How to manage liquidity amid rate hikes

With inflation at a 40-year high, the US Federal Reserve (Fed) has been forced to raise interest rates for the second time this year. And Fed chairman Jerome Powell has made clear the intention to further raise rates and tighten monetary policy, if needed. The goal is to contain the impact of continued supply chain pressure and a tight labour market on a rebounding economy fuelled by a glut of liquidity from years of fiscal stimulus programmes.

The knock-on effect for corporate treasurers is the need for strategic yet nimble decisions about how to manage their own liquidity given a volatile and unpredictable market outlook.

Rate hike demands efficient use of cash reserves

Over the last two years, many corporate treasurers built up a war chest of liquidity by borrowing from banks or accessing capital markets. As the future remained uncertain, expansion plans including capital expenditure were mostly put on hold. Some treasurers parked this liquidity as short term deposits with banks.

This dynamic has now been turned on its head. Corporates now face a double-whammy:  rising interest rates mean they will be charged more for credit, while inflation is adding to the opportunity cost of holding cash.

“Companies must find a more productive use for their cash, either by repaying loans, reinvesting in their businesses through capital expenditure or acquisitions, or increase shareholder value through share buybacks and dividend payouts,” explained Krishna Sampath, head of corporate deposits & liquidity, APAC, at BNP Paribas.

At the same time, treasurers must consider the rising costs of raw materials and energy – leading to higher working capital costs – and an uncertain outlook for the global economy.

Broadly speaking, treasurers have two key objectives when managing cash deposits, Sampath noted. The first is operational; the liquidity required to maintain the day-to-day operations of the business. Here, they must rely on strong banking relationships that are important in making their operations as resilient as possible, optimising working capital and limiting unnecessary credit costs.

Banks are also motivated to work with clients on a long-term basis, as stable, ‘sticky’ corporate deposits are beneficial for banks’ own balance sheets and liquidity ratios. This gives banks an additional incentive to support these clients with a full range of bank services, including solutions that can provide a cushion against increasing credit costs and volatility.

Treasurers’ second goal is to maximise the yield on excess non-operational deposits. In the current environment, there is a higher chance that the short-term liquid investments that were predictable winners last year may suddenly be less reliable, or less suitable for that purpose. The focus on centralisation and global visibility of cash that allowed treasurers to navigate the pandemic will continue to remain at the centre of treasury initiatives this year as well. 

Cross-border matters – managing local currency risk

In Asia, where large multinational corporations (MNCs) have subsidiaries in numerous jurisdictions, fluctuations in interest rates also affect the value of local currency deposits.

At the outset of the pandemic, when the Fed cut rates, all other central banks in the region followed suit. The logic for regional economies is to follow in the Fed’s footsteps to avoid a large depreciation of their local currencies vis-à-vis the dollar.

While many MNCs have their regional headquarters in Singapore or Hong Kong, their core manufacturing operations are spread across ASEAN, India, Korea, Taiwan and China. This means any increase in rates also has an impact on these local operations; in short, their local borrowing requirements become more costly, which requires treasurers to plan ahead by seeking alternative sources of liquidity such as inter-company loans.

The Russia-Ukraine conflict and subsequent heightened geopolitical tensions are also adding to currency volatility and foreign exchange risk.

Corporates with exposure to emerging market currencies need to be mindful of the ripple effects and FX risk on a market-by-market basis to determine the appropriate hedging strategy.

Banks in competition – delivering greater purpose

In the same way as inflation, volatility and rising rates pose challenges for corporations, the same is true for financial institutions.

As companies put more of their excess liquidity to work, corporate deposits have become even more valuable for banks. Yet as the adoption of ESG standards accelerates globally, strong sustainability credentials are increasingly a differentiator for both corporates and financial institutions.

By offering sustainable deposit solutions, banks can offer a win-win solution for clients with purpose: the opportunity to support green and sustainable projects, fulfilling their sustainability goals.

“In these circumstances, a holistic view of the corporate treasury relationship, which combines purposeful and innovative solutions at the right price, is key,” added Sampath.