Effects of currency devaluation

Effects of currency devaluation

Tuesday, February 23, 2016 4:23 pm

Dada Adefolami

Dada Adefolami

Dada Adefolami

Devaluation on modern monetary policy is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged.

Currency depreciation is the loss of value of a country’s currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. It is most often used for the unofficial increase of the exchange rate due to market forces, though sometimes it appears interchangeably with devaluation. Note that monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency

Inflation targeting is a monetary policy in which a central bank has an explicit target inflation rate for the medium term and announces this inflation target to the public. The assumption is that the best that monetary policy can do to support long-term growth of the economy is to maintain price stability. The central bank uses interest rates, its main short-term monetary instrument

The theory of comparative advantage is an economic theory about the work gains from trade for individuals, firms, or nations that arise from differences in their factor endowments or technological progress.

The World Bank governance indicators may also offer clues as to where companies might want to divert their attention to reduce political risk. The figures point to improvements in nations

In economics, the money supply or money stock, is the total amount of monetary assets available in an economy at a specific time. There are several ways to define “money,” but standard measures usually include currency in circulation and demand deposits (depositors’ easily accessed assets on the books of financial institutions).

In monetary economics, the quantity theory of money (QTM) states that money supply has a direct, proportional relationship with the price level. For example, if the currency in circulation increased, there would be a proportional increase in the price of goods

Currency indications
Government can also look to International Monetary Fund (IMF) figures for indications of the victims of financial turbulence, if currency is devalued; can threaten country/companies in several ways. ‘Aside from reducing the currency value of local profits, they make countries more likely to impose capital controls – locking cash inside a country,’ ‘A burst of inflation after devaluation may also encourage countries to impose price controls – hurting corporate profitability.’

Despite a recent bout of strong growth, the IMF data suggests that such financial strains may be mounting in some African countries. For example, the budget deficit in copper-rich Zambia jumped to 8.6% of GDP in 2013, more than double the previous year, the IMF’s Fiscal Monitor showed. Ghana has now run a deficit of over 10% of GDP for several years, despite high prices for its agricultural and gold exports. Several African states, including Kenya and South Africa, have also seen large inflows of hot money into stocks and bonds. ‘Large imbalances are often warning signs of financial unrest to come, ‘Deficits of both budget and current accounts can be particularly threatening.’

Though after a political or financial crisis has hit the headlines, it is not always too late to take defensive action. Russia is a case in point

Russia has the highest levels of trade protection of the main G20 countries, so it is hard to sell goods and services from the outside.’ Instead, the best way to deal with this looming threat, is to carefully select who you interact with.

It may be easier to diversify operations. The worsening situation will dent the profits of multinationals like consumer goods producers even if there is massive oil revenues, the country will face serious shortages of basic commodities. Most economists believe that the situation could go downhill further before it gets better. A debt default and current account crisis are considered possible.

According to an analyst:‘Obviously companies do not want to totally retreat from a nation that might recover in a few years. But trimming operations to the bone in such countries is sensible. It is also a good idea to beef up businesses, and the risks to be much lower.’

There are other ways of hedging risk without fleeing a country. An emerging-market strategist argued: ‘companies can protect themselves against a sharp devaluation by locking in the dollar value of profits in the derivatives market. This can be an expensive option.’ In addition, if the political climate in a country is deteriorating, a company can buy credit default swaps; while these are intended to reimburse investors if the government defaults on its debt payments, they rise in value during times of political turbulence.’

Companies may also be increasingly vulnerable to new kinds of political risk. Another analyst posited: ‘In many parts of Latin America we have seen an emerging middle class who care far more about environmental issues, this can be a real threat for foreign companies.’ Chevron experienced this kind of challenge in 2012 following a leak from one of its Brazilian offshore oil wells. This spill released just 2,400 barrels of oil into the sea, a small fraction of the roughly 4.9 million barrels from BP’s infamous Deep water Horizon accident. But infuriated government officials in Brazil sought to slap the company with a record US$11bn fine – equivalent to almost half the company’s worldwide net income for the year.

