Trends of Currency Exchange Rates in Developing and Developed Nations - Coursework Example

International Business Economics Table of Contents Introduction 3 2. A Brief Understanding about the Issue 5 3. A Detailed Analysis of the Trends of Currency Exchange Rates in Developing and Developed Nations 7 7 4. Impact of Currency Exchange Rate 12 13 5. Reasons for Evaluating Currency Exchange Rates 17 6. Recommendations & Conclusion 20 References 22 22 1. Introduction Economics is a larger phenomenon of social science that includes individuals, business enterprises, government and nation at large. In the present scenario, globalization is determined as an important factor leading to the interdependent of nations on one another. Additionally, it aids organisations in conducting business activities beyond national borders with low barriers. Correspondingly, with this significant change, countries have started to think in a global manner where they are highly affected with the condition of the economy of the other countries. In addition, globalisation allows the businesses to buy and sell commodities in the global market while consumers can enjoy a wide range of products and/or services (Hanley & et. al., 2013). In this regard, organisations are recognised to conduct business operations on a global context with better efficiency and effectiveness. The transactions include transfer of goods and/or services, investment, logistics, manpower, ideas, and technology among others (Economic Watch, 2010). Thus, international business comprises all the elements and activities that take places between two and more countries beyond geographical boundaries. Whereas, the concept of the economics deals with the interaction amid different segments that includes individuals, governments and firms for making necessary allocation and choices from the scare resources in order to satisfy incomprehensible demand. The study of the overall economic comprises both the nations and international environment. The economy of one nation varies with other nations due to differences in the political structure, culture and environmental conditions. International business issues are duly recognised as the key issues in international trade that mainly emerges due to change in the economic environment of the nation Moreover, international trade is highly affected with the fluctuation in the currency rate of the two economies. Currency exchanges rate signify the valuation of one nation’s currency with respect to the other nation’s currency. Moreover, the exchange rate fluctuates with respect to the time frame and thus, the concept of country trade performance is highly depended on the foreign exchange rate, which also plays an important role in international trade (Miles & Scott, 2005). In this regard, it can be stated that international trade is highly affected due to the exchange currency rate. Correspondingly, the essay highlights the international business economic issues in relation to changes in the currency rate during international trade. Besides, the trends of the currency exchange rates with respect to the developing and developed nations are analysed. The most possible effect of currency fluctuation in the international trade and the reason for which nation needs to evaluate the currency rate regularly will also be discussed. Furthermore, the analysis helps to have a better understanding of the trend in the currency rate and its possible impact on the economic performances of the nations. 2. A Brief Understanding about the Issue In the tradition trading system, the barter economic system is followed for trading goods and/or services between the nations. According to this approach, nations trade goods in which they have competitive advantage with respect to other goods. However, this system of exchange is significantly becoming highly complicated to derive the actual monitory value of the trade. Thus, a standard system has been devised and eventually country develops respective currency for trading. Moreover, with the development in the concept of the national currency, the term foreign currency exchange is the prior importance for the transfer payment of the monetary business between the two nations (Miles & et. al., 2012). In particular, for conducting trading business, organisations eventually need to make the payment on the basis of their own national currency. Thus, the exchange of currency is becoming an integral part in the international business. In international trading, foreign exchange rates remain stable as well as fixed due to the dependency on the ‘gold-exchange standard’. Additionally, during the year 1971, US dollars were not exchanged with respect to the gold and floating exchange rate system. Thus, in the current scenario, currencies of different nations valued in accordance with the market forces i.e. demand and supply. The concept of the currency rate involves the rate of exchange in the two different economies. The value of exchange rate derives the value of the foreign currency that the nations can obtain with respect to the one unit of domestic currency. In the current scenario, with the changing requirement and increase in global trading, the trading partners are exposed to the international business issue related to the currency rate fluctuations. In import and export of goods, the involvement of the domestic and foreign currency is the key determinant. Trading with foreign nations is always exposed to risk or international issue of currency rate because the currency transactions are highly sensitive to any fluctuation in the exchange rates, as the prices in which the trading agreement has been agreed for buying