What is an Economic Risk, and Why Does It Matter?
Before starting a business or investing your money, assessing the significant economic risk in your investment area is essential. Economic risks affect businesses by lowering the currency's value, affecting currency exchange rates.
Economic risks are caused by the country's financial and other macroeconomic conditions. They mainly affect foreign businesses because they influence currency exchange. These risks include government policy, political instability, and inflation.
Investors should consider all the potential economic risks and weigh their impacts. If the risks outweigh the benefits of the business's existence, it is advisable to pause implementing the business idea.
Examples Of Economic Risks And How They Affect The Economy
Investing in a business is risky because any changes in the business environment could earn you profits or huge losses. Unluckily, some risks are difficult to notice before they happen and could happen anytime. Some examples of economic risks are;
The political stability of a country is a significant factor that attracts foreign investors. In addition, a peaceful country creates a conducive environment for businesses to operate and grow, making more profits.
However, recession, corruption, or unemployment can lead to demonstrations and violence in the country, causing political instability. In addition, social unrest and chaos can force businesses to close down because the environment is unsafe.
Business closure leads to low profits and losses, especially for businesses that deal with perishable goods. The instability could also fuel the government to implement laws that negatively affect foreign companies.
A country with political instability becomes less attractive to foreign investors, destabilizing its economy and weakening the currency—a weak currency results in expensive imports and cheap exports.
Interest rate is the extra amount lenders charge borrowers and is expressed as a percentage of the principal. An increase in interest rates makes loans expensive, while lower rates make loans affordable.
Money demand and supply, inflation, bank's monetary policy, and government borrowing are some factors leading to a change in interest rates. For example, when money demand is too high, citizens borrow more to satisfy their needs.
The government and financial institutions can increase or lower interest rates to control money circulation. When the interest rates are high, loans become too expensive, hence fewer borrowers.
Without loans, there is limited access to money, reducing investment and job creation. When companies don't have enough money, there is reduced production, leading to reduced profits.
If a company depends on credit to operate, there will be a substantial financial impact caused by increased interest rates. As a result, some companies collapse, leading to slow economic growth. Slow economic growth lowers currency value affecting currency exchange.
Another vast economic risk that most entrepreneurs don't assess is exchange rates. The exchange rate is the price at which a country's currency trades with another. These rates change drastically and could lead to profits or losses.
Some causes of a change in exchange rates are inflation, public debt, a country's economic performance, and terms of trade. These factors affect the value of a country's currency.
A change in interest rates can have a direct impact on your business. For example, increased exchange rates cause an increase in the price of imports. As a result, a company that uses imported raw materials will pay more. This increases the cost of production and ultimately leads to a rise in the prices of the produced goods.
A decrease in exchange rates affects exporters negatively. When they sell their raw materials or finished goods to a foreign country, they will get fewer notes after exchanging the currency.
Unfortunately, financial organizations, foreign currency exchange agencies, and firms charge different exchange rates. If you want to get more Canadian notes after exchanging your currency, consider trading at Knightsbridge FX.
Most entrepreneurs do not think about economic sanctions when investing in a foreign country, but they significantly affect businesses. An economic boycott is a financial and commercial penalty applied by a government against another country, group, or individual, mainly due to political or social issues.
Sanctions are primarily restrictions on trade. In addition, other countries impose sanctions like freezing assets, blocking money transfers, or restricting traveling to certain countries.
Sanctions can significantly affect a country's economy. For example, if a state mainly benefits from tourists from a particular country in summer, its tourism sector will be affected when there are restrictions.
Businesses that export or import to a specific country will suffer losses if an economic sanction is imposed on them or their state. Also, if your business's primary raw material source is the United States, production will be cut short if there is an economic sanction.
Can Businesses Mitigate Economic Risks?
Economic risks are hard to foresee and can significantly affect your business. Although some, like political instability, are unpredictable, investors can prepare to deal with them. Some of the ways to be ready for economic risks are;
Sometimes a rise in interest rates and shifts in exchange rates are foreseen by economic experts. Staying informed about the current trends will help you prepare for any crisis.
For example, if there is a foreseen change in foreign exchange rates that won't favour your business, you can plan to export or import your items earlier. This way, you will make more profits than if you waited.
Have Alternative Suppliers
Most businesses want to be loyal to one supplier, which can take them down if the supplier collapses. Economic risks like sanctions can cut your ties with your supplier, and that doesn't mean you sit and watch your business dying.
Having alternative suppliers keeps you safe from economic risks. Suppliers from different countries also help you mitigate changes in foreign exchange rates between your country and another.
When looking for alternative suppliers, ensure you get multiple customers to export your goods to for security. For example, you can channel more exports to the other country if one is facing political instability.
When crafting your business plan, consider all the risks involved. For example, exchange rates keep fluctuating and can immensely affect your investments.
While having suppliers and customers from different countries helps, consider currency hedging. Currency hedging ensures that your investment's value remains the same regardless of the changes in exchange rates.
Keeping calm in business seems unimportant until you suffer the repercussions of rushed decision-making. Some investors nervously wait for problems to occur to start acting upon them.
Being calm manages your anxiety and prepares your mind for an economic crisis. When you are stable, you can think clearly and make sound decisions. Remember, a small wrong decision can significantly negatively affect your business.
When staying calm, also learn how to approach and manage risks. Then, when you prepare, you will know the decisions to make if certain things happen. Reading and staying informed about the current happenings in the world will help you be calm.
As an investor, researching and preparing for any economic risk is essential. Financial risks cause collapsing of businesses by disrupting the importation of raw materials, reducing profits, or burning exports. They also affect currency exchange by increasing or decreasing the dollar's value. Luckily, investors can prepare for these risks.