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Currency devaluation

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Currency devaluation

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Introduction
Devaluation means decreasing the value of nation's currency relative to gold or the currencies of
other nations.
In common modern usage, it specifically implies an official lowering of the value of a country's
currency within a fixed exchange rate system, by which the monetary authority formally sets a
new fixed rate with respect to a foreign currency. For instance: Rs25=1$. Rs.30=1$ 4.
The first known use of devaluation was in 1914. Devaluation is usually undertaken as a means of
correcting a deficit in the balance of payments. Almost all the countries of the world have
devalued their currencies at one time or the other with a view to achieving certain economic
objectives. During the great depression of 1930 devaluation was carried by most countries of the
world for the correcting their over-valuation.
Example:
The Pakistani rupee has been devalued by around 47% in the past two years, yet the export
growth remained negative in fiscal year 2018-19 and was close to negligible in the first five
months of fiscal year 2019-20.
(Source: Article by Dr. Fahd Rehman)
Definition:
“Currency devaluation is a deliberate downward adjustment of the value of a
country's currency against another currency. Devaluation is a tool used by monetary authorities
to improve the country's trade balance by boosting exports at moments when the trade deficit
may become a problem for the economy.”
History:
Pakistan rupee has devalued by 2100 percent over the last 70 years but the debate on the effects
of devaluation remains unsettled and fiercely contentious.
Following are the dates in which the Pakistan had experience devaluation:
1. On 31st July 1955, first time PKR was devalued:
Reason: The Pakistani rupee was devalued for the first time in 1955 during the post-
Korean War recession. Pakistan had experienced an increased in wholesale price, due to
inelastic production structure, which had generated uncontrollable inflationary pressure.
2. 11th May 1972, second time PKR was devalued:
Reason: Pakistani Rupee was devalued by 56.7% in terms of gold to a new, unified
Official Rate of PRs11.00 per U.S. Dollar and 4.5% fluctuation range for the currency
was also introduced. At the same time, the entire Export Bonus Voucher scheme with its
complex accessory rates was abolished. Another reason was precipitated by the oil crisis.
The rupee was devalued by over 123 percent, from Rs. 4.92 to Rs. 11.00 to the US dollar.
Subsequently, the rate was fixed at Rs. 9.90 to the US dollar, an exchange rate which
prevailed for ten years.
3. On 8th January 1982:
Reason: The Rupee was devalued when the currency was unhitched from its link to the
U.S. Dollar and the fixed Official Rate abolished. A controlled, floating Effective Rate
for the Rupee, initially at the Rupee dollar exchange rate was Rs9.9 per U.S. Dollar was
established in relation to a trade-weighted basket of currencies, Pakistan has been on a
system of managed float since January, 8, 1982, under this system the country has
experienced massive downward slide in its exchange rate.
4. In 1996-1997:
Reason: In 1997, retail prices rose significantly to 20 to 24 rupees/kg (US 55.4 to 66.5
cents/kg), indicating short domestic supplies, the devaluation of the rupee against the
dollar was highest in 1996, which contributed to the rise in price since sugar had been
traded internationally in US dollars. As imports had increased in the 2 years period, the
rising price of imported sugar (in rupees) was also reflected in the rising domestic price.
5. In 2007-2008:
Reason: When the economy was in serious difficulty and our foreign reserves plunged to
$3.4 billion (enough to cover just one month’s imports). At the time the government
obliged by devaluing the currency by 28 per cent and raising import duties on a large
number of products by 15-50pc. But such measures failed to increase exports or improve
the balance of payments.
6. In 2017:
Reason: The value of rupee as against the US Dollar in December 2017 was Rs105. It
has risen to Rs143 these days. It is stated to be the sixth currency devaluation since
December 2017.
Economists believe factors like dwindling foreign exchange reserves, trade deficit, less
manufacturing, growing imports, and political and economic uncertainty is keeping the
rupee under great stress.
(Source: The Devaluation Factor)
Reasons:
There are many reasons for a currency devaluation but only three are the main common ones
among the countries:
1. To Boost Exports
On a world market, goods from one country must compete with those from all other
countries. Car makers in America must compete with car makers in Europe and Japan. If
the value of the euro decreases against the dollar, the price of the cars sold by European
manufacturers in America, in dollars, will be effectively less expensive than they were
before. On the other hand, a more valuable currency makes exports relatively more
expensive for purchase in foreign markets.
