How Foreign Exchange Impacts Manufacturing

Phil Black - PII Editor 13/01/2023

380 4 minutes read

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Foreign exchange impacts all of our day to day lives in profound ways without too many of us ever even realising it. Like gravity, it is a force that weighs heavy on all of our shoulders, yet we never quite feel its touch and can only truly measure it if we use the right instruments and theoretical tools – or at least if we know where to look.

And right now, all any of us have to do is take a look in our nearest supermarket or tentatively tear open our latest energy bill to see some of the impacts that the foreign exchange markets are having on day to life. If you are on the right side of things, the weak Euro could mean that your favourite imported Italian wine is now that bit more affordable. But if you are on the wrong side of it, then the Pound's decline could mean that paying for wholesale gas in Dollars has rendered heating prohibitively expensive this winter.

Of course, gravity is a force of nature whereas foreign exchange is very much a man-made market force. And yet ultimately, foreign exchange is no more accountable and is in fact, infinitely less predictable than gravity. We know full well what the earth's gravitational force will be tomorrow and we can build spacecraft to deal with it. However nobody knows what the USD to THB exchange rate will be tomorrow and as such, central banks and small businesses alike are left to hope, hedge and if they are so inclined, pray.

Foreign Exchange and Manufacturing

Manufacturers often find themselves especially susceptible to ebbs and flows in foreign exchange markets for a number of reasons. Firstly, most manufacturers have to buy in parts or raw materials internationally; afterall in the 21st century there are very few products that can be made using only materials found in any single-one country and as such, a manufacturer will need to import certain metals or microchips in order to make its products.

Take a quintessentially Italian brand like Armani for example, whereas their suits are proudly tailored in Italy (the top-end ones that is. They do run alternative production lines in the developing world), the fabrics they use are sourced from Asia. This means that they regularly need to buy materials from a number of Asian countries and pay for them in Rupees, or Yuan for example. As such, the current Euro against the world exchange rate impacts how expensive those materials become.

You may well have heard that the Euro had a particularly torrid time in 2022 and collapsed to a two decade low around the summer. That means that European businesses importing parts or materials suddenly had to pay a lot more for them.

Let's look at an example.

A year ago, €1 equated to 38.09 Thai Baht (THB). An Italian tailor buying 10kg of fabric worth 10,000 THB would therefore have to pay €262.53.

Today though, €1 is equal to 35.93 THB so that same amount of fabric now costs €278.31. And that’s before we even begin to worry about inflation which is a topic for another time!

At the other side of the production cycle, manufacturers are also mindful of how foreign exchange impacts the saleability of their goods. Many manufacturers make goods for international markets and very few these days can rely entirely on domestic clients. This can sometimes mean that long standing customers may no longer be able to afford to buy the manufacturers goods – for example, this year's strong Dollar performance meant that American exporters were negatively hit as global clients found American made goods to be costly.

What Can Be Done?

As we said in the intro, the forces of foreign exchange are unpredictable and accountable to nobody. Yet, businesses need certainty and there are a few steps they can do to try and “hedge” against changes in the foreign exchange markets. Money Transfer Comparison prepared a detailed, business-oriented guide to foreign exchange but if you are pressed for time, here is a quick summary of what business can do.

Multi Currency Accounts

Many businesses have multi currency bank accounts that allow them to hold cash reserves in a number of different currencies. Because they already have the foreign currency needs, they can simply use it when they need to and do not have to worry about the exchange rate.

Forward Contracts

Businesses can also engage currency brokers and enter into a forward contract. A forward contract is an agreement for a client to buy an agreed amount of a stated current within a set time frame and a fixed exchange rate. This can allow a business to “lock in” a good exchange rate even if they don't have the funds to complete the transaction at present.

Final Thoughts

As you can see, the impacts that foreign exchange has on industry are huge. The examples we have offered here are basic but bear in mind that foreign exchange also affects overseas payrolls, energy costs and import taxes so can well and truly hit a business's bottom line. In extreme cases a bad run on foreign exchange can force some businesses into closure resulting in loss of jobs.

Still, a successful business demonstrates resilience and adaptability and by taking some simple steps to “hedge”, can give itself a good chance of weathering the trade winds of foreign exchange.