FX-related losses deepen for Korean exporters due to unrelenting USD strength

Losses from foreign exchange (FX) hedging for South Korean exporters are widening with little sign of easing in the greenback¡¯s strong solo act.

Aerospace manufacturer LIG Nex1 last week reported an FX-related loss of 27.4 billion won ($19 million) and Hyundai Electric & Energy Systems (Hyundai Electric) 39.6 billion won.

A forex forward contract is an agreement between two parties to buy or sell a specific currency at an agreed rate at a specified future time. Companies that receive payment on their exported goods and services in foreign currencies, such as the U.S. dollar, commonly make a forex forward contract to hedge forex risks to reduce exposure versus the risk of incurring losses due to changes in exchange rates.

For example, if a company signs an export agreement when the dollar sold at 1,000 won and finds the rate below 900 won when it receives payment, revenue on the export contract converted to Korean won loses 10 percent.

Hyundai Electric entered into a $189.6 million worth of forex forward contract in the first half of 2022, according to its half-year report. The contract set the exchange rate set at 1,247 won per U.S. dollar for expiry on Nov. 1.

Since the dollar hovers at 1,423 won Monday, the company¡¯s sales converted to Korean won would fall over 12 percent. The dollar that averaged 1,200 won sharply gained against the world since September due to the fast monetary tightening pace by the U.S. Federal Reserve.

There have been nine regulatory postings on FX-related losses worth 174.4 billion won so far this year

In Korea, a company is required to disclose any gain or loss equal to or greater than 5 percent of its equity capital due to a derivatives contract under the public disclosure rule set by the Korea Exchange.

The disclosure requirement is stricter at 2.5 percent or greater for a publicly-traded company with assets of 2 trillion won or more. LIG Nex1 and Hyundai Electric, both with equity capital of more than 500 billion won, made such disclosure this month upon incurring cumulative losses reaching 6.12 percent and 3.58 percent, respectively, against their equity capitals.

There are two types of regulatory disclosures on derivates-related gains and losses – valuation and transaction. Valuation gain or loss exists only in the book as such is accounted for before a forward contract expires. However, transaction-related loss results in an actual outflow of funds and thus has a negative impact on cash flow. Given this, Hyundai Electric will need to actualize its loss from the forex forward contract when it expires. This will cut is operating and net profits, which in turn would reduce returns to shareholders.

Investors should take extra caution when they invest in a company with assessed loss taking up a large share of operating income, advised Jung Do-jin, an economics professor at Chung-Ang University. But if an export company has fair financial health and a strong order book, loss from derivates may suggest the company is well prepared against forex risks.

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