The Beginning: Hedging Currency Depreciation in Vietnam

6 November 2010 at 10:23 8 comments

This is less than $25!!

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!

Entry filed under: KF13 (Kiva Fellows 13th Class), SEDA (Binh Minh), Vietnam. Tags: , , , .

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  • 1. howard zugman  |  10 November 2010 at 06:56

    Hi Tran,

    Thanx for responding. Of course, all of the above discussion can be mitigated by the fact that ANY short term loan (say six months or so) carries much less exchange rate risk than any longer term loan (say twenty-two months). Further I believe that any entrepreneur who can “turn himself/herself around” with a shorter loan time period than his/her cohorts should be rewarded. I put my money where my mounth is on this topic by continuously favoring the short term (my average loan period is ~ seven months). An additional benefit is that more borrowers can benefit from the same capital.

  • 2. howard zugman  |  9 November 2010 at 07:19

    Hi Tran,

    I looked up the info that Kiva shows for SEDA and it shows 0.00% currancy exchange rate loss for the almost $1,000,000. worth of loans that SEDA has created in the last three years so aparently none of the currancy exchange losses have exceeded 20% to date. The same is true of the two other MFIs in Viet Nam (TYM and FPW) so I guess all three MFI’s have been absorbing whatever loss there has been. The total is almost $ 3,000,000. worth of loans in the past three years with no currency exchange losses absorbed by Kiva lenders so far. So unless somethng has changed in Viet Nam recently, the loans seem to be relatively safe for Kiva lenders.

    • 3. Tran Chau  |  10 November 2010 at 06:29

      Hi Howard,

      Everything you have deduced is correct. Lending to Vietnamese MFIs has been safe for Kiva Lenders and I believe that this will continue to be the case. That said, the depreciation of the VND has decreased the ROA of the MFIs, especially for those that issue longer term loans (the 22 month ones I hinted to in my post).

      From what I have seen, the risk management practice in place is to include within the interest rate an estimate for currency devaluation during the term. This does mitigate risk, but it led me to wonder if the MFI has access to a brokerage account and what derivative products are available. In the field to date, no one I have asked knows what I am talking about. I will write more when I know more.

  • 4. kivacharlie  |  9 November 2010 at 02:58

    very informative

  • 5. Peter J. Frank  |  7 November 2010 at 23:38

    Hi, My name is Peter, It is my pleasure ,! I just wanted to share “I also get all excited’ about Entrepreneur’s, Patents, Designing, ETC. So when I read a Piece about your self, I just had to share with you my Invention! It’s a new Tool that I have Patent Pending’.
    As this tool has been a dream in the works for about the last nine years out of , over twenty five years of detailing automobiles, small aircraft, Fast Boats , ETC…
    I saw your above about Vietnam, which I ironically had been thinking , every-one and the brothers cousins know that China,
    has been our major our manufacture when it comes to many different items! My Point being that I would love to have a manufacturer build my invention , using Bamboo as my idea for Telescoping handle? Maybe give it a look and let me know, if you have any Ideas how I might help the People of Vietnam.
    Respectfully, PeterJames Frank

  • 6. howard zugman  |  7 November 2010 at 20:02

    Hi Tran,

    Thanx for the post. As of today for Viet Nam Kiva shows 3,316 paid back loans and 0 loans ended with a loss. Kiva also shows 645 Paying back loans some of which at least show possible currancy exchange risk. After reading your post my guess is that in those first 3,316 loans the MFI “covered” the currancy exchange losses. Am I correct or is there some other explanation?

    • 7. Tran Chau  |  7 November 2010 at 22:00

      Hello Howard,

      Thank you very much for reading our blog! You are on the right track. If there was any sort of currency depreciation during the term of those 3,316 loans, then the loss was covered by one of the following:

      – The interest income earned by the MFI
      – The retained earnings of the MFI
      – If the currency depreciation was greater than 20% during the term, then Kiva Lenders most likely absorbed the loss above the 20% ceiling

  • […] the original post: The Beginning: Hedging Currency Depreciation in Vietnam « Kiva … Related – UPDATE 2-Vietnam to use FX reserves, won't devalue for now […]

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