Research Paper on "Foreign Exchange Risk Management"

Research Paper 15 pages (5032 words) Sources: 15 Style: Harvard

[EXCERPT] . . . .

Foreign Exchange Risk Management in the Companies of the Steel Industry in Eastern European Countries

Today, there are some interesting developments taking place in Eastern Europe in general and the Ukraine in particular as well as Turkey that will have an important impact on the global steel industry in the years to come. Following the collapse of the Soviet Union in the early 1990s, the Ukraine emerged as an emerging economic powerhouse in the region and Turkey continues to seek accession to the European Union in ways that are bringing its economy in line with its European neighbors. To gain some additional insights into how these trends have affected the steel industry in the countries of Eastern Europe generally and in the Ukraine and Turkey specifically, this study provides a review of the relevant peer-reviewed, scholarly and governmental literature, followed by a case study of two giants of the steel industry, Arcelor Mittal in the Ukraine and Erdemir in Turkey, both of which are highly representative of the progress being made in these countries. A summary of the research and salient findings are presented in the conclusion.

Review and Discussion

Background and Overview

Companies competing in the transnational marketplace have much to consider when it comes to identifying potential opportunities as well as threats, with foreign exchange risk management being one of the most important for both of these purposes. For instance, Chiang and Lin (2005) note that, "Unexpected fluctuations in foreign exchange rates have been an important concern to firms with international business operations since future cash flows, and therefore the value of firms will be affected" (598). The persistent global economic downturn, though, has caused a growing number of multinational corporations to reassess their foreign investment strategies in an effort to minimize their foreign exchange risks while hedging their bets for future improvements in the marketplace and less fluctuation in foreign exchange rates. In reality, this approach is not surprising given that the overwhelming majority of corporate executives competing in the transnational marketplace agree that foreign exchange risk management is just as important as business risk management and that cash management is even more important for transnational corporations (Rugman & Brewer, 2001). According to these authors, "With increased volatility in financial markets, multinational enterprises (MNEs) have learned that their value has become more subject to the risks occasioned by changes in their financial environment" (Rugman & Brewer 2001, 565). In response, a growing number of MNEs have sought to manage these exchange risks by using a comprehensive strategy for foreign exchange risk management that minimizes the impact of market risk (Rugman & Brewer, 2001). Likewise, Chiang and Lin (2005) report that, "To mitigate the impact of foreign exchange rate fluctuations, firms can employ financial hedge strategies through foreign currency derivatives (FCD) and foreign-denominated debts (FDD)" (598). In other words, by keeping their transnational financial administration keyed to the currencies used in the different countries in which they compete, multinationals can minimize the impact that fluctuations in exchange rates have on their invoicing and payables.

Ukraine. Besides the still-enormous Russian republic, at the time of the collapse of the Soviet Union, the Ukrainian republic represented the most important economic component by far, producing approximately 400% as much output as the next-ranking republic (Ukraine 2010). According to Green (2006), "Slightly smaller than the size of Texas, Ukraine has abundant natural resources and a well-educated population with a literacy rate of 99%" (p. 17). Because of the quality of its soil and advantageous agricultural conditions, the Ukraine has also long been the breadbasket for Eastern Europe and the country's diversified heavy industry sector has provided the steel-based materials needed to develop the infrastructure in former satellites of the Soviet Union (Ukraine 2010). Despite some challenging times immediately following the country's independence from the Soviet Union in 1991, a great deal of progress has been made on both the political as well as the economic front, but the Ukraine remains heavily dependent on Russian oil and gas as essential energy sources, a constraint that continues to create problems for its growing economy (Ukraine 2010). In fact, pursuant to its most recent agreement with the Russian government finalized in 2006, the Ukrainian republic will be required to pay almost twice as much for Russian gas in the future (Ukraine 2010).

