How to stay in the money, internationally.

If you've been eyeing emerging markets but worry about foreign-currency risk, fear no more. Three executives explain how their companies cover their overseas exposures with countertrade, put options and a host of other ideas.

SOME ENTERPRISING SOLUTIONS

Since 1984, developing countries have grown at roughly twice the rate of industrialized countries and, in the last two years, have grown three times as fast. As domestic and traditional markets mature, corporations face both increasing competitive pressure and opportunities to enter emerging markets.

Of course, emerging-market countries vary in their economic conditions and policy approaches. The economic and the foreign-exchange hurdles are significant in most of these countries. Often they have greater swings in currency values, and the exchange controls are more severe. For example, China recently unified its currency. It merged the official rate and the swap-center rate, which substantially depreciated the official rate. The Mexican peso has depreciated more than 400 percent since 1986, and almost 300 percent of that change occurred between 1986 and 1988. Companies doing business in developing countries may need to use a great deal of creativity to overcome these barriers.

Still, markets that were once closed are now becoming more open, and they are welcoming and valuing foreign trade in a way they never did before. Some examples are Mexico, the Commonwealth of Independent States, China and Argentina. Governments around the world are privatizing state assets, and this trade liberalization is leading the capital inflows.

What is an "emerging market"? Its characteristics are average or low income per capita, plus widespread exchange or capital controls (particularly for nonresidents). These currency controls are frequently accompanied by wide-ranging import controls. Often domestic financial markets are in their infancy, and communication is poor. The economy tends to lack monetary discipline, causing high inflation rates and currency depreciation. Emerging markets include all of Latin America, the Caribbean, most of Asia (except Japan), all of Africa, most of the Middle East and all eastern European countries.

The range of economic policy and regulatory practice in emerging-market countries often includes currency controls, including currency-convertibility restrictions. Because the markets in some countries have been nearly nonexistent, some local currencies are extremely difficult to exchange for U.S. dollars or other hard currencies. Hard currency refers to any readily convertible, freely traded and relatively stable currency, such as the U.S. dollar, yen, deutsche mark, French franc or British pound.

Even if a currency is convertible in theory, the shortage of hard currency and the lack of effective markets may make it inconvertible in practice. This is especially true in countries with balance-of-payments problems or deficits that use up available foreign currency reserves, such as Honduras, Ukraine or Russia. Some governments require the exchange to be executed through a local bank. This is true for the Brazilian cruzeiro, Indian rupee and Philippine peso. Other currencies can be exchanged only through a U.S. bank. The government might permit a U.S. bank to exchange currency, in addition to some of the local banks, as in Malaysia and Thailand.

PUT YOUR MONEY WHERE YOUR MARKET IS

                       Gross Domestic              Annual Gross
                         Product in               Domestic Product
                      2001 ($ Billions)         Growth Through 2001

China                    1,132                         10%
India                      524                          6%
Brazil                     331                          4%
Mexico                     314                          5%
Indonesia                  239                          7%

Source: The WEFA Group

In countries where the exchange must be handled locally, the U.S. company may need to get approval from some central authority. The government may permit currency exchanges only for certain kinds of transactions, such as imports or dividends, capital flows and interest payments. In Brazil, selling cruzeiros requires formal documentation and approval. However, the long-term trend toward greater currency convertibility is likely to continue as governments around the world recognize the benefits of opening up their economies and liberalizing trade.

WHEN IN ROME...

What can your company do to address currency risks in emerging markets? Some companies have shown a great deal of creativity in working with the limitations and conditions of their host countries. A U.S. company that is dollar-based can set its foreign prices in dollars. This transfers the foreign risk to the local importer. But the host country could still change its convertibility rules or, without any advance notice, impose other restrictions that would cut off hard currency for the importer.

Price indexing, the practice of indexing a foreign price to a U.S. dollar or other exchange rate, is another option. Or the buyer and seller can structure a formal risk-sharing agreement. Buy-back arrangements are also a possibility. This often involves longer-term repayment, and compensation frequently takes the form of industrial products. Offsets also may be necessary. That is, your company may agree to spend money in the host country in return for receiving hard currency as part of the sale. This could mean co-production or research and development, or it could mean purchasing some goods locally.

