Devaluation of currency means:
In very simple terms, devaluation of currency means weakening of the currency of a country by the government or central bank(RBI in case of india) with respect to foreign currencies. But merely reading this sentence can be misleading. People with no complete knowledge generally get confused by taking it similar to the depreciation of economy but you need to understand that they are two different terms.
Depreciation of currency is the loss of value of a country's currency with respect to other currencies. This may seem similar to the devaluation of currency but it is not like that. Devaluation is a deliberate(something done consiously or intentionally) action taken by the government when required but depreciation depends on the economic fundamentals of the country.Generally, countries with weaker economic fundamentals such as high rate of Inflation and bad condition of current account deficits face depreciation of currency.
Devaluation can be done due to many reasons like increasing export, increased trade deficits of country and some other major reasons which we will discuss later in this article.
devaluation of currency leads to:Devaluation is a gaint step that the government can take.Devaluation is not an experiment that scientists can carry out in their labs and than provide the best way to implement it and then predicting it's consequences. Devaluation of currency can lead to positive as well as negative effects on the economy and life of citizens but it is done with the expectations of best results that will help ecoonomy. It is only meant to be done at the time when economy requires it( India devalued INR only when it was necessary) and the governments make it happen in the way it thinks to be best but it may lead to some side-effects also.
positive effects or advantages of devaluation of currencyto increase exports and decrease imports :
When devaluation of currency takes place, it generally leads to increased exports from the country and fall in the imports can also be noticed.How is it possible? Let's understand with the following example.
As of march 2020, 1 USD = 75 INR, now suppose that India devalues the Indian Rupee and now the exchange rate becomes 100 INR to 1 USD. When some is exported from India , than the payment will have to be made in Indian currency. If an indian trader charges 7500 rupees for a product or service, it would cost 75 bucks to an American buyer. But before the devalution, it would be costing 100 dollars to the buyer . So, after devaluation of Indian Rupee , Americans will find Indian products and services to be cheaper than before( though Indians will get the same amount in Indian rupees, devaluation will not bother them).
Such large discounts lead to an rise in demand of indian products and services in American Markets, which lead to increased exports from Indian subcontinent. At the end of day, Indian trader and manufacturer wants more money and in the form of Indian currency , thats why devaluation seems to be a beneficial step for them.
Now , let us observe the above example from an opposite direction i.e. from import point of view. Suppose a commodity of 1 dollar is being exported to India from USA - now, India will have to pay in American dollars. Previously, that product would have cost of 75 Rupee but now , it will cost us ₹ 100. As the price have increased, Indian traders would try to limit their imports.
In both cases, whether imports decrese or exports increase, it is beneficial for Indian Economy. This is always a desirable condition as it favors a better Balance of Payment and this helps a country to cover it's trade deficits.
As of 2020, India and USA are both trade deficit countries. This year data:
As the currency of a Country gets weak, everything becomes somewhat cheap as compared to previous conditions. Therefore, Tourism also become affordable for more number of people ehich may result in invcreased tourism. Positive effects on Aggregate Demand (AD)
Aggregate demand can be described as the total demand for all finished goods and services produced in the country over a given period of time. AD over a long period of time can be considered as an unofficial GDP ( as GDP is all about total production of goods while AD is demand for that production).
as it can be seen above, as the value of ( X - M ) increases, aggregate demand also increase which we can consider as a positive factor for the GDP of a country.
Negative effects or disadvantages of Devaluation of Currency
It is right that due to devaluation, imports in a country may decrease but it is not necessary, there are many inelastic commodities(goods for which demand does not change even on the change of price) imported for which quantity of import can not be reduced for example gas, oil, tobacco etc. However, import on many products and services may decrease, but whatever will be imported, it will be of higher price than before which will result in cost-push Inflation (Increase in price of commodities or decrerase in buying capacity of money over some period of time is known as inflation).
Aggregate Demand can be good but it also contributes to Inflation.Just a thought:
As exports become cheaper, manufacturers become somewhat relaxed to make the process efficient which will again lead to increase of prices and result in inflation.
- Fall in real wages of people
When Inflation occurs, this means that prices of the commodities have also increased.I f a person is earning an x amount of money this year, he will require salary equal to x+y amount where y is the rise in price due to inflation. If the person gets same salary next year, it means that his salary have fallen in real terms. In India, this problem is not faced by the government employeesas their salary increase year to year but a large portion of private sector, daily wage workers may face this problem.
If the salary is increased, it is not necessary that the increase in salary is equal to or more than the inflation rate.
Political Effects of Devaluation of currencyDevaluation of currency can have large negative impacts on the government and the ruling party. As people in India are not much educated to understand the complicaces of such actions , they only think that government has made their currency weak.Opposition can also take huge benefits due to this as people also are generally against the government. Though it is not 100% that government faces negative impactss but it is what we generally observe. Even though devaluation seem to be benefitting, people will argue if why such conditions were created due to which devaluation had to be carried out.India have witnessed the game of devaluation two times since independence, study them unde the following heading and get to know something about the history of rupee also.
Devaluation of currency in IndiaOn June 6, 1966, Indira Gandhi govt. devalued the Indian rupee for first time.At that time, one American dollar was valuing ₹ 4.76 which later changed to Rs. 7.5 for 1 USD .It was about 57% fall In the strength of INR against dollar which triggered a bitter criticism in media and people which claimed it to be a complete “sell-out to America and the world bank”. But, is it really so, lets dive in:
Since Independence, trade deficits were increasing year to year. In 1962, India faced a war against China and again with Pakistan in 1965 followed by a major drought in 1965-6. All these circumstances lead to huge inflation due to large deficit spending which lead to the devaluation of Indian rupee but this laid a distrust between the people and government.
Countries like Oman , Qatar , UAE used the Gulf Rupee that was issued by Reserve Bank of India, but after devaluation of INR , they came up with their own currency.
This devaluation undertook in two stages because Mr. Singh thought that the first move will test the markets and the second move would help to stabilize the INR closer to the desirable level.
On 1 July, 1991, RBI announced a weaker rate for rupee 9% lower than the previous day levels. According to Mr. Jairam Ramesh, Prime-minister Rao was not in favour of devaluation of Indian Rupee due to the political consequences he may face. He had ordered not to carry out the second phase of devaluation but then also, Rupee was devalued second time 11%. Mr. Jairam , working in the department of Mr. singh at that time, have explained the whole incidence in his book “To the Brink and Back: India’s 1991 story” about how the devaluation occurred and the whole story about it.
This devaluation had shriveled the Indian trade deficit to it’s 1/6th in next three years and the non-oil trade balance had moved from deficit to a massive surpulous . This was followed by many other reforms like freeing India Inc. from MRTP Act, easier foreign Investment norms. This devaluation is considered to be very much beneficial for Indian Economy.