The Beginning: Hedging Currency Depreciation in Vietnam
By: Tran Chau, KF13, Viet Nam
I am a multi-millionaire, in Vietnamese Dong that is. The Vietnamese Dong (“VND”) is the official currency of Vietnam. The official exchange rate (a black market one also exists) hovers around $1 = 19,500 VND. Therefore in nearly all business transactions in Vietnam, millions, billions, and even trillions of VND change hands.In 2009, Vietnamese GDP was estimated at $92.4 billion while the value of its imports exceeded the value of its exports by approximately $12.1 billion. As a result of the trade deficit, the VND is quickly losing value relative to major currencies in the world. For example, when I first arrived in Vietnam on October 23, the black market exchange rate was $1 = 20,005 VND. Two weeks later on November 5, the VND had lost 0.3% of its value relative to the USD and the black market exchange rate was $1 = 20,065 VND.
To understand how this dynamic can affect an MFI let us take a look at currency depreciation and the result of not hedging against it.
Loan terms at MFI partners in Vietnam run anywhere from 2 months to 22 months. When a loan is made, a principal value is locked-in from which interest payments are calculated. At the end of the term the principal amount is repaid to the MFI.
To illustrate, let us pretend that in Tran-land, $1 = 1,000 units and that Kiva lends to the MFI and receives its repayments from the MFI in USD. If a borrower took out a loan for 1,000 units at a 30% APR for a one year term with interest paid annually, then the MFI would receive a 300 unit interest payment at the end of the year along with the principal. Next, let us pretend that at the end of year 1, the exchange rate is now $1 = 1,400 units. The borrower will pay the MFI 300 units in interest + 1,000 units in principal for a total of 1,300 units. The MFI now needs to deliver 1,400 units to its bank (ignoring F/X fees) in order to convert units into USD to repay the $1 loan from Kiva, resulting in a loss of 100 units.
The scenario above, although extreme, illustrates the risk an MFI faces if it operates in a nation with a volatile currency. One can see that even with a high interest rate, currency depreciation has the ability to completely destroy profitability and decrease value by taking away retained earnings from the institution.
Financial institutions operating in the developed world use financial products to hedge this risk away, or to mitigate losses in the event of currency depreciation. Most often, forward contracts are purchased from brokers to secure an exchange rate for a future date, taking risk (and gain) away from the institution. Financial products are in their nascent stage in Vietnam, and I am curious to learn more about regulations, potential uses, and applications for our MFI Partners.
Tran Chau is a Kiva Fellow (KF13) currently based in Ha Noi, Viet Nam. Want to volunteer with the Kiva Fellows Program? Learn more here and apply to be a Fellow!