Counterpurchases are similar to offset arrangements. For instance, your company might agree to buy back products from the host country to partially repatriate the sales proceeds. Companies often sell products purchased through offset obligations to other companies to realize the desired funds.

Your company may be able to work out good solutions with other organizations in the country. For example, charities like the Red Cross often receive U.S. dollars as funding, and they need local currency for their operations in the host country. Consider exchanging your local currency for the charity's U.S. dollars or arranging a currency exchange with a company that needs to pay its expenses in local currency.

AT&T receives many offers for countertrade around the world. Of course, we look for other solutions first, because the host country usually does not want to offer for barter something it could readily export itself. So we tend to get offers for goods that we can't use directly. Also, it may be difficult for a U.S. seller to accurately value the products it receives or to dispose of them. If your company decides to participate in a countertrade, it may be a good idea to enlist the help of a third party, trader or broker. Also, the trades often do not occur simultaneously, so you may need some sort of financing.

Although countertrade may be difficult, it facilitates some creative approaches to managing currency risk. Countertrade can preserve hard currency that may be in short supply. Certainly, it provides benefits to the emerging-market buyer, and it allows the host country to find new markets for its goods. The onus is on the U.S. company to find an outlet for the goods and thus increase exports, which helps the host country.

OUT OF THE RUBBLE OF THE RUBLE

A deal that we structured in Murmansk, Russia, is an example of countertrade, although it hasn't been completely executed yet. As you know, inflation is steep in Russia. Since 1971, the ruble has depreciated from 170 rubles per dollar to 1,200 rubles per dollar. Convertibility is difficult, and the exchange process is rather undeveloped. Hedging is essentially unavailable.

Russian enterprises must return half of their hard-currency earnings from export sales to the Russian central bank, which is called the 50-percent rule. However, barter is permitted without central intervention from Moscow. Countertrade allows a Russian enterprise to keep 100 percent of the hard currency it collects, provided these funds remain in an escrow account.

We agreed to sell some switching equipment to Sevtelecom, the local telephone company. The 50-percent rule was an impediment, so we decided to accept half the payment in hard currency and to get the other half through a barter arrangement that involved apatite concentrate, a rock phosphate that we couldn't use.

Sevtelecom will solicit the regional government in Murmansk for a quota on apatite concentrate, and the government will instruct the local apatite producer to make some of it available. AT&T has agreed to take the apatite and sell it on the world market. We have no links to the buyers, so we will engage Helm A.G., a German trading company. Helm will buy the apatite at less than the world-market price and sell it at the world-market price. The difference in the price is considered a cost of financing and must be included in the price of our equipment sale to Sevtelecom.

Helm A.G. will receive U.S. dollars for its apatite sale and deposit them in an escrow account. It will pay some of the U.S. dollars to the apatite producer, and AT&T will receive the balance. So we'll end up with U.S. dollars, the apatite producer will be paid, Sevtelecom will receive its switching equipment and Helm will make a profit on the sale. Helm will finance the apatite sale to a fertilizer producer in Romania, because the Romanian company lacks the hard currency to pay for it. Therefore, Helm will accept fertilizer as its final product, which it can sell on the world market for U.S. dollars.

Despite the risks and problems associated with emerging markets, AT&T has compelling reasons to be in many of them. In Central and South America, for instance, telecommunications investment is growing at about 15 percent annually and is expected to continue growing at that rate for the next five years. We don't currently use countertrade in those countries. The deals are primarily in U.S. dollars, and we often sell through a partner. The partner in turn resells through a buyer, who takes all of the exchange-rate risks.

Our biggest opportunity is in China, estimated to be the world's largest and fastest-growing market in telecommunications switching equipment for the next two or three decades. In 1993, we signed a memorandum of understanding with China -- the first one in its history -- to explore telecommunications opportunities. We've established some joint ventures there already and are planning many more.

