Emerging Market Currency Volatility…It’s Getting “Real”

“Currencies should not be used as a tool of competitive devaluation. The world should not make the mistake that it has made in the past of using currencies as the tools of economic warfare.”
– George Osborne, Britain’s Finance minister

For emerging market finance ministers, the concept and impact of “currency wars” is very real. As loose monetary policies in developed economies encourage high capital inflows to emerging markets (often referred to as “hot money”), emerging countries struggle to control inflation and the upward pressure on their currencies. This often leads to a surge in competitive devaluations as governments feel compelled to intervene in order to protect fragile domestic economic recoveries, which has the resulting consequence of amplifying currency volatility. However, these competitive devaluations should not be considered as “economic warfare”, they are economic stabilization measures and a natural result of expansionary monetary policy. As many media outlets implicitly (or probably explicitly) understand, conflict is much more exciting than accord. By emphasizing the antagonistic aspects of these decisions, they are unfortunately misleading the public into thinking that these interventions are purely for competitive purposes.

However, multinationals are impacted when emerging markets governments respond to capital inflows by more aggressively printing money to sell on the open market to buy hard currencies. The reality is that the selling of local currency to buy developed-market bonds creates a cycle that further depresses yields in developed markets, pushing more capital to emerging markets, restarting the cycle of currency volatility again. Unfortunately for international executives, currency volatility creates many problems, such as difficulties in:

1. Pricing products
2. Anticipating costs
3. Uncertain business planning
4. Greater reluctance to hire new employees
5. Price instability in commodity markets

For international executives that are increasingly focused on profitability, currency volatility is one of the most important trends to watch this year. For example, a 10% increase in profitability in a given market will be essentially wiped out by a 10% decrease in the value of the local currency when results are reported.

Currency Volatility Chart

 

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