Doing Business in Latin America – Foreign Currency Risk

Background

Sources retrieved from the annals of world economies indicate that Latin America economies are predominantly diverse. Spanning the Caribbean, from Argentina’s struggling communist economies to Peru’s flourishing economy registering an annual growth of approximately 7 %, Latin America remains a relatively unfavorable choice for prospectiveforeign investors (Urban, 2013). In Argentina for example, the government nationalizes major corporations, which drives away US capital investors. The International Monetary Fund projects an estimated aggregate growth of less than 3 % for the entire Latin American region ranking below that of Africa and Asia.

Writing in a Forbes quarterly, Melissa Hathaway expresses concerns towards actions by communist economies of Venezuela and Argentina, which notoriously manipulate their currency in order to regulate foreign investment and spin the odds to their favor(Urban, 2013). These countries have shunned the free market enterprise by undertaking such actions as nationalization of foreign companies and denying incentives to importers of capital investments. By dictating the currency terms, Venezuela was known for its pervasive communist approach towards international business and bilateral agreements under the reign of Hugo Chaves, a trend that persists to date.

Currency Risks

While choosing the most plausible and sustainable investment destinations, it is always important to factor in the currency risks involved with respect to the projected benefit. If the benefit outweighs the risk involved, the investment is sustainable. As for Latin America, the currency risk varies depending with the country in question. Sources indicate that Argentina and Brazil are presently undergoing two different paths in terms of their economies – Brazil leans towards a free market enterprise whereas Argentina has a regulatory economy (Stewart, 1991).

In Argentina, the present government has resolved to undertake a series of measures to create hyperinflation across the nation. As the country’s IMF debt default remains unresolved, Argentina has been eliminated from international capital markets. The government resolved to tap Central Bank reserves to pay domestic and sovereign debt. They have also generously raised salaries with an estimated 25 %, a move aimed at increasing the purchasing power of the consumers(Urban, 2013). A rise in income levels leads to an inevitable inflation cycle since there is more money circulating the economy. The government anticipates that the presence of more disposable income creates demand, which in turn leads to higher prices and more proceeds from taxation. The greatest weakness in such a resolve is that the government creates an unnecessary hyperinflation. The increasing income inevitably flows back into consumer markets creating a hyperinflationary cycle.

According to the Economist, Latin American economies are also known to devalue their currency in an attempt to get more proceeds from experts while charging more for foreign direct investments and imports. Devaluation is part of the regulatory measure of a communist economy such as the aforementioned ones. Currency devaluation is a great investment risk since it leads to more money coming in and less money going out, which is basically another form of inflation. The currency risk associated with inflation is that the value of the foreign currency visa vis the local current goes up forcing an investor to gain more money in terms of the local currency but less in terms of their foreign currency.

China’s Place

It is important to keep in mind that that the country that the plant is in does not necessarily have to be where the financing is done. In this case study, the preferred investment destination is Latin America. However, the financing will be done from China. What is China’s place in this arrangement? How does this inform prospective decisions moving forward?

The Chinese economy has strategically placed itself with a high bargaining power in the global economy. As the fastest growing economy, economists believe that by 2030, China will account for an estimated 22 % of the global Gross Domestic Product (GDP).  China’s influence in the world economy had been minimal until the end of 1980 (Alon& McIntyre, 2008). The country began economic reforms after 1978 to create significant growth amid ongoing investment and growing consumption (Perry & Wong, 2011). China now participates extensively in the world market especially in developing nations.

China implements economic reforms quite radically, but systematically too. The country’s role in world trade has increased dramatically as its presence in the international economy continues to be felt around the globe and especially so in the developing nations of Africa and South East Asia. China’s foreign trade has grown faster than GDP over the past 25 years (Wei, 2011). China’s growth comes from both massive government investment in infrastructure and heavy industry and the expansion of private sector in the light industry, rather than just exports, whose role in the economy seems to have been much overrated. State-owned companies provide significant input tools, heavy industry, energy and resources that facilitate the growth of private sector. Economists believe that China’s private sector-led investment is the foundation for national growth.

The decision by the Chinese government to attract multinational companies to expand the country’s export platform caused China to emerge as the most formidable competitor trouncing other Asian export-led economies such as Korea, Singapore and Malaysia. China emphasizes raising personal income and consumption and introducing new incentives to increase the productivity of its workforce. The country also emphasizes on foreign trade as an important instrument for economic growth. The restructuring of the economy and profit efficiency gains have contributed to a tenfold increase in GDP since 1978 (Wei, 2011). Some economists believe that economic growth in is China actually underestimated for most of 1990s and early 2000s (Forbes.Com)

Recommendations

While doing business in any given place, the fundamental starting point is understanding the risks and the projected benefits.

  • Always take advantage of the opportunities. Latin America economies are predominantly diverse. Despite various struggling communist economies, others are doing remarkably well, for instance, Peru’s flourishing economy registers an annual growth of approximately 7 % makingthe country a relatively more favorable choice for prospective foreign investors.
  • Understand the risk: Do not ignore any aspect of the risk. The key concern in this case is the currency risk involved as seen in the actions by communist economies of Venezuela and Argentina to notoriously manipulate their currency in order to regulate foreign investment and spin the odds to their favor. According to the Economist, Latin American economies are also known to devalue their currency in an attempt to get more proceeds from experts while charging more for foreign direct investments and imports.
Order Unique Answer Now

Add a Comment