Does PPP Eliminate Concerns about Long$-$Term Exchange Rate Risk?

Point

Yes. Studies have shown that exchange rate movements are related to inflation differentials in the long run. Based on PPP$,$ the currency of a high$-$inflation country will depreciate against the dollar. A subsidiary in that country should generate inflated revenue from the inflation, which will help offset the adverse exchange effects when its earnings are remitted to the parent. If a firm is focused on long$-$term performance, the deviations from PPP will offset over time. That is$,$ in some years the exchange rate effects may exceed the inflation effects, whereas in other years the inflation effects will exceed the exchange rate effects.

Counterpoint

No$.$ Even if the relationship between inflation and exchange rate effects is consistent, this does not guarantee that the effects on the firm will be offsetting. A subsidiary in a high$-$inflation country will not necessarily be able to adjust its price level to keep up with the increased costs of doing business there. The effects will vary with each MNC$$s situation. Even if the subsidiary can raise its prices to match the rising costs, short$-$term deviations from PPP may occur. The investors who invest in an MNC$$s stock may be concerned about short$-$term deviations from PPP because they will not necessarily hold the stock for the long term. Thus, investors may prefer that firms manage their operations in a manner that reduces the volatility in their performance in short$-$run and long$-$run periods.