In other words, exporters become more competitive in a global market. Exports are
encouraged while imports are discouraged. There should be some caution, however, for
two reasons. First, as the demand for a country's exported goods increases worldwide, the
price will begin to rise, normalizing the initial effect of the devaluation. The second is
that as other countries see this effect at work, they will be incentivized to devalue their
own currencies in kind in a so-called "race to the bottom." This can lead to tit for tat
currency wars and lead to unchecked inflation.
2. To Shrink Trade Deficits
Exports will increase and imports will decrease due to exports becoming cheaper and
imports more expensive. This favors an improved balance of payments as exports
increase and imports decrease, shrinking trade deficits. Persistent deficits are not
uncommon today, with the United States and many other nations running persistent
imbalances year after year. Economic theory, however, states that ongoing deficits are
unsustainable in the long run and can lead to dangerous levels of debt which can cripple
an economy. Devaluing the home currency can help correct balance of payments and
reduce these deficits.
There is a potential downside to this rationale, however. Devaluation also increases the
debt burden of foreign-denominated loans when priced in the home currency. This is a
big problem for a developing country like India or Argentina which hold lots of dollar-
and euro-denominated debt. These foreign debts become more difficult to service,
reducing confidence among the people in their domestic currency.
3. To Reduce Sovereign Debt Burdens
A government may be incentivized to encourage a weak currency policy if it has a lot of
government-issued sovereign debt to service on a regular basis. If debt payments
are fixed, a weaker currency makes these payments effectively less expensive over time.
Take for example a government who has to pay $1 million each month in interest
payments on its outstanding debts. But if that same $1 million of notional payments
becomes less valuable, it will be easier to cover that interest. In our example, if the
domestic currency is devalued to half of its initial value, the $1 million debt payment will
only be worth $500,000 now. Again, this tactic should be used with caution. As most
countries around the globe have some debt outstanding in one form or another, a race to
the bottom currency war could be initiated. This tactic will also fail if the country in
question holds a large number of foreign bonds since it will make those interest payments
relatively more costly.
Reason behind Currency Devaluation in Pakistan
 An Increased Account Deficit:
Condition of Pakistan’s economy in term of budget deficit and balance of payments is not
encouraging. According to media reports that quote the financial experts, Pakistan faced
an account deficient of almost $12 billion during the fiscal year 2017-18 which makes for
the 4 percent of the GDP.
 Fall in Foreign Exchange Reserves:
As a result of increase in account deficit the foreign exchange reserves of Pakistan have
declined to $12.1 billion from $17.4 billion in 2017. The decline in foreign exchange
reserves calls for an increase in country’s exports which are likely to boost due to
depreciation of currency.
 Meeting the Pressures of Payment:
Media reports also suggest that State Bank of Pakistan has allowed the currency to lower
due to some “payment pressure”.
Well, governments across the globe depreciate their currencies for servicing the
sovereign debts, which might be a payment pressure in recent case of Pakistan.
Effects:
The main effects are:
 Exports are cheaper to foreign customers
 Imports more expensive.
 In the short-term, devaluation tends to cause inflation, higher growth and increased
demand for exports.
Positive Effects of Currency Devaluation:
Following are the positive effects:
 Exports cheaper:
A devaluation of the exchange rate will make exports more competitive and appear cheaper
to foreigners. This will increase demand for exports.
For instance: after devaluation, UK assets become more attractive; for example, devaluation
in the Pound can make UK property appear cheaper to foreigners.
 Increased aggregate demand (AD):
Devaluation could cause higher economic growth. Part of AD is (X-M) therefore higher
exports and lower imports should increase AD (assuming demand is relatively elastic). In
normal circumstances, higher AD is likely to cause higher real GDP and inflation.
Negative effects of currency devaluation:
Following are the negative effects:
 Imports more expensive:
A devaluation means imports, such as petrol, food and raw materials will become more
expensive. This will reduce the demand for imports. It may also encourage British tourists to
take a holiday in the UK, rather than the US – which now appears more expensive.
 Inflation is likely to occur following devaluation because:
 Imports are more expensive – causing cost push inflation.
 AD is increasing causing demand pull inflation
 With exports becoming cheaper, manufacturers may have less incentive to cut costs
and become more efficient. Therefore over time, costs may increase.
 Improvement in the current account:
With exports more competitive and imports more expensive, we should see higher exports
and lower imports, which will reduce the current account deficit.
Impact of Currency Devaluation on Pakistan Economy
The positive impacts of currency devaluation:
• May be good for the economy
• Economic growth
• Stimulation of merchandise exports
• Discouraging merchandise imports
• Improving trade
• Increase revenue collection and savings
• Stop illegal foreign exchange
The negative impacts of declining value of currency are evident on all the sectors of economy.
