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Tug of war

Wei Gu 

Volatility: Tensions are simmering at the Group of 20 meeting in Seoul. Western leaders want emerging market currencies to rise, and emerging countries said foreign hot money have added to their problems. The disunity isn't just a problem for politicians. It is also causing big headaches for companies investing across borders.

Bosses of emerging market businesses have two complaints. One is that rising domestic currencies hurt profits. For those who sell in dollars or euros, domestic currency appreciation will inevitably lead to short-term pains. But over the long run, stronger currencies will help to balance trade. Emerging market CEOs may just have to get used to that.

The other complaint, about short-term currency fluctuation, looks more valid. Businesses have to pay more to hedge their foreign revenues and costs. Currency fluctuation also raises the returns companies expect when they decide to add employment, capacity or new products in other countries. For countries who depend on foreign investment for their development, anything that delays needed investment flows should be a real concern.

Expected volatility on foreign exchange markets has fallen about 35 per cent from late 2008 levels, but remains elevated. The implied volatility of one-year options on yen, sterling and rupee has doubled from the level seen in mid-2007. Korean won option volatility almost tripled during the same period, according to Thomson Reuters data. Talk of currency wars and worries over US quantitative easing are the likely culprits.

Of course, not everyone fears volatility. Banks who sell currency hedges may welcome it. And even governments may appreciate some froth. China, for example, is keen for investors to feel like yuan appreciation isn't a one-way bet, and can go down as well as up. But G20 leaders may be prone to forgetting that wobbly currencies can be as much of a problem as undervalued ones. That makes compromise all the more important.

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First Published: Fri, November 12 2010. 00:07 IST
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