Introduction
For companies engaged in international trade or with access to foreign labor, fluctuations in currency pairs due to changes in national economies and external factors are of practical importance. If the economy within which the parent company organizes its work weakens, it leads to a depreciation of the local currency, resulting in cheaper work processes for the parent company, and vice versa (Abuselidze, 2019). This paper examines the case of Blades, Inc. (hereafter referred to as Blades), a company that sells Speedos and manages sales in the US and UK.
The parent company’s primary production and raw material suppliers are located in Thailand, which means that the cost of work and internal operations is determined by the state of the Thai national economy and the value of the local currency. The study provides a thorough and critical financial analysis considering three scenarios: no change, a 5% baht depreciation, and a 10% baht depreciation. Thus, the outcomes of the paper have an increased practical value with respect to financial and organizational decision-making for Blades.
Thailand’s High Inflation
Before measuring the impact of Thai inflation on the parent business, the theoretical framework of the term should be briefly defined. Strictly speaking, inflation should be understood as an increase in the cost of goods and services to consumers due to the depreciation of the local currency. For example, one Thai baht can buy fewer goods today than it could a year ago, which characterizes inflation trends (Jaravel, 2021). Inflationary costs include, in addition to reduced consumer spending power, higher unemployment rates and increased import costs.
It is this negative consequence that will concern Blades, as the company’s operational costs in Thailand will increase in relation to the amount of dollars allocated for this work. To illustrate, previously, the hypothetical cost of a workday for a team of workers in Thailand could be estimated at $100, which, at the early exchange rate (0.0220 USD per baht), was roughly equivalent to 2,250 baht. When the local currency depreciates by 10%, which is caused by and leads to inflation, currency fluctuations occur, causing the spot rate to change — 0.0198 USD per baht — this means that Blades will have to pay 5051 baht for the same labor already. The situation becomes more complicated when the Thai supplier extends the commitment for three years, as imports of products from Thailand will suffer due to the increased cost of domestic production, while exports will become cheaper as the goods will be shipped abroad at a lower price due to the depreciation of the local currency.
Evaluation Decision
Decisions to extend or suspend commitments with national partners should be based on forecasts about the state of the Thai economy. The forecast of organizational choice depends on how the Thai economy is expected to develop over the next few years (Witt, 2019). In particular, if the national economy continues to decline, inflationary growth rates increase, and the local currency depreciates, it is not unlikely that the importer will be reluctant to renew the commitment when it expires. This decision may be because if the local currency depreciates, the same amount of labor and materials will cost more, which increases transaction costs.
On the other hand, if Thailand’s national economy shows improvement over the next few years, it is not excluded that the importer will want to extend the deal, as the harmful and undesirable effects shown earlier will not be relevant. If, on the other hand, the growth proves to be extraordinary and Thailand reaches a level higher than it currently has, this will lead to an appreciation of the local currency and, thus, a relative cheapening of the work of the same volume. Thus, it is impossible to state definitively whether Holt was right or wrong, as it depends on specific and measurable economic projections for Thailand.
Estimation of Cash Flows
In the financial analysis, three scenarios were examined: no change, a 5% depreciation of the baht, and a 10% depreciation of the baht. The cash flow results are presented in Figure 1. In more detail, total sales, total cost of materials for production, and total operating expenses were calculated. As can be seen from the results, all indicators tend to decrease (in dollar terms) as the currency depreciates. A 5% currency depreciation would cause a 1.56% decrease in sales, while a 10% depreciation would cause a 2.21% drop in sales. Drops in material costs and operational processes cannot be described as a positive trend because, on the one hand, the company finds itself having to spend more dollars to purchase raw materials.
On the other hand, production may be less optimized when internal operations costs are reduced (Smith, 2021). Further depreciation options would have an even greater impact on Blades’ revenues due to the deterioration of the exchange rate. From this evidence, it appears that the parent brand is moderately exposed to market risk, as the described sales declines are not critical in view of the severe local currency depreciation. Nevertheless, it should be reiterated that further depreciation scenarios would have an even more substantial impact on sales performance, which could create even more tangible consequences for Blades.
Baht and Pound Correlation
In an alternative scenario, there is a correlated depreciation of both currencies; again, the three scenarios have been considered, and the results are shown in Figure 2. For this, the values of the spot rate of the dollar/British pound pair were reviewed, and the calculated correlation parameter for them in combination with the dollar/baht spot rate was 1.00, indicating a perfect positive correlation (Fernando, 2023). All the same parameters as for the previous level of analysis were calculated this time as well.
However, the variation in the sales figure was even higher: 2.07% for a 5% currency depreciation and 4.24% for a 10% depreciation scenario. This implies that the correlated nature of the two foreign currencies is a negative outcome for the parent brand, as the dip in sales turns out to be even more significant. The rationale for the increased vulnerability seems obvious: Blades creates net inflows in both currencies at once, so when their depreciation is correlated, it creates a joint effect (Alfaro et al., 2021). In a different scenario, as shown in the previous section, the currency correlation was only 0.65, indicating that the risks were more diversified.
Recommendations for Blades
To determine the potential consequences for Blades, a comprehensive financial analysis was conducted, forecasting the economic situation in the countries where the company’s production is represented, as well as based on spot rates. The results showed that decisions to extend the contract with the Thai importer would depend on the current economic situation in Thailand and could have either a negative or positive impact.
Additionally, the data revealed that local currency depreciation scenarios hurt the financial metrics of the parent brand. If the currencies are correlated, this further creates economic vulnerability for Blades as the risks appear to be compounded (Alfaro et al., 2021). These findings should inform recommendations for Blades to mitigate the economic impact on Thailand.
The pool of such recommendations should be divided into separate strategies, each associated with an expected benefit to the Blades. First, Blades should consider shifting production to countries whose currencies exhibit a weak correlation with the US dollar. This strategy is similar to asset diversification in investing; if the currency of one country depreciates (resulting in a loss), the company will not necessarily incur a loss in another country as well (through compensation). However, it is fair to say that this strategy requires significant investment since it will be necessary to rearrange logistics routes completely, conduct a thorough financial analysis of national economies, and select those countries that will not only be weakly correlated with respect to their currency fluctuations but will also be convenient enough for joint logistics.
Second, there is a less complicated approach to mitigate the impact in Thailand for Blades, namely borrowing the local currency. Specifically, the company could borrow Thai baht to loosen the local governance link to the dollar. This would enhance the company’s management capability at the Thai level and reduce its dependence on dollars. Still, it is true that if the national economy deteriorates, the Central Bank of Thailand may make such borrowing uneconomic (Christelis et al., 2020). Thus, both proposed recommendations require further study, either logistical or predictive, and a decision should be made based on the results of additional analyses to ensure that risks are mitigated.
References
Abuselidze, G. (2019). Modern challenges of monetary policy strategies: Inflation and devaluation influence on economic development of the country. Academy of Strategic Management Journal, 18(4), 1-10.
Alfaro, L., Calani, M., & Varela, L. (2021). Currency hedging: Managing cash flow exposure [PDF document].
Christelis, D., Georgarakos, D., Jappelli, T., & Van Rooij, M. (2020). Trust in the central bank and inflation expectation [PDF document].
Fernando, J. (2023). The correlation coefficient: What it is, what it tells investors. Investopedia.
Jaravel, X. (2021). Inflation inequality: Measurement, causes, and policy implications. Annual Review of Economics, 13, 599-629.
Smith, A. (2021). How do operating expenses affect profit? Investopedia.
Witt, M. A. (2019). De-globalization: Theories, predictions, and opportunities for international business research. Journal of International Business Studies, 50(7), 1053-1077.