Purpose of Currency Devaluation:
Currency devaluation is a deliberate monetary policy action taken by a country’s central bank or government to reduce the value of its domestic currency relative to other foreign currencies. The primary purposes of currency devaluation include:
• Boosting Exports: Devaluation makes a nation’s goods and services cheaper for foreign buyers, which can stimulate exports (Bordo & Flandreau, 2003).
• Correcting Trade Imbalances: When a country faces a persistent trade deficit (importing more than it exports), devaluation can help correct this imbalance by encouraging imports to become more expensive and exports to become more attractive (Krugman & Obstfeld, 2008).
• Attracting Foreign Investment: A devalued currency can make a country more appealing to foreign investors, as their investments can yield higher returns when converted back to their own stronger currencies (Rose, 2007).
• Reducing External Debt Burden: If a nation has a significant amount of foreign-denominated debt, devaluation can reduce the real value of this debt, making it more manageable to repay (Calvo & Reinhart, 2002).
Currency revaluation is the opposite of devaluation. It involves a country’s central bank or government increasing the value of its domestic currency relative to foreign currencies. The purposes of currency revaluation may include:
• Controlling Inflation: Revaluation can help control inflation by making imports cheaper and reducing the cost of imported goods and raw materials (Rogoff, 1996).
• Stability and Confidence: Revaluation can enhance economic stability and boost investor confidence, as it signals a strong and stable economy (McKinnon & Ohno, 1997).
• Reducing Imported Inflation: Revaluation can prevent imported inflation by making imported goods less affordable, which can be particularly important if the country relies heavily on imports (Mundell, 1960).
Circumstances for Currency Devaluation:
A nation may consider currency devaluation under various circumstances, including:
• Persistent Trade Deficits: When a country faces chronic trade deficits that are causing economic imbalances, devaluation can help correct this by making exports more competitive.
• Economic Downturn: During an economic recession or crisis, devaluation can stimulate exports and encourage foreign investment, aiding in economic recovery.
• High Inflation: Devaluation can be used to combat high inflation by making imports more expensive and reducing the cost of exports.
• Overvalued Currency: If a country’s currency is considered overvalued and hurting its trade competitiveness, devaluation may be used to bring it in line with market conditions.
Developing Country with Currency Board:
An example of a developing country that adopted a currency board system is Bulgaria. Bulgaria implemented a currency board arrangement in 1997 as a way to stabilize its economy and establish credibility in the international financial market.
Choosing Currency Board over Dollarization:
Bulgaria chose a currency board system over dollarization for several reasons:
• Independence: A currency board allowed Bulgaria to maintain control over its domestic monetary policy while still ensuring exchange rate stability.
• Credibility: By maintaining a currency board, Bulgaria demonstrated its commitment to a stable exchange rate and low inflation, which helped attract foreign investment.
• Fiscal Discipline: A currency board enforced fiscal discipline as the government couldn’t print money to finance budget deficits, which encouraged responsible fiscal policies.
• rade Benefits: A fixed exchange rate to the euro promoted trade and investment ties with the European Union, of which Bulgaria aimed to become a member.
• Economic Transformation: The currency board was seen as a step toward aligning Bulgaria’s economic and financial systems with EU standards, facilitating its integration into the European Union.
Bordo, M. D., & Flandreau, M. (2003). Core, periphery, exchange rate regimes, and globalization.
Krugman, P. R., & Obstfeld, M. (2008). International economics: Theory and policy (8th ed.). Pearson.
Rose, A. K. (2007). The foreign service and foreign trade: Embassies as export promotion. Journal of International Economics.
Calvo, G. A., & Reinhart, C. M. (2002). Fear of floating. The Quarterly Journal of Economics.
Rogoff, K. (1996). The purchasing power parity puzzle. Journal of Economic Literature.
McKinnon, R. I., & Ohno, K. (1997). Dollar and yen: Resolving economic conflict between the United States and Japan. MIT Press.
St2/ KHALID ALHAZZAA
Devaluation of a country’s currency refers to the process of systematically lowering the value of that country’s currency in comparison to another currency or national benchmark. Countries that have a fixed or semi-fixed exchange rate are the ones who use this technique for their monetary policy management. For the objective of increasing exports, decreasing trade deficits, and lowering the burdens of national debt, devaluation is being implemented. If a nation lowers the value of its currency, it can increase the competitiveness of its exports on the international market. At the same time, it can raise the cost of its imports, which can contribute to the achievement of trade balance and the reduction of deficits. However, devaluation can also have unfavorable effects, such as elevating the price of imports and the amount of debt denominated in a foreign currency among other things. In general, the fundamental objective of currency devaluation is to enhance the trade balance and economic competitiveness of a country compared to other countries. (What is Devaluation and how does it affect my Finances, 2022)
A currency revaluation raises a country’s exchange rate relative to a baseline, such as wage rates, gold prices, or foreign currencies. This makes buying foreign goods in foreign currencies cheaper for domestic importers but more expensive for foreign importers, which might hurt exports. In fixed exchange rate regimes, only a country’s government, such as its central bank, can change the currency’s official value. In floating exchange rate systems, currency revaluation can be triggered by various events, such as interest rate changes between countries or large-scale economic events (Hayes, 2020).
A foreign exchange rate is used to revalue a financial account or transaction from a foreign currency to a company’s reporting currency. A system-generated transaction tracks exchange rate changes’ influence on base currency valuation.
A nation may depreciate its currency during particular periods. Countries with fixed or semi-fixed exchange rates devalue their currency to lower its worth relative to another currency or standard.
This technique may help countries compete in global commerce, increase exports, minimize trade deficits, and lower sovereign debt. A country can increase exports by devaluing its currency, while imports fall as foreign goods become more expensive. Devaluation might attract overseas investors to cheaper assets. (Hayes, 2020)
Devaluation can lead to inflation, higher import costs, and lower domestic industry efficiency without competition. Therefore, devaluation should be employed sparingly and under specified conditions. (Majaski, 2019).
Argentina is an example of a developing nation for which a currency board was implemented. After experiencing a period of hyperinflation, Argentina decided to implement a currency board in 1991 in order to stabilize its economy. The most important purpose for establishing a currency board is to implement a policy that is openly intended to combat inflation.
Due to the fact that it mandates that the domestic currency be completely supported by foreign exchange reserves, a currency board is a more stringent and rule-based organization that has the potential to create a genuine anti-inflationary strategy. Countries that want to demonstrate a strong commitment to price stability may find this to be an attractive option. By contrast, dollarization of the monetary system would include the adoption of a foreign currency, such as the United States dollar, as the official currency of the currency system. Despite the fact that dollarization can also bring about price stability, some nations may choose a currency board since it enables them to keep their own currency and provides them with a greater degree of control over the money supply (Enoch and Gulde, 1998)
Enoch , Charles , and Anne-Marie Gulde. “Finance and Development.” Finance and Development | F&D, Dec. 1998, www.imf.org/external/pubs/ft/fandd/1998/12/enoch.htm.
Hayes, Adam. “Revaluation.” Investopedia, 2020, www.investopedia.com/terms/r/revaluation.asp.
Majaski, Christina. “Understanding Devaluation, the Causes, and the Downsides.” Investopedia, 2019, www.investopedia.com/terms/d/devaluation.asp.
“What Is Devaluation and How Does It Affect My Finances?” Www.santander.com, 5 Sept. 2022, www.santander.com/en/stories/devaluation.