Exchange Rate Devaluation Analysis

Devaluations- do they help?

Devaluation can be defined as the deliberate downward adjustment with the value of a country's currency, which is subject to change with the change in another currency, group of currencies or standard.

When we talk about devaluation its of prime importance to know the procedure through which a country’s value of currency is arrived at. In the foreign market the value of a currency is always pegged against the value of currency of another country. For example, rupee when pegged against the dollar will be traded at its current rate which is $1= Rs 66.38. So what this rupee will buy for an Indian citizen will be the same for what a U.S national will get for $1.Factors that determine the value of a currency are:-

1. Interest

Supply and Demand of the currencies of both the countries

Devaluation generally occurs in fixed exchange rate system. This takes place mostly in developing countries which are averse to the fact of currency prices being fixed by market forces. Hence, to avoid financial crisis and to minimize the risk associated with exchange rate devaluation is adopted. A country generally indulges in devaluation of currency when its market is too weak to justify the exchange rate. If a country is low on forex reserves then its not credit worthy to borrow from the IMF(International Monetary Fund) then to pay for the imports the country has to make use of devaluation. Another case in which devaluation comes in handy for a country is when it wants to reduce its trade deficit. Devaluation has several effects on a country’s economy which are as follows:-

1. Exports become cheaper- A devaluation of the exchange rate will make the export of goods very competitive and also cheaper for the foreigners which will in turn lead to increase in demand leading to increase in exports.

2. Imports become costlier- A devaluation of currency leads to import becoming expensive which will lead to a reduction in

Current Account- There might be an improvement in the current account as more competitive the exports become the more the expensive the imports will be which will lead to higher exports and lower imports which will result in current account deficit.

Devaluation has both pros and cons which can be observed as follows:-

Pros

1. Exports tend to become cheaper and more competitive to foreign buyers. This provides a major boost to the domestic demand and also help in job creation in the export sector

2. The domestic goods prices remain the same as the country can attain increasing foreign exchange reserves without affecting the domestic value of their currency.

3. There is growth in the economy due to increased money supply in the economy which will lead to an increase in the aggregate consumption, demand, and savings. With the onset of increase in all of the above the economy is bound to grow.

4. Devaluation in a way leads to discourage in imports which may also lead to the trade deficit by making imports costlier

5. Decrease in imports will lead to demand for domestic goods, hence this will increase the domestic supply of goods in the economy which in turn will lead to requirement of manpower, hence creating employment and reducing unemployment