Devaluation of currency is the major cause of inflation in Pakistan. Inflation is so high that it can
be stated as hyperinflation. This inflation is responsible for the increase in prices of Pakistan real
estate. On the other hand the employment level is also at lowest end which is worsening the
buying power of the people.
The devaluation of currency increases the external debt and liabilities of the economy. For every
further 1% devaluation the national debt will climb up by approximately Rs. 125 billion. It
discourages the investment and negatively affects the export industry of the country by making
the exports cheaper for foreigners. It makes the imported goods expensive for domestic
consumers which discourages the imports. It has also negative effects on social welfare which
depends upon real GDP and rate of unemployment.
(Source: The Frontier Post)

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Currency devaluation

  • 1. Introduction Devaluation means decreasing the value of nation's currency relative to gold or the currencies of other nations. In common modern usage, it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign currency. For instance: Rs25=1$. Rs.30=1$ 4. The first known use of devaluation was in 1914. Devaluation is usually undertaken as a means of correcting a deficit in the balance of payments. Almost all the countries of the world have devalued their currencies at one time or the other with a view to achieving certain economic objectives. During the great depression of 1930 devaluation was carried by most countries of the world for the correcting their over-valuation. Example: The Pakistani rupee has been devalued by around 47% in the past two years, yet the export growth remained negative in fiscal year 2018-19 and was close to negligible in the first five months of fiscal year 2019-20. (Source: Article by Dr. Fahd Rehman) Definition: “Currency devaluation is a deliberate downward adjustment of the value of a country's currency against another currency. Devaluation is a tool used by monetary authorities to improve the country's trade balance by boosting exports at moments when the trade deficit may become a problem for the economy.” History: Pakistan rupee has devalued by 2100 percent over the last 70 years but the debate on the effects of devaluation remains unsettled and fiercely contentious. Following are the dates in which the Pakistan had experience devaluation: 1. On 31st July 1955, first time PKR was devalued: Reason: The Pakistani rupee was devalued for the first time in 1955 during the post- Korean War recession. Pakistan had experienced an increased in wholesale price, due to inelastic production structure, which had generated uncontrollable inflationary pressure. 2. 11th May 1972, second time PKR was devalued: Reason: Pakistani Rupee was devalued by 56.7% in terms of gold to a new, unified Official Rate of PRs11.00 per U.S. Dollar and 4.5% fluctuation range for the currency was also introduced. At the same time, the entire Export Bonus Voucher scheme with its complex accessory rates was abolished. Another reason was precipitated by the oil crisis. The rupee was devalued by over 123 percent, from Rs. 4.92 to Rs. 11.00 to the US dollar. Subsequently, the rate was fixed at Rs. 9.90 to the US dollar, an exchange rate which prevailed for ten years.
  • 2. 3. On 8th January 1982: Reason: The Rupee was devalued when the currency was unhitched from its link to the U.S. Dollar and the fixed Official Rate abolished. A controlled, floating Effective Rate for the Rupee, initially at the Rupee dollar exchange rate was Rs9.9 per U.S. Dollar was established in relation to a trade-weighted basket of currencies, Pakistan has been on a system of managed float since January, 8, 1982, under this system the country has experienced massive downward slide in its exchange rate. 4. In 1996-1997: Reason: In 1997, retail prices rose significantly to 20 to 24 rupees/kg (US 55.4 to 66.5 cents/kg), indicating short domestic supplies, the devaluation of the rupee against the dollar was highest in 1996, which contributed to the rise in price since sugar had been traded internationally in US dollars. As imports had increased in the 2 years period, the rising price of imported sugar (in rupees) was also reflected in the rising domestic price. 5. In 2007-2008: Reason: When the economy was in serious difficulty and our foreign reserves plunged to $3.4 billion (enough to cover just one month’s imports). At the time the government obliged by devaluing the currency by 28 per cent and raising import duties on a large number of products by 15-50pc. But such measures failed to increase exports or improve the balance of payments. 6. In 2017: Reason: The value of rupee as against the US Dollar in December 2017 was Rs105. It has risen to Rs143 these days. It is stated to be the sixth currency devaluation since December 2017. Economists believe factors like dwindling foreign exchange reserves, trade deficit, less manufacturing, growing imports, and political and economic uncertainty is keeping the rupee under great stress. (Source: The Devaluation Factor)
