Any multinational company is exposed to risks such as change of foreign currency exchange rate, commodity prices and interest rates because it denominates its transactions in foreign currencies. That’s why there is also some uncertainty in future earnings, liabilities and assets values.
Although foreign licensing adds some problems, it gives an opportunity to locate close to the customer base, hence, achieve exploitation benefits and close control - a direct presence in the market.
But it should be considered that Ukraine is a country where political and, consequently, economical situation is quite unstable. Hence, governmental or legislative changes its new government may introduce can affect both internal and external market and influence the balance of trade between the two countries. There is a possibility that in case Ukraine accepts some unfavorable for the US decision, American companies will simply reduce investing in Ukrainian economy. But this will no be crucial for our company because we deal with direct sales. Besides, political situation does not affect demand for good coffee.
However, if US-Ukrainian relationships develop poorly, Ukraine may give its preferences to other than American coffee-suppliers and raise the import duty for American companies. This of course will lead to increase in our coffee’s end price and may lower the demand.
Coffee is not among the most popular products to export to Ukraine. It also is not excised, it is only subject to value-added tax. Besides, there are no importers of green coffee in Ukraine, only several roasting companies and around 40 importers and distributors of roasted coffee. (Reminny, 2006) Ukraine is now considered to be one of the most important economies of the former Soviet bloc after the Russian Federation.
There are direct and indirect taxes in Ukraine. Import tariffs apply for all imports. (Ferdinand, Burakovsky, Selitska and Movchan, 2004) On January 10, 2002 the Ukrainian government lowered the import duty on instant coffee to 10% but not less than EUR 0.5 per kilo for up to 10-kg packages, and to 5% but not less than EUR 0.3 per kilo for above 10-kg packages. (Infobank News Agency, 2002)
There are more than 40,000 bars and restaurants in Ukraine, most of them sell coffee as a menu product and 40% of them specialize in "Espresso" coffee. (East European Development Institute, 2003)
Number of bars, shops and department stores is steadily increasing in the country while most companies at the market sell only instant coffee. That’s why, having developed a well-organized distribution network, it would be profitable to sell our coffee in stores, shopping-centers, cafes and restaurants as well as to smaller distributors.
Raiffeisenbank Ukraine is chosen to be the bank to work with (exchange UA hryvnas for US dollars). According to the Association of Ukrainian Banks (AUB), it is the country's seventh-largest bank in terms of total assets (€ 790 million as of 30 June 2005). The bank is also the largest among the country's international banks and has a special focus on structured trade finance products, tailor-made for the complex local environment. (Raiffeisen International, official website) The best variant would be opening of current account in hryvnas and dollars. The bank has also a clear system of international money transfers.
Forward market is possible to be used when selling in Ukraine in order to avoid currency exchange risks in case currency rate suddenly significantly changes.
Now the bid price for 1 USD in cash is 5,03 UAH and 5,02 cashless. The ask makes 5,08 in cash and 5,04 cashless. However, there is a tendency of decreasing cashless bid and ask prices. (Finance.ua, 24 Jyly, 2006)
During the last year the exchange rate of Ukrainian hryvnas was rather stable. According to Interbank the lowest bid for the last year made 4.73720, the highest - 5.19000. The average ask price made 5.12421. (FXHistory, Time period: 07/20/05 to 07/20/06)
During the last three months the ask price has gone down from 5.280 on the 22nd of May to 5.23690 on the 22nd of July. At its lowest points the average ask price was on the 2nd and 3rd of July and made 5.19060 while on the 24th of May it made 5.27570. The bid rate ranged from 4.73720 to 4.86830 during the given time period. (FXHistory, Time period: 04/22/06 to 07/22/06)
During the last month the ask price ranged from 5.19060 to 5.27240 and has gone up from 5.23870 on the 20th of June to 5.27240 on the 20th of July. The bid rate ranged from 4.73720 to 4.84820 during the given time period. (FXHistory, Time period: 06/20/06 to 07/20/06)
National economy of Ukraine is one of the key factors to affect the value of hryvnas. That’s why it is extremely important to consider political and economical situation. Instability or unclearness of some legislative regulations, laws and policies may cause great problems for a foreign company.
However, a domestic firm may also face such problems as state policy changes, increasing taxation, and change of customers’ demands. In such a situation the only way to solve problems is reorientation, transformation, adjusting to newly arisen market conditions. But at the same time a company which has additional markets abroad will lose less in the same situation. The reason for it is the fact that while the domestic office is working on the development of new profitable managing strategies, foreign subdivisions of the company are working and getting profits while a purely domestic company puts all its resources for solving the current problem and has no additional income.
