Currency Devaluation – Effects and Consequences

Currency Devaluation – Effects and Consequences

Currency devaluation means the decrease of purchasing power of specific currency/ domestic currency against gold, SDR or foreign currencies that is determined by the government. Currency devaluation occurs when a country allows the value of its currency to drop in relation to other currencies.

Devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged. It means there is a fall in the value of a currency. In common modern usage, it specifically implies an official lowering of the value of a country’s currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency, in contrast, depreciation, is used for the unofficial decrease in the exchange rate in a floating exchange system. The opposite of devaluation is called revaluation.

Consequences of currency devaluation:

  1. Import reduction.
  2. Export encouragement.
  3. Reduction of trade deficit.
  4. Checking unfair trade practice.
  5. Counter the foreign dumping policy.
  6. Encourage foreign investment.
  7. Increase domestic employment.
  8. Effects on wages and policies.
  9. Effects on domestic income.
  10. Effects on foreign prices.

Effect:

  • Exports cheaper – A devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports.
  • Imports more expensive – A devaluation means imports, such as petrol, food and raw materials will become more expensive.
  • Falling real wages – In a period of stagnant wage growth, devaluation can cause a fall in real wages.

Consequences of Currency Devaluation in Developing Countries –

(a) Import reduction: Currency devaluation decreases the purchasing power of a foreign currency. So the primary effect of currency devaluation is to reduce import with the increase of currency price.

(b) Export encouragement: For the reason of currency devaluation, short terms capitals are acquired by exporting goods or services. That means it helps to increase export.

(c) Reduction of trade deficit: Generally the developing countries are to import goods more than they exported. Curren4 devaluation is a technique that can create a reverse situation by encouraging export and reducing import, which reduces the trade deficit.

(d) Checking unfair trade practice: Many countries involved in unfair trade practice in their business. Devaluation is a way that can create effective action to prevent them.

(e) Counter the foreign dumping policy: Protectionism is necessary for controlling the dumping policy. Devaluation is an effective method of Protectionism which can easily control dumping policy.

(f) Encourage foreign investors: Foreign investors invest their money when they get some facilities from a country. Devaluation provides financial advantages which encourage investors to invest their capital.

(g) Increase domestic employment: Employment opportunities are made with the increase of foreign and domestic investment in a country. Devaluation has an option to create this situation which can create job opportunities.

(h) Effects on wages and policies: Actually wages and prices are increased for the reason of currency devaluation. But it cannot be if free trade policy is made after devaluating currency.

(i) Effects on domestic income: Devaluation increases alternative industries of import-export business. And also reduces imported goods and services from abroad. This has a role in the trend of domestic income.

(j) Effects on product prices: Reducing import, increases the supply of an export-related product which decreases product prices.

(k) Political impact: A political government can be lost their popularity for taking the policy of currency devaluation at an unsuitable time.

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