What are the effects of currency value on business firm's performance?

Answer 1

Qn. Discuss the effects of currency value towards the firm's business performance

A currency is a unit of exchange facilitating the transfer of goods and for services it is one form of money, where money is anything that serves as a medium of exchange, a store of value, and a standard of value.A currency is the dominant medium of exchange to facilitate trade between currency zones.There are exchange rates which are the price at which currencies can be exchanged against each other.

The "power " on which the currency hold is called currency value.

The effects of currency value on business firm's performance can be traced by looking at both when the value of currency is low and when value of such currency is high in relationship to the performance of business firms.

Basing on monetary tools, there are both officials and unofficial fall or increase in the value of currency.

The effects of currency value are due or are the results of monetary tool's both official and those unofficial, there can be categorized as follows.

Officials Monetary tool's

☼-Devaluation

☼-Revaluation

☼-Appreciation

UN OFFICIAL MONETARY TOOLS

☼-Depreciation

☼-Inflation

☼-Deflation

Business firm's performance is affected by currency value during or at the time of International foreign currency exchange buying (importing) or selling (export) of goods and / products.

It depends on the economic status of the Country where the business firm is belongs during trade compared to economic status of the corresponding country, This can be shown as follows basing on different economic status of the country.

During Devaluation and Depreciation.

Devaluation is a reduction in the value of currency with respect to the other monetary units, Inn common modern usage.

It is specifically implies an official lowering of the value of a country currency within a fixed exchange rate system by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency.

In contast (currency) Depreciation is the most often used for unofficial decrease in the exchange rate in floating exchange rate system

.

Depreciation and devaluation are sometimes used interchangeably, but they always refer to the value in terms of the oher currencies.

Present day currencies are usually Fiat currency with insignificant inherent value .

The value of currency is determined by interplay. As some country hold floating exchange rates, rates other maintain fixed exchange rate policy against major currencies ie Usd,Euro etc.

There are fixed rates are usually maintained by a combination of legally enforced capital control or through government trading of foreign currency reserves to manipulate the money under fixed exchange rates

.

Persistent capital out flows or trade deficits may lead countries to lower or abandon their fixed rate policy, resulting in a devaluation (As a persistent surpluses and capital inflows may lead them towards revaluation).

However that the devaluation would reduced deficits depends on fulfilling the mearsshall lerner condition. The sum of export and imports elasticities ( In absolute value must be greater than one).

In an open market the perception that a devaluation in imminent may lead speculators to sell the currency in exchange for the country's foreign reserves, increasing pressure on the issuing country to make an actual devaluation.

So the devaluation of a currency to make a Country's goods more competitive on the international is called " competitive devaluation " This has the following effects to the business firms performance.

Firstly, Increase/ Encourage Export.

The value of the curre ncy has been devalued against a counter part foreign currency, the domestics business firms has been highly encouraged to export in return of foreign currency this boosts the performance and increases the revenue/ profit of the firms. Also foreigner increases their demands for products of the firm as their one foreign currency units buys more domestics products

.

Secondly, Discouraging importation.

Devaluation discourage importation as the domestics currency has low value more currency units of a domestics firm buys less the products from foreign countries. This improves freeness of the business firm due to low competition from foreign products.

Thirdly, Increase in foreign currency reserve

Devaluation leads to the increase of foreign currency reserve as the export will be higher than imports, this leads to the well being of the business firm to exchange currency.

During Revaluation / Appreciation

Revaluation means a rise of the a price of goods or products where it is a rise of currency to the relation with a foreign currency in a fixed exchange rate. Where in floating exchange rate it is called " Appreciation" the autonyme of revaluation is Devaluation.

In some cases a country may revalue its currency higher ( the opposite of devaluation ) in response to a positive economic condition, to lower inflation or to please investors and trading partiners. This would imply that existing currency increased in value as opposed to the case where a country issues a new currency to replace an old currency that had declined excessively in value.

During inflation :

Inflation is a rise in general level of prices of goods and services in a given economy over a period of time. It may also refer to the rise in the prices of some more specific sets of goods or services. In either case.It is measured as the percentage rate of change of a price index.

The high rates of inflation are caused by high rate of growth of the rate of money supply changes in inflation are sometimes attributes mostly to changes in real demand for goods and services or fluctuation in available supplies (ie changes in search ) and sometimes of value of currency as the result this affects the business firm performance as follows.

Effects of inflation

A small amount of inflation is generally viewed as having a positive effect on the economy. One reason for this is that it is difficult to renegotiate some prices, and particularly wages, downwards, so that with generally increasing prices it is easier for relative prices to adjust. Many prices are "sticky downward" and tend to creep upward, so that efforts to attain a zero inflation rate (a constant price level) punish other sectors with falling prices, profits, and employment. Efforts to attain complete price stability can also lead to deflation, which is generally viewed as a negative by Keynesians because of the downward adjustments in wages and output that are associated with it. More generally because modest inflation means that the price of any given good is likely to increase over time there is an inherent advantage to making purchases sooner than later.

This effect tends to keep an economy active in the short term by encouraging spending and borrowing, and in the long term by encouraging business firms performance in investments.

High inflation, though, tends to reduce long-term capital formation of the business firm by hurting the incentive to save, and to effectively reduce long-term spending by making products of the business firm less affordable.

