Sunday, 27 February 2011

High inflation rate causes currency related problem to businesses in Vietnam


In addition to some common methods of financing business mentioned in previous blog post, venture capital is known as popular effective way to finance big projects and entrepreneurs. The term “Venture Capital” (VC) was first introduced in United State with an establishment of American Research and Development (ARD) in 1946 by Karl Compton – a president of MIT University, Professor Georges F. Doriot of Harvard Business School and other Boston business leaders (Arnd Plagge, 2006). This kind of Fund is called Venture partly because it normally invests in large projects with high risks. Nowadays, VC has developed in many countries all over the world, especially in some developing countries where potential ideas are not expanded due to the limited financial sources. When investing in foreign countries, besides common risks that VCs possibly face, they always need to prepare in advance the currency related risks. Expressly, this kind of risk might be most noticeable in import-export trades and multinational firms.

Let’s take Vietnam as a case to examine what risks currency exchanges can cause to business. Over the last decade, the increase of inflation has strongly reduced the value of Vietnam Dong compared to other foreign currencies. Within only 7 years (from 2000 to 2007), the inflation rate in Vietnam went up dramatically from -0.6% to 12.6%. Although government had plans to reduce the inflation rate, it did not decline much and is forecasted to reach warning point.

Inflation rates in Vietnam from 1995-2007 (Sources: Saga)

Taking an example of VND and USD exchange rate, in 2005, 1 USD can buy about 16,000 VND, and at this time, 1 USD is worth of 20.800 VND or so. This is a bad news for foreign companies operating in Vietnam (which use USD as official currency) that they can face ‘translation exposure’. It means the book value of revenue earned in Vietnam will be low when being converted to USD. So do import-export businesses. The increasing gaps between VND and other currencies help to higher the prices of imported goods and lower the profits from exporting (this is because high inflation caused growth in all goods’ prices resulting in higher production costs, whereas manufacturers cannot put the price too high).

Considering the idea that high inflation causes increase in products cost/price, the matter VCs might be worried about is the insufficient investment. Some investors (maybe, fortunately) foresee this risk and prepare the back-up plan in advance. Thus, they might overcome the problem. Considering the idea that high inflation causes increase in products cost/price, the matter VCs might be worried about is the insufficient investment. Some investors (maybe, fortunately) foresee this risk and prepare the back-up plan in advance. Thus, they might overcome the problem.

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