IOE Tradeportal

Economic Exposure

Economic exposure is the risk that the currency of the overseas country will weaken or strengthen over time due to the economic and/or political management of the country.

The strength of the economy will be reflected in the balance of payments, level of inflation, local interest rates, and rate of exchange. The level of investments into the country, which forms part of the balance of payments, will depend on confidence in the government.

It is a macro economic exposure outside the control of the investor, exporter or importer.

It is the risk that future cashflows generated by the overseas investment will vary in terms of the parent company's currency.

Economic exposure can be regarded as representing the impact that exchange rate movements will have on the net present value of an overseas interest's future cashflows. Such an exposure can render a project forecast to be profitable, into a loss making contract.

It can affect the:

Running costs of a subsidiary

Operational and construction costs of single, long term projects, etc.

Economic exposures manifest themselves in translation exposures (see above) or transaction exposures (see below).

Whilst identification of both transaction and translation exposures is relatively straightforward, identifying economic exposures can be more complex as they tend to be very broad and represent a business's overall economic exposure to future movements in exchange rates.

Because of the complex nature of some company's economic exposures, they risk being ignored or mismanaged, leading to inactivity or worse, counter-productive hedging strategies.

Weakening currencies can increase the cost, in parent company currency terms, of import duties and therefore increase the overall imported cost, and reduce competitiveness relative to locally produced goods.

Strengthening local currencies can result in increased profits as price lists for imported goods would be unchanged yet the income from sales would be greater when exchanged for the exporter's domestic currency.

Speculators controlling large capital sums can greatly influence and exaggerate the currency volatility. If the exchange rate fluctuates it alters the relative competitiveness of a company’s cost base.