and selling with foreign traders changes on a daily basis. In the current market condition, the economic climate changes in a rapid manner due to different factors that include political condition and environment among others, which in turn are also accountable for faceting the currency rates. In this respect, it is difficult to interpret fluctuation in exchange rates. Correspondingly, economic analysts and the policy makers revealed the fact that some countries to gain trade advantage are significantly using unfair exchange rate policies. In this regard, various unfair policies are used by policy makers in a nation. Policy makers with the assistance of unfair practices deteriorate currency valuation, so that the export value of the goods is boosted and create high jobs opportunities. This underlying situation is accountable for creating “currency war” in the global economy context, as the other nations are highly affected with the same. Moreover, the currency rate is becoming very crucial international business issue especially for many companies and business units dealing in the overseas product and/or services. Besides, the changing trend of the currencies on a continuous basis is of the direction that can lead either to significant gains or losses in various aspects (The Library of Congress, 2013). Conceptually, the reliance of a nation in the foreign market for trading goods and/or services, investment, people and organisations need to purchase the currency in which the transaction has taken place. In this regard, with the increase in the trading activities the foreign exchange rate management is becoming a noteworthy consideration for making decisions regarding the currency exposure. Moreover, selecting an appropriate strategy to minimise this issue is often becoming a difficult task due to higher complexity involved in measuring the accurate currency risk exposure (Papaioannou, 2006). 3. A Detailed Analysis of the Trends of Currency Exchange Rates in Developing and Developed Nations Exchange rate is the value of the one nation currency with respect to the other nation’s currency. In this respect, for better valuation of a currency, the exchange rate of the currency is determined on the value of another country for better trade operations. The comparative demand of one currency reflects the fundamental demand of the good that are dominated with that particular currency whereas, international flows of capital is also having a stronger influence over the demand of other currencies. In this regard, the respective central bank of the nation also plays a crucial role to form a proper equilibrium in the market by regulating the supply of its currency in the larger international market. In both developed and developing nation there are two regimes through which the exchange rates of the country is been determined that includes fixed rate and floating rate. Floating rate reflects that the valuation of their currency fluctuates with respect to the demand and supply of the currency in the market. Whereas, fixed rate valuation is dependent on other currency or commodity like gold. Besides, a nation adopts hybrid policy, which is either not purely fixed or floating exchange rate in order to maintain consistency in the currency trend and stabilise an economy for the longer duration. This approach allows a nation to fluctuate the currency with the significant action from devaluating currency in an effective manner. Thus, the extent to which currency rate is fixed or floating varies on the basis of the characteristics that include growth, size as well as relationship. In this context, in order to have a better understanding, it is important to have an in-depth knowledge of the trends in the various developed and developing nations (Nelson, 2013). China China is the world fast growing economy from the past few decades. The government of China has securely undertaken significant measures to manage the value of its national currency i.e. Rimini (RMB) or Yuan against the other currency especially with US$. Additionally, the various analysts believed that China’s currency policy promotes “unfair” trade practices to support its export. From the year 1994 to 2005, China ‘peg’ their currency with the US$ at a constant rate. Besides, from the mid of 2005, Chinese government has been managing the peg system and allowed the currency to fluctuate to respective level and the currency has shown a significant growth during that time. Moreover, during the time year 2008, national currency halts appreciation due to financial crisis in the world, which affected its export. However, the government in the year 2012 allows higher flexibility in valuation of the national currency against the US$, which significantly helped in boosting the national currency by 25% during the year 2005-2012. Moreover, the Chinese government has taken significant measure and policies in the foreign currency as well as in the capital market to manage the appreciation of RMB with respect to US$ (Nelson, 2013). The figure below is related to China’s exchange rate trend. China’s Exchange Rate and Foreign Exchange Reserves (Source: Nelson, 2013) Switzerland During the period of the financial crisis in the year 2008-2009, Switzerland government applied floating exchange rate to control the valuation of the currency. Additionally, having crisis in the economy, Swiss franc is highly regarded as “safe haven” currency and investors are identified to have significant trust in the currency as compare to the other currencies this led to increase the demand of the currency, which raise the concern of the Swiss government regarding the competitiveness of national