How exchange rates impact hotel performance

31 Dec, 2021 - 00:12 0 Views
How exchange rates  impact hotel performance

eBusiness Weekly

Dr Keen Mhlanga

In 2020, the International Monetary Fund (IMF) estimated that the global output due to the onset of the coronavirus had fallen by 3,5 percent. The outbreak of the Covid-19 contagion has been extraordinary, and its impact on the world’s markets has been reflected in the fluctuations in the foreign exchange as well. 

As exchange rate is one of the major important indicators of economics, it has also been affected by the pandemic, and the volatility can be seen in the unpredictability of the exchange rates. 

Exchange rates influence and affects pricing strategies in the marketing environment and ever since the pandemic hit globally, there has been a battle to balance “the official exchange rate versus the parallel market exchange rate war”. 

Aside from factors such as interest rates and inflation, the currency exchange rate is one of the most important determinants of a country’s relative level of economic health. Exchange rates play a vital role in a country’s level of trade, which is critical to most every free market economy in the world. 

For this reason, exchange rates are among the most watched, analysed and governmentally manipulated economic measures.

If the exchange rate falls, the buying power of the country would suffer, eventually leading to significant inflation. The occurrence of two separate values of a currency for different sets of monetary transactions, resulting in official and parallel exchange rates, is referred to as a dual exchange rate system. 

Dual exchange rates for foreign exchange are prevalent in developing nations, and data on the implications of such parallel foreign exchange systems on macroeconomic performance is beginning to emerge. Parallel foreign exchange systems, sometimes known as black markets, are the ones in which a market-determined exchange rate coexists with one or more pegged exchange rates, usually for finance transactions but sometimes for a percentage of commercial transactions as well. In developing countries like Zimbabwe, such partnerships are frequent.

In some cases, as the Zimbabwean inflation skyrocketed in May 2008, the official annual inflation rate reached 1 million percent with limited scope for external financing. A large part of the public sector’s financing needs were met via money creation, which further fuelled the rapid monetary expansion and a sharp rise in inflation.

 The Zimbabwean dollar continued to lose value, trading for about $6 million to the US dollar in January 2008 and falling to $70 million to the US dollar by March 2008, even though the official rate was $30 000 to the US dollar according to Robertson Economic Information Services in 2008. 

The Government responded to a balance of payments crisis by creating a legal parallel (or dual) foreign exchange market for financial transactions.

The goal is to limit the short-term consequences of a depreciation in the currency rate on local prices while keeping capital outflows and foreign reserves under control. Extensive foreign exchange regulations in some circumstances limit access to legitimate markets, resulting in the formation of an illicit parallel market. 

As the Government tighten and expand currency restrictions in response to a deteriorating balance of payments, the underground market becomes more important. In general, the black market for foreign currency emerges as a direct result of the implementation of exchange rate regulations in many emerging nations that are experiencing significant macroeconomic imbalances. 

Despite the fact that it has a detrimental influence on Zimbabwe’s economy, there is an underlying link between official and parallel market currency rates.

Black markets in foreign currency have emerged in most countries since time immemorial mainly as a result of Government controls on access to foreign exchange. These controls are initiated by an over-valued currency and in most cases these controls precipitate the foreign currency shortage leading to the development of foreign exchange black market. 

That is, a country with an over-valued currency (in most instances) fails to meet the demand for foreign exchange with sufficient supply. As a result, it rations the scarce available foreign currency and imposes controls on imports and exports, as well as on capital account transactions. 

Basically, the controls are imposed to try and protect Government’s limited stock of foreign currency reserves. The need for this protection is in turn, stimulated by trade deficits and/or capital flight which result in net demand for foreign exchange at the central bank. It logically follows that once the Government imposes restrictions and limitations on the holding foreign exchange or on transferring it overseas, demand for alternative sources for that currency emerge. 

Thus, Government’s inability to meet the demand for foreign currency and its interference in the operation of the market has a propensity to fuel the creation of parallel market for foreign exchange. 

Although foreign currency shortages have been a perennial economic problem for Zimbabwe since Independence, the severity of the problem first came to light in 1987 due to economic factors categorised within the context of poor governance, economic mismanagement, and loss of support of the international community, before subsiding and reappearing again since 1993 when the Government decision was to ignore fiscal constraints by making large payments to veterans of the Independence struggle. 

