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Opinion-Volume 1, No. 1, December 2011

Understanding the Impact of Exchange Rate Fluctuation on the Competitiveness of Business

Prof. Chanan Pal Chawla*

With the increasing level of globalization of economies of all the countries, the markets for all the goods and services have become hyper competitive. The relationship between the values of local currencies in terms of foreign currencies and export competitiveness of any country is very complex. In the short run, devaluation of local currency may have the positive effect on exports but also makes the imports costly. This relationship will become more complex if there is heavy dependence of imported resources in the exported products. In the long run, though it is the brand and value addition which will have more profound effect on export competitiveness rather than cost based strategies which are easier to copy by other countries.As the economies of the countries develop more depth and width, thereby reducing the export component of primary products and increasing the exports of engineering goods, chemicals and services etc, the competitiveness based on currency depreciation will have lesser effect, but changes in the value of local currency still have profound effect in the short run. One of the problems being faced by some European Union countries is the loss of this leveraging of currency devaluation with the emergence of single currency for all European countries. If China revalues its currency to reduce its current account surplus by reducing its exports then Chinese organizations may buy western companies because it will become cheaper to acquire them. So it becomes two sided sword. Keywords: Hyper, Devaluation, Current Account, Exchange rate

If we look at the best brands in any country almost all the brands will be global brands. With the emerging business environment of reducing tariff barriers, reducing transport costs, increased role of information technology in leveraging the cost component of doing business and treatment of globe as a common reservoir of resource, the emergence of global brands will become more and

more common in future. At the same time there are hardly any local markets left. Every local market has become a global market for somebody else from across the geographical boundary of the country. Global markets are becoming more and more competitive than ever before. This global competition has decreased the average life span of organisations to almost 50 years. In fact this competition is reducing the life cycle of products, technology and even knowledge.

*Dean, Institute of Innovation in Technology and Management (Affiliated to GGSIP University) New Delhi - 110 058

Understanding the Impact of Exchange Rate Cluctuation on the Competitiveness of Business


The basic purpose of any business is to fulfill some felt, concealed or perceived needs of the society. This fulfillment of the need will have the monetary value in the mind of the customer. He is ready to pay the price equal to or less than this perceived monetary value.The challenges of any business is to create goods/ services to satisfy these needs at a cost which is less than the price that the customer is ready to pay for this value. This difference between the value and cost is profit. Every business has to aspire to either increase the value at a particular price or reduce the cost incurred in creating this value. With increasing importance of competitiveness in the global markets, the margins of profit are coming down. In such a scenario, the importance of exchange rate stability assumes greater significance. Almost all the countries are following the system of managed float exchange rate, to some degree, now a days. Because of huge imbalances in the current account of many countries like China, Japan, Germany, Saudi Arabia having positive current account to U.S.A. having negative current account, the stability of exchange rates has come under pressure. As even the local markets have become international markets because of

globalization, it is obvious that the international value of local currency will have a profound effect on the competitiveness of the products/ services. If a product can be sold profitably for one dollar in the international market and rupees earned by this sale is RS. 50.00 (Assuming the present rate of exchange is 1$= 50 Rupees), then if the exchange rate becomes 1$= 100 Rupees, then the same product can be sold at half the dollar, thereby increasing its global competitiveness. But at macro level, it is easier said than done. Exchange rate changes will have the reverse effect on imports than on exports. In a country like India, where there is heavy dependence on imported energy resource, the currency devaluation may cause energy prices to go high thereby causing inflation. This is turn will cause factor cost to go higher in making of the export products. This will again reduce its competitiveness in the international market. Also this relationship between currency devaluation and export may lead to reduced local consumption, investment and economic growth, thereby cancelling the effect of increased exports, if it is increased because of only currency depreciation. In fact there are many factors which affect the competitiveness of exports of any

Figure 1

*Real effective exchange rate is the weighted average of a countrys currency relative to a basket of other major currencies adjusted for effects of inflation.


