3. Conclusions

dr

de

national currency depreciates, i.e. exchange rate rises.

264 Financial Management from an Emerging Market Perspective

2.3. Effects on firms

listed as follows [23, 24]:

dG <sup>¼</sup> �Ly

dG <sup>¼</sup> �LrZy

LrSy þ IrLy

ð Þ Ze � Xe LrSy þ IrLy

According to the three multipliers Eqs. (42)–(44), fiscal policy affects only current account so

Firms are influenced by exchange rate changes due to the effects they have on the general economy and also because of the activities they carry out in foreign currency. Fluctuations in exchange rates affect firms either positively or negatively, which is defined as exposure to exchange rate or exchange rate risk in financial literature. The exchange rate sensitivity is the potential for changes in exchange rates, company cash flows and hence the market value. Exchange risk is not an issue if the change in the cash flows of a firm that is exposed to this exchange rate effects can be predicted in advance. In short, if there is no difference between expected cash flows and realized cash flows due to exchange rate changes, exchange rate risk is not a concern. Openness to exchange rate, in general, becomes clear in three ways: accounting, economic and transaction effects. The accounting effect, also called the translation exposure, is an effect that occurs when the financial statements of the subsidiary are converted into the central currency of the country during the consolidation of the financial statements, and it is the measurement of the change that this effect causes on the firm's equity. The main way of protecting from accounting effect is to increase liabilities by reducing assets from weaker currencies and reducing liabilities by holding assets from stronger (revalued) currencies. A position in the derivative markets can be taken to support this approach. The economic impact, defined as the effect of unexpected changes in the exchange rate on the future cash flows of firms, is important as much as the degree it affects company value. However, since future cash flows are not easy to predict, many researchers describe the effects of exchange rate changes on the firm value, which is assumed to be the present value of future cash flows, as an economic impact. Since the effects of exchange rate changes on the economic side are long term, the hedging methods in derivative currencies lose their validity in decreasing the economic effect; instead, firms can develop their own strategies and avoid the risks of economic vulnerability. The transaction effect is the effect of exchange rate changes on the sales and profitability plans together with the foreign currency denominated receivables and payables of firms. In order to be able to determine the presence of the transaction effect, the estimation of the net cash flows in foreign currency, and its potential effect should be measured. Since they are mostly short lived, it is possible to solve the problem with the help of derivatives (forward, future, option contracts) and money (hedge transactions) markets. Due to the growth strategy that Turkey has embraced, exporting companies have a critical prescription in the economic structure. For this reason, it is important for policymakers to determine the effect of the exchange rate variability on firms' performance. The effects of changes in exchange rates on firms can be

> 0 (43)

<sup>&</sup>gt; <sup>0</sup> (44)

We can summarize the fiscal and monetary policies under fixed and flexible exchange rate with different types of capital movements as can be seen in Table 1 [4]. We see that fiscal policy is efficient under fixed exchange rate regime with perfect capital mobility. In addition monetary policy is efficient under flexible exchange rate regime with perfect capital mobility.

By the early 1960s, macroeconomics had become firmly established as an approach to open economy questions. The standard analysis was one of the comparative statics in a model with income demand determined and with the exchange rate setting relative prices. The following years brought the highly influential work of Robert Mundell, who created models under fixed and flexible exchange rates [8, 21, 22].


Table 1. The effects of monetary and fiscal policies under various exchange rate regimes.

Toward the early 1970s, the field opened up in many directions. The formal orientation had led to interest in empirical work, and soon questions of capital mobility, or trade and payment adjustment, become popular areas of applied research.

There was a perception, almost up to the late 1980s, that the emerging countries were not different from the developed ones except for levels of per capita. The developed country represented to the developing country a mirror image of its future [15]. However, it is not like that. There are completely different problems in emerging countries because of the differences in social life, geography, that is, the location of the country and political problems. Emerging countries' lack of structural reforms and shallow financial markets curb economic growth. To overcome this obstacle, emerging countries must give priority to the reforms and financial markets.

The early 1990s have witnessed a large increase in capital inflows to emerging countries. These flows are characterized according to their magnitude, timing, regional and country destination, asset composition and sectoral destination. This chapter examines the nature of the capital inflows in a theoretical way. There may be various responses undertaken by the recipient countries against capital inflows. Capital inflows result in huge expansion of aggregate demand resulting in an increase in domestic inflation and an appreciation of the real exchange rate. Specifically, with a predetermined exchange rate, capital inflows generate an overall balance of payment surplus. This may cause appreciation of the nominal exchange rate. The Central Bank has to intervene in the foreign exchange market to buy the excess supply of foreign currency at the current rate to avoid an appreciation of the nominal exchange rate. Thus, monetary base expands. Base expansion would lead to growth in broader monetary aggregates, which results in an expansion of aggregate demand. This would increase domestic price level. Rising domestic prices with fixed nominal exchange rate would imply an appreciation of the real exchange rate. Policymakers can break this chain trough a policy intervention. These interventions are as follows [23]:

There exist policies, which:

• Limit the net capital inflow. This can be done in two ways: firstly, by limiting gross capital inflow and secondly by allowing more gross capital outflow. Inflow of capital usually faces administrative controls, whereas there is a reduction in limitations on the outflow of capital. Exchange rate bands can also be widened to increase the uncertainty.