Nevertheless, the black-market premium was very small for the greater part of the 1990s, only to start increasing towards the end of 1999 when the Government announced a substantial price increase in basic foodstuffs, with cornmeal, cooking oil, bread, and sugar all doubling in price. 

The economic crisis, brought about by high interest rates and inflation, a weak currency, and rising unemployment. Seeing the train coming, international money markets began devaluing the Zimbabwean dollar. 

Between April and October 1998, the currency lost half its value, plummeting from 17 to the US dollar to 38. In January 1999, an agreement between Zimbabwe’s central bank and the commercial banks pegged the Zimbabwean dollar at 38 to the US dollar. 

That exchange rate could not be justified for very long, however, and inflation began to grow, peaking at about 70 percent in 1999 as researched by one economist, McDonald in 2000. By 2002, the country’s black market activities had grown in depth and breadth to such an extent that the black market premium reached its highest percentage figure of 2 898 in December 2002 and January 2003 as Western donor nations and organisations halted economic said to and investment in Zimbabwe. 

In October 2000, for example, the World Bank announced that it would extend no more loans to Zimbabwe. According to Robertson Economic Information Services in 2008 with limited scope for external financing, a large part of the public sector’s financing needs was met via money creation, which further fuelled the rapid monetary expansion and a sharp rise in inflation. 

The Zimbabwean dollar continued to lose value, trading for about $6 million to the US dollar in January 2008 and falling to $70 million to the US dollar by March 2008, even though the official rate was $30 000 to the US dollar and up to date the plunge is still on with the February 20, 2019 Monetary Policy Statement of the fixed 1:1 exchange rate peg between the US$ and the Bond note. 

The intention was to strip the US dollar as a medium of exchange and serve more as a reserve currency. Simultaneously, the RTGS dollar was expected to assume all other functions of a domestic currency. 

However, since its adoption, the RTGS dollar has continuously lost value against the US Dollar at a pace of, on average, approximately 1 percent per day. 

On February 25, the official interbank rate stood at US$:$2,5, and climbed to US$:$6,28 as at June 21. On the parallel market, rates climbed from US$:$3,5 to US$:$12 during the same period.

Numerous factors determine exchange rates namely differentials in inflation, interest rates, public debt of a country, inability to supply forex by governments and high demand for forex. 

Many of these factors are related to the trading relationship between the two countries, but we also note that exchange rates are relative, and are expressed as a comparison of the currencies of two countries. 

There is a clear sketch of how exchange rate movements affect a nation’s trading relationships with other nations. A higher-valued currency makes a country’s imports less expensive and its exports more expensive in foreign markets. 

A lower-valued currency makes a country’s imports more expensive and its exports less expensive in foreign markets. A higher exchange rate can be expected to worsen a country’s balance of trade, while a lower exchange rate can be expected to improve it. 

The first two determinants of exchange rates globally are inflation and interest rate differentials. Typically, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. 

During the last half of the 20th century, the countries with low inflation included Japan, Germany, and Switzerland, while the US and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency about the currencies of their trading partners hence befitting a higher exchange rate in order to match the inflation statistics. 

Interest rates, inflation, and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. 

Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest rates — that is, lower interest rates tend to decrease exchange rates. 

The third factor determining exchange rates is a county’s public debt whereby countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors in the sense that a large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future.

The last determinants influencing a parallel market (black-market) exchange rate is the ability of a government to supply foreign currency and demand for foreign currency in an economy. 

Parallel market systems represent a subset of the broader category of multiple exchange rate regimes, which refer to any regimes in which two or more exchange rates are applied to the same currency which is rather too common in developing countries as Zimbabwe.

By contrast, a parallel market for foreign exchange is distinguished by the fact that the parallel exchange rate is determined freely in the market. Usually, the official exchange rate in parallel market systems is pegged by the authorities at a particular fixed (or crawling) rate, although in principle the official rate could be floating as well. 

Additionally, it is frequently — although not always — the case that the official exchange rate applies to current account transactions, while the parallel market rate, whether legal or illegal, applies to capital account transactions. 

A parallel market arises when the government limits the amount of foreign exchange that can be bought or sold for particular transactions, causing excess demand or supply to spill over into a parallel market, or authorises that exchange rates for certain transactions be pegged and for other transactions be floating. 

In the worst-case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. This falls under a perfect example of Zimbabwe’s 2008 scenario. Zimbabwe’s peak month of inflation is estimated at 79,6 billion percent month-on-month, 89,7 sextillion percent year-on-year in mid-November 2008 according to Corporate Finance Institute (CFI), a Canadian based analyst certification organisation. 

