FX Strategy Considerations For Nearshoring

Understanding FX Risk and Business Stability with Nearshoring

Managing global trade risks due to currency fluctuations is necessary for maintaining business stability as supply chains get reallocated. Nearshoring has emerged as a strategic approach for companies seeking to minimize disruptions from distant supply chains, offering both financial benefits and smoother operations. This strategy is significant for finance teams, potentially outweighing the impact of developments in artificial intelligence in the near to medium term. However, the transition is accompanied by challenges, including increased costs, quality issues, or production halts. For example, Whirlpool's move to Argentina for better operational visibility amid supplier issues in China. But at the same time walked into a currency crisis due to Argentina's dollar shortage paints the picture of complexities of managing FX risks in nearshoring decisions. This led to considerations of transacting in Chinese Yuan for importing parts for a new factory in Argentina. Whirlpool Argentina

Growing Importance of FX Risk Management for Nearshoring

U.S. businesses are increasingly looking to Mexico and South America to protect their supply chains from disruptions, Canada is involved in this as well but with more moderate growth, demonstrated by a significant increase in imports from Mexico since 2019. The anticipated investment in Mexico's manufacturing sector highlights the confidence in nearshoring. Assessing the impact of production relocation on FX risk management is difficult, and lack a universal guide and presenting an internal challenge. It emphasizes the consideration needed in this business process, as it is not a flip of the switch process change. There are hundreds of moving parts that come with it.

Pivoting from Offshoring to Nearshoring

The trend towards nearshoring reflects change, with trade disputes, attempts with avoiding capital controls, and pandemic-induced supply chain challenges diminishing the attractiveness of offshoring to countries like India and China. The benefits of nearshoring to within North America that are driving this momentum include lower shipping costs, quicker delivery times, and enhanced operational visibility. These advantages, coupled with North American policies, emphasize the strategy movement, but also the bumps in the road firms may face like the need to manage more volatile currencies with new exposures and suppliers.

Incorporating FX Strategy into Nearshoring

Effective nearshoring requires putting currency risk management into the financial planning process. This encompasses:

1. Identifying and Assessing Currency Exposure: Evaluating how nearshoring affects currency risks is important. Companies need to consider historical currency volatility, as seen with Argentina's dollar shortage affecting potential future lower cost manufacturing opportunities or increased sales growth. This assessment helps in identifying and giving visiblity to the financial impacts and determining whether hedging strategies are necessary, alongside their associated costs.
2. Strategic Planning: Nearshoring decisions must be brought into the company’s broader financial and operational plans. This includes understanding the capital controls in the target country, how currency fluctuations could affect manufacturing costs, and the overall financial strategy. Whirlpool's consideration of using Chinese Yuan for transactions in Argentina to manage the dollar shortage is one example of strategic response to these challenges.
3. Monitoring and Adjusting: Developing a process for continuous monitoring of currency risks and adjustments to the management strategy is crucial. Monitoring implied FX volatility and the yield curve for currency exposures, a must for managing risks in volatile currencies like the Mexican Peso or Brazilian Real.

Making Strategic Nearshoring Work

Though nearshoring can introduce risks and potentially increase costs, incorporating specific FX risk management actions can enhance supply chain resilience. This requires a deep understanding of global trade dynamics, thoughtful decision-making, and strategic flexibility. By prioritizing FX risk management, companies can approach challenges of nearshoring, ensuring business stability and growth in a competitive global market.

If you'd like to discuss specific corporate FX risk management process topics with us, you can reach our team at +1(415) 678-2808 or email us at [email protected].

Klarity FX is an independent fx risk management advisory partnering with corporations to help develop new or support existing treasury and risk management processes. Our team has worked for over 400 corporations across North America with our focus on supporting management teams to ensure they are better informed with their fx treasury decisions, remaining within compliance guidelines, executing with confidence, and ultimately improving their organization's financial flexibility.?Our team is not an fx bank, broker, or payments provider. We do not offer fx transactional products.

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