In coping with the foreign currency flows and exposures of day-to-day commerce, New Zealand companies are mostly familiar with hedging tools such as forward exchange contracts and currency options.
But in using those tools many have no consistent approach to policy or strategy, relying instead on intuition or their bank's exchange rate forecast.
Neither is particularly useful.
Some forecasters are bullish, pointing at an exchange rate of US90c or even US$1 as a target. Others think it will fall, citing the 10-year average of US69c or some other random statistic that ignores what has changed in the world over that time.
In truth, both outcomes are possible and relying on just one of them is not a prudent way to manage risk. It is better to step away from such noise and look at the bigger picture.
Currency risk management should be more of a "what-if?" process.
What if it goes up, what if it goes down? What does each scenario mean for your business?
The aim should be to defend profit margins in a manner consistent with the business's characteristics, while leaving the door open for better.
This means adopting a more considered "little and often" approach to hedging, with core percentages covered while regularly chipping away at exposures on a rolling horizon basis as the opportunities arise.
That's not to say that currency trends should be ignored; only that specific forecasts are inevitably inaccurate and that it's not wise to commit fully to an expected up or down move.
An old market saying holds that "the trend is your friend".
In practice that means a hedging strategy should take account of the current trend and not fight it with mere hope.
And here's the thing - foreign exchange rates are relative relationships.
For all the short-term gyrations caused by global currency markets, the general trend will ultimately be driven by real business and real people.
Asia and Australasia have escaped the worst of the GFC, largely due to the pivotal resilience of China and the financial resources it brought to bear in defence of its growth ambitions.
In this part of the world, we can watch with wonder the self-destruction being wrought in Europe and the US, though that is small comfort in what is still a difficult local environment.
New Zealand has low interest rates but not as low as in the major economies so we still attract foreign investment; unemployment is up, but is less than in most places and nowhere near the levels of a Spain or a Greece; our Government has had to increase its borrowings, but still has far less debt than the UK or US.
For all our flatlining frustration, New Zealand's economic environment looks relatively good.
Indeed, the second quarter's GDP data was ahead of expectations at 0.6 per cent for the quarter and 2.6 per cent for the year. And the Canterbury rebuild is yet to come.
That's why the kiwi has been recovering so well against the US dollar, the pound and the euro over these last three years.
At the onset of the GFC, the "risky" NZ dollar plummeted. The NZ trade weighted index fell from 73.5 in February 2008 to as low as 51.5 less than a year later - a fall of 30 per cent.
But the index is now back to pre-crisis levels, and the US83c exchange rate is exactly on the longer-term trend line (regression) from its low of under US40c in October 2000.
Given that the economic relativities between New Zealand and the rest of the world appear to have shifted in our favour since the pre-crisis days when everyone was in party mood, one suspects that the dollar's upward trend will continue.
This is a challenge for exporters, of course, who will have to find more non-price reasons to win custom. But it's also a challenge for importers, especially of retail goods, who face the threat of the internet enabling more customers to buy directly from overseas at price differences enhanced by a stronger dollar.
It would be nice to believe both sides can win, no matter what the exchange rate. But all will have to manage their risks carefully in order to stay in business and have that chance to succeed.
Good financial risk management involves:
Identifying risks, assessing materiality and deciding how to manage them.
Adopting a disciplined approach to making risk count - i.e. risk management, not speculation.
Having appropriate financial risk management rules and practices - and sticking to them.
Regular, transparent and meaningful communication among management and with the board.
Cliff Brown is a client adviser at Bancorp Treasury Services.
