Don't add FX volatility to your trade woes

posted by Jeremy Cook
18 May 2018

Retailers are the household names of UK business and a key component of the supply chain. But the past six months has seen some of the venerable occupants of the nation’s high street start to crumble – and this will likely hurt the entire supply chain, says Jeremy Cook, chief economist and head of currency strategy at WorldFirst.

There is no doubt that the landscape has changed irrevocably in the past few years. However, SMEs and the retail sector remain the backbones of the UK economy with over two thirds of UK economic output coming from companies in either category. 

According to our Global Trade Barometer, the number of SME retailers trading abroad for example decreased from 52% in Q4 2016 to just 26% in Q4 2017 – the equivalent to around 86,000 SME retailers. These retailers cited Brexit fears, currency volatility and a decline in consumer confidence as reasons why they had retrenched. The outlook seems almost certain to remain challenging and this will have a knock-on effect on the rest of the supply chain.

It’s not surprising to see retailers are retrenching when two-fifths of businesses asked by CIPS in a recent survey about Brexit are planning to increase their prices in the future to offset the potential costs resulting from the UK exiting the EU. The survey also found that 42% of EU supply chain managers did not think British products “stand out from the crowd” and more than a third said it would be less expensive to work with a local supplier. For a UK business looking to make money away from our dwindling high streets, this is tough reading.

Tight margins is nothing new for the procurement industry. But the recent combination of higher costs, lower consumer spending and lower brand loyalty has made it harder to prosper than ever before.

FX can exacerbate supply chain woe

Furthermore, if a business is part of an international supply chain then the threat is doubled. Currency volatility and translation risks can turn a healthy margined product into an overnight loss maker.

The majority of UK supply chains are integrated with Europe and therefore ripples in the GBP/EUR exchange rate can turn into waves along integrated supply chains. Brexit and particularly the impact of the Northern Irish border are likely to keep the pair volatile.

The first step to avoid this is budgeting internally. Businesses need to be watertight on their foreign currency needs in order to make a profit on their goods. They say knowledge is power, and ignoring this knowledge will leave your business vulnerable.

Foreign exchange shocks can seriously derail budgets and negatively impact trading. As protection from future shocks, those importing should set a budget rate – a price from buying from overseas suppliers – that needs to be obtained to remain profitable.

Once this is established, they can protect themselves from additional losses using a “forward contract” – a foreign exchange product that allows them to fix an exchange rate for as long as needed.

The recent announcement of a transitional arrangement postpones the cliff edge of Brexit until December 2020. Changes in business conditions are always seized upon by low margin industries. The successful ones are those who adapt to the new environment with the fewest pain points.

The transition deal takes the boot off the neck of the international supply chain community for a few crucial months. It could be enough to prompt enough investment or reorganisation to keep the sector moving forward, especially as we draw closer to the eventual date of departure.

Consumer confidence will strengthen the chain

The greatest help will come from a confident consumer, although there are still many hurdles to jump. We have just entered the twelfth consecutive month of falling wages once inflation is included and although real wages may turn positive soon, in the long run, average pay is still down. Similarly, borrowing costs may still rise following an interest rate hike in November and further increase the squeeze on living standards.

There will be many great challenges to the procurement sector this year, but there is no need to make currency one of them.

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