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Navigating Currency Risks

By May 9, 2018October 7th, 2020No Comments
Navigating Currency Risks

Entering new markets comes with unique opportunities and challenges. Not least among the latter is navigating the complexities of transactions in multiple currencies. From inflation to purchasing power stability, currency considerations should be a central part of any business’ global expansion strategy. But the challenges extend beyond just the currencies; many payroll teams lack the experience or training to effectively manage, hedge risks, or track global currency markets. Though currency complexities and outright headaches are rife in some markets, there are also ways of navigating these obstacles. Below we highlight examples of currency risks in specific markets, as well as how international payroll solutions can benefit global expansion efforts.

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Know Your History

Currency risks in specific countries rarely occur in a vacuum; there are myriad reasons these risks exist. And having at least a broad understanding of a target country’s social, political, and economic histories will aid a business well when weighing these risks. Argentina is a prime example of why gaining this understanding benefits businesses looking to expand into new markets.

In the late 19th and early 20th centuries, Argentina’s GDP grew at an annual rate of 6%, making it the fastest-growing GDP recorded. Further, it was then among the ten richest nations in the world, outpacing European economic powerhouses France, Germany, and Italy. This steady rise in GDP attracted scores of European and South American immigrants. Indeed, this economic boom attracted so much foreign attention that, by 1914, half of Buenos Aires’ residents were born outside of the country.

But Argentina’s meteoric GDP growth would soon dwindle; World War One, the Great Depression, import and export woes, and the first of several military coups each contributed to Argentina’s coming economic decline. Yet perhaps one of Argentina’s biggest pitfalls was betting heavily on its then-booming agriculture sector, and placing more faith in it than was equally spread among other industries.

When countries do not — whether they cannot or will not — diversify their economy in a manner that allows them to adequately absorb external shocks, their economic vulnerability is exceedingly heightened, contributing to inflation, devaluation, and/or other unsavory considerations. And while Argentina has made strides to avoid repeating its 20th century economic struggles, it is still reeling from its 2001 economic crisis; its central bank recently attempted to stabilize the country’s currency, raising its benchmark interest rate to 40% — one day after the Argentine peso fell 8.5% against the United States dollar.

Pegged

The United States dollar has long been recognized as the world’s reserve currency, earning this status during the 1944 Bretton Woods Agreement. Currently, dozens of countries peg to the dollar, each largely for specific reasons. In the Caribbean, several countries choose to do so because a large percentage of their income stems from tourism paid in U.S. dollars. In the oil-rich Middle East, several countries peg to the dollar due to the United States being a primary trading partner and oil buyer.

Eastward, Hong Kong and Macau are pegged to the dollar — but China’s case is more complex. While China does not peg its yuan to a basket of currencies that includes the dollar, it does benefit from its blooming export economy, with the United States being a major trade partner.

While then-presidential candidate Donald Trump routinely spoke poorly and accused China of intentionally keeping the yuan weak, the currency has gained nearly 9% against the dollar — its strongest since its 2015 devaluation. However, the devaluation of the yuan forced other Asian nations’ currency to devalue in a “fight to the bottom.” The reasoning behind this is that a weaker currency is better for exports, making Chinese goods cheaper, thus forcing other Asian countries to compete on currency arbitrage to keep exports competitive. This can spell additional challenges for businesses looking to break into Asian markets.

Black Market Influence  

In many frontier markets, the central bank will tightly manage the currency. But in reality, local black markets indicate the actual supply and demand market value. While this gap can be managed in the short-term, market forces tend to always correct. When this correction happens, it is common to see drastic shifts in foreign exchange rates. This risk must be managed, planned for, and can affect day to day business dealings.

Specifically, Uzbekistan recently experienced a 9% gain against the dollar on its black market. The Central Asian nation abolished mandatory sales by exporters of a quarter of foreign currency revenue. This allowed a select number of financial institutions and private companies to deviate from the country’s official exchange rates. While it remains unclear whether or not Uzbek officials will formalize this reform, the black market rate has already begun adjusting. Black market influence is not unique to Uzbekistan; businesses that are considering breaking into new markets should be mindful of the influence these unofficial markets may have on regulated markets.

If you’re considering an international expansion but are concerned about currency risks you may experience due to black market influence or other factors, reach out to Velocity Global today to learn how our experts can assist you in formulating your global expansion plan, international payroll solutions, or talent acquisition in your desired country.