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Country Profiles

the bank service side is to implement


cash management solutions that will
concentrate cash so that it can be
invested or repatriated. Effective cash
management and dealing with local
bank credit/counterpart risk will remain
high treasury management priorities.
Collections and disbursements. As
with the other Latin countries, payments are primarily by check, and like
Argentina, with long float times. Most
banks have limited branch networks.
Rejected items can take two weeks to
collect on. Some banks have attempted
to respond to this with special collection services, specifically designed to
handle rejected items.
Technological Infrastructure. Here,
too, the bulk of the technology lies
with electronic banking systems. Most
banks are able to provided semi realtime reporting on balances and initiate
electronic funds transfers.

Interest Rate Consensus Forecast


(Sample countries)
Major rates
France

10/7/96

3 mo

12 mo

3.3
3.6

3.4
3.7

3.1

3.1
3.2

3.6
3.7

0.4

0.7
0.6

1.1
1.0

1.5

1.8
1.6

2.2
2.2

5.9

5.9
5.9

6.8
6.7

5.0

5.3
5.1

5.4
na

6.9

6.6

7.2

3.6

3.9

4.4

5.6

5.8

6.1

3mo Interbank (PIBOR)

Consensus
Futures

3.5

Germany
3mo EuroDM Dep.

Consensus
Futures

The above summaries, and those in


part I, should be used as a starting
point for efforts to understand the
changing (and mostly positive) treasury
management dynamics taking place in
each of the major Latin American
counties.

3mo Yen CDs

Consensus
Futures
Switzerland
3mo EuroSFR Dep.

Consensus
Futures
United Kingdom
3mo Interbank

Consensus
Futures
3mo Treasury Bills

Consensus
Futures
Others
Australia
90-Day Bank Bills

Consensus
Canada
3mo Treasury Bills

Consensus
Since the environment is changing
rapidly it is therefore important not to
rely on information obtained anywhere
but from sources on the ground, in
country.

3mo Interbank

Consensus
Italy

3mo Treasury Bills (gross)

8.1

7.3

6.5

2.8

3.0

3.6

3.2

3.3

3.3

6.8

6.7

6.7

4.8

4.9

5.2

Netherlands
3mo EuroGuilder Dep.

Consensus
Singapore
3mo Interbank

Consensus
Spain
3mo EuroPeseta Dep.

Consensus
Sweden
3mo EuroKrona Dep.

Consensus

Ms. OBrien is a first vice president with


ABN AMRO in Chicago, +312-904-2415.
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While currency rates are influenced by a


variety of other factors, the globalization
of capital markets and increasing capital
mobility make interest rates increasingly
important.

In looking to manage a firms currency


risk, it is often a good idea to incorporate
your view on interest rates. Indeed, the
practice of managing the net impact of
fluctuations in both FX and interest rates
on a given position or portfolio, not the
impact of each in isolation, is often promoted to improve risk management. The
idea is that there is likely to be some
offsetmeaning the net exposure to both
rates in that currency will be lessor
leverage impactmeaning the exposure
will be greater than anticipatedwhich
should be considered.
To help make this determination,
London-based Consensus Economics,
publishers of the Foreign Exchange
Consensus Forecasts, like other producers
of forecast information, will often include
interest rate predictions along with their
FX view.

Hong Kong

Consensus

Its definitely worth a trip to assess the


situation first hand. It is also useful to
coordinate with an experienced local
treasury practitioners, either your companys own or another, to focus your
fact-finding mission. This along with
making the most of your local and
international bank relationships can
help you keep your practices up to
date and ready for regional efficiencies.

