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Currency of Denomination

Figure 1 graphs the shares of total fob exports (by value) that are denominated in foreign currencies. Figure 2 graphs the shares of total export transactions denominated in foreign currencies. In each case, we split currencies into USD, AUD and Other; all remaining transactions are denominated in NZD. The data period is restricted to the period of full electronic capture, beginning in March 2004.

A striking aspect of the graphs is the much higher share of export values denominated in foreign currency than of export transactions. This comparison implies that larger value exports tend to be denominated in foreign currencies whereas smaller exports (possibly reflecting smaller exporting firms) are more likely to be denominated in NZD. There is a slight upward trend in the foreign currency shares over time, both by value and by number of transactions.²⁸

A second aspect that is apparent from the graphs is the importance of transactions in USD and AUD as proportions of foreign currency transactions (and values). In (calendar) 2006, of foreign currency denominated export transactions, 51% were in USD and 28% in AUD. The proportions of merchandise export values expressed in USD and AUD were 69% and 12% respectively in the same year.

Very little has hitherto been known about the currency of denomination of New Zealand exports by country of destination. Figure 3 summarises the currency denomination shares of exports to New Zealand's five largest export markets over the period March 2004 – February 2007.

Almost equal proportions of exports to Australia (by value) are denominated in AUD and NZD (47.1% and 43.3% respectively). These shares are almost identical to the surveyed shares for 1999 reported in Grimes et al (2000) showing 46% of exports to Australia denominated in each of AUD and NZD. The 2004-2007 data reveal that a further 9.5% of exports to Australia are denominated in USD, with virtually no use of other currencies of denomination.

Exports to the United States are dominated by USD-denominated exports (86.2%); a further 13.6% of exports by value are denominated in NZD. Again there is virtually no use of other currencies of denomination.

The USD also dominates when it comes to New Zealand exports to Japan (53.2%) and, especially, to China (80.9%). NZD-denominated exports form a material portion of exports to these two countries (22.5% and 15.8% respectively). "Other" currencies, predominantly JPY (Yen), are important for exports to Japan (at 24.1%) but not for China (3.0%). By contrast, "Other" currencies (Sterling and, possibly, Euro) are the most important denomination for exports to the UK (67.9%). NZD-denominated exports are material (25.2%) with a small proportion (6.8%) denominated in USD.

In interpreting these figures, we stress that each of the figures relates to the unit of account used to denominate export values. They do not necessarily refer to economic exposure of exporters to the currencies concerned. Further, the nature of economic exposures may vary according to the time horizon being considered. For instance, an export to Japan may be "priced to market" so effectively being set by Japanese economic conditions. It may nevertheless be denominated in USD, set three months ahead of the export transaction based on market conditions at the time and the then prevailing exchange rate between JPY and USD. Once the USD price has been set, the New Zealand exporter has an economic exposure to the USD. However for any period beyond three months, the underlying economic exposure of the exporter is essentially to the JPY relative to the NZD. We therefore urge caution in applying the shares depicted in Figures 1-3 when interpreting the economic importance of various exchange rates for the New Zealand merchandise export sector over different horizons.

Hedging Proportions

Figure 4 graphs the proportion of non-NZD transactions ("lines") that are explicitly hedged (with the hedge rates based on the electronically captured data). Additionally, it graphs the proportion of non-NZD fob export values that are hedged. Both measures indicate similar behaviours but with a stronger upward trend in the value-based measure than in the transactions-based figure. In each case, the hedging ratio increased temporarily in 1998 and again in 2000.²⁹ Subsequently we investigate whether these movements were associated with exchange rate movements. The hedge ratio increased to a more stable plateau (on both measures) from 2004 onwards.

At the end of the sample (early 2007), approximately 65% of non-NZD exposures by value were hedged, with a smaller proportion (approximately 55%) by transactions. An implication of the higher value figure is that larger firms (or at least larger exporters) tend to hedge more fully than do smaller firms (or exporters). This is investigated more formally below.

