selling US Dollars, British pounds or SA Rand to the bank) or how much Kwacha he must pay (if he is buying dollars, pounds or rand from the bank) to their suppliers.
FECs enable companies to fix in advance future exchange rates on an agreed quantity of foreign currency for delivery or purchase on an agreed date. These are generally set up via banks and are non-negotiable, and are legally binding contracts. The advantage of these FECs is that they can be tailor made with respect to maturity and size in order to meet the requirements of the company. A FEC is an immediate firm and binding contract, between a customer and a bank, for the purchase or sale of a specified quantity of a stated dollar, Pound and Rand foreign currency, at a rate of exchange fixed at the time the contract is made. It is entered into for performance (delivery of the dollar, pound or rand and payment for it) at a future time which is agreed when making the contract.
FECs allow you to buy and sell currencies at a fixed exchange rate for a specified time period. They are a straightforward way to protect against adverse fluctuations in exchange rates and guarantee the value of future transactions. Their benefits include budget for large cash outflow projects with more financial security, the business knows exactly what the costs or income will be and can be arranged in most major currencies.
Further, since the rate of exchange is fixed on foreign currency transactions for a specified date or time period of your choice, they enable the customer or importer/exporter to have peace of mind and concentrate on strategies on expanding the business. You pay the foreign exchange rate which is based on the spot rate on the day of the deal. FECs are binding and will have to be cancelled if you do not use them. This may result in a profit or loss depending on the exchange rate on the day of cancellation.
In the next article, I will endeavor to explain another form of foreign currency hedging that businesses and individuals can use to protect their financial assets in this volatile financial environment.
By Sidney Kawimbe