exports. Swiss central bank has taken significant measure during the year 2009-10 by intervening in ‘foreign exchange markets’ in order to prevent the uneven appreciation of Swiss franc as compare to euro by selling the same for foreign currencies. Moreover, euro zone crisis again puts upward pressure on the Swiss currency and central bank during the year 2011 announces to buy “unlimited quantities” of other currencies in order to appreciate the national currency above the specified value (Nelson, 2013). The figure related to Swiss currency exchange rate trend is depicted below: Switzerland Exchange Rate and Foreign Exchange Reserves (Source: Nelson, 2013) Other Countries With respect to the trend in other developing nations, the emerging nations stated that expansionary policies in the countries including the US, European and the British, are having floating currencies, which have caused the currencies of these nations to depreciate. In this context, Brazilian government concluded that in developed nation, ‘quantitative easing’ was the key factor in the appreciation of their currency is more than 25% as compared to US$ in 2009-10. Whereas, with the implementation of rolling back through the expansionary monetary policies, subsequently helped the developed nation like the US to strengthen its currency. On the other hand, significant alternation in the monetary policies of Japan with the fiscal inductive measure helped in strengthening the nation’s economy. Besides, the ‘expansionary monetary policies’ has played a major role in relative fall in the Japan’s yen, which has fallen at around 25% in the mid of 2012 to 2013 (Nelson, 2013). The figure related to Brazil and Japan exchange rate trend is depicted below: Brazilian Exchange Rate and Foreign Exchange Reserves (Source: Nelson, 2013) Japanese Exchange Rate and Foreign Exchange Reserves (Source: Nelson, 2013) 4. Impact of Currency Exchange Rate Currency exchange rate plays an important role to not only the traders undertaking the export and import activities but also the nation as a whole. The fluctuation in the currency rate is the key determinate in the economic performance of a country. Moreover, to measure the impact of fluctuation of currency in the economy, it is important to estimate its effects in the output, growth, price, inflation, and demand and supply. However, the fluctuation in the currency generally taken place due to the ‘floating rate system’ norm of various economies. The exchange rate fluctuation highly taken places due to the influence of various fundamental as well as technical factors that include the demand and supply of currencies, inflation rate, economic trend, differentials in the interest rate and flow of capital among others. As the result, fluctuation is exchange rate is determined to influence an economy’s fortunes as well as the business environment (International Monetary Fund, 2013). Impact on the Economy The economic environment of a nation is highly affected with the currency level or currency fluctuation. Interest rates, inflation and exchange rate are among the key variable of any country’s economic performance. Whereas, the exchange rates are also identified to play a vital role in a country’s trading operations, this is an important factor to meet the ever changing demands of the citizens of a nation. Thus, it can be stated that there is direct relation between the exchange rate and economic policy, which significantly manipulate the economic condition of the nation (Musyoki & et. al., 2012, Melander, 2009). Effect on the International Trade Exchange rate has a significant impact over international trading, as weaker currency will highly stimulates the import and export to become expensive for trade operations, which ultimately affects the trade balance. Moreover, by having strong control over the exchange rate, the export competitiveness can be reduced and import will become cheaper (Musyoki & et. al., 2012, Melander, 2009). Impact on Economic Growth The trading activity of the nation having the direct relationship with the GDP, as the GDP is calculated by the formula mentioned below: GDP=C + I + G + (X-M) Where, C = consumption I = Investment G = Government spending (X-M) = Export – Import Thus, from the above analysis, it can be affirmed that the GDP of a nation is highly affected with the trade activities, and high GDP is achieved by increasing the export activities for which currency exchange rate plays prior role (Musyoki & et. al., 2012, Melander, 2009). Impact on the Cash Flow In the general context, the flow of the foreign capital is only possible when the nation has high prospect of growth, strong governance, stable currency exchange and dynamic economy. Thus, a nation needs to build high stabilisation in the currency rate to attract more and more investor towards investing their capital in the economy. On the other hand, investors will hesitate while putting their money into the slow growth or a nation whose currency fluctuates in a regular interval. Besides, there are two main sources through which the capital flows in an economy that includes ‘foreign direct investment’ (FDI) and ‘foreign portfolio investment’. In FDI, foreign investors take the stake in the nation by acquiring existing company or establishing new. In foreign portfolio investment, foreign investors invest in the securities of an invested country. Both FDI and foreign portfolio investment are important sources of cash flow mostly from the prospective of the developing nations. Thus, it was important for a country to have a stabilised currency rate, as it highly influences the cash flow activities (Musyoki & et. al., 2012, Melander, 