Figure 5 charts the proportion of foreign currency transactions that are hedged for exports denominated in AUD, USD and "Other". One notable feature of the graph is the relatively low proportion (around 30%) of AUD transactions that are hedged. In 1999, approximately 25% of export transactions were hedged, leaving 75% unhedged. In the Grimes et al survey covering the same year, 61% of firms answered that none of their AUD exposures were hedged and a further 30% had hedged only some of their AUD exposures. These responses are broadly similar to the findings from the Customs data. This is reassuring given that in 1999 slightly less than half of export transactions were captured electronically. The similar hedging ratio figures indicate that selection issues may not be material, at least for that year.

The share of "Other" exposures that are hedged plateaus at around 60% after 2004, but with considerable variability prior to then. Considerable variability is also observed in the share of USD exposures that are hedged prior to 2004, with much greater stability (between 60% and 70%) thereafter.

Relationship of Hedged Rates to Spot Rates

Figure 6 presents the monthly AUD/NZD exchange rate together with data for the rate observed on hedged currency transactions as at time of export. In order to present a measure of dispersion of these latter rates, we present the 25^th and 75^th percentiles of the distribution. Figure 7 presents comparable data for the USD/NZD exchange rate.

It is apparent, from both graphs, that the reported hedged rate closely mirrors the spot rate and that the dispersion around the spot rate is very small. We examine the lag relationship between the two. Specifically, if the hedge has been taken out prior to the export transaction we would expect a higher correlation between the median hedged rate and a lag of the spot rate than with the current spot rate. Table 1 presents the correlation coefficients of the median hedged rate with the current and up to three (monthly) lags of the spot rate, for each of the AUD/NZD and the USD/NZD.

The correlations indicate that hedges are very short term for both the AUD and USD. The one month lag relationship is fractionally stronger than the contemporaneous relationship for the USD, whereas the two relationships are virtually identical for the AUD. The correlations drop off sharply for the second and third monthly lags.

These results do not necessarily indicate, however, that firms fail to hedge expected transactions more than one month out. It is possible that (some) firms adopt rolling one month hedges to retain flexibility. This behaviour could be related to opportunities for selective hedging (rolling monthly hedges enable regular choices of whether to conduct or renew a hedge on a monthly basis), or it could be related to uncertainties over export transactions. Without pinpointing the reason, we infer that the hedges we observe principally reflect short term decisions, with a modal horizon of one month.

Sectoral Hedging Patterns

Figure 8 depicts hedging rates for merchandise export transactions disaggregated by export sector (2-digit HS code).³⁰ Different hedging patterns are apparent across sectors and across time. All sectors show considerable variability in hedge ratios across time, although all four ratios tend to be much more stable from 2004 onwards.

At the start of our sample (1997:8), Agriculture and Mining had low hedge rates (19% and 0% respectively) whereas Manufacturing and Forestry were each higher (30% and 52% respectively). These ratios compare with Berkman et al's (1997) survey findings for listed New Zealand corporates that found hedging usage rates of 29% for commodity-based firms and 82%-86% for manufacturing firms. The difference especially in the hedging ratios for Manufacturing firms between the two studies may be attributable to the fact that Berkman et al cover only listed firms, whereas our study covers all exporters. Listed firms are, on average, both larger than the median firm in the economy and may face different accountabilities and incentives.³¹

Table 2 presents the correlation coefficients between the hedge ratios of each of the sectors over the full period (1997:8 – 2007:02). Two groups of industries emerge. First, the two biologically-based industries – Agriculture and Forestry – have a moderate positive correlation (0.345). Second, Mining and Manufacturing have a strong positive correlation (0.655). Both correlations are significant at the 1% level. Remaining correlations are close to zero.

Pending multivariate analysis using the unit record data, we cannot ascribe specific reasons to these correlation patterns. Possible underlying reasons may relate to currency of export denomination, firm size, or other firm characteristics (such as leverage, liquidity, R&D intensity, etc). In future analysis, once we control for the wide range of factors potentially relevant to optimal hedging choices, we will examine whether sector retains any significant explanatory power.

