The Impact of Exchange Rate Fluctuations on The Foreign Economic Activity of Enterprises

 

It is apparent that the current global economy has grown due to an increase in investments, which are facilitated by foreign economic activities such as trade, investment, and immigration. In addition, a decline in unemployment rates has been experienced, thereby increasing disposable income among the population (Shiller, 2014). However, it would be prudent for organizations that have the capability of supporting growth by expanding their operations overseas and making significant contributions to economies of scale. Organizations, whose objectives are to expand abroad, find it difficult to decide to do so because they cannot afford to risk losing market share once more companies enter the industry. Even though there is huge potential to create jobs and support economic development from foreign countries, many factors determine whether firms will venture into regions where local businesses might not offer opportunities for growth (Grewal 2010). As such, many governments and institutions have formulated policies that ensure favorable international business environments for domestic investors. This paper explains the impact of exchange rate fluctuations on the future of FDI, focusing its effects on both positive and negative dimensions. The analysis presents some of the most important concepts to address at this point in the discussion, including Diversification, Market Access, Multinational Growth, Cross-Border Operations, Competition, Product Differentiation, Technology Development, Intellectual Property Rights, Intellectual Property Laws, Environmental Policies, International Policy Instruments, Trade Liberalization, Trade Protection, Taxes, Human Resource Management, Global Reporting System, Non-Tariff Barriers and International Labor Law.

The impacts of changes in interest rates

International markets play a key role in determining economic trends in the world. They allow investors to take advantage of opportunities for increased returns to invest in international industries. Generally, investments in industries that have low barriers to entry (i.e., lower costs of production) tend to perform relatively well than those based on higher barriers to entry (i.e., greater levels of capital resources to expand) (Shiller, 2014). A general view of the interplay between macroeconomic factors and external environmental conditions in international financial markets identifies two main types of variables that affect international financial markets: primary and secondary variables. Primary variables include inflation, exchange rate, and monetary policy. Secondary variables include taxation, fiscal and regulatory conditions (Dodgson 2015). Changes in these variables have a direct effect on foreign economic activity, whereas a change in one variable affects other variables. For example, if we consider changes in exchange rates as shown below, the subsequent diagram shows how exchange rates can affect both international credit flows and investment decisions for multinational enterprises. The following section presents various measures that account for currency volatility and their impacts on FDI decisions as described earlier in this article, including liquidity and security shocks, interest rate spreads exchange rate swaps and forward contracts.

Financial risks

Over the past few years, the financial system has undergone dramatic changes due to the introduction of new technologies that have led to significant changes in how we live, work, and interact with each other (Bajpai 2016). These changes create new issues in the application of accounting, tax, financial reporting, credit reporting, and financing management that must account for the full range of changes. Consequently, the finance sector has had to develop practices designed specifically for the future. Currently, financial organizations need to prepare for events that may occur in the future, even when they have happened in the past, but they cannot predict them. Future events change how we view different aspects of our lives as they apply to all aspects of life. If we anticipate that something will happen, then we can make decisions quickly and act appropriately. There are certain events, such as natural disasters or terrorist attacks, that do not have an immediate impact on us. Nevertheless, the same event could lead to a long-lasting change in our way of living. Similarly, future events could alter what is considered acceptable behavior of society, including people’s preferences for goods and services. Therefore, although no future event will have the same magnitude of impact as a natural catastrophe, our ability to adapt quickly by adjusting our behavior to accommodate a changing world, or changes in our behaviors, has diminished. Consequently, the future must also reflect the consequences of past events and plans for dealing with future ones.