2009). Impact on the Inflation Changes in the exchange rate of one nation also have a major impact on the imported products and inflation rate due to high cost involvement. Devaluation of the currency leads to increase cost of acquisition of import for the same level. For instances, the decline in the domestic currency at around 30% will significantly results in increasing the cost of import by 40% or more (Musyoki & et. al., 2012, Melander, 2009). Interest Rates The consideration of the exchange rate is most important factor through which the central banks of different nations formulate their monetary policy. Additionally, a strong domestic currency helps to have a significant control in the economic activities. Moreover, through further controlling the monetary policy, when the currency is extensively stronger will lead to the problem of hot money in the economy for higher interest or exchange rates (European Commission, 2013). Impact on the Business As stated above, an economy affected with the currency fluctuation has had a significant impact on the business units too. As most of the companies are having branches in the overseas markets or rather they are highly engaged in the international trading activities the in such cases any change in the currency valuation will have a noteworthy impact over its operations. For example, any change in exchange rates will have a significant impact on private investments, profit and losses. Thus, organisations have to regularly evaluate the threat in international trading operations for fluctuation in currency. As during the year 2011, McDonald’s apart from having significant growth in its sales in the Europe market it also has noticed that their yearly profits have been down due to weak performances in Euro. Thus, the currency rate will have high impact not only on the traders involved in international trading but also on the domestic trades because with devaluation in the currency level, the aggregate demand of the domestic products reduces significantly and face losses in its overall activities. Moreover, this will also result in reducing the purchasing power of the people and the cost of rendering the raw material increases (Euro Investor, 2012). Global Influence Correspondingly, having a major influence over the economic as well as business operation, fluctuation in the currency rate is also identified to affect the global market at large. As the foreign exchange market is large financial market with a trade volume in trillion for the various financial instruments. In certain scenarios, currency movement is significantly felt in the world at large. For instance, fluctuation in euro will have multiple impacts on the economy under the euro zone (Musyoki & et. al., 2012, Melander, 2009). 5. Reasons for Evaluating Currency Exchange Rates The currency rate highly affects all the countries irrespective of the facts the whether such countries are developing or developed nations. For instance, during the year 2013, one US dollar exchange for 0.76 Euros, 98 Japanese yen (¥) and 0.65 British pounds (£). Generally, the exchange rates in the international market are reflected in $/foreign currency or foreign currency/$. Consumers, organisations or governments evaluate the exchange rate in order to derive the overall cost of production in the different nations. For example, the US government uses exchange rates to compute the cost it has to bear for importing the goods from Australia in the US dollars. In the similar manner, Australian traders will use exchange rates to calculate the cost of the US goods in terms of Australian dollars. Moreover, the worth of the currency with respect to other currency is been determined through the demand and supply of the currencies in the foreign exchange market. With the increasing international trading activities, the foreign exchange market is significantly developing. In this regard, during the year 2013, trading activities in the foreign exchange markets amounted to around $5.3 trillion per day, which was estimated to be $3.3 trillion in the year 2007 (Bank for International Settlements, 2013). Both overvaluation and undervaluation of the currency are recognised to have significant impact on the economic performances of a nation. On the one hand, overvaluation is the situation at, which currency position itself too high that relatively make the imports cheaper and exports highly expensive. Whereas, devaluation in the currency leads to a situation where exports become relatively cheaper and imports become expensive. For the above discussed facts, it can be affirmed that fluctuation in the currency rate is having a major impact on the various factors of an economy (Sloman & Garratt, 2013). Thus, proper evaluation of the currency exchange rate will result in stating how much an economy is affected from the same. The fluctuation in exchange rates is required to be closely monitored by various policy makers, economists as well as practitioners, so that economic policies and measures are formulated in an effective manner. Furthermore, the exchange rate fluctuation is identified to involve various risk factors that significantly affect trade operations, business operations market conditions and an economy as a whole (Doidge & et. al., 2005). The key reason behind the evaluation of the currency exchange rate includes different factors that are discussed hereunder. Elasticity of Demand Currency exchange rate and demand are directly related to each other, as demand of a product may either be price elastic or inelastic whereas, the fluctuation in currency rate affects the aggregate demand due to changes in the import and export activities. Moreover, the