How should multinational companies deal with currency devaluation?

Recently, under the influence of dual uncertainties from both internal and external sources, the exchange rate of the US dollar against the real closed at 5.87 reals on November 1, setting the second highest level in history, second only to the closing price of 5.90 reals during the epidemic on May 13, 2020.

Emerging market currencies generally weakened against the U.S. dollar, such as the Mexican peso

What impact does currency depreciation have on multinational corporations?

1，Challenges

• Increased exchange rate risk

For multinational companies, if the currency of the country where they are located depreciates, the company's overseas revenue will be adversely affected when it is remitted back to the country. For example, if a multinational company operates in a depreciating country and its revenue is denominated in the currency of that country, then its revenue in that country will decrease when converted into the currency of the home country, thus affecting the company's overall financial performance.

• Decrease in asset value

Currency depreciation will also lead to a depreciation in assets denominated in that currency. The value of multinational companies' investments in depreciating countries, such as fixed assets such as factories and equipment and cash reserves, will shrink, thereby reducing the company's net asset value. For example, when a foreign company invests in building a factory in Turkey and the Turkish lira depreciates, the book value of the factory will decrease accordingly. In financial statements, the shrinking value of assets will affect the company's net assets, causing its valuation in the capital market to suffer setbacks.

• Rising inflationary pressure

Currency depreciation is usually accompanied by inflation. Because rising prices of imported goods will push up the overall domestic price level, especially countries that rely on imports are more likely to be affected. For multinational companies, if inflation is severe in a depreciating country, operating costs will rise rapidly. In this case, companies need to pay higher costs to obtain raw materials, hire labor and other resources, resulting in lower profit margins. Inflation may lead to an increase in demand for labor, and companies need to pay more wages to stabilize employees, further increasing operational pressure.

• Increased difficulty in financing

Currency depreciation often leads to economic instability in a country, which in turn affects the country's credit rating and the ability to attract investment. For multinational companies, if the financing environment in a depreciating country deteriorates, the cost of local financing will increase. Currency depreciation is usually accompanied by rising interest rates, which increases the debt burden of companies. Due to the unpredictability of exchange rate fluctuations, multinational companies find it difficult to determine the actual cost of borrowing, which makes it more difficult to manage capital flows.

2，Opportunity

• Good opportunities for mergers and acquisitions

Currency depreciation often leads to a decline in the valuation of local companies, which brings good opportunities for multinational companies to acquire companies. For companies with cash reserves, they can acquire local companies at a lower cost in the depreciating country and quickly enter the market. In particular, those companies that are greatly affected by the depreciation may urgently need foreign investment to tide over the difficulties. At this time, multinational companies can directly obtain market share through mergers and acquisitions and enhance their competitiveness in the local area.

• Devaluation also creates export advantages for local companies.

For multinational companies, if they can establish production bases in devalued countries, utilize local low-cost labor and resources, and then export products to countries with higher exchange rates, they can obtain higher profit margins. The increase in export competitiveness brought about by currency devaluation is a favorable opportunity for expanding international markets.

• Finding emerging markets

Currency depreciation reflects the instability of economic adjustment to a certain extent, but it may also indicate the potential of emerging markets. Especially in emerging market countries with rapid economic development, although they will be hit by depreciation in the short term, in the long run, these countries often have the potential for economic growth and consumption upgrades. Multinational companies can take advantage of the low cost during the depreciation period to plan for future market demand in advance. For example, in Latin American and Southeast Asian countries where the currency is depreciating, investors can take the opportunity to enter the consumer market with great potential and seize market share in advance.

3，Strategies for multinational companies to deal with currency depreciation

• Strengthen exchange rate risk management

Facing the exchange rate risk brought about by currency depreciation, multinational companies should actively adopt hedging tools, such as locking in exchange rates through foreign exchange forward contracts, options and swaps, to reduce the impact of exchange rate fluctuations on finance. Multinational companies can also consider dispersing assets in different regions and diversifying investments to avoid concentrated risks caused by depreciation in a single market.

• Adjust supply chain strategy

To cope with inflation and cost increases, companies can adjust their supply chains and transfer part of their production to low-cost countries or localize production to reduce import dependence. Multinational companies can also establish close cooperation with local suppliers and take advantage of their local price advantages to control costs during currency depreciation.

• Localized financing and asset allocation

When operating in a country with a depreciating currency, companies can give priority to localized financing. Through borrowing and lending in local currency, companies can better balance the financial pressure caused by exchange rate fluctuations. In terms of asset allocation, companies can give priority to using assets for projects with great growth potential to ensure that assets can be appreciated even in a depreciating environment.

4, Conclusion

Currency depreciation brings complex challenges and opportunities to cross-border investment.

Enterprises need to optimize their globalization strategies by taking advantage of the mergers and acquisitions, exports and new market opportunities brought about by currency depreciation based on a full understanding of the risks. By strengthening risk management and strategic layout, multinational companies can remain invincible in the storm of currency depreciation and even reap rich rewards.