Introduction
Sygma Ltd is a multinational company that benefits from the globalized world. It is incorporated in the United Kingdom but operates in multiple emerging economies, including Bolivia. This approach poses additional challenges for the organization, as it must consider and address regional issues.
One of them occurred in 2011 when the central bank of Bolivia introduced a crawling peg system for its currency against the USD. That decision had significant consequences for businesses operating in this environment. As the CEO of Sygma Ltd, I need to understand and communicate the positive and negative implications of the country’s new system and offer an effective strategy to manage the resulting exchange rate exposure.
Implications
To begin with, one should describe what the crawling peg system means. This term introduces a soft version of fixed arrangements because “the exchange rate is adjusted in small amounts at a fixed rate of change.” This system is typically used as a response to changing inflation differentials and other macro indicators. This phenomenon occupies an intermediary position between fixed and floating approaches because the exchange rate can only fluctuate within a particular range, called a crawl.
The implementation of the given system has several significant implications for the country’s economy, and it is reasonable to begin with the positive aspects. Abdai, Gyimah, and Poku-Aguemang (2020, p. 3) mention that a state’s fiscal policy is effective under this regimen. This statement manifests in several specific factors, as further described. First, this step results in a relatively more stable exchange rate.
Volatility disappears as the currency is allowed to adjust gradually over time, creating a more predictable environment for investors and businesses. These stakeholders receive an explicit signal that the local currency can only fluctuate within two limits. Second, the central bank uses the selected regimen to achieve low inflation rates (Abdai, Gyimah, and Poku-Aguemang, 2020, p. 8). This outcome is achieved since the regulatory authority can influence the prices of imported goods and services by adjusting the exchange rate at a particular moment.
In addition, it is worth noting the significant drawbacks that may arise from the new system. The main disadvantage is that a pegged exchange rate results in lower net export volumes (Abdai, Gyimah, and Poku-Aguemang, 2020, p. 9). The rationale for this finding is that this regimen, if applied inappropriately, can lead to overvaluation or undervaluation of the local currency. This condition can make products and services less competitive in foreign markets.
The predictability of the crawling peg system can attract speculative activity when traders anticipate and exploit the central bank’s adjustments, thereby increasing volatility. Finally, the system’s insufficient flexibility prevents it from adequately responding to sudden shocks and crises. When such adverse events occur, utilizing this practice can cause countries and businesses to suffer from misalignment between economic fundamentals and the exchange rate.
Management Strategies
As a CEO, I would advocate using an appropriate technique to manage exchange rate exposure. First, I would prefer to rely on local sourcing and products to run operations in Bolivia, which can help protect the business from exchange rate fluctuations (Chen et al., 2020, p. 3477). This situation is similar to raising tariffs because local currency undervaluation means the organization must pay more to import goods. If one company offers products for 6,900 Boliviano (BOB) and a different contractor requests $100, the former partner should be preferred. I would advocate for cooperating with local suppliers and contractors to avoid price changes.
Second, it is possible to rely on a flexible pricing strategy to protect the company from negative exposure. This strategy implies that the business can determine its prices depending on the current exchange rate. Table 1 below presents hypothetical pricing strategies and demonstrates that the business should align its BOB prices with the prevailing exchange rate to achieve identical earnings in dollars across scenarios.
Table 1: Flexible Pricing
However, hedging appears to be the most suitable technique, as the following discussion demonstrates. Futures contracts are a common form of this methodology and allow an organization to protect itself against exchange rate changes (Oglend and Straume, 2020, p. 7). A specific real-life scenario can demonstrate how the company can benefit from this intervention. It is possible to imagine that the organization is expected to earn 100,000 BOB in three months, which will equal $14,492.8 at the current exchange rate of 6.9.
Since the exchange rate is expected to increase to 7.1 by this date, the organization should enter into a futures contract to lock in the current rate of 6.9. If this scenario occurs, the company will receive the stipulated $14,492.8 against $14,084.5 as per 7.1. That is why his option can help the business protect its earnings in dollars against potential depreciation. However, this approach has a significant disadvantage if the Boliviano strengthens over time. If the exchange rate is 6.7, Sygma will not be able to receive $14,925.4 because the futures contract will obligate it to sell Bolivianos at the predetermined rate.
Conclusion
A state’s decision to adopt a crawling peg system implies various implications for the national economy and businesses operating within it. Outcomes can be positive or negative, and organizations should implement specific measures to minimize adverse impacts. As the CEO of Sygma, I could rely on local sourcing, flexible pricing, and hedging. The latter option seems more preferred because futures contracts will allow for securing dollar earnings against Boliviano depreciation.
Reference List
Abdai, B., Gyimah, A. G. and Poku-Aguemang, K. (2020) ‘Exchange rate regimes and global cocoa trade: to float or to peg?’ Cogent Economics & Finance, 8(1), pp. 1-11.
Casas, C. (2020) ‘Industry heterogeneity and exchange rate pass-through,’ Journal of International Money and Finance, 106, pp. 1-65.
Chen, K. et al. (2022) ‘The impact of tariffs and price premiums of locally manufactured products on global manufacturersˈ sourcing strategies,’ Production and Operations Management, 31(9), pp. 3474-3490.
Oglend, A. and Straume, H. M. (2020) ‘Futures market hedging efficiency in a new futures exchange: effects of trade partner diversification,’ Journal of Futures Markets, 40(4), pp. 617-631.