For any corporate dealing in multi nationals the changes in currency rate with their local currency changes the possible transaction value which in turn impacts their revenue numbers. A falling exchange rate increases the home currency value thereby making the exports lucrative while an appreciation in the domestic currency or a decrease in the exchange rate, then the import of goods can be done at cheaper rates. Any change in the foreign exchange markets, changes the Currency Rate, directly changes the import and export value of the country.
As the global economies have inter-linkages to other economies, the financial being of one country impacts that of the other. Access of products and services from across the globe has given umpteen choice to the end consumers to seek what best suits them. A similar outflow of products to other countries has also helped increase the revenue generated from exports. Though export and import balance needs to be kept in mind to maintain the currency balance. The currency may devalue if the imports are on a rise but a similar rise isn’t visible in the exports. Thus a country’s economic performance is highly measured by the value of its currency.
Excess of exports over imports results in a trade surplus which indicated a growth in the economy as there is more surplus funds at the hands of the consumers thus leading to more spending from them. Alternatively, when the imports are higher than exports, then the country has a trade deficit. This indicates a high demand for imports which maybe in the form of capital expenditure like equipments and machines. These are productive assets as they will lead to higher production of goods and thus employ more people as demand further increases. Both imports and exports should be growing for a healthy economy.
Convertible foreign exchange
Ideally in foreign exchange markets, currency value is determined, amongst other factors, by supply and demand of the currency pair. So for a free and fully convertible foreign currency, the economies will decide the natural equilibrium rate. But sometimes central banks of a country intervenes in the currency market, like in developing economies, the Foreign Exchange Rate is held down to encourage exports whereas the rates are kept up to decrease the inflationary pressure. Thus the foreign exchange rate is said to be manipulated.
Goods and raw material price changes
When the exchange rate falls, for an exporter the products will become relatively cheaper but the importer will have to pay more as currency price falls as now the raw material costs has increased. Thus exchange rate directly impacts the value of the imports for a country. Thus Foreign Exchange Risk increases with the change in the currency value.
Other way to look at this would be through an example, where the USDINR exchange rate is assumed at 70. When an auto component is exported from India to US and is sold at USD 10, then the exporter would get INR 700 against the export proceeds. Now, assume that the foreign exchange rate is now increased to 72 per USD, so now the same product can be sold at USD 9.72 instead as his inflow remains the same at INR 700, thus making his pricing more competitive in the US market than it was earlier with no change in any quality of the product.
Similarly, a chemical importer buys chemicals from US at USD 10 for which he has to pay INR 700 to buy those dollars. If the USDINR foreign exchange rate increases from 70 to 72, the importer would need 7200 to buy the same product without making any changes to quality or quantity. This foreign exchange risk may increase chances of sourcing the same chemical from other company thus losing the competitiveness of the US exporter. The quantum here is just for one quantity of the product, but when multiplied for bigger volumes, the impact would be much larger. The above examples show the impact of any changes which are there in Foreign Exchange Markets on the imports or exports of an economy.
To ensure the impact of Foreign Exchange Fluctuation is not affecting one’s bottom line, it is important to hedge the foreign exchange risk. This calls for minimizing the effects of fluctuation on the exports and imports. There are several ways to hedge one’s forex portfolio. The same should be discussed with forex advisors to ensure the portfolio is not exposed to volatility and is hedged appropriately. Myforexeye has been a pioneer in aligning foreign currency rates with the real-time market rates to ensure transparency is achieved especially when transacting in derivative forex products like forward contracts, futures and options. Each importer or exporter who has forex transactions should understand the impact of the currency volatility to their portfolio.
10 Dec 2019 05:19 PM
Most of us understand the importance of the global interest rate benchmark LIBOR – London Inter-Bank Offered Rate, especially when millions of dollars are benchmarked against it for decades since 1984.
29 Nov 2019 02:16 PM
Ideally a trade constitutes a foreign exchange transaction but currency can be traded without any underlying which makes it a risky proposition.
26 Nov 2019 12:29 PM
Foreign exchange risk is a financial risk which exists when a home currency is converted into another during the transaction.
14 Nov 2019 02:54 PM
A foreign exchange transaction is recorded in the books of accounts at an exchange rate though the payment is made at a different exchange rate. This leads to transactional foreign exchange loss or gain.
07 Nov 2019 10:48 AM
Modern foreign exchange market started its shift from a fixed exchange rate to a floating exchange rate system. Thus a global decentralized, over the counter (OTC) market for trading of currencies evolved which determines the forex rates.
29 Oct 2019 05:00 PM
Trading in the financial markets is what increases the volumes especially when some markets are open across the borders over different time zones. Each market has its underlying asset which is tradable over the exchange.