Why Do Governments Devalue Their Currency Rates?

By: Sahil_Hafeez

Currency Devaluation:
Currency devaluation occurs when a country allows the value of its currency to drop in relation to other currencies.

Why do countries let their currency fall in value?
Almost all the countries of the world have devalued their currencies time to time to achieve certain economic objectives. Following are the main objectives of devaluation:

1. To Encourage Exports:
Devaluation policy is adopted to increase the exports of the country. As the currency of any country is devalued, the commodities of that country become cheaper for the other countries and they increase their demand.
2. To Discourage The Imports:
As the currency of any country is devalued the other countries goods becomes costly to import from that country. So the people reduce their demands for foreign goods.
3. To Correct The Balance Of Payment:
When the balance of payment of any country is unfavorable the devaluation policy is adopted. When the currency is devalued, the value of imports increases but the value of exports will be greater than the value of imports; we will say that the balance of payment is favorable.

POSITIVE EFFECTS:
1. Correction of Deficit:
Devaluation makes home goods cheaper to foreign countries and foreign goods expensive in the home country. In this way deficit in the balance of payment is correct.
2. Adjustment of Currency Value:
When the currency is overvalued, devaluation brings equilibrium in the external and internal value of the currency. So the various imbalances in the economy remove.
3. Increase in Foreign Aid:
The international lending agencies like the IMF, IBRD insists upon devaluation, especially in underdeveloped
countries like India, Pakistan etc. Foreign investor also feels pleasure to make the investment in those countries where the currency is devalued.
4. End of Uncertainty:
Devaluation removes the uncertainty in the business circles. The rate of investment also increases.
5. Inflow of Remittances:
The workers who are working abroad they would prefer to send capital in the country, because they will get the more value in terms of foreign currency.

NEGATIVE EFFECTS:
1. Temporary Curve:
History shows that devaluation is a temporary curve for the unfavorable balance of payment. Its effects are for the short period. Some under developed countries were adopted this policy but its effects were only for a few months.
2. Increase in Prices:
A costly import brings inflation inside the country. So the price level in the country also rises, due to devaluation. So it creates a problem for the consumer.
3. Increase in Debt Burden:
Devaluation increases the foreign debt burden in terms of the home currency. This is a big loss for the poor country like India, Pakistan. Foreign debts become more difficult to service, and they reduce confidence among the people in their currency
4. Competition in Devaluation:
There is a chance that if one country devalues other countries also follow this policy then this policy will become useless.
5. Terms of Trade Problem:
On one hand country has to pay a greater amount of money for imports, on the other hand, she gets less money for her exports. So devaluation causes deterioration in terms of trade.

Sahil Hafeez, CFA, FRM, MBA
Financial Analyst
sahilhafeez@ymail.com

Qualifications: MBA, CFA, FRM

Current City: Hong Kong

© 2013 Copyright  Sahil Hafeez - All Rights Reserved

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