Financial review

Exchange rates, reporting currencies and currency exposure

Rio Tinto's shareholders' equity, earnings and cash flows are influenced by a wide variety of currencies due to the geographic diversity of the Group's sales and the countries in which it operates. The US dollar, however, is the currency in which the great majority of the Group's sales are denominated. Operating costs are influenced by the currencies of those countries where the Group's mines and processing plants are located and also by those currencies in which the costs of imported equipment and services are determined. The Australian and Canadian dollars and the Euro are the most important currencies (apart from the US dollar) influencing costs. In any particular year, currency fluctuations may have a significant impact on Rio Tinto's financial results. A strengthening of the US dollar against the currencies in which the Group's costs are partly determined has a positive effect on Rio Tinto's underlying earnings.

The following sensitivities give the estimated effect on underlying earnings assuming that each exchange rate moved in isolation. The relationship between currencies and commodity prices is a complex one and movements in exchange rates can cause movements in commodity prices and vice versa. Where the functional currency of an operation is that of a country for which production of commodities is an important feature of the economy, such as the Australian dollar, there is a certain degree of natural protection against cyclical fluctuations, in that the currency tends to be weak, reducing costs in US dollar terms, when commodity prices are low, and vice versa.

Earnings sensitivities - exchange rates

	Average exchange rate for 2008	Effect on net and underlying earnings of 10% change in full year average +/- US$m
Australian dollar (a)	US 86 cents	502
Canadian dollar (a)	US 94 cents	214
Euro	US 147 cents	34
Chilean peso	US$ = 522 pesos	17
New Zealand dollar	US 71 cents	29
South African rand	US 12 cents	47
UK sterling	US 186 cents	22

Notes	Expand
The sensitivities in the "Average exchange rate for 2008" column are based on 2008 prices, costs and volumes and assume that all other variables remain constant.

The exchange rate sensitivities quoted above include the effect on operating costs of movements in exchange rates but exclude the effect of the revaluation of foreign currency financial assets and liabilities. They should therefore be used with care.

Given the dominant role of the US currency in the Group's affairs, the US dollar is the currency in which financial results are presented both internally and externally. It is also the most appropriate currency for borrowing and holding surplus cash, although a portion of surplus cash may also be held in other currencies, most notably Australian dollars, Canadian dollars and the Euro. This cash is held in order to meet short term operational and capital commitments and, for the Australian dollar, dividend payments. The Group finances its operations primarily in US dollars, either directly or using cross currency interest rate swaps. A substantial part of the Group's US dollar debt is located in subsidiaries having a US functional currency.

However, certain US dollar debt and other financial assets and liabilities including intragroup balances are not held in the functional currency of the relevant subsidiary. This results in an accounting exposure to exchange gains and losses as the financial assets and liabilities are translated into the functional currency of the subsidiary that accounts for those assets and liabilities. These exchange gains and losses are recorded in the Group's income statement except to the extent that they can be taken to equity under the Group's accounting policy which is explained in note 1 of the 2008 Full financial statements. Gains and losses on US dollar net debt and on intragroup balances are excluded from underlying earnings. Other exchange gains and losses are included in underlying earnings.

Under normal market conditions, the Group does not generally believe that active currency hedging of transactions would provide long term benefits to shareholders. The Group reviews on a regular basis its exposures and reserves the right to enter into hedges to maintain financial stability. Currency protection measures may be deemed appropriate in specific commercial circumstances and are subject to strict limits laid down by the Rio Tinto board, typically hedging of capital expenditure and other significant financial items such as tax and dividends. There is a legacy of currency forward contracts used to hedge operating cash flow exposures which were acquired with Alcan and the North companies. Details of currency derivatives held at 31 December 2008 are set out in note 34 to the 2008 Full financial statements.

The sensitivities below give the estimated effect on underlying earnings, net earnings and equity of a ten per cent strengthening in the full year closing US dollar exchange rate, assuming that each exchange rate moved in isolation. Financial assets and liabilities will not remain constant throughout 2009, however, and therefore these numbers should be used with care.

Earnings sensitivities - exchange on financial assets/liabilities

	Closing exchange rate US cents	Effect on net earnings of 10% strengthening of US$ US$m	Of which amount impacting underlying earnings US$m	Effect of items impacting directly on equity US$m
Functional currency of business unit:
Australian dollar	69	(12)	78	5
Canadian dollar	82	159	193	56
South African rand	11	13	19	-
Euro	141	249	28	2
New Zealand dollar	58	21	2	-

Notes

Expand

The sensitivities show the net sensitivity of US dollar exposures in Australian dollar functional currency companies, for example, and Australian dollar exposures in US dollar functional currency companies. The sensitivities indicate the effect of a ten per cent strengthening of the US dollar against each currency. Rio Tinto Alcan Inc., which has a US functional currency, has a significant amount of US dollar denominated external and intragroup debt held in Canada and is taxed on a Canadian currency basis. The above sensitivities as at 31 December 2008 for a ten per cent strengthening of the US dollar do not include any tax benefit related to this debt because the capital losses generated would not be recognised. If the US dollar weakened below 97 Canadian cents then tax charges would begin to be recognised at 15 per cent. The sensitivities include the Rio Tinto share of the sensitivities of equity accounted units. Some US dollar functional currency companies are exposed to exchange movements on local currency deferred tax balances. The only material exposure is to the Canadian dollar and a 10 per cent strengthening of the US dollar would reduce underlying earnings by US$115 million. This would partially offset the US$193 million gain shown above.

The functional currency of many operations within the Rio Tinto Group is the local currency in the country of operation. The former Alcan aluminium and alumina producing operations primarily use a US dollar functional currency. Foreign currency gains or losses arising on translation to US dollars of the net assets of non US functional currency operations are taken to equity and, with effect from 1 January 2004, recorded in a currency translation reserve. A weakening of the US dollar would have a positive effect on equity. The approximate translation effects on the Group's net assets of ten per cent movements from the year end exchange rates are as follows:

Net assets' sensitivities - exchange on translation

	Closing exchange rate US cents	2008 Effect on net assets of 10% change in closing rate +/- US$m
Australian dollar	69	1,264
Euro	141	621
Canadian dollar	82	180

Back to top