Exchange rate exposure for a Te Puke kiwifruit exporter
Te Puke kiwifruit exporter Hine has signed a contract to sell 100,000 trays of Gold kiwifruit to a Japanese importer at US$28 per tray, with payment in US dollars on delivery in June. When the contract was signed in February the exchange rate was NZ$1 = US$0.60; by June it is US$0.66. Freight has risen from $4,800 to $6,100 per 40-foot container, and the shipment uses 40 containers. The importer, facing a weak yen, has asked Hine to cut the US dollar price by 8% or it will buy Chilean fruit instead. Hine's orchard costs are fixed in NZ dollars: growing, picking and packing come to $3.1 million for this crop, and she has already spent $40,000 on the export licence and audit. She did not hedge. Her bank offers a forward contract at US$0.655 for next season.
1. Calculate Hine's NZ dollar receipts under (a) the February exchange rate and (b) the June exchange rate, before the importer's discount. Explain the effect of the exchange rate change on her profit.
Read the worked answer
US dollar revenue = 100,000 trays × US$28 = US$2,800,000.
(a) At NZ$1 = US$0.60: NZ$ receipts = 2,800,000 / 0.60 = NZ$4,666,667.
(b) At NZ$1 = US$0.66: NZ$ receipts = 2,800,000 / 0.66 = NZ$4,242,424.
Difference = NZ$424,243, or 9.1% lower. The NZ dollar has appreciated against the US dollar, so each US dollar buys fewer NZ dollars.
Costs in June: growing, picking and packing $3,100,000 + freight (40 × $6,100 = $244,000) + licence and audit $40,000 = $3,384,000. Profit at the June rate = 4,242,424 − 3,384,000 = $858,424. If the exchange rate had stayed at 0.60, profit would be 4,666,667 − 3,384,000 = $1,282,667. The appreciation alone cuts profit by $424,243.
Explanation: the contract is in US dollars, so Hine bears the exchange-rate risk. A higher NZD means lower NZD receipts unless she raises the foreign price. Her costs are mostly in NZ dollars, so the margin is squeezed. A higher NZD makes imports cheaper, but that does not help much because her main costs are local labour, land and packing.
Judgement: the appreciation, not the freight increase, is the largest single hit to profit in this example.
2. The importer asks for an 8% cut in the US dollar price. Calculate the new NZ dollar revenue at US$0.66 and advise Hine, using the concept of price elasticity of demand and her sunk costs.
Read the worked answer
New US dollar price = $28 × 0.92 = US$25.76. Revenue = 100,000 × 25.76 = US$2,576,000. At 0.66, NZ$ revenue = 2,576,000 / 0.66 = NZ$3,903,030. Costs are $3,384,000, so profit = $519,030 - still positive, but $339,394 lower than without the discount.
If Hine refuses and the importer buys Chilean fruit, she gets $0 revenue. The $40,000 licence and audit is sunk; picking, packing and freight may be partly avoidable, but the fruit has little alternative use once picked. The relevant comparison is revenue against avoidable cost, not against total cost. At US$25.76, revenue per tray is NZ$39.03; total cost per tray is $33.84, so each tray still contributes about $5.19.
Elasticity: the importer's threat is credible because Chilean fruit is a close substitute, so demand facing Hine is relatively elastic. A price cut loses some revenue per tray but keeps the sale; refusing risks losing all of it. However, accepting an 8% cut may set a precedent for future contracts.
Judgement: accept the discount this season if there is no better buyer and the fruit is already packed, because any contribution above avoidable cost reduces the loss. Then hedge next season with the forward contract at 0.655 and/or price in NZ dollars.
3. Explain how the exchange rate change could affect New Zealand's terms of trade and current account, using this example.
Read the worked answer
The terms of trade = index of export prices ÷ index of import prices × 1000.
The exchange rate does not directly change the foreign-currency price of Hine's kiwifruit - it is still US$28 - so the world-price terms of trade are unchanged by the currency move alone. What changes is the NZ dollar value of those exports.
In NZD terms, export receipts fall from $4.67m to $4.24m. If import prices in NZD fall because the NZD buys more foreign currency, the terms of trade could improve; if import prices are sticky, the current account worsens because export income is lower.
For New Zealand as a whole, a higher NZD tends to reduce the NZD earnings of exporters and make imports cheaper. The effect on the current account depends on the relative price and volume responses. If export volumes are unchanged and import volumes are unchanged, lower export receipts and lower import payments could roughly offset. In Hine's case the fall in receipts is not offset because her costs are local.
Judgement: the currency move redistributes income from exporters to importers and consumers of imports. The terms of trade may not change much, but the current account balance can still deteriorate if export volumes are fixed.