Cross-border payments are an often overlooked area of business. When paying for products or supplies from abroad, we tend to think in terms of dollars – what we know best. Given that it’s the world’s reserve currency, it seems intuitive to expect others to accept our currency.
However, the market for cross-border B2B payments is rapidly on the rise. With expectations to exceed $40 trillion, it’s clear that there has been a shift towards handling business in multiple currencies. This isn’t just to be courteous, though, as there are some real money and time-saving benefits to doing so.
The JP Morgan Perspective: Why Local Currency May Be Better
Paying invoices in a foreign currency, be it for a freelancer or inventory, proves to have many different advantages that are often overlooked. As pointed out by JP Morgan, this can significantly improve one’s cash flow.
This is because you may score an extra couple of days of cash availability by converting your currency with your current vendor. When sending US dollars, on the other hand, your bank usually withdraws the funds immediately for them to be sent.
A bank transfer overseas, when denominated in dollars, is more likely to take a few days to wire. However, when sending local currency, transfers are performed much quicker. But it’s not just speed, it’s also less complex. Regarding the seller’s invoice receivables, it’s tricky to reconcile them when converting USD to a local currency – they may not match the invoice. When sending local currency, however, you’re sure of the amount that the vendor will receive.
Case study: Importing from China
Consider a wholesaler who is importing goods from China who is paying in USD. By negotiating to pay in CNH instead – China’ local currency outside the mainland – the vendor agrees to a new, cheaper pricing. This is because the cost of the transactions has decreased, as well as currency risk for the vendor.
Businesses often believe that dealing in USD is less risky. But, this overlooks the embedded costs of conversion, along with exchange rate fluctuations. It may be that the vendor perceives USD as risky, because it’s a foreign currency, and thus includes a price premium to account for currency risk.
The Financial Landscape: Dollar Rates and Inflation
The US dollar has been a hot topic of 2023. This is in part because of not just global economic headwinds, but how different central banks have dealt with inflation. The Fed was an early leader in rising rates, which saw the US dollar reach parity with the Euro, and almost reached parity with the British Sterling.
With rates being hiked around the world, the USD has been fluctuating heavily. Falling since its September 2022 peak, it’s difficult to predict where it will go from here.
For US businesses, a strong dollar makes it cheaper to import raw materials and inventory. However, it makes it more expensive for customers overseas to pay for US goods and services. Beyond the direction, movements in and of themselves create currency risk, making it difficult for firms to predict their cash flow and manage expenses.
Alternatives and Tools for Managing Currency Risk
Paying for overseas goods and services in local currency has its merits, but it’s important to consider the bigger picture and establish a strategy. For example, not just paying in foreign currency, but holding that currency as partial cash reserves may reduce friction down the line.
CurrencyCloud, a Visa-acquired cross-border payment solution, puts forward the argument that if companies modernized their payment systems, they can scale up international growth. Their claim is that customers are ready to buy overseas, and so businesses should seek out two key B2B payment solutions: international invoice-to-pay along with third-party cross border solutions for payments.
The former refers to streamlining the way we handle tax, languages, currencies, regulations, payment preferences, and ultimately, currencies. Essentially, this solution takes away the pain of overseas invoices, reducing errors and allowing for easier reconciliation. Meanwhile, third-party solutions for cross-border payments mitigates the high fees and inefficiencies of traditional intermediaries.
Sophisticated solutions
Payment optimisation strategies for FX involves a few things. Firstly, you need to make sure that you’re getting a competitive rate in both the exchange rate and low fixed fees. Secondly, transactions should be smooth and fast, both in setting them up and the delivery time. Finally, managing exchange rates is also important to mitigate the risks of currency fluctuations.
When it comes to FX risk management, instruments such as forwards, options, and swaps can play a key role. These are hedging products that help lock-in an exchange rate for a future transfer. This means that any fluctuations in the time leading up to the transfer – perhaps in 2 months time – doesn’t affect your currency conversion.
Conclusion
The US dollar is considered the safest currency in the world. Whilst this is true in a vacuum, it doesn’t mean that paying in local currency doesn’t have its advantages. During a period of high inflation and fluctuating exchange rates, along with a more globalized market, it’s time that businesses seek out more sophisticated solutions to cross-border payments.
In some situations – particularly where the local currency is vulnerable, as seen in Argentina – invoicing in USD may be preferred by the other party, and this may lead to better prices. However, this isn’t a blanket strategy; consider the situation with each vendor regarding a currency strategy to ensure that friction, costs, and risk are kept to a minimum.
