How To Handle Wildly Fluctuating Exchange Rates In Regional Market Assessments

Exchange Rate Analysis Highlights

• Don’t trust a forecaster who can’t explain the effect of exchange rates on growth
• The fluctuation in foreign exchange rates against the $US has been wild in recent quarters
• Single currency views of growth are corrupt
• Handling exchange rate issues by selecting token currencies by region is helpful
• ‘Constant Currency’ views help compare regional growth without currency distortion
• If possible keep data in local currency for the local market and calculate common values with accurate exchange rates

Exchange rates have moved wildly over the last few years (see Figure 1), making market assessment increasingly difficult. Many analyst organisations are letting industry planners down by their failure to understand the complexities involved and are giving inaccurate advice about market opportunities.
The reason the issue isn’t properly addressed is partially due to the dominance of our industry by American suppliers (and researchers). When thought of a purely as an export market the dollars that get put into the revenue figure can’t be changed historically. For some reason all countries appear to be parochial when thinking about exchange rates. In the UK for instance the pounds dramatic fall in the second half of 2008 was scarcely documented by the government, despite the 35% improvement in productivity it brought.
‘A dollar is a dollar’, ‘a pound is a pound’ is too simple an analysis for financial results made up of money from multiple countries in multiple currencies. It’s necessary to pick a token currency in which to represent the total and think about exchange rates. I’ve updated my thoughts on the subject first talked about in April 2009 in this article. Taking the combined revenues of the 72 ITC vendors I track on a quarterly basis you get substantial values as shown in Figure 2.

The same data can be shown as annual growth by region, which, I’ve shown in Figure 3. From this you’d think that the market in the Americas had been doing substantially better than the other two regions until 2008, when it fared worse. We should think of this as a ‘Current $US’ view, because the revenues from each region were converted at the exchange rates of the quarter in which they were made.

However if you convert each quarter’s revenues into a different currency (say the Euro) you get a different picture. The shapes are very different by region, even if the comparative positions tend to remain the same. Of course the difference between the two pictures is due to the change in exchange rates. Figure 4 is a ‘Current Euro’ view of growth.

By converting each regional result into a token currency (say – the Euro for EMEA and the Chinese Yuan for Asia Pacific) you arrive at the combined picture shown in Figure 5. You’ll notice that the Americas and World growth are identical to those shown in Figure 3 and that the growth of the EMEA market is the same as in Figure 4.

By selecting currencies to represent continental results we’ve been able to reduce the effects of currency and show a more realistic comparison of growth in each of the three areas. Effectively we’re showing a ‘Constant $US’ view of growth rates. Of course vendors talk about this in their financial announcements, referring to ‘Local Currency’ growth in addition to growth in their home currency whether in $US, Euros, Yen, Pounds or Taiwanese Dollars.
You can (and should) go further if you are able to access local results in each quarter – calculating these current market values back to the chosen currency to create a constant (in this case $US) currency vision. You should always aim to hold financial data in local currency for each period (quarter) if you can and must be able to quote the specific rate for the chosen currency in each quarter (OANDA’s historical exchange rates are a good source).
It’s worth thinking about how the new view of history can affect the forecast for future revenue growth. I’ve shown my ITC forecast in Constant $US in Figure 6. I’ve described the reasons for regional differences elsewhere. You can imagine how a researcher with just Figure 3 or Figure 4 (but not both) as reference for historical growth might come up with very different shapes for future growth.

Why is all of this important? It’s because market growth is a vital measure of out industry’s success. Plotting how one region is doing against the next can help us decide where to invest for the upturn. Don’t forget to ask any forecaster about how they deal with currency in their forecast. If they can’t tell you it’s quite possible that their forecast is unreliable.
Is this helpful? Do you deal with multiple currencies, countries and regions in a different way? Please let me know if I can help simplify the challenge.