In April 2009, Zimbabwe stopped printing its currency, with currencies from other countries being used as the Rand from South Africa and dollar from US. In mid-2015, Zimbabwe announced plans to have completely switched to the United States dollar by the end of that year. 

As in several other African countries — although to a much more extreme degree in Zimbabwe — the cause of this was large Government budget deficits and rapid growth of the money supply. There was an insufficient supply of foreign currency at the official, pegged rate, and a parallel market emerged with a heavily depreciated, market determined exchange rate.

Zimbabwe has been enjoying a healthy trade balance boosted by tobacco, nickel and gold exports. Overall, the economy presents a mixed picture. 

The country is starting from a very low base and still lags behind its peers in Southern Africa, such as Tanzania, which have seen modest but sustained growth trajectories at 301,92 billion US dollars in 2020 in South Africa and 2,0 percent in 2020 for Tanzania. 

However, good progress has been made in Zimbabwe. According to official figures, the key economic indicators — such as the inflation rate, gross domestic product (GDP) growth rate and infrastructure development — are fairly positive. This year the inflation rate dropped from a three-digit figure of 838 percent in July 2020 to 51,5 percent in September 2021.

However, all these developments are underpinned by the exchange rate and price stability — and that is where things get interesting. The currency crisis is at the heart of the country’s economic struggle and threatens the gains made so far.

The Reserve Bank of Zimbabwe introduced the Foreign Exchange Auction System in June 2020 in a move that was initially seen as progressive. But it didn’t succeed in liberalising the foreign currency market, as the Reserve Bank interfered in the auction in an attempt to maintain control over the exchange rate according to the Interim Economic Partnership Agreement (IEPA). 

Through this auction system, the Reserve Bank allocates foreign currency that it expropriates from exporters. 

As a result, the gap between the formal exchange rate and the parallel market continues to widen fast. The parallel market reflects more closely the real value of the local currency against the US dollar. 

When the auction system was introduced in 2020, the parallel market rate stood at $80 for US$1, and today it’s anything from $150 to $200 against the US dollar claims the report from Institute for Security Studies Africa. 

The formal exchange rate stands at US$1 — $90, which is less than half of the parallel market’s rate. Businesses are opting to price goods based on the parallel market rate because the local currency is undervalued. 

To deal with this, the Reserve Bank of Zimbabwe implements a litany of measures, including the arrest and freezing of bank accounts of those using exchange rates outside the auction system, or illegal money changers abusing the auction system. 

This penchant for Government control seems to be facing much resistance, for instance on October 11, 2021 a bag of cement was selling at USD10,00 which was $930,81 using the official rate of 93,081 and $1 600,00 under the parallel exchange rate yielding a difference of $669.19.

In addition to this, economic trade has fallen from 12 percent to 32 percent in 2020 as well as a downfall of 3,8 percent in the economic growth of the US. The nation’s economy is fuelled by abundant natural resources, a well-developed infrastructure, and high productivity. 

It has the seventh-highest total-estimated value of natural resources, valued at Int $45 trillion in 2015. The United States has the most technologically powerful and innovative economy in the world and its dollar is the currency most used in international transactions and is the world’s foremost reserve currency, backed by its economy, its military, the petrodollar system and its linked euro-dollar and large 

US treasuries market. With its well-recognised and successful economy, the nation has never recorded any form of parallel market for forex. 

The country operates at an official exchange rate system but the continued deterioration in fundamental factors such as US fiscal and current-account deficits and relatively strong economic growth in the rest of the world are among the significant headwinds that should push the US dollar meaningfully lower. 

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Parallel markets for foreign exchange are back in the news in Argentina, South Sudan and Nigeria respectively. On December 17, 2015, Argentina’s peso plunged after the new government floated the currency. The official exchange rate went from 9,8 pesos per dollar to 13,95, close to the parallel rate of 14,5. 

It then closed the trading day at 13,4. Earlier, on December 15, South Sudan’s central bank switched to a float from its fixed exchange rate. Its pound dropped like a stone from 2,95 per dollar to the parallel market rate of 18,50 per dollar. In contrast, Nigeria has been in the news mainly for reintroducing foreign exchange (FX) rationing following the precipitous decline in oil prices. 