According to Bajpai (2016), the banking sector should focus on the real estate business rather than property-related mortgages that may become outdated over time. Most of the problems in this sector go to underwriters who do not fully understand what consumers want, as well as the consumer-oriented products offered by banks. According to Shiller, (2014, p. 744), “[m]ostly, asset managers tend to look for assets that meet both standards of high liquidity and solvency such that the investor does not see much room for loss in value if it fails to grow through earnings- and cash flow-based approaches” (Shiller, 2014, pp. 737-739). Another problem with property-related mortgages arises at the level of the buyer itself. Mortgage brokers normally require buyers who purchase assets from others to provide guarantees that will cover the loan, but without guarantees, the buyers assume the financial risk when buying the loans from mortgage brokers because the payments of deposits of this type do not cover the loans that are required to buy the items. Therefore, the mortgage brokers do not receive any compensation for their efforts, and sellers lose money while buyers pay the mortgage broker fees. Moreover, another issue associated with property mortgages and other related securities is their tax implications. Although property-related mortgages are only available in some countries, they face a variety of taxes. Additionally, property-related mortgages are subject to penalties such as interest rates, transfer taxes, and stamp duties, among others. All the above taxes often apply to property-related mortgages and other mortgages available even outside of the country of issuance and can have enormous effects on a firm’s performance. The above changes must be addressed before moving beyond the developed countries where properties-related mortgages have already gained ground as asset classes.

The impact of exchange rate fluctuations on the foreign economic activity of enterprises

As mentioned earlier, foreign economic activity in developing countries relies heavily on the expansion of companies. Countries with attractive macroeconomic conditions, such as China, Brazil, India, and Korea, among others, create significant advantages for growing firms looking to establish themselves in these markets, especially in terms of access to resources, labor, technology, information, and infrastructure (Shiller, 2014). Consequently, a surge in the number of multinational corporations in international markets occurs, thus creating opportunities for multinational firms that want to diversify their portfolios in the emerging markets. Unfortunately, this phenomenon creates several challenges for the companies that want to take up positions that are critical to successful growth in the emerging markets because of intense competition, which is exacerbated by fluctuations in exchange rates. For instance, according to Shiller (2014), “ [f]rom 2007 to 2011, when the dollar was trading at near $1.00 per barrel, equity markets were typically down approximately 16 percent compared to the S&P 500 market index, whereas bond markets were typically down about 28 percent” (Shiller, 2014, p. 737). In addition, an overall slowdown in growth-oriented sectors tends to result in more limited supply chains to satisfy needs (i.e. food, shelter, and clothing) among other requirements for employees. Consequently, employers often have trouble recruiting enough staff, leading to wage pressures that add pressure to job satisfaction and productivity (Hernandez 2013). In addition, international demand for workers in the form of outsourcing increases the likelihood of wages, which increases the cost of hiring employees. Due to rising costs, it becomes increasingly difficult for employers to recruit highly skilled workers in the form of university graduates. Furthermore, companies struggle with meeting internal demands by improving employee relationships and fostering collaboration within work units, leading to diminishing motivation. Finally, it becomes difficult to recruit, train, or retain qualified workers because labor law and health insurance policies are inadequate in international employment legislation. Thus, despite having competitive prices, foreign workers in multinational organizations in developing countries lack the means to improve upon this situation.

Even though globalization has contributed significantly to the rapid distribution of wealth, the current economic climate is experiencing a period in which “growth and innovation are slowing down and growth in GDP is expected to remain below potential for many years” (Shiller, 2014, p. 737). Economists argue that this phenomenon might result in a prolonged period of poor quality, reduced flexibility, and stagnant growth because of decreasing possibilities for improved quality, flexibility, and sustainable growth. The outcome of this scenario would be a slower growth rate because of less opportunity to implement innovations and investments. As a result, large gaps between rich and poor become evident, resulting in inequality, which prevents progress in improving the conditions of workers (Bartels & Barry, 2018). In addition, globalization creates obstacles in the transition from rural to urban areas, which reduces rural wages more than urban wages. Thus, the net effects of globalization are seen in uneven growth, which decreases the relative size of the middle and poor in their share of economic growth (Bartels & Barry, 2018). Consequently, multinational companies that operate in developing countries experience severe pressure to compete with global corporations, which results in the emergence of a unique challenge of maximizing shareholders’ value. Because the margins in the stock markets are determined by shares in publicly traded corporations, multinational corporations face greater threats to profitability if their shares do not rise beyond pre-crisis highs. By applying the principle of shareholder value maximization to multinational companies, analysts have found that non-performing companies have a relatively smaller influence on the price of their stocks as compared to publicly listed companies. Moreover, studies show that non-performing companies earn less than those at a similar stage in their lifecycle, which can eventually lead to massive losses.