  • 3. Reasons: There are many reasons for a currency devaluation but only three are the main common ones among the countries: 1. To Boost Exports On a world market, goods from one country must compete with those from all other countries. Car makers in America must compete with car makers in Europe and Japan. If the value of the euro decreases against the dollar, the price of the cars sold by European manufacturers in America, in dollars, will be effectively less expensive than they were before. On the other hand, a more valuable currency makes exports relatively more expensive for purchase in foreign markets. In other words, exporters become more competitive in a global market. Exports are encouraged while imports are discouraged. There should be some caution, however, for two reasons. First, as the demand for a country's exported goods increases worldwide, the price will begin to rise, normalizing the initial effect of the devaluation. The second is that as other countries see this effect at work, they will be incentivized to devalue their own currencies in kind in a so-called "race to the bottom." This can lead to tit for tat currency wars and lead to unchecked inflation. 2. To Shrink Trade Deficits Exports will increase and imports will decrease due to exports becoming cheaper and imports more expensive. This favors an improved balance of payments as exports increase and imports decrease, shrinking trade deficits. Persistent deficits are not uncommon today, with the United States and many other nations running persistent imbalances year after year. Economic theory, however, states that ongoing deficits are unsustainable in the long run and can lead to dangerous levels of debt which can cripple an economy. Devaluing the home currency can help correct balance of payments and reduce these deficits. There is a potential downside to this rationale, however. Devaluation also increases the debt burden of foreign-denominated loans when priced in the home currency. This is a big problem for a developing country like India or Argentina which hold lots of dollar- and euro-denominated debt. These foreign debts become more difficult to service, reducing confidence among the people in their domestic currency.
  • 4. 3. To Reduce Sovereign Debt Burdens A government may be incentivized to encourage a weak currency policy if it has a lot of government-issued sovereign debt to service on a regular basis. If debt payments are fixed, a weaker currency makes these payments effectively less expensive over time. Take for example a government who has to pay $1 million each month in interest payments on its outstanding debts. But if that same $1 million of notional payments becomes less valuable, it will be easier to cover that interest. In our example, if the domestic currency is devalued to half of its initial value, the $1 million debt payment will only be worth $500,000 now. Again, this tactic should be used with caution. As most countries around the globe have some debt outstanding in one form or another, a race to the bottom currency war could be initiated. This tactic will also fail if the country in question holds a large number of foreign bonds since it will make those interest payments relatively more costly. Reason behind Currency Devaluation in Pakistan  An Increased Account Deficit: Condition of Pakistan’s economy in term of budget deficit and balance of payments is not encouraging. According to media reports that quote the financial experts, Pakistan faced an account deficient of almost $12 billion during the fiscal year 2017-18 which makes for the 4 percent of the GDP.  Fall in Foreign Exchange Reserves: As a result of increase in account deficit the foreign exchange reserves of Pakistan have declined to $12.1 billion from $17.4 billion in 2017. The decline in foreign exchange reserves calls for an increase in country’s exports which are likely to boost due to depreciation of currency.  Meeting the Pressures of Payment: Media reports also suggest that State Bank of Pakistan has allowed the currency to lower due to some “payment pressure”. Well, governments across the globe depreciate their currencies for servicing the sovereign debts, which might be a payment pressure in recent case of Pakistan.
  • 5. Effects: The main effects are:  Exports are cheaper to foreign customers  Imports more expensive.  In the short-term, devaluation tends to cause inflation, higher growth and increased demand for exports. Positive Effects of Currency Devaluation: Following are the positive effects:  Exports cheaper: A devaluation of the exchange rate will make exports more competitive and appear cheaper to foreigners. This will increase demand for exports. For instance: after devaluation, UK assets become more attractive; for example, devaluation in the Pound can make UK property appear cheaper to foreigners.  Increased aggregate demand (AD): Devaluation could cause higher economic growth. Part of AD is (X-M) therefore higher exports and lower imports should increase AD (assuming demand is relatively elastic). In normal circumstances, higher AD is likely to cause higher real GDP and inflation. Negative effects of currency devaluation: Following are the negative effects:  Imports more expensive: A devaluation means imports, such as petrol, food and raw materials will become more expensive. This will reduce the demand for imports. It may also encourage British tourists to take a holiday in the UK, rather than the US – which now appears more expensive.  Inflation is likely to occur following devaluation because:  Imports are more expensive – causing cost push inflation.  AD is increasing causing demand pull inflation  With exports becoming cheaper, manufacturers may have less incentive to cut costs and become more efficient. Therefore over time, costs may increase.  Improvement in the current account: With exports more competitive and imports more expensive, we should see higher exports and lower imports, which will reduce the current account deficit.