Oil accounts for 70-80 percent of the country’s fiscal revenues and the lion’s share of its exports. As a result, the naira price of the dollar is some 40 percent higher in the parallel market than the official exchange rate (280 versus 200 naira per dollar). The battle has been elite in the 3 countries of how to balance or eliminate black markets exchange rates worse off with the pandemic strike on most economies.

China’s foreign exchange system used to be strictly controlled by the central government. Yet since China began its economic reform in the late 1970s, the foreign trade system has been liberalized gradually. In the early 1980s, Chinese currency RMB was non-convertible and the foreign exchanges were strictly supervised by the state. 

Two exchange rates were in operation during that period: an official rate published by the government and another special one for foreign trade. Such a system was aimed at enhancing the country’s exports and restricting its imports, as China suffered from a serious lack of foreign exchange at that time. 

In 1984, as a result of improved performance in foreign trade and the economy as a whole, the government adopted a new policy of exchange retention. This policy allowed domestic enterprises and institutions to retain some of their foreign currency earnings, in contrast to the previous one in which these units turned over all of their foreign currency earnings to the state and ever since this move was made the emergence of a parallel market with its own exchange rate policy emerged in China which has made it difficult for the nation to internationalise its currency. 

China has successfully navigated an exit from pandemic lockdowns and has experienced a quick rebound in economic activity. After the pandemic china’s recovery took hold and growth was already broadly converged to pre-pandemic trend levels, and projected growth for 2021 at about 8,0 percent as reported by Geoffrey Okamoto, IMF First deputy managing director at the Forum on National Affairs. 

As the global recovery is gaining momentum, export demand is expected to keep industrial capacity utilisation high in the short term. China’s yuan eased against the dollar as Marco Sun, chief financial markets analyst at MUFG Bank, also noted three high frequency indicators including bank lending, power generation and rail freight transportation all slowed in August 2021, suggesting that the economy’s recovery in the second half of this year was facing multiple obstacles. 

However, the contribution of net exports to growth will moderate in the medium term as import growth picks up and international travel slowly resumes in 2022. 

Determining the appropriate level at which to set the exchange rate is a challenging problem for any country pursuing a managed or fixed exchange rate policy. In developing countries subject to macroeconomic instability or structural change, this identification is even more difficult. 

The determination of the equilibrium real exchange rate is especially uncertain if the economy is in the midst of trade liberalisation and other reforms that promise to change previously existing relations between trade performance and the exchange rate. 

The issue of how to estimate long-run equilibrium real exchange rates has been addressed from a variety of different empirical perspectives, such arrangements, formal and informal, legal and illegal were the norm for developing countries until very recently. 

Because parallel exchange rates continue to exist in important countries and because specific analytical issues in estimating the long-run equilibrium real exchange rate (LRER) that do not arise in the context of unified rates present themselves in this case, the implications of parallel rates merit separate attention. 

In cases in which a parallel market for foreign exchange exists, it may appear natural to consider the parallel exchange rate as a proxy for the “underlying” equilibrium real exchange rate — that is, the rate that would tend to prevail over the long run in a unified exchange market. 

This interpretation suggests itself because the parallel exchange rate usually has the benefit of being determined in a free market and hence may not appear to be obviously contaminated by the distortionary effects of government policy. 

Notwithstanding the appeal of a parallel market determined exchange rate as a guide to setting the official exchange rate but only under a relatively narrow set of circumstances may the parallel market rate serve as a useful guide to determining the equilibrium value of the official exchange rate. 

The growth of foreign exchange parallel market causes the government to lose control over foreign exchange as more and more of the official transactions are diverted to the parallel market. At the same time, black market premium for foreign exchange functions as an implicit tax on exports, serving at once as a disincentive to export production and a source of hidden fiscal revenues. 

The parallel exchange rate feeds back into the economy through illegal trade and prices. However, there is an argument of how black  market rates are often more informative than official rates since they are forward-looking, sensitive to news, and more representative of how people view the prospects for their currencies. 

Fixed official rates by contrast typically change only due to necessity and have frequently borne little relation to a country’s actual economic circumstances hence it has been debatable that parallel market exchange rates give a clearer reflection of the country’s economic growth and performance.

Whilst the purge goes on in other countries experiencing off balance of dual exchange rate systems some countries have been desperately seeking ways to promote global economic stability and hence their own prosperity ever since the abandonment of the gold standard at the outbreak of WWI and the Bretton Woods Conference following WWII. 

For the majority of these countries, the optimal way to obtain currency stability has been to peg the local currency to a major convertible currency.