Firm Size

We examine whether hedging practices differ by firm size. While theory suggests that firm size may be positively or negatively related to hedging decisions, most international and domestic evidence indicates that large firms hedge currency exposures more comprehensively than do small firms.

Figure 9 presents the average hedge ratio for all firms (i.e. proportion of all foreign currency transactions that are hedged) together with the ratios for large and small firms. Large firms here are the largest quarter of firms by sales (BAI Sales).³² Small firms are the smallest quarter of firms by sales. In each case, we take the ratio of all transactions that are hedged aggregated across all the relevant firms. Our sales data extend to the 2005/06 year; thus we present the information through to 2006:1.

Over the full sample, the average proportion of foreign currency export transactions hedged across all firms is 39%. Small firms, by comparison, hedged an average of 33% of their transactions, while large firms hedged an average of 49%. These results are consistent with the international evidence, cited earlier, that small firms on average hedge a smaller proportion of their exposed currency transactions than do large firms. Surprisingly, however, second and third quartile firms hedge even less than do small firms. The average hedging ratios for second and third quartile firms across the period are 21% and 22% respectively.

The findings for the second and third quartile firms raise doubts that shortages of resources or high fixed costs are the reasons behind the smaller than average level of hedging by small firms. Possibly the relationship is non-linear. Our theories indicate that hedging involves fixed costs and that this favours hedging by larger firms relative to smaller firms. Theory also suggests that costs and probability of financial distress raise the likelihood of hedging; small firms are generally considered to be more risky than are larger (often longer established and better diversified) firms. Our results may be reflecting both sets of factors. Again, once controls for a range of factors are introduced at unit record level in future analysis, the contributions of these alternative explanations may be uncovered.

While average hedging behaviour differs across quartiles, Table 3 shows that the dynamics of hedging choices are positively correlated across firms in each of the four size quartiles. Furthermore, the standard deviation of hedge ratios over the sample for each of the four quartiles is similar (14%, 10%, 12% and 10% respectively). These results suggest, to the extent that firms engage in selective hedging, this behaviour is reflected across firms of all sizes, and does not just reflect behaviour by firms in certain size classes.

Export Intensity

Figure 10 presents information on whether export intensity (zero-rated sales/total sales)³³ is related to firms' hedging decisions. The figure is drawn in an analogous fashion to Figure 9. Firms in the highest export intensity quartile hedge considerably more than the average across all firms, while those with low export intensity hedge less. This is consistent with rationales relating to costs of financial distress, since firms with high export intensity face greater balance sheet risks arising from currency fluctuations than do firms with low export intensity (controlling for other factors).

Firms in the lowest export intensity quartile on average hedge just 11% of their export transactions. This contrasts with 34%, 35% and 52% respectively for quartiles 2, 3 and 4. In this case, therefore, the hedging ratio increases monotonically with the relevant quartile. The second quartile of firms have the highest standard deviation of hedging ratio (at 18%, compared with 9%, 13% and 14% for quartile 1, 3 and 4 firms respectively); the reason for this result is unclear and is left for future investigation.

Table 4 examines how the dynamic behaviour of hedging choices varies by export intensity quartile. Firms in the lowest three quartiles exhibit small to moderate positive correlation of behaviour. However, firms with high export intensity behave in an opposite manner to other firms, and especially to quartile 1 and 2 firms. The difference in behaviour between quartile 1 and 4 firms can be seen from Figure 10. Over the first half of the sample, high export intensity firms appeared to take larger and more consistent positions relative to their normal behaviour, although both sets of firms showed volatile hedging behaviour. Over the second half of the sample, low export intensity firms have hedged only a small (below 10%) and relatively stable proportion of their export transactions; in contrast, high export intensity firms have moved to a hedge ratio of around 65%, with considerable volatility remaining in their hedging choices.

It is possible that this dichotomy in behaviour reflects a stronger penchant for selective hedging by high export intensity firms, possibly because of actual or imagined expertise within those firms with respect to currency markets. We investigate some aspects of this issue in the next section; in future, we will use the unit record data directly to examine this question in more detail.