2020 has been a year of currency fluctuations, with most prominent Asian currencies like the Malaysian Ringgit, South Korean Won and the Philippine Peso, depreciating against the greenback, at alarming rates over the course of a year. Agreeably, the depreciation of a currency is concerning for the country in question; however, the far-reaching effects of currency fluctuations are often overlooked.
What causes currency fluctuations?
Currency fluctuations arise from the floating exchange rate system, which is followed by most major economies. The exchange rate of currencies against others depends on various factors such as relative supply and demand for currencies, economic growth of countries, inflation outlook, capital flows, and so on. As these factors are continually changing, currencies fluctuate with them. The fluctuation of a country’s currency can have a far-reaching impact on the country’s economy, consumers, businesses and remittance inflows. This means that whether a country’s currency appreciates or depreciates, it will have both positive and negative impacts on a country’s economy, depending on the sector. Let’s take a closer look at the impact of exchange rate on economic growth.
One of the most prominent impacts of currency fluctuations can be seen in international trade. Generally, a weaker currency stimulates exports and makes imports expensive, thus decreasing the country’s trade deficit depending on the sector. On the other hand, a strong currency can reduce exports and make imports cheaper, effectively widening the trade deficit. While it is generally assumed that a strong currency is a good thing for a nation’s economy; in reality, it might not be so. An unjustifiable strong currency can cause a drag on the economy over the long term, as entire industries are rendered uncompetitive and thousands of jobs are lost. As GDP is directly linked to exports, a weaker currency may actually help the country’s economy, contrary to popular belief. On the other hand, a depreciating currency can result in inflation as the cost of importing goods increases. Currency fluctuations also have a direct impact on the monetary policy of a country, as exchange rates play a vital role in deciding exchange rates set by a country’s central bank. Constant currency fluctuations can also affect the market adversely, causing it to become volatile, and affecting both local and foreign trade.
Currency fluctuations have a significant impact on the consumer. As mentioned above, a weak currency increases the cost of imports and eventually, this cost is borne by the consumer. For example, buying a foreign car might get more expensive if your country’s currency depreciates, which means that you might end up paying more money to get an item of the same value. On the other hand, a stable currency allows consumers to buy more. This increased spending further benefits the overall economy of the country. Gas prices are also affected in a big way due to foreign currency fluctuations. When the US dollar strengthens against other currencies, we see a dip in oil prices. To decode why that happens, it’s important to know that major oil-exporting countries like Saudi Arabia have their currencies pegged to the US dollar. So, when the greenback gets stronger, so does the Saudi Riyal, making Saudi Arabia’s imports cheaper. Due to this, Saudi Arabia can afford to charge lower prices for oil. With oil prices affecting the cost of commodities worldwide, consumers can directly feel the effect of these inter-linked fluctuations.
Currency fluctuations affect all kinds of businesses, but businesses that export or import supplies from other countries are most severely affected. A change in currency can have a direct impact on a business’s bottom line. For example, if a company headquartered in the U.S projects a profit margin of USD 6 million in a year, it could reduce to USD 5.5 million if the dollar weakens against the ringgit. Similarly, they could see an increase in their profit if the dollar performs strongly against the ringgit.
Even if a business does not buy or sell to other countries, these fluctuations can have some unforeseen consequences. For instance, if a company uses trucks to move its products and a currency change fluctuates the cost of fuel, there will be a direct impact on shipping costs. On the other hand, a depreciating currency can also help domestic businesses sell more locally by reducing the country’s imports.
Some smaller businesses might lack the back-up finances to deal with exchange rate fluctuations. They usually establish a ‘forward contract’ to hedge their financial risk and ensure that their business will be protected from significant losses arising from foreign currency fluctuation.
Remittances not only benefit individuals; they also benefit the economy. According to the World Bank, remittances come second only to Foreign Direct Investment (FDI) as a country’s resource inflow. For many small and developing countries, there will be a direct impact on the steady flow of foreign currency into the country.
Expats who send money back home on a regular basis keep a constant eye on exchange rate fluctuation, since they stand to benefit or lose from any fluctuation. When a country’s currency weakens, its expats in other parts of the world get more value on their money transfers; and we can see a rise in inward remittances to the country. Being a preferred money transfer brand for millions of expats around the world, Monest witnesses a direct impact of exchange rate fluctuations. Some expats go to the extent of taking loans to make the most of the exchange rates. In turn, an increase in remittance inflows helps the country’s economy by enabling its citizens to spend and invest.
Foreign currency fluctuations have an impact on almost every aspect of our lives, from the highest rungs of the government to the smallest piece of clothing we import, even though we may most often overlook the link. Understanding how it all works can help you make the right financial decisions at the right time.
By Suren Subramaniam | 19 November 2020