Competitive exposure -
September 10th, 2010
Competitive exposure is the most crucial dimensions of the currency exposure. Its time horizon is longer than of transactional exposure – say around three years and the focus is on the future cash flows and hence on long run survival and value of the firm.
Consider a firm, which is involved in producing goods for exports and /or imports substitutes. It may also import a part of its raw materials, components etc. a change in exchange rate gives rise to no. of concerns for such a firm, example,
1. What will be the effect on sales volumes if prices are maintained? If prices are changed? Should prices be changed? For instance a firm exporting to a foreign market might benefit from reducing its foreign currency priced to foreign customers. Following an appreciation of foreign currency, a firm, which produces import substitutes, may contemplate in its domestic currency price to its domestic customers without hurting its sales. A firm supplying inputs to its customers who in turn are exporters will find that the demand for its product is sensitive to exchange rates.
2. Since a part of inputs are imported material cost will increase following a depreciation of the home currency. Even if all inputs are locally purchased, if their production requires imported inputs the firms material cost will be affected following a change in exchange rate.
3. Labour cost may also increase if cost of living increases and the wages have to be raised.
4. Interest cost on working capital may rise if in response to depreciation the authorities resort to monetary tightening.
5. Exchange rate changes are usually accompanied by if not caused by difference in inflation across countries. Domestic inflation will increase the firm’s material and labour cost quite independently of exchange rate changes. This will affect its competitiveness in all the markets but particularly so in markets where it is competing with firms of other countries
6. Real exchange rate changes also alter income distribution across countries. The real appreciation of the US dollar vis-à-vis deutsche mark implies and increases in real incomes of US residents and a fall in real incomes of Germans. For an American firm, which sells both at home, exports to Germany, the net impact depends upon the relative income elasticities in addition to any effect to relative price changes.
Thus, the total impact of a real exchange rate change on a firm’s sales, costs and margins depends upon the response of consumers, suppliers, competitors and the government to this macroeconomic shock.
In general, an exchange rate change will effect both future revenues as well as operating costs and hence exchange rates changes, relative inflation rates at home and abroad, extent of competition in the product and input markets, currency composition of the firm’s costs as compared to its competitors’ costs, price elasticities of export and import demand and supply and so forth.
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