A company operating overseas will certainly get interest and dividends from its international investments and realize capital gains. But the fact is that the firm won’t necessarily gain a positive , or that the return will be as strong as the return of a company making the same investment with euros, yen, or pounds.
This happens because most currencies have no fixed value — that’s why currencies float one against another. Sometimes the dollar is stronger than other currencies, sometimes it’s comparatively weaker. When the dollar is strong, the company will have to spend fewer dollars in order to get a particular amount of another currency, and, when the dollar loses value; such an operation will be more expensive.
Currency futures are often used to hedge currency exchange risks. It is a futures contract which enables a company to exchange hryvnas for dollars on some certain day in future at a price that is fixed on a last trading day. This can be profitable depending on the rising or falling exchange rate. If we, for example, buy a 25 July CME Hryvnas currency futures at 5.27240 UAH/USD, and the future close at 5.2900 at the end at the day, having bought a contract for 100,000UAH, we get a profit of USD 1,760 because the change in price made 0,0176.
In case the Ukrainian currency rises in price, currency options may used to hedge the currency exchange risks. Currency options allow the company to buy or sell certain amount of hryvnas at a specified price before the specific date. Such an option may help the company to avoid possible results of unfavorable currency movements.
Unfortunately the Ukrainian hryvnas are not included into the CME futures list; hence, this particular option of hedging currency exchange risk is not available in Ukraine.
In case dollar gets strengthened and its value rises relatively to hryvnas, our product will become relatively more expensive to sell in Ukraine and this may bring negative outcomes for the company. If, on the contrary, dollar’s value decreases, the price of our coffee may be lowered as well. On the other hand, if we leave the price fixed, profits in dollars will be higher. If the interest rates of the United States rise, the downward pressure on dollar will be offset. In such a case, our company will not be much affected.
Indirect intervention of the central bank’s can affect not the exchange rates themselves, but the factors that influence exchange rates. That’s why it actually affects the natural equilibrium exchange rate. Ukrainian Central Bank (The National Bank of Ukraine) intervenes to control hryvnas in currency markets. It affects currency intervention by purchasing and selling the currency values “in order to influence the exchange rate of the national currency with regard to foreign currencies, as well as the total demand for and supply of money in Ukraine”. (The Law of Ukraine on the National Bank of Ukraine)
During the last five weeks the daily rate of hryvnas ranged from 5.19060 to 5.27240. The average rate, however, makes 5.23589. Having compared to average rates for the last year and last three months, it can be concluded that hryvnas value relatively to dollar remains rather stable and will be so in the nearest future as well.
Taking into consideration the current political and economical situation in Ukraine, our company is not likely to face the risk of transaction exposure. If, however, such an exposure arises, we can use forward rates to lock in the exchange rate and, thus, eliminate the exposure. As the company is rather small and operates at Ukrainian market only, it is unlikely to be affected by economic exposure as well. As for the translation exposure, the company may be affected by it in case the company’s assets, equities, income or liabilities change their value due to the changes of exchange rate.
Any company operating abroad is exposed to exchange rate risk because the value of such a company’s operation will be affected by exchange rates. That is changes of hryvnas’ exchange rate will affect the company’s loss or gain when invested in hryvnas funds get converted to dollars again. Under such circumstances forward contracts may act as a useful tool of hedging risks. For example, if there appears a trend of negative currency movements, our company may lock-in a price for the next delivery of coffee in order to avoid the exchange rate risk. Currency option is also a good way of hedging currency exchange risk. For example, if the USD/UAH rate is going to increase, we are sure to consider buying a call option on USD/UAH in order to stand to gain from the given increase.
When forming the exchange rates between the two currencies the most important role plays the difference between interest rates between the two countries (interest differential). If, for example, the U.S. Central Bank rises the interest rate level will cause change in increase of revenue in the given currency, revenue from investments in dollars will be higher, demand for the currency and its rate will go up. Change in the U.S. interest rates influences the markets most of all.
As for the hryvnas interest rates, growth of the world interest rates will be keeping internal hryvnas interest rates from lowering. Besides, interest rates on credits and deposits are influenced by the U.S. interest rates. However, in present high interest rates and stable hryvnas attract a good amount of portfolio capital to Ukraine. On the other hand, as the U.S. interest rates are growing, it will be more profitable to borrow dollars as long-term funds.
At the same time, holding assets denominated in both currencies reduces the risk of being affected by changes in one of the currencies’ rates. The gains in one currency’s exchange rate will help offset the depreciation in another.
When company operates in Ukraine, converting into investments in hryvnas over time can also help to reduce currency exchange risk. Converting gradually, the cost will be averaged out and converting under unfavorable exchange rates may be avoided. (Blampied, 2004)
Such banking document as a Letter of Credit can be used to ensure payments of the company and is often used when importing or exporting. Another way is a partial up-front payment which would function as a deposit.