More recently, growth or declines in the country's gross domestic product (GDP) have been directly affected the global demand for steel. According to U.S. analysts, "Real GDP growth exceeded 7% in 2006-07, fueled by high global prices for steel - Ukraine's top export - and by strong domestic consumption, spurred by rising pensions and wages. The drop in steel prices and Ukraine's exposure to the global financial crisis due to aggressive foreign borrowing lowered growth in 2008 and the economy contracted more than 14% in 2009, among the worst economic performance in the world" (Ukraine 2010, 3). In response, the Ukrainian government finalized an agreement with the International Monetary Fund in November 2008 in the form of a $16.5 billion credit that could be used to offset the impact of the economic downturn; ongoing political dissension in the country though has adversely affected the nation's ability to sustain an economic recovery (Ukraine 2010).

Turkey. Long known as a "crossroads" because of its geographic proximity to Asia and Europe, Turkey stands at quite another crossroads today as it seeks to gain full membership in the European Union while balancing the demands of its increasingly vocal Muslim population concerning the need to proceed cautiously in terms of adopting Western styles and traditions.

Like the Ukraine, Turkey remains highly dependent on its agricultural sector that represents approximately 30% of the country's employment, with a slightly smaller percentage competing in the textiles and clothing industry (Turkey 2010).

The march towards modernization during the first half of the 20th century resulted in the mining, energy, iron-steel industry and railways in Turkey being nationalized but with assurance that privatization would quickly follow (Altunisk and Tur 2004). These assurances did not materialize by the 1950s, but progress has been made since that time (Altunisk and Tur 2004). Although the Turkish government has been actively pursuing divestitures of its previous state-owned enterprises, it still holds significant interests in many of the country's industries. In addition, and also like its counterpart in the Ukraine, Turkey's economic performance in recent years has outpaced some its neighbors and the global performance rates as well, with real GDP growth surpassing 6% in many years, but the worldwide economic downturn has impacted the Turkish economy but not as sharply as in the United States and other industrialized countries; in fact, inflation stands at a 34-year low and international investments are strong (Turkey 2010). Despite these accomplishments, the Turkish economy remains characterized by a high current account deficit and high external debt but continuing economic and judicial reforms and the country's potential entry into the European Union have continued to attract foreign direct investment (Turkey 2010).

In sum, U.S. analysts note that Turkey has much going for it today, but some significant obstacles stand in the way of further progress in the future: "Economic fundamentals are sound, but the Turkish economy may be faced with more negative economic indicators in 2010 as the global economic slowdown continues to curb demand for Turkish exports. In addition, Turkey's high current account deficit leaves the economy vulnerable to destabilizing shifts in investor confidence" (Turkey 2010, 3). Notwithstanding the importance of the agricultural, textiles and clothing industries to the Turkish economy, recent trends suggest that Turkey is well situated to become a major actor in the global steel industry as well. According to Green (2006), "Turkey is a big market in itself, but it also serves as an export platform to Europe. There is a misperception that it exports small, cheap products. But it is increasingly exporting items like auto parts and cars to Europe" (28). These trends will undoubtedly affect steel-producers in Eastern Europe, including Arcelor Mittal, and these issues are discussed further below.

Steel Industry in Eastern Europe and Ukraine.

The steel industry in Eastern Europe struggled under the state-controlled policies of the former Soviet Union in ways that created lasting problems. "What proved to be a more lasting problem was the fact that steel was needed as a base for other industries, yet there was not adequate consumer demand to support either a viable steel industry nor a domestic industrial market using steel as an intermediate product" (Mangum, Kim and Tallman 1996, 37). By 1955, the countries of Eastern Europe and the Soviet Union were exporting just 10.6% of the world's supply of steel altogether compared to 14.2% for the U.S. And 9.9% for West Germany alone (Mangum et al. 1996). By the 1990s, though, things had changed in major ways for the eastern European steel producers. For starters, an increasing number of European Union members in Eastern Europe have adopted the euro as their currency, including the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Romania and Slovenia, thereby… READ MORE

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