This shift toward emerging markets has been very significant for AT&T. At divestiture 10 years ago, we had very little international business other than long-distance service. Last year, about one-quarter of our revenues were from international sources, and we now have more than 50,000 employees located outside the United States. As our involvement in emerging markets continues, we expect those numbers to keep increasing.

NOT EXACTLY COUNTERTRADE

Christoph Adamski Vice President, World Trade Pepsi-Cola International

Countertrade at Pepsi is only one of the tools we use to manage our currency risk overseas, but we use it quite aggressively. We don't use it as a last resort but as an active tool in developing our business. In fact, what we're doing is not countertrade but what we call "reciprocal business development."

In countertrade, you specifically take an existing product off the shelf or you try to find a market. You wait for an offer from your business partner, who typically goes into the back room and looks around to see what he can sell. And brand-marketing shadow trades -- transactions where someone else takes title, and we just engineer the transaction and get the benefit -- are unsatisfactory arrangements. At the end of the day, you lose control over what's going on. You can do this once successfully, but after you introduce other business partners, the chances that you can do it again are fairly remote.

We take a different approach. We look at the country's competitive advantages -- for example, Russia's abundant engineering capability -- and then build long-term businesses around those strengths. Pepsi-Cola International is the one division of the company that's spread out worldwide, so we have the capabilities to finance this international business arm. Our group is a separate organization functionally directed from headquarters. Our people are on area division staffs so that they have an administrative home. The priorities for the field teams are negotiated with Pepsi's business areas and divisions. We're a service unit, so we don't charge the divisions for what we do.

We're in the business of creating hard currency to get our partners in soft-currency countries to buy our products, to repatriate our earnings and to get access to foreign markets. Our global infrastructure allows us to act as a business development arm and leverage our worldwide connections, our business know-how and the country's need for hard currency. And this leverage is an important tool when you want to extract concessions from a foreign government, because you can say, "I don't take commodities that you might want to sell for hard currency. Instead, I'll work with your business people and your infrastructure and drive your business forward and open your markets." Through our desire to build freestanding businesses, we've become a profit center. So we conduct countertrade today at no cost to Pepsi or our customers, and we make money on it.

One way to do that is to invest in production facilities. For example, we do spice processing in Shanghai in conjunction with McCormick, with the goal of creating hard currency for our Chinese markets. We have strategic alliances with trading houses, and we've developed new value-added products.

If you go to ethnic markets, you may find basmati rice under the brand name Seasons Harvest. That's a Pepsi brand we developed in India under our own label. We market it in the United States, the Middle East and Europe to discharge our export obligations towards the Indian government. This enabled us to get into the Indian market three or four years ahead of Coca-Cola, which in our little world is quite a feat. And, in China, we gained access to the Szechwan province, where we're building two Pepsi plants, one in Chengdu and one in Chonquing.

Why did we get this business? Because we agreed to open a silk dying and printing factory in Chengdu, which is a multinational joint venture combining Italian technology with Korean management expertise. We're there as a promoter of the business, and we also have our Chinese market. That's a business that we're setting up as a profit center to run independently. We'll have access to the foreign exchange generated in this venture so that we can feed our operation. Plus, we have the added benefit of transferring a technology that is in high demand to China, and in doing so, reaping political benefits that have helped us get a license.

Those aren't our only ventures. Besides the rice product and the silk venture, we export vegetables, too. At one point, we were the largest exporter of frozen vegetables from Mexico. We built a tomato paste processing plant. We have mushrooms in China, a toy factory in Huangjo and a marketing joint venture for fruit beverages.

OPENING THE DOOR IN THE UKRAINE

Our activities in the Ukraine are a good example of our emerging-market philosophy. The Ukraine isn't exactly an easy market for Western businesses. No hard currency exists. The macro-economic conditions are rapidly deteriorating because the country is vacillating between adherence to old-style Soviet management and some timid experiments with free markets and privatization. And then the political environment is very uncertain. Nobody really knows if civil war will break out in the Ukraine six months from now.