However, another option is to abandon the local currency in favour of the exclusive use of the US dollar (or another major international currency, such as the euro) and this is known as full dollarisation. 

As an alternative to maintaining a floating currency or a peg, countries have decided to implement full dollarisation. The main reason a country would do this is to reduce its country risk, thereby providing a stable and secure economic and investment climate. 

Countries seeking full dollarisation tend to be developing or transitional economies, particularly those with high inflation like Zimbabwe.  There’s no doubt that the US dollar has immense power. Its value is determined by the strength of the American economy, which is one of the reasons why it’s the world’s dominant currency. 

Not only is it the world’s most commonly used currency, but it’s also the world’s reserve currency, meaning it’s held in large quantities by central banks around the globe. Commonly known as the greenback, it’s also one of the most commonly traded currencies on the foreign exchange market. 

Full dollarisation, however, is an almost permanent resolution: the country’s economic climate becomes more credible as the possibility of speculative attacks on the local currency and capital market virtually disappears. 

The diminished risk encourages both local and foreign investors to invest money into the country and the capital market. And the fact that an exchange rate differential is no longer an issue helps reduce interest rates on foreign borrowing. 

Despite its rampant use by numerous countries around the globe the policy of dollarisation poses negative impact on a country with a volatile environment as Zimbabwe. There are some substantial drawbacks to adopting a foreign currency. When a country gives up the option to print its own money, it loses its ability to directly influence its economy, including its right to administer monetary policy and any form of exchange rate regime.

While everyone recognised high parallel FX market premia as a costly distortion, how to unify official and parallel rates remained a hotly debated topic. It suggests that the black market has gone beyond being just tolerated by the Government to becoming a stable institution, despite the fact that it is still officially “illegal”. 

The fact that some Government departments also resort to the black market for settling “important” foreign currency payment obligations, is in itself a death blow towards successfully eradicating this pervasive market. Findings suggest that successful unification of the parallel and the official markets for foreign currency will require long-term measures, strong and sustainable enough to “destabilise” the parallel market and in order to unify these two strategies and policies have to be made. 

Firstly, it is also a well-known economic fact that exports are one of the nearly endogenous variables that any country can manipulate and use for its benefit to earn foreign exchange. Though export prices are exogenously determined on the international market, a country can still be able to reduce the scarcity of foreign currency by increasing its exports, both in quantity and quality terms through relevant export promotion strategies and state of the art production techniques, respectively.

If Zimbabwe could be able to revive her export sector, much of the pain brought by black market maybe, reduced to a greater extent. Secondly, another important factor which is a prerequisite for these policies to succeed is the restoration of the country’s long-term macroeconomic and political stability. 

Even if the authorities were willing to implement the trade and exchange rate reforms that are necessary for a successful unification policy, it will be difficult to achieve and maintain macroeconomic discipline in a hyper inflationary, politically polarised and sanctioned/isolated country. Reducing the country’s hyperinflationary environment and taking steps to mend the battered relations with the international community (among the array of ills to be corrected) would not only lay the basis for long-term development initiatives, but will also reactivate international cooperation with the country and boost confidence in Zimbabwe’s economy. 

Other countries have capitalised on expatriates, created systems and structures credible enough to attract investment by their own “diaspora”. Other measures should include the government fostering a more competitive banking sector as well as general financial stability (especially following the financial crisis which hit the country, resulting in more than four banks placed under curatorship in 2004) in order to increase efficiency in the use of the country’s limited financial resources, including foreign currency.

Despite the propaganda in trying to settle and solve parallel markets in countries, the dollarisation strategy has proved to be very effective if applied under the bad money versus good money theory by Thomas Greshaw. 

The idiom stands to phrase out bad money drives out good money meaning if both low quality and high- quality currencies exist in an area or market together; people will keep the high-quality currency for themselves and only use the low-quality currency with each other. Hence dollarisation can only curb black- markets if the Government employs or adopts on one player as the major currency in the nation similar to the 2009 period when the rand was being used as the main currency before switching to the American dollar. 

China is a good example of a country which has made perfect progress due to the adoption of a singular currency in its nation.  Economically developing nations would also benefit considerably with the introduction of a stable currency, which would form a base for future economic development. For example, Zimbabwe suffered through one of the worst hyperinflation crises in history. 

The Zimbabwean dollar had to be replaced in April 2009 by foreign currencies, including the US dollar.

Founder and Chairman of FinKing Group [email protected]/+263777597526

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