Of course, our company will have to pay and accept payments in foreign currency. An open account is may be used to credit check the buyer, and organize an appropriate credit period and credit limit for payment. When our coffee arrives to Ukraine the buyer with whom we have long-term business relations will have to pay for it in a set number of days after. Such a type of payment will help us to keep a positive cash flow.
So, the most important risks that a multinational company may face are those of political instability/uncertainty and changing in foreign currency exchange rates. As for all the other aspects, risks of domestic firms are basically similar to those of multinational ones and, hence, a decision of the company not to operate overseas may be caused only by these two mentioned above factors.
Surely, political factors are not the only ones which determine the final decision of the firm. But in general political and economic stability of the target country are necessary requirements for a company to start operating in that particular country. Especially important is a profound evaluation of political risk for unstably developing countries. There are many variables which should be taken into consideration when evaluating the country's political risk. However, some of them are more important that others and are to be paid much more attention.
Conclusion
Entering an international market requires any company to use certain specific and unique for each country strategies to gain an immense success.
Having discussed and analyzed some of the most important risks a multinational company may face, we can come to a conclusion that even if there is only one serious competitor in the country’s market, the company should never forget that it is a guest in the country and, hence, should first of all study the country’s internal political and economical situation, some national culture features, tastes and demands of its citizens before offering any product or service.
The mistake of some companies entering foreign markets consists in using the same strategies that were used in their home countries. Yes, they were successful, but one must consider that a foreign market is a completely different thing: different culture, different legislative regulations, laws and policies, different tastes. National culture – a concept which includes a great number of specific issues – is also one of the first factors to be evaluated when starting business abroad.
And, notwithstanding the fact that purely domestic company faces less number of risks, it is as risky as a multinational one. Besides that, I think a multinational company, despite larger number of risks, has more advantages in comparison with a domestic one. And the most serious issue for a company to consider when starting operating in a foreign country is actually inner political and economical situation of the given country which are to be deeply analyzed.
Hence, I believe, in situation when a company is deciding whether to start operating abroad the most important issue is the political and economical climate of the target country because all the other risks may be either managed or even be of some positive use for the company.
In summary, I would conclude that domestic companies face not less different risks than multinational ones, and if a company takes a decision not to work overseas, such a decision may have been caused mostly by independent political and economical risks in the particular country.
Works cited:
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Coffee in Ukraine in 2004... …tastes better, yet smacks bitter. East European Monitor. East European Development Institute, 2003. Available online: <http://eedi.org.ua/eem/1-kava_eng.html> Accessed 24 July, 2006.
Exchanfge rates in Ukraine. Finance.ua. Available online: <http://finance.com.ua/en/> Accessed 24 July, 2006.
Ferdinand Pavel, Burakovsky Igor, Selitska Natalya and Movchan Veronica. Economic Impact of Ukraine’s WTO Accession. First Results from a Computable General Equilibrium Model. Working paper #30. Institute for Economic Research and Policy Consulting. December 2004, p.4. Available online: <http://www.ier.kiev.ua/English/WP/2005/wp_30_eng.pdf> Accessed 24 July, 2006.
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FXHistory: historical currency exchange rates. Conversion Table: USD to UAH (Interbank rate) Time period: 06/20/06 to 07/20/06. Available online: <> Accessed 20 July, 2006.
FXHistory: historical currency exchange rates. Conversion Table: USD to UAH (Interbank rate) Time period: 04/22/06 to 07/22/06. Available online: <> Accessed 22 July, 2006.
Infobank News Agency. Verkhovna Rada Lowers Import Duty on Coffee adn Textiles. UKRAINE TODAY. Main weekly events from Infobank News Agency. 14 January 2002. Available online: <http://www.ukrainianstudies.org/aaus-list/0201/msg00007.html> Accessed 24 July, 2006.
Reminny, Sergey. Ukraine – a political and coffee revolution. Specialty coffee Association of Europe. 21 February 2006. Available online: <> Accessed 24 July, 2006.
The Law of Ukraine on the National Bank of Ukraine. Section I. General Provisions. Article 28. Management of the Gold and Currency Reserves. Available online: <http://www.bank.gov.ua/ENGL/B_legisl/index.htm> Accessed 20 July, 2006.
Ukraine. Raiffeisen International, official website. Available online: <http://www.ri.co.at/eBusiness/rzb_template1/0,6589,184404838712238398-186035374803330367_186035629548578254-211079278033380120-NA-3-EN,00.html> Accessed 24 July, 2006.
