Lock in Your Profits: How Nigerian Businesses Can Hedge Against Currency Fluctuations

Currency instability can cause anxiety for business owners who have not adopted risk management strategies to weather the fluctuations of the foreign exchange market.

When the Central Bank of Nigeria unified all exchange rate windows  as part of the government’s economic reforms in 2023, the goal was to create a fairer exchange rate system with equal access for all businesses. The long-term impact of this reform, however, remains to be seen.

Companies have been hard hit by losses since the unification. Though, it is not all doom and gloom. There are actionable strategies to circumvent this new economic reality and ensure your business continues to thrive.

Impact on Major Companies in Nigeria

Analysis of annual reports and financial statements for the year ended 31st December 2023 reveals that Nigerian corporate giants incurred post-tax losses due to the exacerbated cost of servicing dollar-denominated obligations compared to the previous year.

 Figures are in billions of naira

Table 1: Impact of Naira Devaluation on Major Nigerian Companies  culled from published 2023, annual reports and financial statements.

The impact of currency volatility underscores the vulnerability of businesses reliant on dollar-denominated expenses, irrespective of size or industry standing. It is imperative to recognize that no enterprise is immune to the disruptive effects of exchange rate fluctuations.

To assess your business’s susceptibility to FX losses, consider the following key indicators:

Does your business rely on imported products or raw materials? Fluctuations in exchange rates can significantly impact procurement costs.

Are your debts foreign currency-denominated and you wish to use naira to offset them? Currency depreciation can dramatically increase debt servicing costs.

When a business operates in a highly competitive market with global competitors, currency fluctuations can affect your pricing and profitability. If they import raw materials or components from countries with a stronger currency, production costs would rise, exerting pressure on profit margins.

Here are some strategies to safeguard your profits.

Urgent Need for Currency Hedging

Hedging is a way to protect against adverse changes in exchange rates. Nigerian businesses can adopt the following strategies to manage currency volatility.

1. Forward Contracts: These are agreements to buy or sell currency at a set rate on a future date.

Think of a forward contract like a handshake deal with a currency exchange. You agree on a specific exchange rate today (let us say ₦1000 to €1) for a future date (3 months from now). This way, even if the Euro gets stronger, in the meantime, you will still pay ₦1000 for each €1 you need.

Forward contracts let businesses lock in an exchange rate for future transactions. This provides certainty in pricing and budgeting, helping to protect against adverse currency movements that might hurt profits.

1. Futures Contracts:  Futures contracts are similar to forward contracts; however, they are created with standard terms and are traded on an exchange like FMDQ. This adds a layer of regulation and makes them easier to find and manage.

The table below shows details of various currency futures contracts. This contract that expired on May 29th, 2024 (NGUS MAY 29, 2024), for instance, allowed the owner to lock in an exchange rate of ₦849.84 for every $1. But on expiry, the actual market rate was ₦1,401/$1. This means the contract owner saved a big chunk on each naira converted to dollars.

Table 2: An Example of Futures Contracts, FMDQ, May 29, 2024 

The Key Difference: With futures contracts, you do not receive Euros, for example, instead, you settle the difference between the agreed-upon rate and the actual market rate on the expiry date. So, if the Euro weakens and is worth less than ₦1000 on that day, you might receive some naira as compensation.

1. Currency Options: These give businesses the right, but not the obligation, to exchange currency at a set rate on a future date. Currency options serve as a protective mechanism against adverse exchange rate fluctuations while affording flexibility to exit the position if market conditions become favourable.

By paying a premium upfront, businesses acquire the right, but not the obligation, to purchase a specific currency at a predetermined rate on a future date.

1. Natural Hedging: This approach helps streamline your finances. A company whose imports are priced in Dollars, but its final product sells in naira can face the brunt of currency fluctuations. With natural hedging, however, they can aim to ‘match’ their income and expenses in the same currency.

In this case, the importer works smart to find suppliers who are willing to accept naira. This way, they are less exposed to dollar-denominated debt, therefore, reducing the impact of exchange rate fluctuations on profits.

Internal Risk Management and Regulatory Guidelines

Besides using hedging strategies, companies should have internal risk management processes to identify and address currency risks. Each company’s approach will vary based on its industry and business operations. Following regulatory guidelines and obtaining government support can also assist businesses manage currency volatility effectively.

Overall, it is crucial to note that hedging options are mitigation strategies for currency fluctuations, hence, using them still involve elements of risk that require careful observation, audit and control measures.

Partner with Coronation Merchant Bank to protect your business today.

Contact details: GMT@coronationmb.com

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