Many foreign affiliates operate under inflationary economic conditions. Thus it is important for MNCs to determine the effects of an increasing local price level or devaluation on their inventory management policies. The type of inventory normally stocked by subsidiaries is of impor tance in this decision. Some subsidiaries rely heavily on imported inventories, while other subsidiaries depend heavily upon locally acquired inventories. Some other subsidiaries may rely almost equally on imported and locally acquired inventories.
If a subsidiary relies heavily on imported goods, it should seek to build its inventory of supplies, equipment, and components in advance of an expected devaluation, because devaluation at a later date effectively increases the costs of imported goods. For example, if a host country declares a 10 percent devaluation of its currency in relation to the dollar, a subsidiary should pay 10 percent more local currency for the same amount of imported goods from the USA.
On the other hand, if a subsidiary depends heavily upon locally purchased goods, it should seek to minimize its inventory of supplies, equipment, and components, because devaluation at a later date effectively reduces the dollar value of inventories acquired locally. If inventories are translated at current rather than at historical exchange rates, a 10 percent devaluation of the local currency against the dollar would reduce the dollar value of its inventory by 10 percent.
Finally, if a subsidiary relies almost equally on imported inventories and locally purchased inventories, it should seek to reduce its locally acquired inventories and to increase its imported inventories in advance of an expected devaluation. However, if accurate forecasts of devaluation are not possible, a company should maintain the same amount of imported goods and locally purchased goods to avoid foreign-exchange risks, because a devaluation would affect both types of inventories equally, and thus the subsidiary would experience neither a gain nor a loss.
Up to this point, our discussion has centered on preventive measures that MNCs can take to reduce risks associated with devaluation. Additional action can be taken in pricing to reduce these risks.
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