Earlier this month, the Rand plunged to its lowest point ever, reaching R19.51[1] against the Dollar. This decline was influenced by various geopolitical factors including allegations of Russian military support, the ongoing economic threat of severe loadshedding and a recent credit rating downgrade by S&P.
According to Stian van Zyl, currency and treasury manager at leading South African foreign exchange (FX) company Kuda, the Rand is still facing pressure and remains at risk of further weakening. “It’s not surprising that local businesses are becoming more cautious about the South African investment landscape and considering offshore options,” he says.
However, van Zyl warns against making impulsive decisions. Instead, he urges companies to explore the opportunities that arise during crises. One such opportunity is hedging, which involves using financial tools or strategies to reduce or eliminate the risks associated with currency fluctuations.
“Hedging can help local businesses manage risk and limit their exposure to potential losses in volatile markets with unpredictable currency fluctuations,” adds van Zyl.
With the Rand still experiencing instability, van Zyl suggests three hedging strategies that businesses can use to protect themselves.
Swaps
A currency swap is an agreement between two parties to exchange cash flows based on a specific set of criteria. Swaps can be used to hedge against interest rate risks, foreign exchange rate risks, and commodity price risks.
Forward contracts
Similar to futures contracts, which are standardised contracts traded on a centralised exchange, a forward contract is a private agreement negotiated between two parties to buy or sell an underlying asset at a predetermined price and date in the future. It offers more flexibility than a futures contract as it can be customised to suit the needs of the involved parties.
Collars
A collar is a risk management strategy that involves combining options contracts to limit the potential range of gains and losses of an underlying asset. By setting a floor and a ceiling on its price, collars can be used to hedge against price movements while limiting potential gains or losses.
“As a small open emerging market, South African exporters and their revenues are severely affected by exchange rate fluctuations,” says van Zyl. To address this, he suggests businesses enter into forward contracts and lock in the exchange rate at the time of the contract. “This ensures a fixed price for goods in their local currency, removing the uncertainty and volatility associated with exchange rate movements. It also enables exporters to plan and forecast their cash flows more effectively.”
Similarly, van Zyl notes that importers’ costs can be significantly impacted by exchange rate fluctuations. “By engaging in currency futures contracts, importers can secure the exchange rate for a specific period, reducing the risk of adverse currency movements during that time. This helps them to manage their cash flows, plan their expenses and protect their profits more effectively.”
As the South African Reserve Bank looks to raise rates once more, van Zyl says it is even more crucial to employ hedging strategies to mitigate inflation risks and ensure stability.
“By adopting these smart strategies, investors and businesses can proactively safeguard their positions, plan for the future and turn volatility into a pathway for financial resilience,” concludes van Zyl.
[1] S.African rand sets record low, volatility seen ahead | Reuters
