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Advantages and disadvantages of

devaluation
Tejvan Pettinger February 10, 2013 economics

Readers question: what are the advantages and disadvantages of devaluation?


Devaluation is the decision to reduce the value of a currency in a fixed exchange rate. A
devaluation means that the value of the currency falls. Domestic residents will find imports and
foreign travel more expensive. However domestic exports will benefit from their exports becoming
cheaper.

Advantages of devaluation
1.

Exports become cheaper and more competitive to foreign buyers. Therefore, this
provides a boost for domestic demand and could lead to job creation in the export sector.

2.

Higher level of exports should lead to an improvement in the current account deficit. This
is important if the country has a large current account deficit due to a lack of competitiveness.

3.

Higher exports and aggregate demand (AD) can lead to higher rates of economic growth.

Disadvantages of devaluation
1. Is likely to cause inflation because:

Imports more expensive (any imported good or raw material will increase in price)

AD increases causing demand pull inflation.

Firms / exporters have less incentive to cut costs because they can rely on the
devaluation to improve competitiveness. The concern is in the long-term devaluation may lead to
lower productivity because of the decline in incentives.
2. Reduces the purchasing power of citizens abroad. e.g. more expensive to go on holiday
abroad.
3. A large and rapid devaluation may scare off international investors. It makes investors less
willing to hold government debt because it is effectively reducing the value of their holdings.
4. If consumers have debts, e.g. mortgages in foreign currency after a devaluation they will see
a sharp rise in the cost of their debt repayments. This occurred in Hungary when many had taken
out a mortgage in foreign currency.

The impact of a devaluation depends on many factors:

The state of business cycle In a recession a devaluation can help boost growth without
causing inflation. In a boom a devaluation is more likely to cause inflation.

Elasticity of demand. A devaluation may take a while to improve current account because
demand is inelastic in the short term.

If the country has lost competitiveness in a fixed exchange rate, a devaluation could be
beneficial in solving that decline in competitiveness.

MEANING OF DEVALUATION :

It means to depreciate the value of domestic currency interms of foreign currencies. For example the rate
of exchange between India U.S.A. is 35 Rs. = 1 Dollar. If India readjusts the exchange rate and offers Rs.
45 = 1 Dollar. The Indian currency will be said to have been devalued or depreciated.

OBJECTIVES OF DEVALUATION :
Almost all the countries of the world have devalued their currencies time to time to achieve certain
economic objectives. During great depression of 1930 most of the countries devalued their currencies.

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 becomes cheap 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 then the value
of imports, we will say that balance of payment is favourable.

MERITS OR POSITIVE EFFECTS OF DEVALUATION :


1.

Correction Of Deficit :Devaluation makes home goods cheaper to foreign countries and foreign goods expensive to
home country. In this way deficit in the balance of payment is corrected.
2. Adjustment Of Currency Value :When the currency is over valued, devaluation brings equilibrium in the external and internal
value of the currency. So various imbalances in the economy removes.
3. Increase In Foreign Aid :The international lending agencies like IMF, IBRD insists upon devaluation, specially to under
developed countries like India, Pakistan etc. Foreign investor also feels pleasure to do the
investment in those countries where currency is devalued.
4. End Of Uncertainty :Devaluation removes the uncertainty in the business circles. Rate of investment alsi increases.
5. Inflow Of Remittances :The workers who are working abroad they would prefer to send capital in side the country.
Because they will get more currency in terms of foreign currency.

DEMERITS OR NEGATIVE EFFECTS OF DEVALUATION :


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 police but its
effects were only for few month.
2. Increase In Prices :Costly imports brings inflation inside the country. So price level inside the country also rises, due to
devaluation. So it creates problem for the consumer.
3. Increase In Debt Burden :Devaluation increases the foreign debt burden in terms of home currency. This is big loss for the
poor country like India, Pakistan.
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 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.

Devaluation, its Merits and Demerits


Devaluation means to increase in the value of domestic currency in terms of foreign currencies. For
example if the rate of one US dollar was equal to rupees 50. Now government of Pakistan decided to
devalue her currency and new rate may be fixed as one US dollar equal to 60 rupees. This process is
known as devaluation. In case of the devaluation the currency becomes cheaper from the point of
view of other countries.
OBJECTS OF DEVALUATION
1. BALANCE OF PAYMENTS
Devaluation may be used to correct the balance of payment position, because when a country

devaluates her currency then its exports are increased.


2. ENCOURAGE THE EXPORTS
Devaluation policy is also adopted to encourage the exports of the country. Because when the
currency is devalued then commodities become cheap for other countries and they increase their
demand.
3. DISCOURAGE IMPORTS
Another object of devaluation is to discourage the imports. Because when the currency is devalued
then imported goods become costly, so people reduce their demand for imported goods.
4. FOREIGN LOANS
If the value of home currency is higher then foreign countries are not agreed to give loans. So then
main object of devaluation is to get the foreign loans for economic development of the country.
5. PRICE STABILITY
Price stability is an other object of devaluation. When government finds that prices are decreasing
then government devalues the currency for stability in price.
6. RETALIATION
Some times one country devalues her currency to increase the exports but other countries also
devalues their currencies so that the former can not get benefits.
7. OVER VALUATION
Some times value of currencies is artificially higher than its true value. So the main object of
devaluation is to correct the over valuation of the currencies.
MERITS OF DEVALUATION
1. FOREIGN INVESTMENT
With the help of devaluation the foreign investment is increased. Because foreigners find it more
cheaper to invest in devaluing country.
2. FOREIGN LOANS
When the currency is devalued then foreign countries are agreed to give loans at lower rate. These
loans may be utilised for the development of the country.
3. CONTROL ON SMUGGLING
Due to devaluation the smuggling becomes unprofitable because the foreign goods become costly.
4. BALANCE OF PAYMENT
With the help of devaluation the level of exports is increased while the level of imports is decreased.
So in this way the balance of payment position is improved.
5. ECONOMIC DEVELOPMENT
With the help of devaluation the foreign investment is encouraged. When the investment increased
then economic development is increased.
6. EXCHANGE RATE
Devaluation is helpful weapon to set up new exchange rate which is more practical and realistic.
When the currency is over valued devaluation brings equilibrium in extreme and internal values of
currency.
7. FOREIGN RECEIPTS
When the currency is devalued then the living in foreign countries sent more foreign currency to home
land because they can get more home currency. In this way the foreign exchange is also increased.
8. ENCOURAGEMENT TO INDUSTRY
When the currency is devalued then the demand of goods produced by domestic industries is
increased in international market. In this way the sales volume of domestic industries rise up.
DEMERITS OF DEVALUATION
1. RETALIATION
Some times one country devalues her currency to increase the exports but other countries also follow
the same policy. So devaluation becomes useless.
2. FOREIGN DEBTS
Devaluation increases the burden of foreign debts in the term of home currency because the amount
of loan increases in relation to home currency.
3. PRICE LEVEL INCREASE
Due to the devaluation prices of imported goods become high which bring the inflation. The prices of
imported raw materials and machines become also high due to which goods manufactured in
domestic industry also become costly.

4. TERMS OF FOREIGN TRADE


If the currency is devalued then country has to pay the large amount of money for imports. So the
foreign trade is adversely affected.
5. SHORTAGE OF CAPITAL
If the currency is devalued then goods and machines become costly. So large amount of capital is
required for starting business.
6. TEMPORARY TREATMENT
Devaluation is a temporary treatment for the correction of adverse balance of payment. But it is not
useful in long run.

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