Currency depreciation happens when a nation’s currency exchange rate (e.g. the Chinese Yuan) decreases in value in comparison to another country’s currency (e.g. the U.S. Dollar).
So, if the dollar increases in value compared to the Yuan, it means U.S. based businesses or individuals could receive more for their money from an overseas supplier than they did previously, even if the price in the foreign currency is unchanged. On the other hand, Chinese companies will pay more for their imports and receive less for their exports.
It is, for this reason, that currency appreciation/depreciation can severely impact companies that primarily export or import goods. While securing customers and generating sales can increase an individual company’s profit margin, it is a country’s economy that can determine the growth and survival of an entire industry.
Drawbacks of Currency Depreciation
Currency depreciation has the largest impact on companies that import the majority of their raw materials because that means that the value of their currency is falling meaning that foreign suppliers require the company to pay them more for the same product. It is equivalent to a price increase to the buyer even though the supplier still gets the same amount of their own currency.
The impact the exchange rate will have on an organization will be determined by various factors. For instance, if a company imports the majority of its raw materials and only sells their finished product to the domestic market, they will lose money due to currency depreciation. However, if they sell a large enough percentage of their finished products overseas, it is possible that they will make money from the depreciation.
The Benefits of Currency Depreciation
Currency depreciation isn’t bad for all businesses. In fact, it can positively impact small US companies who sell to foreign parties. Recently China announced that they were devaluing the value of the Yuan in an effort to make their exports cheaper in foreign markets.
Tourism might also increase following currency depreciation, as overseas travelers might view a nation as a more affordable destination to visit, as they will receive a bigger sum when they convert their money to the country’s currency. As a result, popular tourist destinations might experience increased visitors, which can financially support stores, restaurants, bars and other businesses during a tough economic period.
The Indirect Impact of Currency Depreciation
Even if your organization doesn’t buy from or sell products to other countries, it is likely the global economy will still impact your business. For example, currency depreciation can increase the price of imported fuel, so U.S. based businesses could spend considerably more on gas for transportation and logistics services across the United States.
A weakened dollar can lead to businesses and consumers suffering from higher rates of inflation. As most products across the United States are imported, increased import fees can lead to higher prices for various products. This is because companies will need to boost their own prices to meet the rising cost of products and employee salaries.
While this tactic can help businesses to survive during a difficult economic crisis, it is the customer who will face the financial burden, which can lead to them spending less money at bricks and mortar or online stores.
An Increased Likelihood of Mergers and Acquisitions
When a currency drops in value, the nation’s businesses will often be targeted for foreign merger and acquisition attempts. Similar to exported goods, the companies will be viewed as cheaper in value, so international companies will be more likely to buy them by exchanging their own currency for the dollar. However, this can be a handy option for both shareholders and business owners who are eager to sell up.
The Effects of Currency Depreciation on Financial Instruments
The depreciation of the US dollar can provide an incentive for foreign investors (and nations) to buy U.S. Treasury Bonds and Notes. At least initially it allows foreigners to buy more bonds and perhaps get a higher interest rate return on their investment. However, in the longer term if the Dollar continues to slide they will end up receiving fewer of their own currency when the bond matures.
Thankfully, there are ways organizations can protect themselves from exchange rate fluctuations, so their finances are not affected by exchange rate volatility. For example, they can use fixed contracts when buying imported raw materials, which will allow them to enjoy a set rate for between 12 to 18 months, regardless of the financial climate. It can, therefore, provide business certainty when other companies are faced with an uncertain financial future.
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