balance of payments depends on demand and supply of import and export. Thus, evolution helps to make key measures of exchange rate fluctuation (Corte & Tsiakas, 2011). Global Economy Currency valuation is identified to have a major influence on the global economy in an immense manner and thus, appreciation and devaluation will significantly affect the demand and supply. Appreciation in the currency value is recognised to increase the demand. On the other hand, devaluation creates inflation situation in an economy. In this regard, the evaluation helps to make key changes in the economic policy and measures (Rodrik, 2008). Inflation Inflation in an economy is highly dependent on various factors in which the currency rate also plays an important role. As devaluation in the currency rate is the major reason responsible for inflation (Corte & Tsiakas, 2011). Measuring the Economic Growth Exchange rate and economic growth are highly interdependent to each other. Both the factors have major impact on each other, as fluctuation may either boost or hinder the overall economic growth. Thus, proper evaluation of the currency rate is an important consideration in the present global market scenario to avail the opportunity and reduce the threats (Corte & Tsiakas, 2011). Other Factors Moreover, evaluation of the currency is necessary and an important factor for ascertaining the possible reasons behind currency fluctuation. In order to remove the obstacles relating to currency fluctuation, currency evaluation is important for the policy makers to have proper understanding about reasons for fluctuation. Thus, proper evaluation will assist the key forces and the government to restore the overall competitive position of a market to contribute to the economic growth (APEDA Agri Exchange, n.d.). 6. Recommendations & Conclusion From the above analysis and discussion, it can be ascertained that the phenomenon of globalisation has facilitated organisations, people and nations at large to conduct business and trading activities beyond national borders with minimal barriers. Correspondingly, traders conduct trading operations on a global context in economically stable nations for enhanced profitability and growth opportunities. International transactions may include transfer of goods and/or services, investment, technology and transportation among others. Moreover, having an increase in the global trading activities, the interdependencies between various countries throughout has also been raised at large. In this regard, an economy has to emphasize over the growing international business issues with respect to the currency exchange rate fluctuation. It can be ascertained that with an increase in the rate of fluctuation in the currency rate, international trading is highly affected. In this context, it can be apparently observed that the global economy faces high imbalances for the emergence from such international business issue. Besides, the trading activities conducted in the foreign exchange market are rapid developing the economy of the various nations is highly influenced by the fluctuation in the currency. In certain scenarios, it has been noticed that despite of having high growth in the domestic economic activities prevailing in a nation, the issue of current devaluation will hinder the entire economy. The factors including inflation, monitory policy, interest rates employment, cash flow from the foreign market as well as the economic growth are affected significantly for fluctuation in the exchange rate. Moreover, the business units were also highly influenced in terms of its profitability and overall operational activity because devaluation reduces the price of the goods and/or services, as it becomes quite cheaper for the foreign traders. Thus, it is quite important that the investors as well as regulatory bodies must adopt certain key measures with the assistance of currency fluctuation can be mitigated successfully. Currency risk arises with the fluctuation in the exchange rate in different scenario and thus, the changes will result to significant gain and loss by converting a national currency into foreign currencies. In order to reduce impact of currency fluctuation, different techniques are used that include financial instruments to hedges the currency along with various other techniques to offset the possible impact. Furthermore, the value highly fluctuates with the supply and demand of the currency in the international market. Thus, by investing in the currency market, investors can make significant impact on the currency valuation, which would be done through investing in the forwards, currency future and currency option. Moreover, the government and various regulatory bodies of a nation need to tighten its monitory policy, which would significantly be helpful to further devaluates the currency rate. The strategy from the government includes effective use of Forex reserves, interest rates measures and tax reforms as important reforms to measure exchange fluctuation. It is expected that these measures will certainly aid in reducing the exposure of currency fluctuation (Döhring, 2008). References APEDA Agri Exchange, No Date. How to Avoid Foreign Exchange Risk. Exchange Rates, Forward Exchange Contracts, Currency Futures & Currency Options [Online] Available at: http://agriexchange.apeda.gov.in/Ready%20Reckoner/How_to_Avoid_Exchange.aspx [Accessed October 29, 2014]. Bank for International Settlements, 2013. Foreign Exchange Turnover in April 2013: Preliminary Global Results. Triennial Central Bank Survey, pp. 1-21. Corte, P. D. & Tsiakas, I., 2011. 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