Exchange Rate Risk Mitigation

Contractual arrangements, tariffs paid in hard currency and matching payment streams have been reported as the most effective instruments for reducing exchange rate risks.

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  • Contractual arrangements might include tariffs and public payments linked to the exchange rate, directly transferring the exchange rate risk to the public side. A peg of user fees or subsidies to exchange rates has not, however, proved promising in the past.
  • Matching payment streams involves companies matching their revenue streams to expenditure streams for inputs/supply in the same currency. For example, infrastructure projects could be financed through local currency denominated loans, which will match debt service payments and revenue streams of the infrastructure project.
  • Derivative contracts include forward contracts, currency futures, swaps and options. Only 31% of respondents reported them as one of the most effective instruments. This appears relatively low, given that hedging exchange rates or currency risks is seen as a commonly used instrument. Availability of derivative contracts in the region might however be limited to highly-traded and liquid currencies.

 

The availability of swaps/futures to hedge against devaluation and exchange rate risks is often restricted in several ASEAN economies, according to interviewed experts. The availability of long-term hedges appears to be restricted in Indonesia, the Philippines and Thailand. Furthermore, currency swaps involving the local currencies of Cambodia, Lao PDR, Myanmar and Viet Nam are not available on the private market. This bottleneck might constrain access to financing in these countries. Shallow domestic capital markets require investors to access international capital markets, whose loans and bonds are mainly denominated in hard currencies in these countries, even though revenue streams are in local currencies.

Other mitigation strategies might include currency risk-sharing agreements, letter of credits, back-to-back loans and credit swaps.