Dictionary meaning of devaluation is reduction in value, in this world where everybody wants to increase their value whether it is related to profession, wealth or any other thing but when it comes to currencies there are many countries which want to devalue their currency. Devaluation is the term used in the context of currency markets, it refers to that procedure using which a country reduces the value of its home currency with respect to other currencies. It can be better understood with the help of an example, suppose currency A is trading at 10 to 1 with respect to currency B implying that for one unit of currency B one can get 10 units of currency A. Now suppose country A decides to devalue its currency by 10 percent then new exchange rate with respect to currency B will be 11 to 1. In order to understand devaluation better, let’s look at some of the advantages and disadvantages of devaluation –
Advantages of Devaluation
- First and foremost advantage of devaluation is that it results in exports of a country getting competitive in international markets hence a country which has more exports as compared to imports will get benefit due to the devaluation of the currency.
- Due to higher level of exports country’s domestic economy get a boost due to increase in production of goods required for increased demand from export market which in turn give more employment opportunities to the people of the country leading to increase in the income of the people.
- As far as imports are concerned if the demand for imported goods is elastic then devaluation will lead to decrease in demand for imported goods because imports will be getting expensive due to devaluation and hence devaluation will save the country lot of foreign exchange reserves as people will consume indigenous goods instead of imported goods due to cost factor.
Disadvantages of Devaluation
- The biggest disadvantage of devaluation is that it leads to shortage of confidence of international investors because due to devaluation the real value of assets of foreign investors decline which leads to flight of capital from country which in turn results in panic like situation in stock market and other markets in which foreign investors have invested money.
- Another disadvantage of devaluation is that it results in increase in value of external debts which the country has taken which in turn leads to higher interest payment on debt and also it leads to increase in foreign tour expenses of domestic tourists and all other exports become expensive, so if a country has more net exports than net imports than devaluation is not a good option.
- Another limitation of devaluation is that it leads to complacency on the part of exporters because they tend to get more profit due to currency devaluation without increasing the productivity. Hence in a way currency devaluation has an indirect impact on the productivity of the exporters of the country.
As one can see from the above that devaluation has benefits as well as limitations and government of any country thinking about doing devaluation should apart from considering monetary implication should also consider the other long term non-monetary implications.