DEVALUATION OF CURRENCY- By Neelambari Kakaraparthi and Rohit Burman

Devaluation is the intentional reduction in a country’s currency value in comparison to another

currency, group of currencies or a currency standard. When a government wants to improve its

trade balance (exports minus imports), it devalues its currency in order to do so. The government

does this by changing the fixed or semi-fixed rate at which its currency is valued in relation to

currencies of other nations. With fixed rate it is easier to revaluate as the pegged value is in

government’s control whereas market forces make it difficult to revaluate currency in floating

system.

Devaluation as a tool for policy is pertinent, particularly when there is misalignment in the

components of foreign trade. Long-standing political and economic priorities for developing

countries include addressing the issue of devaluation. Countries devalue their currencies for a

number of reasons, including correcting price distortions and establishing accurate prices for the

proper operation of market forces and to alter the relative prices of traded versus nontraded

goods in order to increase competitiveness in international markets. As a result, it would reduce

the foreign trade deficit, enhance the balance of payments (BOP), and most importantly, achieve

a sustainable rate of economic growth and output growth which is the main driving force behind

economic progress in developing economies. Also, if the economy is in distress when a

significant amount of public expenditure is funded by borrowings, governments may support

devaluation. It will gradually lower the cost of debt payments by devaluing the currency.

Countries across the world devaluated their currencies many a times to sustain in the world trade

or simply because they tend to lose their value overtime like the US Dollar. It is estimated that

US Dollar lost its value by almost 96% since 1913 when the Federal Reserve took over the

banking system. This happened as more money was printed overtime which led to pure monetary

inflation without sufficient economic activity being carried out. Also inconsiderate decisions by

the government such as suspending the Gold Standard in the year 1971, fueled inflation sharply.

Removing the gold standard meant that there was no limit on the amount of money being

printed. So even if US Dollar is ideally considered as a standard for foreign exchange, even this

was devaluated to make the US economy look attractive for businesses. Evaluating the situation

almost a decade ago, the German Mark was devalued sharply against the US Dollar from 1USD

being equivalent to 4 German Marks in 1914 to 1USD being valued against 70 German Marks in

1923. With the onset of WW1, the expenditure of the country increased and so did the war

reparation to other countries thereafter. Alongside the reparations, a trade union’s strike triggered

the devaluation which by the end of year 1923 stood at 1USD equal to 4 trillion Marks. Another

striking example can be considered that of Zimbabwe which left all the economically alarming

factors to accumulate and breed overtime eventually ending in an a hyperinflation. The currency

which was initially pegged at 1000 Zimbabwean Dollars (ZWD) for 1USD in 2008 devaluated to

almost 300 million ZWD to 1USD in February of 2009.

The very Indian Rupee too was devalued many times since the independence. To place the

country on the track of progress, the then Prime Minister Nehru opted to implement the five year

plans. As the reserves faced crunch, funds required for public expenditure were borrowed

extensively as foreign loans which brought the value to 1$ = Rs. 4.75 in the 1950’s. Wars with

China and Pakistan and a severe drought in the late 1960’s further disabled the economy’s

productive potential, leading to inflationary pressures. Technological input was required to boost

domestic production and the government devalued the currency to $1 = Rs. 7 to procure

technology as well as to attract international trade. Organization of Arab Petroleum Exporting

Countries (OAPEC) had cut their crude oil supply in 1973 which made oil costlier. To meet the

payment of imports, Rupee had to be brought down for the third time to almost 1 USD =

Rs.17.50. In the years that followed, many subsequent and deliberate reductions had to be made

so that foreign loan could be paid back without defaulting. With this the exchange rate which

was 1 USD = Rs. 1 in 1947 came down to almost 1 USD = Rs. 79.08 in the current day. Though

it looks like quite a downfall, devaluation against the dollar has always helped the Indian Rupee

in every crisis and improved the prevalent setting.

Many more examples of currency devaluations can be observed from time to time as to keep

their international participation in continuum, countries opt for currency devaluation which

makes it easier for them to export goods and attract investments. With devaluation, imports start

to fall as a result of perceived higher prices by local consumers and domestic goods become

cheaper, thus will be preferred more which would encourage the flow of money within one’s

own economy. However governments need to keep a keen watch on the inflationary trends as

prices can sharply increase due to increased demand from households as well as for exports.

Therefore it is necessary to have a strategic plan backing the whole process so that the objective

of devaluation i.e., to kick-start development in the economy can be met.