But Ukraine's 50 million inhabitants make it an important market for us. We have seven plants operating there; we don't have an equity stake in them, but they are franchise accounts. To pursue our interests there, we created a company -- Ukrainian Development Corporation. It's a joint venture between Zaliv, one of the leading shipyards in the Crimea, and my group, and we have two other partners, one in Ukraine and one in the West. This joint venture focuses on marketing Ukrainian-built ocean-going oil tankers internationally.

By positioning ourselves in the joint venture, we've allowed the Ukrainians to gain access to the international shipbuilding community. If you do business in Eastern Europe or in the former Soviet Union, you'll remember that in the good old days everything went through Moscow, where foreign-trade organizations took care of the export business. Companies were told, "This is what you manufacture. This is where you deliver it." Therefore, no one in the enterprise had any international business know-how.

So we opened the door for the Zaliv shipyards through the international community. We invited international buyers and put our name behind the marketing efforts, and we financed the ongoing shipbuilding transactions. Of course, we get access to foreign exchange from the exports, too. And our international network has been very helpful in managing Zaliv's business.

We've negotiated with the Ukrainian government a concession that we have an offshore bank account. In other words, none of the sales proceeds that we collect from the sale of the ships enters the Ukraine. It all goes to a foreign bank account, where the funds remain. They still belong to the Ukrainian Development Corp., but they're earmarked for specific purposes. We have a currency investment account, joint-venture collateral account, our investment account and an umbrella account.

We use the collateral account to extend guarantees to two Western banks for the Western ship buyer. If you're buying a ship, you typically make progress payments, but no one in his right mind is going to make progress payments to the Ukraine, never knowing if the ship will ever be delivered, because of the political risk and even the manufacturing risk. So we use the off-shore collateral account to reduce the risk to the buyer. That allows manufacturing activities to go on.

Here's how the process works. The Ukrainian Development Corp. finds a Western buyer for the ship. The Western buyer pays for the ship; the ship gets delivered. That's the easy part. The Ukrainian Development Corp. then receives its money.

After that, we go to our network, take the money from there and pay it to the supplier, who delivers to our Ukrainian business the goods that have been purchased. Those businesses pay in local currency into the joint-venture operating account, so the joint venture now has local currency. Part of that goes to the joint-venture investment account, and part of that goes to pay for the ship that we've purchased.

With the funds in the currency investment account, we can now upgrade the shipyard. In spite of all the difficulties in the Ukraine, we have a very aggressive shipyard modernization program going on. In fact, we're investing $20 million in the Ukraine. We control the flow of currency and foreign exchange, and that's the key to this whole thing. We sit on top of every dollar that goes in, and that gives us credibility with the central bank, which receives multiple statements from us and can see where the money is and what we're doing with it.

And last but not least, some of the shipyard's suppliers also need funds to conduct their business. We use the rubles out of the currency investment account to work with these suppliers.

We try not to do any local-currency financing. Through our structure, we can switch local-currency financing into hard-currency financing. We make local currency available to our business partners at hard-currency dollar cost, and since the whole thing is collateralized through an export stream of merchandise, the borrower doesn't run the risk of being unable to meet his commitments, and we don't get stuck with a position that we can't liquidate. Our structures put people in a position to denominate their credit requirements in the country where they're operating in dollars, which helps them because their revenue is in dollars.

This is just a small example of what we're doing in order to get our business growing. We're doing similar things in China and in Africa. As a result, we have a very profitable business that helps us tremendously. It gives us a leg up in markets where other people don't want to go. But we wouldn't have been able to do it without support at the top of the organization. It takes commitment by senior management to use countertrade or reciprocal business development as an aggressive tool to build business in difficult markets.

A POWERFUL BID

Kevin Skehan Analyst, Foreign Exchange General Electric Co.

General Electric's philosophy on foreign-currency risk management has always been very conservative: Identify exposures and hedge them. We've become more proactive in managing our foreign-currency exposure, but our philosophy remains the same. This has been much easier to adhere to with the major currencies, where a very liquid market has evolved for both spot transactions and forwards for as far out as five years. In emerging markets, however, it's not always as easy to accomplish this objective.