The authorities also ordered top Chevron executives to surrender their passports and threatened criminal charges. Chevron eventually managed to diffuse these tensions. But companies need to proactively build goodwill where they operate. ‘A solid programme of corporate and social responsibility can really help reduce such threats, ‘Companies need to ensure that they are minimising ecological or social damage. But also that they constantly remind emerging markets of the benefits they provide, in terms of job creation, royalty and tax payments.’

Political risk is impossible to avoid for global companies. In many cases, a country’s large consumer market, rich natural resources or efficient workforce can make such risks worth taking. Chevron, for example, has been investing heavily in Argentina’s energy sector – despite the fact that the nation expropriated Spanish Oil Company however the following definition analysis will be decision guard:

Competitive advantage is a business concept describing attributes that allow an organization to outperform its competitors. These attributes may include access to natural resources, such as high grade ores or inexpensive power, highly skilled personnel, geographic location, high entry barriers

The velocity of money (also called the velocity of circulation of money) refers to how fast money passes from one holder to the next. It can refer to the income velocity of money, which is the frequency at which the average unit of currency is used to purchase newly domestically-produced goods and services within a given time period.

The reserve requirement (or cash reserve ratio) is a central bank regulation employed by most, but not all, of the world’s central banks, that sets the minimum fraction of customer deposits and notes that each commercial bank must hold as reserves (rather than lend out).

The velocity of money (also called the velocity of circulation of money) refers to how fast money passes from one holder to the next. It can refer to the income velocity of money, which is the frequency at which the average unit of currency is used to purchase newly domestically-produced goods and services within a given time period.

In economics, the monetary base in a country is defined as the portion of the commercial banks’ reserves that are maintained in accounts with their central bank plus the total currency circulating in the public.

Money creation is the process by which the money supply of a country or a monetary region A central bank may introduce new money into the economy (termed “expansionary monetary policy”, or “money printing” by detractors) by purchasing financial assets or lending money to financial institutions.

In banking, excess reserves are bank reserves in excess of a reserve requirement set by a central bank. They are reserves of cash more than the required amounts. In the United States, bank reserves are held as FRB (Federal Reserve Bank) credit in FRB accounts; they are not separated into separate “minimum reserves” and “excess reserves” accounts

Demand deposits, bank money or scriptural money are funds held in demand deposit accounts in commercial banks. These account balances are usually considered money and form the greater part of the narrowly defined money supply of a country.

In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the real value of money over time; conversely, deflation increases the real value of money — the currency of a national or regional economy.

An interest rate is the rate at which interest is paid by borrowers (debtors) for the use of money that they borrow from lenders (creditors). Specifically, the interest rate is a percentage of principal paid a certain number of times per period for all periods during the total term of the loan or credit.

In economics, the equation of exchange is the relation: where, for a given period, is the total nominal amount of money in circulation on average in an economy. is the velocity of money, that is the average frequency with which a unit of money is spent. is the price level. is an index of real expenditures. Thus PQ is the level of nominal expenditures. This equation is a rearrangement of the definition of velocity: V = PQ / M. As such, without the introduction of any assumptions, it is a tautology. The quantity theory of money adds assumptions about the money supply, the price level, and the effect of interest rates on velocity to create a theory about the causes of inflation and the effects of monetary policy. In earlier analysis before the wide availability of the national income and product accounts, the equation of exchange was more frequently expressed in transactions form: where is the transactions velocity of money, that is the average frequency across all transactions with which a unit of money is spent

Modern portfolio theory (MPT) is a theory of finance that attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets

Dada Suraju Adefolami, Professor of Finance, School of Business Administration, UNEM University Costa Rica, is a Finance / Management Consultant and Certified Forensic Accountant. You can reach him via: surajudada@yahoo.com; 08052043855

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