With globalization, international businesses have changed from what they used to be. Foreign exchange rates are truly a global phenomenon affecting the profitability of international businesses.
Let’s investigate how do exchange rates affect international trade, their effect on international business, and the strategies to cope with the fluctuation in exchange rates.
What are Exchange Rates?
The exchange rate between two currencies is the rate at which one currency can be exchanged for the other. It is also referred to as the foreign exchange (FX) rate.
The currencies work in pairs in the Forex market, meaning one currency is exchanged with another in every transaction exchange.
For instance, if we relate with euro to the rupees exchange rate, one euro equals 223.53 rupees, meaning you will have to pay more if you want to purchase a product, commodity, or service in rupees; the euro is stronger than the rupee.
If we look at INR to euro conversion, INR is stronger than the euro. One INR is equal to 0.0136 euros.
Factors Causing Foreign Exchange Rate Fluctuations :
Various factors are involved in exchange rate fluctuations between any two currencies.
These factors may include:
- Pace of economic activity
- Recent political scenarios
- Market interest rates
- Unemployment rates
- Changes in the gross domestic product (GDP)
- Inflation rates
- Geopolitical factors
- Industrial production
- Unemployment rate in each country
- Global events, e.g., pandemics, natural disasters, war, etc.
How Exchange Rates Affect International Business :
Whatever affects the value of the currency will also impact international business. This is true, especially in the import-export business.
Foreign exchange rates are set in the global financial marketplace, where currencies are traded. Foreign exchange rates continue fluctuating daily, even minute to minute, due to the twenty-four-hour global nature of currency markets.
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These fluctuations in foreign exchange rates affect the profitability of the international business in many ways, such as by changing the cost of supplies purchased from a different country and the attractiveness of their products to overseas customers; we will be discussing the major ones.
Flux In US Dollar Exchange Rate :
The currency that is mostly used in trade is the US dollar. Most valuable commodities, such as gold, copper, aircraft, and aluminum, are priced in US dollars.
If the US dollar is strong against your country’s currency, you will have to pay higher prices to get these commodities; this reduces your competitive advantage and makes it less desirable to consumers.
Thus, if the dollar price falls compared to the home currencies of some of his customers, the products on the online store will significantly become cheaper.
In case the price of the US dollar rises against some other customers’ home currencies, the products on the online store will be dearer to them.
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Supplier Payments And Raw Materials :
Entrepreneurs are dependent on an overseas suppliers for services or raw materials. When an entrepreneur signs a deal with an overseas supplier, the business is open to variations to get the best foreign exchange rate.
The problems can erupt in imports if a currency your business operates in depreciates; however, it benefits exporters. On the other hand, if a currency appreciates, its value is increased, meaning the entrepreneur can pay far less for materials. In this case, the exporters are badly impacted, and importers are benefitted.
Conversion Fees of Foreign Currency :
International businesses involve international payments; currency conversions in businesses require charges when they send and receive money because banks charge a premium on foreign currency rates.
When it comes to sending money internationally, wire transfers are done by many banks. This long-established method can be slow and expensive.
An intermediary bank is sometimes used in the middle of a transaction when banks lack established connections in the receiving country. In this case, intermediary banks take their charges besides wiring fees.
Indirect Impact On Business :
Volatility in foreign exchange rates also impacts businesses indirectly, even when you are not involved in overseas sales purchases.
For instance, if products need to be delivered around the country, the increase in fuel costs is due to exchange rate fluctuations; consequently, you will have to pay more for your shipments.
Managing Impact of Foreign Exchange Rate Flux :
The impact of change in currency rates on international business can be managed in the following ways:
Monitor change in Foreign Exchange Rates :
Stay informed of the level and direction of the exchange rates that matter to your business (i.e., those of the countries you buy from or sell to).
Find the best foreign exchange rates or alternative suppliers :
If an entrepreneur finds that the US dollar is weak compared to a foreign supplier’s currency, and it can drive up the price you have to pay to foreign suppliers, he can explore alternative suppliers at home or in countries with the best exchange rates.
Renegotiate Business Deal :
In case the US dollar is getting a stronger position as compared to a foreign supplier’s currency, and prices are not adjusted downward by your foreign suppliers, it may be time for you to reconsider or renegotiate your business agreement keeping in mind that your dollars are now worthier than they used to be.
Increase Marketing of Products/Services :
If you want to boost your sales, you may increase the marketing of the products or services in countries whose currencies have appreciated versus the U.S. dollar. Your products are effectively on sale without you having to drop the price.
Finally, the risk of your exposure to fluctuations in foreign exchange can be mitigated through the financial markets. Still, it should be discussed with a credible financial professional with expertise.
Final Thought :
Globalization has offered many benefits to the entrepreneurs, such as providing a marketplace for selling products and comparing shops for goods from around the world.
Besides being beneficial, globalization is also challenging, especially if you have an international business and are dealing with a global customer base.
One of these challenges is fluctuations in foreign exchange rates, which can impact your international business transactions.
Monitoring exchange rates and considering the best foreign exchange rate for the profitability of the international business can help mitigate the risk.
