In order to operate in international markets, companies need to find the best solutions in terms of market conditions. One of the most important economic factors of multinational company operations is the exchange rate. However, companies are working with different currencies worldwide; therefore, exchange rate changes, even the most insignificant ones, can affect great parties of goods and quality of production, which might result in customer satisfaction increase or decrease.
The companies can search for various ways of meeting the standards of delivery and timing, but no services can replace the actual products which are paid for by the clients. That is why logistics and operations need to be fully organized and independent in relation to the national economy problems in the country of production and operations.
Exchange rate being the volatile economic performance indicator is the source of the financial risk associated with international markets. As Yusof notes, ‘the successful company is managed by people who understand what risk in business is, and how this risk should be managed or mitigated’.
That is why it is necessary to point out the importance of risk management and understanding the potential problems that the companies may face on international markets. The major source of these problems is undoubtedly the exchange rate. Since there are many conditions in which exchange rate exists in the economy of the country and various forms in which the exchange rate is managed by the government, it is proposed to look at how these options impact the multinational company with subsidiaries that are operating in each particular country. The research is aimed at exploration of the three basic forms of the exchange rate: managed floating exchange rate, fixed exchange rate that is linked to a basket of currencies, and fixed exchange rate that is backed by the currency board system.
Managed floating exchange rate
The exchange rate is not fixed in most of the countries with market economy. However, some countries where market economy is developed still prefer to fix their currency with the help of the currency basket. The situation with floating exchange rate, even if it is managed by the government and even if the Central Bank allows for certain regulation rules, is very volatile and can be changed dramatically due to unforeseen events in the world economy and politics in a very short period of time.
In general, Yusof (2007) quotes Cornell and Shapiro who defined exchange rate risk as ‘the impact of the sudden changes of the real exchange rate on companies’. As managed floating exchange rate is exposed to these changes, the consequences can be hardly planned and forecasted. As the author further implies, ‘transaction exposure occurs when the unanticipated fluctuation of the nominal exchange rate affects cash flows that are related to monetary assets and liabilities such as contractually fixed cash flows’. Moreover, overall liquidity of the assets that the company’s subsidiary owns will be affected if the exchange rate rises dramatically. All domestic inflationary processes are harmful for the company development, in this case.
The accounting system of the company subsidiary which is operating in the country with managed floating exchange rate should be in the same currency all the time in order to avoid great accounting mistakes. It is necessary to develop a system of exchange rate monitoring. However, the companies can never predict what might happen to the world economy. Therefore, the multinational companies are usually developing their production subsidiaries in countries where exchange rate is fixed, and where the level of government intervention in the economy is higher than in the developed countries.
Fixed exchange rate linked to a basket of currencies
In any case, fixed exchange rate is far more predictable than the floating exchange rate. Despite the fact that the currency market has been unstable during the past few decades, the fixed exchange rates, without the government intervention that is made in self-interest, are a good tool for company subsidiary financial and treasury management.
Basket of currencies provides dependency on other foreign exchange markets. However, at the same time, the basket itself is a balancing tool which represents more than one economy. That is why this scenario is the best option for the multinational companies with subsidiaries worldwide.
According to Madura and Fox, ‘in a fixed exchange rate environment, MNCs can engage in international trade without worrying about the future exchange rate’. That is why, the management of such subsidiaries usually requires less planning and activities, and the financial reporting system is much less complicated than in the case with the floating exchange rate.
However, the actions of the government in this case should be directed towards the economic growth and not revaluing or devaluing national currency on purpose. If this happens, multinational company will face multiple financial problems. At the same time, as Levi implies, ‘if, by maintaining external balance, flexible rates avoid the need for these regulations which are costly to enforce, then the gains from trade and international investment can be enjoyed’.
Fixed exchange rate backed by the currency board system
Fixed exchange rate that is linked to the basket of currencies is a normal practice in the world economy. However, when the country applies the currency board system to back the exchange rates, this already describes a different situation.
Currency board system is usually implemented by the governments of the small countries with economies that are exposed to the world economic activity (Culp 2002). The examples of these economies include Hong Kong and Argentina (Levi 2005). In this case, the board is usually attached to one currency. For multinational companies, this has a significant meaning: if this international currency coincides with the currency of the country of origin (e.g., the United States), then the interest rate fluctuations will hardly be noticed. However, in all other cases, such type of exchange rate is not an advantage for a multinational company.
Moreover, currency board system has strict operations rules and regulations that should be met by the market players. Such regulations are in many cases not favourable for multinational companies. Beside the fact that the government actively promotes national currency backed by the currency board system, in addition the national currency should be backed with hard currency.
Managed floating exchange rate system is an advanced version of the floating exchange rate. However, this system is severely criticized by the researchers. Yusof believes that this system is not working in reality due to its weak control system by the government of the country.
Fixed exchange rate systems are quite easy for multinational companies to be managed; however, they also involve a certain degree of financial risk. The basket of currencies can support national currency only if the actions of the government does not mean artificial rate fixation. At the same time, the board system should be fully backed by hard currency; otherwise the currency exchange rate will be exposed to all forms of crises just as the floating exchange rate. As seen from research, the best option is the fixed exchange rate linked to the basket of currencies. Only this option is likely to fully support the operations of MNC’s subsidiary.