  • 6. Impact of Currency Devaluation on Pakistan Economy The positive impacts of currency devaluation: • May be good for the economy • Economic growth • Stimulation of merchandise exports • Discouraging merchandise imports • Improving trade • Increase revenue collection and savings • Stop illegal foreign exchange The negative impacts of declining value of currency are evident on all the sectors of economy. Devaluation of currency is the major cause of inflation in Pakistan. Inflation is so high that it can be stated as hyperinflation. This inflation is responsible for the increase in prices of Pakistan real estate. On the other hand the employment level is also at lowest end which is worsening the buying power of the people. The devaluation of currency increases the external debt and liabilities of the economy. For every further 1% devaluation the national debt will climb up by approximately Rs. 125 billion. It discourages the investment and negatively affects the export industry of the country by making the exports cheaper for foreigners. It makes the imported goods expensive for domestic consumers which discourages the imports. It has also negative effects on social welfare which depends upon real GDP and rate of unemployment. (Source: The Frontier Post)
  • 7. How Currency Devaluation Can Be Prevented? There are several factors that contribute to a currency’s valuation. But, mostly, it is a matter of supply and demand. Like any other product, the value of your currency increases if there is a lot of demand for it, and diminishes if there is too much supply. The main reason for having a lot of demand is to be a net exporter, to have a trade surplus. If your country sells a lot of products abroad, the buyers will seek your currency to pay for those products. Thus, its demand increases, and the currency becomes more valuable. So, one path to preventing devaluation is to sell more and buy fewer products abroad. The supply is controlled by your currency’s central bank. If they issue a lot of money, the money will be in great supply, and its value will tend to decrease. So, another path for preventing currency devaluation is to keep a low public deficit or even try to achieve a small superavit. That way, the government won’t feel the pressure to issue more money than demand warrants, and thus supply and demand will remain balanced. The third path for preventing devaluation is to provide a nice income to people who decide to hold your currency. That is done by imposing a certain interest rate by the currency’s central bank. Basically, the interest rate that the central bank influences defines the financial return of your currency. So, if your currency’s supply far outweighs demand, you can announce that loans in your currency earn a rate of x% above other currencies. If x is enticing enough, investors will want to buy your currency, in order to earn the interest premium you announce. Of course, the price is that your economy will have less access to credit, as it will have to pay a higher interest rate for having access to money. How Can We Control It In Pakistan? The Govt. and State Bank of Pakistan should regulate their policies to bring stability in Pakistani currency and stop it from devaluation. They should document the record of transactions, incomes of individuals with a stringent plan and effective monitory policy to curb inflation and devaluation of currency from Pakistan.
  • 8. Devaluation and Aviation Sector: Devaluation of a country’s currency makes imports in that country more expensive, and makes its exports less expensive to foreigners. So, when currency devaluation takes place, Aviation sector is the first industry in country to get affected by it. Pakistan is not a major aviation producer. And the aviation industry uses lots of petroleum, of which Pakistan is not a major producer and which is priced in US dollars internationally, not in Pakistani rupees. So devaluation of the rupee will raise costs for new aviation parts and equipment in Pakistan. And it will raise the cost of aviation fuel in Pakistan, other things equal. Fortunately, some other things aren’t equal. For instance, the dollar price of petroleum has been falling lately (early March, 2020), so the cost of aviation fuel may not change much in Pakistan right now despite the devaluation of the rupee. (Source: Quora)
  • 9. Currency Devaluation & Other Countries: Devaluation of a currency has become very common in the present age. Countries facing financial strains due to unfavorable economic conditions have no alternative but to devalue its currency so as to push up its exports earnings and simultaneously to decrease imports. Such countries usually officially decrease the value of their currency in relation to gold as well as other foreign currencies. For Example: China has been accused of practicing quiet currency devaluation, trying to make itself a more dominant force in the trade market. Some accused China of secretly devaluing its currency so it could revalue the currency after the 2016 presidential election and appear to be cooperating with the United States. However, after assuming office, U.S. President Donald Trump threatened to impose tariffs on cheaper Chinese goods partly in response to the country's position on its currency. Some fear this may lead to a trade war, putting China in a position to consider more aggressive alternatives if the U.S. were to go ahead. Let’s say that on Monday $1 bought five rubles and that today, after the devaluation, it buys 10 rubles (not actual figures). Under this scenario, the ruble has devalued by 50%.