It is important to note that any local currency introduced is only good – as long as people have confidence in the government backing it
By Clemence Mupfunya
Currency fluctuations are a natural outcomes of floating exchange rates which are the norm for most major economies in the world.
There are numerous factors that influence exchange rates, to name but a few, this includes; country’s economic performance, interest rates differentials, capital inflow, inflation outlook and among many more.
Due to economic dark cloud moving upon the face of Zimbabwean economy, the government was forced to introduce a multicurrency system hence, leading to local currency volatility.
This article assesses some of the major effects of currency fluctuations in developing economy like Zimbabwe.
Currency fluctuations are some of the most analysed aspects of any economy. Slight change in the value of a currency can have great repercussions across the economy.
The Zimbabwe local currency so-called bond notes and coins, I call them “fiat” money. Money that can’t be converted into anything tangible like gold or silver.
It is important to note that any local currency introduced in the economy is only good as long as people have confidence in the government backing it.
Hence, the need by policymakers to insure that economic agents have confidence in the local financial sector of any economy.
Currency fluctuations levels can have drastic effects on the health of an economy. Markets like forex and other trading sectors are heavily reliant on how strong or weak a particular currency is. The strength of a currency can also determine how a particular country handles international trade.
Indeed, strongest currencies in the world like US dollar, Euro and pound to mention just a few, are so influential in the world that many economic activities in the global trade are tied to them. Below are some of the effects of fluctuations of a currency:
Currency fluctuations changes the market competitiveness. Fluctuating of a currency either takes the form of a strong currency or a weak currency. When the currency becomes strong for an extended period, the economy can experience internal pressures.
This can lead to dormancy and reduced competitiveness. These factors can in turn cause job losses and an overall economic downturn. A weakened currency, can on the other hand attract investment but leaves the economy in a vulnerable position at the hands of big investors or the elite.
Hence fluctuating currencies affect the competitiveness of the market and vibrancy of the economy. An increase in the real exchange rate means that the exchange rate is stronger and therefore, the economy will face a decline in market competitiveness.
In addition, currency fluctuations affects inflation. Inflation is the general increase of price of goods and services in the economy. Depending on the general trading patterns of Zimbabwe’s economy, currency fluctuations leads to huge levels of inflationary gaps, hence resulting in hyperinflation.
Because of lack of local production and low consumption the whole economy is heavily affected by inflation.
Developed countries that have high local production and high marginal propensity to consume (MPC) are usually not affected by inflation when the currency fluctuates.
Developing countries that rely on imports can experience huge inflation levels when the currency fluctuates.
This is mostly with cases where the fluctuation leads to a devalued currency. The resulting inflation of such kind affects other sectors of the economy and cause the long-run economic growth to shrink.
Apart from inflation, currency fluctuations creates volatility in the economy. With a lot of fluctuations the market becomes highly unpredictable and both local and global markets are affected. The bond and treasury bills securities are heavily affected since they mostly depends on the value of the currency.
Volatility is not always bad, especially in currency exchange. Its effects can, however, be dire when measures are not taken to keep it under control. The economy can deteriorate and returns to investment can be negative or slightly positive due to higher risks.
Currency fluctuations cause changes in the levels of investment. A fluctuating currency can also affect investment levels in a major way. Both local investors and direct foreign investment depends on a stable currency. A weaker currency creates uncertainties within the economy.
An unpredictable currency is a cause of concern for business people who want to have long-term investments in the economy.
While a weakened currency is usually a major pull for foreign direct investment, a currency that tends to change in value quickly has the opposite effects. As the motive for investors is to maximize profits after payback period. When currency is changing that much, it becomes difficult to arrive at specific timeliness. Local investors suffers a lot under a fluctuating currency.
More bottlenecks are created in the business and hence, results in shortages in the commodity market.
Last but not list, currency fluctuations affects lending. Changes in currency fluctuations affects interest rates as well as lending. The monetary policy of any economy depends on the exchange rates of the currency.
Most central banks take keen interest in the performance of both local currency and international currencies.
Policymakers can be able to come up with policies that are good for the economy if a currency is strong, the interest rates becomes high. Higher interest rates discourage lending and lead to a slowdown in demand for loanable funds. In this article loanable funds includes all forms of credit, such as bonds, loans and savings deposits.
A strong currency can thus force monetary policy formulators to come up with measures that could bring in more foreign direct investors.
Currency fluctuations occurs due to law of invisible hand in the forex market. In most economies fluctuations are natural and comes as a result of the market forces.
The fluctuations however, have vast exponential ramifications for the economy. Most after-effects of currency fluctuations are not particularly harmful but some can affect the economy immensely.
For a country like Zimbabwe the only way to fix the local currency, it’s by finding factors that derail the manufacturing sector and fix them so that the manufacturing industry can reignite.
Economist Clemence Mupfunya is a correspondent for The Sunday Express. He writes in his personal capacity. Contact him at (27) 67 208 2236. Email: firstname.lastname@example.org
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