Interest Rates &


FX Management

Japan

United States

Keeping up to date

Professional development

Source: Consensus Forecasts survey of 250 economists on 10/7/96

What interest rates tell about FX


In its survey of interest rate trends, included with its October 7 report, Consensus
Economics explores some examples of
how interest rates affect rates of foreign
exchange. The driving influence on currencies are interest rate differentials (the
spread between interest rates for the currency pair being analyzed). Given the
globalization of capital markets and the
mobility of investors to seek higher returns
abroad, wide spreads generally will attract
capital inflows into the country with higher interest rates, causing the currency to
appreciate.
However, these higher rates will not
always equate with higher returns for the
investors flocking to the higher rates.
Parity conditions, according to the textInternational Treasurer/October 28, 1996

Currency Management
book explanation, will ensure that
exchange rates adjust to equalize real
returns across currencies. For example,
high rates of interest relative to the dollar would tend to be offset by a devaluation of the high interest currency relative to the dollar (or vice
versa)though the immediate impact
may be to support the currency.
Thus, under parity conditions, the currency with a lower interest rate should
be at an equivalent forward premium in
terms of a currency with a higher interest rate.
Over time, arbitrage will drive the
markets to equilibrium. This is part of
the same conceptual basis suggesting
that forward rates are the best predictor
of future spot rates.
The trick is to determine the change
in the real rate differential, and not that
in nominal rates. It is typically the former that drives the corrective currency
rate adjustments. As Consensus
Economics notes, in many cases, higher
interest rates are a necessary offset to
expected inflation or other economic
risks. In these cases, it is important to
adjust nominal rates for these factors to
determine their bearing on FX. Note
that the consensus view for short-term
rates often deviates slightly from futures
(see table on p. 4)
Further clouding the issue, is the fact
that while rising rates can support a currency, falling rates may do so also. For
instance, if the rate reduction improves
the countrys deficit financing burden,
where interest rates have been historically high, a reduction can be equally
good news for the currency.
This is all a way of saying that the
relationship between interest rate and
currency moves is not entirely straightforward. FX markets may place greater
weight on other influences, such as
trade balances, which can overshadow
the interest rate impact. Consensus
Economics shows how this has been
the case with Japan (see chart 2).
Another factor is that markets tend to
discount expected changes in advance,
so exchange rates can respond as much
to changing expectations as they can to
the rate movements themselves.
International Treasurer/October 28, 1996

Chart 1 shows the differential


between Eurodollar and EuroDM
interest rates future, with the scale
inverted, so that a decline in the
series reflects a widening in the
expected interest rates differential in
favor of the dollar.
The differential reflects the futures
markets changing expectations of
the USD/DM rate differential on a
particular contract date (in this case,
the December 1996 contract). In
Consensus Economics analysis, this
chart suggests that changes in
DM/USD exchange rate have been
closely linked to changes in interest
rate expectations. However, this relationship appears to have broken
down somewhat during July and
August. This may be due to changing
sentiments on the likely start date of
European Monetary Union (see IT,
9/2/96).
Changing expectations also play
on Canadian/US dollar rates. Chart 3
plots the consensus forecasts for the
Canadian and US interest differential
12-months out. It implies that
changes in interest rae expectations
have historically tended to lead fluctuations in the exchange rate
between the two. More recent experience shows a deviation, however,
with cuts in Canadian short term
rates and expectations for a US rate
hike pushing the expected interest
rate differential into a negative situation without hurting the Canadian
dollar.

Chart 1

Source: Consensus Economics Inc.

Chart 2

Source: Consensus Economics Inc.

No easy answer
These examples show the difficulties
Chart 3
inherent in using changing interest
rate differentials to guide FX management; and by the same token,
indicate the complexities of attempts Source: Consensus Economics Inc.
to integrate FX and interest rate
exposure into a single net position or Monte Carlo simulation, and what-if
value-at-risk number. Parity rules and analysis should be used as insurance for
historical correlations are useful, but your risk management efforts, as well as
cannot be relied upon to hold in every to round out your FX forecast.
instanceeven in the Euromarkets,
which serve as the paragon example of For information on Consensus Economics,
interest parity at work. Stress testing, contact Michael Sykes at +44-171-491-3211.
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