Surprising new evidence on the impact of dollar volatility
OTTAWA - Manufacturing industries, along with the mining and oil and gas extraction industries, are - contrary to the conventional view - most likely to weather a volatile Canadian dollar because they have more ways to hedge against currency fluctuations. Service industries may be more exposed to currency volatility, since they have fewer means to hedge against the dollar. A new Conference Board of Canada report from its International Trade and Investment Centre identifies the industries that are most and least exposed to the changes in the currency.
"Manufacturing industries have traditionally been considered the most sensitive to exchange rate movements because of their dependence on export markets," said Louis Theriault, Director, International Trade and Investment Centre. "This study finds that industries that are highly reliant on foreign markets and suppliers, as well as those with limited strategies to do business in international markets, are not as well-positioned to respond to fluctuations in the exchange rate.
"In today's global economy, Canadian industries must continue to internationalize to remain competitive. 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."
In recent years, the Canadian dollar has both peaked and rapidly declined against most major currencies. The loonie moved from a low of US$0.62 in 2002 to a record high of US$1.09 in November 2007. It fell back to US$0.77 in May 2008, and then reached US$0.97 recently. The currency movements have made it increasingly difficult for businesses to develop a workable cost structure.
The report, Dollar Volatility: Who Should Care?, uses four indicators to identify the degree to which 27 industries rely on international transactions to conduct business and the nature of that internationalization. The four indicators are:
- export intensity,
- import intensity of inputs,
- import intensity of machinery and equipment investment, and
- the extent of Canadian direct investment abroad (CDIA).
Highly-internationalized industries, as indicated by high rankings on multiple indicators, are likely to have more flexibility in their operating structures. In general, manufacturing industries, as well as mining and oil and gas extraction industries are the most broadly internationalized. They are therefore likely better able to weather currency volatility. Specific industries with low levels of exposure to the dollar because of their high degree of internationalization include:
- Non-metallic mineral product manufacturing;
- Computer and electronic product manufacturing;
- Plastics manufacturing;
- Primary metal manufacturing; and
- Mining and oil and gas extraction
Service industries are potentially more exposed to the currency, since they generally internationalize via only one of the four indicators, and therefore have a more limited hedging capacity. Five out of six industries that are identified as highly exposed to the movements in the dollar are in the services sector:
- Transportation and warehousing
- Retail trade
- Wholesale trade
- Information and cultural industries
Electric equipment manufacturing is the sixth industry considered most at risk of a volatile currency. Otherwise, manufacturing industries have a low-to-moderate exposure to currency fluctuations, since they have built-in flexibility to compensate for movements in the dollar. It must be noted that these indicators capture only a few dimensions of the multi-faceted reality of business. Many of these manufacturing industries have undertaken or continue to undergo difficult restructuring processes to offset changes in global demand or world prices, or to compensate for lagging productivity. This composite indicator provides insight into the degree of exposure to the volatility of the dollar, notwithstanding its direction. However, the indicator is not a measure of absolute risk.
Businesses, particularly small and medium-sized enterprises, need to examine where they fit in global supply chains and identify both risks and opportunities in the international marketplace. It also means forming strategic partnerships with other firms and industries to share resources, risk, expertise and capital in foreign markets.
Policy makers can undertake indirect measures to prepare for, and mitigate, exchange rate effects on Canadian industries. These measures include increasing trade liberalization and renewing policies on foreign direct investment.
The report is published by the Conference Board of Canada's International Trade and Investment Centre (http://www.conferenceboard.ca/ITIC/default.aspx).