 | | Louis Theriault
Director, International Trade and Investment Centre |
The Canadian dollar is trading close to parity with its U.S. counterpart and is expected to remain strong for a long period of time. In a recently published Conference Board report, Dollar Volatility: Who Should Care?, we argue that a firm that uses various approaches to globalization simultaneously will be better positioned to reduce the financial risks associated with changes in the value of the Canadian dollar, and with the strong dollar we see today.
The finding of this report is contrary to general perceptions that manufacturing industries are the most sensitive to exchange rate movements. Instead, we found that services industries could be more exposed to dollar fluctuations given that they are less engaged in global markets. Services industries typically rely heavily on imported inputs or direct investment abroad alone as a way to internationalize which makes them particularly vulnerable to exchange rate volatility.
The highly competitive retail industry is a good example of the vulnerability associated with limited internationalization strategies. If a retailer built inventory for the coming business season while the dollar was at US$0.90 back in September 2009 while another retailer made the same purchases in October when the dollar reach US$0.95, a competitive hedge was created for the second company solely based on the exchange rate appreciation. For larger international big box retailers this is a not as much of an issue since they are typically highly internationalized. However, for the majority of small and medium size retailers, this creates a distortion that can make the difference between staying in business or closing shop.
This example highlights the challenge non exporting industries face in the current context of rapid change in the value of the Canadian dollar. It is therefore surprising to still hear that a high dollar is an impediment to economic growth in Canada simply because it reduces the price of our exports. Also, Canadian businesses have had time to adapt to a strong currency since this situation is all not a new phenomenon. Recall that the situation started to change in 2002 after the dollar reached a record low of US$0.62 and surged by 60 per cent over the next five years. In the spring of 2007, the loonie reached parity with the U.S. dollar. In November 2007, it peaked at US$1.09, driven by high commodity prices, a weakening U.S. dollar, and higher interest rates in Canada. In October 2008, the dollar plunged more rapidly than it had increased, to just below US$0.77, paralleling a swift decline in world oil prices triggered by the international financial crisis and the recession. The dollar appreciated by 20 per cent in the last year alone amid hope that the worst of the recession was over. The pattern since 2007 also highlight a new reality: Businesses need to cope with extreme volatility in the loonie and this has created new strategic challenges for Canadian industries. The sometimes unpredictable currency movements have made it increasingly difficult for businesses to develop a workable financial structure.
The good news is that the traditional view that a high dollar is just bad for the economy is becoming obsolete. Today, the reality of Canadian industries is that they are being more engaged in overseas trade than at any other time in their history, even in the context of the recent decline in global trade. Firms of all sizes are moving parts of production abroad or importing more inputs of goods and services to remain competitive in the world economy. Further, many industries—from commodities to manufacturing to services—are increasingly turning to foreign direct investment as a means of creating or sustaining new markets for Canadian goods and services. In other words, a strong currency also means that imports, outsourcing and opening and expanding plants abroad become less expensive not simply that export prices are lower.
Rather than focusing on the high dollar, the real question is what proactive strategies business can adopt to alleviate the impact of exchange rate movements on their operational and financial planning? We argue that broad involvement in international activities which means relying on exports, imported inputs and machinery and equipment and direct investment in plants outside Canada should be pursued simultaneously. This is what we call a high degree of internationalization. Industries that are highly internationalized are likely to have more flexibility in their operating structures. This makes them better positioned to adjust business operations—such as shifting production facilities and supply chains, or reallocating resources to diverse export markets—to compensate for currency fluctuations. Conversely, narrow involvement in international activities using only one or two of these strategies is a weaker currency hedging strategy.
In the end, the parity of the dollar is not good or bad on its own. Over the years, many businesses have adapted to a stronger loonie. Internationalization strategies are a key part of the arsenal required to survive in a more challenging and competitive global business environment, particularly when currency volatility is high. Businesses that internationalize via multiple avenues, after doing their due diligence, will be much better positioned to weather our currency gyration.