Massive losses signal lack of judgment in currency bets

In emerging markets globalization typically means to have your market flooded with foreign products. Yet a few corporations, while still firmly grounded in their home emerging markets, have wet their feet abroad and have learned the hard way.

The large corporations which ventured out of advanced economies first probably have no one left on their staff who still remembers what it felt to be a pioneer venturing abroad. Yet, for an emerging market corporation frequently there are no known precedents, and of course, there are staffing problems to overcome.

One of the most difficult staffing problems became painfully obvious in the last three months, as the American dollar suddenly appreciated, reverting its longer term depreciation. The trend reversion caught most swap operators in emerging markets wrong footed. Swap operators had become used to a deteriorating dollar and seem not to have though twice that, under abnormal circumstances, such as the current financial crunch and its ensuing recession, the price of commodities would fall and the dollar with which they are paid scarcer and dearer.

Yet, in emerging markets currency swap operators continued to bet on the appreciation of their local currencies against the dollar, generating massive losses to their employers.

Brazil’s Aracruz was one of the first to get beaten to the ground. Informed sources claim that it may take Aracruz, the world’s largest producer of pulp from eucalyptus, about a decade to regain its ground. Brazil’s Votarantim’s own paper and pulp operation (VCP) got beaten twice, first as shareholder of Aracruz and then in a bad currency bet of its own, losing about a billion dollars more. Steelmaker Companhia Siderúrgica Nacional (CSN) may have lost $700 million in a sour ADR swap. Poultry farm Sadia fired its CFO, who wasted $415 million, allegedly by indulging on bad currency debts beyond his mandate.

But Brazilian corporations were not alone, Comercial Mexicana, Mexico’s second or third largest retailer, threw the towel after wasting $4 billion on derivatives contracts (see The Economist, October 16). The Mexican tortilla maker Gruma had its trading halted as it disclosed losses amounting to almost $700 million. Asian corporations were not spared either. Citic Pacific, is a Hong Kong-listed conglomerate partly owned by the Chinese government and generated bad currency debt close to $2 billion, (see The Australian, October 22nd). Operators in Latin America, and in China, seem to know how to implement swaps but miss on the direction of the hedge to be made.

Such widespread bad currency debts suggest that there is a swap-training gap in emerging markets. Because the reported losses, so far, have been more frequent and larger, in Latin America, it is possible that the training gap may be larger there. This region is a relative newcomer to globalized operations and swap operators may not be as experienced, or the information sources on which their work depend, not as developed.

Of course, operators are not alone, for instance, they are rewarded on bonuses when they succeed encouraging them to take substantial risks. Their bosses should have known better, but on the other hand, aren’t they all relatively new to the international arena? The size of the losses, painful as they have been, is in itself an opportunity to internationally-oriented business schools in emerging markets, for proper training is obviously lacking.

Alfredo Behrens
Professor of Cross-Cultural Management
FIA International Executive MBA
November 2008