Buisiness Implication of Exchange Rates

BUSINESS IMPLICATIONS OF EXCHANGE-RATE CHANGES BUSINESS IMPLICATIONS OF EXCHANGE-RATE CHANGES Market Decisions On the marketing side, exchange rates can affect demand for a company’s products at home and abroad. A country such as Mexico may force down the value of its currency if its exports become too expensive owing to relatively high inflation. Even though inflation would cause the peso value of the Mexican products to rise, the devaluation means that it takes less foreign currency to buy the pesos, thus allowing the Mexican products to remain competitive.

One interesting ramification of a peso depreciation is the impact of the cheaper Mexican goods on exporters from other countries. For example, the cheaper Mexican goods flooding the market in Argentina might take away market share from Italian exporters, thus affecting the Italian economy. A good example of the marketing impact of exchange rate changes is the problem that Japanese car manufacturers were having selling to the United States in 1986 and 1987 due to the sharp rise in the value of the yen.

As the dollar fell 47 percent against the yen in the 16 months ending in December 1986, Japanese car companies found that their cost advantage had disappeared, prices had to be increased, and profit margins had to be trimmed in order to remain competitive. In addition, Korean cars were making inroads due to the low costs and prices of Korean products. Thus a currency depreciation could result in foreign products becoming so expensive in a country like the United States that U. S. roducts soon would pick up market share from imports. The key is whether or not the percentage of devaluation exceeds the relative increase in inflation. In the case of Japan, the strengthening of the Japanese yen in the latter part of 1990 was advantageous to the Japanese in one sense—the cost of imports. Oil prices skyrocketed in late 1990 as Iraq invaded Kuwait, and oil is priced in dollars. Because the yen was rising against the dollar, the stronger yen offset the higher cost of oil.

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However, a firm could accomplish the same purpose by going to any country whose currency is expected to remain weak in relation to that of the parent-country currency. The attractiveness of a weak-currency country must be balanced with the potential problems of investing there. Financial Decisions The final business area where exchange rates make a difference is in finance, The areas of finance that are most affected are the sourcing of financial re- sources, the remittance of funds across national borders, and the financial statements.

There might be a temptation to borrow money where interest rates are lowest. However, we mentioned earlier that interest-rate differentials often are compensated for in the money markets through exchange-rate changes. In the area of financial flows, a parent company would want to convert local currency into the parent’s own currency when exchange rates are most favorable so that it can maximize its return. However, countries with weak currencies often have currency controls, making it difficult to manage the flow of funds optimally.

Finally, exchange-rate changes also can influence the reporting of financial results. A simple example can illustrate the impact that exchange rates can have on income. If the Mexican subsidiary of a U. S. company earns 100 million pesos when the exchange rate is 200 pesos per dollar, the dollar equivalent of income is $500,000. If the peso depreciates to 300 pesos per dollar, the dollar equivalent of income falls to $333,333.

The opposite would occur if the local currency appreciates against the parent currency. LOOKING TO THE FUTURE The international monetary system has undergone significant reform in the past two decades. As the historically planned economies undergo a transition to market economies, they will feel significant pressure on their exchange rates. High rates of inflation and weak demand for those currencies will lead to major devaluations—certainly a key factor affecting the Russian rouble in March and April of 1991.

The European Monetary System should continue to strengthen, and national economic policies will be coordinated more closely as the Europeans move closer to a common currency. However, the weaker economies of some of the new entrants into the EC will continue to plague harmonization and the problems arising during the reunification of Germany will keep the German mark from soaring too high against the currencies of the other EC members. Some of the most interesting changes in currency values will take place in the “more flexible” category.

Countries in the “adjusted according to a set of indicators” and “other managed floating” categories need to gain greater control over their economies in order to move to the “independently floating” category. Countries in the latter category are under constant pressure to control inflation and to keep from being tempted to intervene in the markets. Firms will face constant pressure to understand the factors influencing particular exchange rates and to adjust corporate strategy in anticipation of rate movements. Their job will only get easier if exchange rate volatility diminishes

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