devaluation

Updated on Dec 18th, 2023

Meaning of devaluation

Devaluation of the currency is when the government reduces the value of a currency under the Fixed-Rate System or the Bretton Woods System.
The apex monetary authority of the country sets a lower exchange rate for the national currency in relation to a foreign reference currency or currency basket in case of devaluation.
Historically, devaluation has been used as a tool to control the balance of payment deficits.
India has faced the devaluation of currency in the years 1966 and 1991.

Imports become more expensive and exports become more competitive and lucrative. This in turn must have a positive impact on the trade account balance.
A devalued currency might also encourage a greater quantity of export from that country.
It has been a stumbling block for growth in case of developing economies.
It can also result in an inflationary pressure on the domestic economy.
It can result in the increase of cost of production of all those commodities that extensively depend on imported inputs.
Domestic companies that have taken international loans will face greater servicing costs.
Devaluation also results in reducing competition among domestic companies.
If the country has limited labour supply, then there will be a significant rise in the wages resulting in cost push inflation in the economy.

Exports must be provided a boost through relaxation of strict rules, removal of policy barriers, and other structural changes.
Foreign portfolio investment must be encouraged.
Interest rates must be kept attractive to ensure that exchange rate fluctuations have a lesser impact on investment.
As a long term measure, the country must focus on reducing import dependence to make the currency less vulnerable to external shocks.

Devaluation is an exercise undertaken by the government whereas, depreciation takes place under the floating exchange rate system that is market determined.
Devaluation can trigger currency wars like in the case of China- USA.