This occurs when a country lowers the official value of its currency in relation to foreign currencies. This is intended to raise the price of imported goods and increase the value of the countrys exported goods. This can be a risky economic move because it can spark hyperinflation. Both of these concepts involve international economics and foreign exchange trading. Devaluation is a result of natural changes within the world economy. Devaluation can occur because of several different circumstances. These circumstances also might not necessarily be the fault of the country whose currency was devalued.
Other countries currencies can get stronger which results in a devaluing domestic currency. Currency depreciation is an active economic move with the desired result being devaluation of currency on the foreign exchange market. Relating Devaluation & Depreciation to Currency Regime * In a freely and managed floating currency regime, a loss in currency value is conventionally called depreciation, whereas an increase of currencys international value will be called appreciation. If the dollar rises from 10,000 yen to 12,000 yen, then it has shown an appreciation of 20%.
Symmetrically, the yen has undergone 8. 3% depreciation. Example of Depreciation * If you were able to get Rupee1 for every $2 on one day, then the next day you can get Rupee 1. 5 for every $2, the value of the Re has decreased. This decrease is known as depreciation. To look at it another way; if country As currency was equal to the currency of country B; you would be able to get a one-to-one exchange of each of the currencies. The next day you attempt to trade $1 of country As currency, and you only get $0. 50 of country Bs currency in return; hence, country As currency has depreciated.
It is now worth only half of the amount it was before in relation to country Bs currency. But central banks can also declare a fixed exchange rate, offering to supply or buy any quantity of domestic or foreign currencies at that rate. In this case, one talks of a fixed exchange rate. Under the latter regime, a loss of value, usually forced by market or a purposeful policy action, is called devaluation, whereas an increase of international value is a revaluation. One can call it a purposeful Governmental intervention for economic reasons.
In other words currency depreciation/appreciation is controlled by the international currency rates based on the international stock market indicators; and currency devaluation is controlled by the central banks (RBI in Indias case) which forces exchange rates, that subsequently devalues the currency. Alternately, depreciation is due to international economic pressures, while devaluation is done by the government. Conclusion: Under a floating exchange rate a devaluation is not possible as a means of improving international competitiveness but a depreciation is
Phenomenon responsible for present situation and its effects Currency market is driven by a basic concept of economics i. e. demand and supply. Currencies are exchanged in the currency market. If there is high number of sellers than the buyers for any currency, the value for that currency goes down technically known as depreciation. Relating to Indian rupee, if there are more sellers of Re and more buyers for $, then the value of Indian rupee goes down. Since, India follows a managed float type of currency regime; it allows currency to free float to certain extent.
RBI might intervene when a certain defined ceiling or low is reached. At this time, investors are unwilling to hold on to Indian Rupee considering the current interest rates. Inflation in India is at 12% while rate of interest is hovering around 8. 5%; which mean negative 3. 5% return. Nobody would want to hold to such currency because of the short term uncertainty. Although, we can argue that foreigners would not be impacted by Indian inflation, why would they leave the currency then! Well, any currency reflects purchasing power of the people.
If the inflation is persistently high, then there is expectation for currency to weaken. This has the dual effect on depreciation. In the currency market, history shows that any time any steps are taken to hide the currency depreciation signs, the market starts selling that currency out of fear, which eventually further results in depreciation. Same thing has happened with India Rupee as well. Though, everybody is aware of growth prospects considering persistently high inflation, everybody is en-cashing their $s and exiting the India market.
This has resulted in further depreciation; resulted in Indian rupee depreciating to Rupees 54 in Jan 2012. In India, one can also relate this to fiscal irresponsibility in last 5-7 years. Government is unable to control expenditure; there is very low revenue channel; Government is resorting to populist programs, eventually resulting in higher expenditure compared to revenue which further results in fiscal deficit. RBI policies are exemplary, but since the fiscal deficit is too high, they have very limited tools to control the inflation.
This resulted in RBI not willing to interfere to hold the currency depreciation beyond 50 Rupees to $1. Any depreciation in currency is useful for exports considering everything is equal i. e. if the buyer of the exported goods is having job/cash. If he cant buy, then the exports do not grow. This is happening at many global markets recession in developed market. Depreciation would cause the imports to be costlier. This will have rippling effect on the economy and raise the inflation. Considering Indian scenario, since more than 50% of the imports are oil products, we end up paying more for the same quantity of oil.
This increases the cost of oil products, further impacting the transport and food sector. Further passed on to other sectors indirectly overall economy is affected. Increase in imports and with decreased exports, caused deficit further causing budget deficit. This becomes a vicious cycle until fiscal problem is identified and controlled i. e. dependence on imports and lending. This in turn creates more pressure on currency for depreciation. Government is currently just doing firefighting and handling situations as they arise.
Beyond short term intervention this is no long term solution. This has resulting in lack of confidence over years what culminated this no economic reforms. Whether devaluation or depreciation both is favorable for exporters but on the other side makes imports expensive. A series of devaluation/depreciation can make even a strong currency a weaker one. Fluctuations in exchanges rates impact different sectors in a different way depending on their volume of exports & imports and also their margin of operations.