The exchange rate refers to the “rate at which one nation’s currency can be exchanged for that of another” (Beardshaw 45).
There are two types of exchange rates namely; the fixed exchange rate and the floating exchange rate. Under the floating exchange rate, the demand and supply forces determine the rate at which the currency of a country is exchanged with that of another country. The government usually determines the rate at which its currency can be exchanged with a foreign currency in the case of a fixed exchange rate. The factors that cause changes in exchange rate include “inflation, balance of trade and the real interest rate” (Beardshaw 46).
The changes in exchange rate have both positive and negative impacts on economic activities. It particularly influences the level of import and export in a country. This paper will focus on the impact of changes in exchange rate on imports and exports in an international business.
Impacts on Exports and Imports
Prices of Commodities
Changes in the exchange rate can result into either an increase or a decrease in the prices of imports and exports. In the context of exports, an appreciation of the local currency will result into an increase in the prices of the exports in the international market. This is because when the currency of the exporting country becomes stronger than that of the importing country, traders in the later purchase the currency of the former at a high rate in order to pay for the goods (Case and Fair 67). This means that the traders will be spending more on the goods even if their actual prices have not been increased.
Thus an appreciation of the domestic currency will make the business’s products to be more expensive in the foreign market. However, a depreciation of the domestic currency will make the exports cheaper (Lipsey and Hurbury 23). This is due to the fact that the customers will purchase the local currency at a low rate in order to pay for the products. An appreciation of the domestic currency will make the imported goods to be cheap. This is because the business will purchase the currency of the country from which the goods have been imported at a low rate (Thurbecke 113). This means that importers will spend less money to import the goods and this translates into low prices. On the other hand, a depreciation of the domestic currency will force the business to purchase the foreign currency at a high rate. Thus it will spend more in importing the goods and this translates into higher prices (Kwack 61).
Demand and Supply
The demand for the export products will be high if the domestic currency depreciates. This is due to the fact that the customers in the export market will spend less to import the goods and this translates into low prices. The low prices will increase the demand and supply of the export products (Mallick and Marques 770). However, the demand for the export products will reduce if the local currency appreciates. This is due to the fact that such appreciation will translate into high prices as customers spend more in importing the goods. This leads to low demand and supply of the export products. The demand for imports will be low if the domestic currency becomes weak (Amor 113).
This is because the business will spend more to import the goods as the cost of purchasing the foreign currency in order to pay for the goods increases. This leads to high prices and this translates into low demand and supply. However, the demand for imports will be high if the local currency appreciates since the favorable exchange rate will lower the costs of importing the goods.
The marketing of both imports and exports is directly influenced by changes in the exchange rate. It particularly influences the marketing mix and segmentation process in regard to the exports and imports (Blinder and Baumol 134). A depreciation of the domestic currency results into high demand for the export products. Thus the business will focus on increasing distribution and identifying new segments in order to increase sales.
However, an appreciation of domestic currency lowers the demand for the export products. Thus the focus of marketing will shift to promotion and segmentation. Promotional activities will be emphasized in order to increase sales.
Besides, only products whose demands are not price elastic will be distributed. As the demand for the imports increases due to the appreciation of the domestic currency, the marketing team will focus on increasing distribution and identifying new segments in order to increase sales (Ito, Isard and Bayoumi 23). However, as the demand for the imports reduces due to the depreciation of the domestic currency, the marketing team will focus on promotion and selective distribution in order to increase the sales of the imported goods.
Sources of the Imports
Changes in exchange rate will influence the diversification of the sources of import goods. In order to avoid the risks associated with fluctuations in exchange rate, businesses usually diversify their sources of import goods.
This means that they import the same product from different countries. They will always import from countries whose currencies are depreciating or are weaker as compared to that of their country (Thorbecke 509). This enables them to take advantage of the low cost of purchasing the foreign currency in order to pay for the imports. This leads to low prices and high demand for the products.
Currency Selection and Payment Contracts
Since countries use different currencies, an export and import business must decide its preferred currency for accepting payments or making payments. As discussed above, the fluctuations in the exchange rate has a direct impact on prices and demand for both imports and exports. Thus in order to avoid or to reduce the risks associated with exchange rate flactuations, international businesses always focus on sharing such risks with their partners (Blinder and Baumol 79). This has always been done by choosing a currency that is relatively stable. The selected currency must be accepted by both the exporter and the importer. For example, the US dollar is commonly used in international trade due to its stability. Thus changes in exchange rate determines the currency for paying for the imports and exports.
Returns on Exports and Imports
The changes in exchange rate have a direct impact on the profits that accrue from both import and export trade. A depreciation of the local currency will increase the demand for the export goods. This leads to high sales and an increase in profit margins (Case and Fair 75). However, an appreciation of the local currency leads to a reduction in sales and profit margins as the products become more expensive in the export market. In the case of imports, an appreciation of the local currency leads to high demand and this translates into high sales and profits.
However, the depreciation of the local currency will negatively affect sales as prices increase due to the high cost of purchasing foreign currency in order to pay for the imports. As the sales reduce, the profits also reduce.
A stable exchange rate will enable the business to sustain the desired level of revenue. This is because the demand and supply as well as sales will not be adversely affected by the fluctuations in exchange rate as discussed above. Thus the company will be able to obtain the funds that are needed for research and development in order to produce the goods and services that meet the expectations of the customers. However, fluctuations in the exchange rate undermine the financial performance of an import and export business (Kwack 62).
This forces international companies to direct a high percentage of their revenue towards the implementation of strategies that enables them to survive the negative effects of exchange rate fluctuations. Such strategies include sales campaign and sharing the costs of importation or exportation with the customers. Consequently, very little funds are allocated for research and development and this undermines the process of product development.
The above discussion shows that the exchange rate has a great influence on import and export businesses. The businesses gain when the exchange rate is favorable as discussed above. However, they lose when the exchange rate is unfavorable. The undesired effects of changes in exchange rate on exports and imports include increase in prices and reduction in demand and profit margins (Case and Fair 58).
Changes in the exchange rate can also lead to a reduction in prices and an increase in demand and profits. Thus it is upon the business owners to understand the dynamics of the exchange rate in the market in order to avoid the risks associated with exchange rate fluctuations.
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