Opinion-Volume 1, No. 1, December 2011

But only cost based strategies are not sustainable in the long run. Such strategies are susceptible to be copied easily. If the strategies for competition are product differentiation or innovation then exchange rate variation may not affect the export potential. To large extent some variations may be offset by taking hedging options as well. But many economists still think that China has been able to have large current account surplus based on the depressed value of its currency Yuan in comparison to U.S. Dollar. In theory, suppose China allows Yuan to appreciate, then it may become cheaper for Chinese organization to acquire U.S. companies. So it becomes two sided sword. Table 1
Year Exports (Annual Percentage Change U.S. -1.6 20.3 21.1 30.8 23.4 22.6 29.6 13.6 -3.5 29.5 Imports (Annual Percentage Change U.S. 1.7 19.4 27.3 42.7 33.8 24.5 35.5 20.7 -5.0 19.0 Exchange Rate Real Effective Exchange Rate 48.81 47.56 43.52 43.72 44.63 43.57 39.96 50.97 45.15 44.86

2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

46.73 44.74 39.71 38.52 38.91 36.81 33.11 40.58 34.57

In the case of India, if we analyze the Table 1 and Figure 2, we see that there is no significant correlation between Real Effective Exchange Rate and percentage change in annual exports. Similar is the case in respect of import also. For example in the year 2006-07 Real Effective Exchange Rate (REER) was 43.57 to one US Dollar and exports increased by 22.6 percent and imports by 24.5 percent. Next year in 2007-08 though Rupee appreciated to 39.96 to one US Dollar, exports increased from 22.6 percent to 29.6 percent. Similarly in the year 2008-09 when Rupee depreciated to 50.97 to one US Dollar, exports still decreased by 13.6 percent. This happened because of financial crisis of the world and exchange rate variations could hardly offset this effect on the export from India. This trend shows that Indian basket of exports of goods and services are well diversified and have moved up on the value chain. Earlier when our exports consisted mainly of primary goods our competitiveness was based on cost only with very little part being played by product differentiation. Now our exports competitive advantage is not necessarily tied to cost only. The changing nature of Indias exports basket is shown below. Table 2
Product Category Percentage Share2000-2001 16.0 23.6 16.6 15.7 10.4 4.4 2.8 4.3 2009-10 (April to September) 13.4 11.3 17.0 19.5 12.7 2.0 0.5 13.3

Primary Product Textiles Gems & Jewellary Engineering goods Chemical & related Products Leather & Leather goods Handicrafts Petroleum & its products Others

Source: Business Standard New Delhi Monday 23 May 2011 and Economic Survey of India 2010-11. P161. Figure 2

Source: Economic Survey 2010-11. Page 167. As the economy of any country gets developed and diversified, it is the brand of goods/ services along with country brand which will create long run advantage over competitors. Cost advantage can be easily copied and does not give long term competitive advantage.

Impact of Business Process Re-Engineering in Commercial Banks on Customers......


Compared to 2000-01, the share of engineering goods has increased while that of textiles and readymade garments has decreased. Leather and leather products have lost shares while chemicals, related products and petroleum products had handsome gains. Similarly, African economy is also based on commodities like

Nigeria exports crude oil instead of refined petroleum products, Zambia exports copper instead of copper wire and S.A. exports diamonds instead of diamond jewelery. Hence exchange rate has profound effect on their global competitiveness for their exports.

References 1. Swenson, Deborah L., 2005. Overseas assembly and country sourcing choices, Journal of International Economics, Elsevier, vol. 66(1), pages 107-130, May. Other versions: 2. Ware, Roger & Winter, Ralph, 1988. Forward markets, currency options and the hedging of foreign exchange risk, Journal of International Economics, Elsevier, vol. 25(3-4), pages 291-302, November. 3. Aksoy, Yunus & Riyanto, Yohanes E, 2000. Exchange Rate Pass-Through in Vertically Related Markets, Review of International Economics, Wiley Blackwell, vol. 8(2), pages 235-51, May. 4. Saeid Mahdavi, 2002. The response of the US export prices to changes in the dollars effective exchange rate: further evidence from industry level data, Applied Economics, Taylor and Francis Journals, vol. 34(17), pages 2115-2125. 5. Yang, Jiawen, 1998. Pricing-to-market in U.S. imports and exports: A time series and cross-sessional study, The Quarterly Review of Economics and Finance, Elsevier, vol. 38(4), pages 843-861. 6. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. Goods Prices and Exchange Rates: What Have We Learned?, Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September. 7. Kenneth A. Froot & Paul Klemperer, 1989. Exchange Rate Pass-Through When Market Share Matters, NBER Working Papers 2542, National Bureau of Economic Research, Inc.