Like many companies, we've recently decided to grow our business in Asia and Southeast Asia, and along with this decision comes new currency risk. In emerging markets, the foreign-exchange market isn't always able to provide the same types of hedging instruments that are available for the major currencies. When faced with a new exposure in an emerging market, we consider all traditional hedging alternatives, including the possibility of borrowing locally to offset our exposure.

Asian foreign-currency markets are becoming more liquid, and currency restrictions are diminishing. Malaysia's economy has been growing significantly, which has spurred an increasing demand for electrical power generation. As a result, the Malaysian government has begun to award large contracts for electrical power plants to independent power producers. These power producers then put the project together through a competitive bidding process. Recently, our power-generation business was involved in a bid for one of these projects.

Because these independent power producers are private companies, they don't have available to them traditional sources of U.S. dollar financing, such as Eximbank financing. Therefore, their costs are largely denominated in local currency. Sometimes the power producers don't want to assume all of the foreign-currency risk from outside bidders, so they've begun to require that bids be submitted in both local currency (Malaysian ringgits) and U.S. dollars. To remain competitive, we complied with this requirement. In the past, we would simply submit our bid in U.S. dollars, thus eliminating our direct exposure. In today's environment, however, we can no longer afford to do this.

TIMING IS EVERYTHING

Our corporate treasury is involved in the bidding process in several areas. We supply forward points so that the business can develop a price that incorporates the cost of money in the foreign country. In the case of Malaysia, we had a relatively liquid market for three to six months forward. After that, however, the bid spread begins to widen significantly. It can reach as high as 1,000 points out past one year. That makes it difficult to come up with realistic forward rates.

We also supply our business with a currency forecast for the country in which it's doing business. Although we can't predict precisely where foreign currencies will trade in the future, we do receive reliable market intelligence and perform economic analyses, which allow us to predict the likely short-term trends for a currency.

After we come up with the currency forecast, we analyze the foreign-currency exposure by breaking it down between the contingent exposure during the bid period and the actual exposure that will result in the long run if we are awarded the job. In deciding how to hedge the bid-period exposure, we take into account several factors, including the amount of the exposure, the length of the bid period and the likelihood that we'll get the job. With the Malaysian project, we had a significant exposure (more than $200 million), the bid period was relatively short (approximately 90 days) and we felt confident that the power producer would accept our bid.

As far as the hedging instruments are concerned, we don't hedge the bid period with forward contracts. Because of the contingent nature of the bid, we don't want to lock ourselves into a foreign-currency obligation without a firm commitment. We encourage the use of risk-sharing agreements whenever practical. If the contractor won't agree to this, we prefer to hedge the bid period with currency options or self-insurance, which helps provide needed flexibility.

In this case, we decided to hedge the bid period with an out-of-the-money Malaysian ringgit put option. Initially, we received quotes from several banks that varied greatly in their premium costs. Finally, one of our banks worked closely with us to come up with the out-of-the-money strategy which allowed us to cover the entire exposure with a relatively modest earnings or cash effect.

We submitted the bids to this independent power producer in both Malaysian ringgits and U.S. dollars. About halfway through the bid period, the power producer accepted our bid and awarded us the job, choosing the U.S. dollar price. (Apparently, the local-currency bids from all the competitors must have been extremely high.) So we no longer needed the ringgit put option that we'd purchased. One of the benefits of options, however, is that they're always worth something before they expire. Therefore, we decided to sell our option back to the bank for its time value, thus recouping a portion of the premium.

As GE's presence overseas continues to expand, we will be required more and more to find creative solutions to currency-risk problems. In the past, we've been somewhat insulated from these pressures because the nature of our products allowed us to dictate the terms of the contract to a greater extent than we can now. Our strategic decision to expand our business in Asia, coupled with increasingly aggressive international competition, demands our continued adaptability in this difficult area.