‘Swap point’: a hidden threat to exporters

THE THAI BAHT has been the most indomitable currency in Southeast Asia so far this year as it gained roughly 8 per cent against the US dollar. Exporters view a strong currency as undesirable because it reduces how much in a local currency they will earn after converting their revenues into foreign currencies. To mitigate foreign exchange risks, exporters sometimes utilise forward contracts to lock in their future revenues. However, looking forward, Thai exporters will see reduced benefits from hedging their FX risks. That’s because of the impact of the “negative swap point”.
Typically, when exporters hedge their FX risks via forward contracts, they agree to convert their foreign currencies (usually US dollars) to Thai baht at a preagreed exchange rate called the “forward rate”. The forward rate is actually the spot rate plus a “swap point”, or forward point. Therefore, in addition to the spot rate, the swap point is also a major determinant of the rate which exporters would receive when they hedge. 
So, what determines the swap point?
The main driver is the interest rate differential between Thai and US central banks. Usually, the Thai interest rate should be higher than its US counterpart to reflect the country’s higher risk. When the rate differential becomes smaller, (ie the Fed fund rate moves closer to the Thai policy rate), the swap point will get lower. Since the beginning of US interest rate normalisation in 2015, the US interest rate gradually increased from 00.25 per cent to 1.001.25 per cent, while the Thai policy rate has been held constant at 1.50 per cent. The narrowing interest rate gap has been pushing the swap point downward. Recently, the swap point went down to the negative territory, making the forward rate lower than the spot rate. 
How low could the swap point get?
Given TMBA’s forecasts of two Thai policy rate hikes in 2018, compared to one hike this year and three hikes next year for the US Fed fund rate, the rate differential will become negative at 0.25 per cent. Given this circumฌstance, we forecast that the six-month swap point will fall to 0.1 THB at the end of 2018 from its position at +0.02 THB at the end of 2016. Additionally, based on our baht forecast based on robust Thai economic fundamentals, the Thai baht could continue to rise to 32.50 per US dollar.
The combination of a discounted swap point and a stronger Thai baht suggests that the forward rate could get more unpleasant for exporters.
Which types of export businesses would be most affected under this combination? 
Those businesses taking the largest negative hit would be exporters of merchandise that uses domestic materials as inputs. They include rubber products, tapioca, rice, food and jewellery exporters, most of which are Thai firms. In contrast, exporters whose merchandise are produced using imported materials would be less affected as their businesses are naturally-hedged. These types of businesses are mostly foreign firms such as vehicle, computer and electronic, and chemical exporters.
Since no one could precisely foretell the future of the exchange rate, it is futile for any exporters to keep speculating on Thai baht movements. Even though the rate received from hedging through forward contracts may become less favourable, exporters should still hedge their FX risks. By hedging, exporters could then estimate their future earnings from the forward rate. Without worrying about what level the Thai baht will be when their clients make payments, exporters could spend their precious time to focus on expanding their business.
 
Views expressed in this article are those of the author and not necessarily of TMB Bank or its executives. This article was coauthored by Duangrat Prajaksilpthai and Poon Panichpibool. They can be reached at [email protected]