Deflation, by contrast, leads to an incentive to save more and encourages less short term spending potentially slowing economic growth of the business firm.

Inflation is also viewed as a hidden risk pressure that provides an incentive for those business firms with savings to invest them, rather than have the purchasing power of those savings erode through inflation.

In investing, inflation risks often cause investors(business firms) to take on more systematic risk, in order to gain returns that will stay ahead of expected inflation. Inflation is also used as an index for cost of living adjustments and as a peg for some bonds. In effect, inflation is the rate at which previous economic transactions are discounted economically.

Inflation also gives central banks room to maneuver, since their primary tool for controlling the money supply and velocity of money is by setting the lowest interest rate in an economy - the discount rate at which banks can borrow from the central bank. Since borrowing at negative interest is generally ineffective, a positive inflation rate gives central bankers "ammunition", as it is sometimes called, to stimulate the economy. As central banks are controlled by governments, there is also often political pressure to increase the money supply to pay government services, this has the added effect of creating inflation and decreasing the net money owed by the government in previously negotiated contractual agreements and in debt hence affecting business firms performance economically

However, in general, inflation rates above the nominal amounts required to give monetary freedom, and investing incentive for the business firms, are regarded as bad, particularly because in current economic theory, inflation begets further inflationary expectations.

Increasing uncertainty may discourage investment and saving of the business firm.

Redistribution

It will redistribute income from those on fixed incomes, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits business firms. which may keep pace with inflation.

Similarly it will redistribute wealth from those business firms which lend a fixed amount of money to those which borrow. For example, where the business firms are a net debtors, as is usually the case, it will reduce this debt redistributing money towards the business firms. Thus inflation is sometimes viewed as similar to a hidden tax.

International trade

If the rate of inflation is higher than that abroad, a fixed exchange rate will be undermined through a weakening balance of trade.

Shoe leather costs

Because the value of cash is eroded by inflation, people will tend to hold less cash during times of inflation. This imposes real costs, for example in more frequent trips to the bank. (The term is a humorous reference to the cost of replacing shoe leather worn out when walking to the bank.) this results to failure of the business firm since the value of currency is low and the business may have a risk in holding money ,which will cause less profit during currency exchange with other international foreign currency.

Menu costs

Business Firms must change their prices more frequently, which imposes costs, for example with restaurants having to reprint menus and advertisements.

Relative Price Distortions:

Business firms do not generally synchronize adjustment in prices. If there is higher inflation,business firms that do not adjust their prices will have much lower prices relative to firms that do adjust them. This will distort economic decisions, since relative prices will not be reflecting relative scarcity of different goods.

Hyperinflation:

if inflation gets totally out of control (in the upward direction), it can grossly interfere with the normal workings of the economy, hurting the ability of the business firms to supply.

Bracket Creep (also called fiscal drag) is related to the inflation tax. By allowing inflation to move upwards, certain sticky aspects of the tax code are met by more and more people. For example, income tax brackets, where the next dollar of income is taxed at a higher rate than previous dollars, tend to become distorted. Governments that allow inflation to "bump" Business firms over these thresholds are, in effect, allowing a tax increase because the same real purchasing power for raw matelials and or products for resale are being taxed at a higher rate.

As noted, some economists see moderate inflation as a benefit; some business executives see mild inflation as "greasing the wheels of commerce. Some economists have advocated reducing inflation to zero as a monetary policy goal - particularly in the late 1990s at the end of a long disinflationary period, when the policy seemed within reach; and some have even advocated deflation instead of inflation.

High inflation can cause many problems in relation to control and operate of the business firm as the value of currency depreciates:

It hurts people on fixed incomes (e.g. pensioners, students) by reducing their purchasing power. This has a significant effect on GDP,,where by in one way or another reduces the consumer capacity for the business firms products, leads to decrease in business revenue and profit affecting the economic decision and plans of the business firms.

Rising inflation can prompt business firms to demand higher wages, under the circular logic that wages must keep up with inflation. (Of course, rising wages can help fuel inflation.) In the case of collective bargaining, wages will be set as a factor of price expectations (Pe). Pe will be higher when inflation has an upward trend. This can cause a wage spiral.

Also, if strikes occur in an important industry (business firms) which has a comparative advantage, productivity could decline.

If inflation is higher in one country than in its trading partners', and that country maintains fixed exchange rates, then the country's business firms exporters will become more expensive abroad and it will tend toward a current-account deficit.High inflation distorts relative prices. The pricing mechanism allows for the efficient allocation of resources and if prices are misaligned this will lead to an economically inefficient allocation of resources

Business firms which are debtors, helped by inflation due reduction

of the real value of debt burden.

Recommendation.

As it has been observed from the foretold explanation looking at the effort of currency value on business performance.

It is now well known that fluctuation of the power of currency ( value of currency) has both negative and positive effects. This has been shown basing on every possible economic status of a country ,which means during when the value of currency value is high (during appreciation ,revaluation ) and during when currency' value is low (during inflation ,devaluation ,and depreciation )

So the business firms performance will tend to be high and convincing during when the currency value is high and moderate ,but when the currency value is low it is not a comfortable situation for the performance of the business firms

BY PATRICK MWISUA CHAPEWA

TANZANIA INSTITUTE OF ACCOUNTANCY.2008