Devaluation of a currency was a
matter of prestige in the past. However, with the lapse of time it has been
learnt that such an operation is sometimes necessary to save the country from
economic hardships.
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 export 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
According to many economists, weakening of the currency could actually
strengthen the economy, since a weaker currency will increase the production,
which in turn will uplift employment and raising the economic growth. The
increase in the demand for domestic goods and services increases their
production, triggering the economic growth. Hence, in order to keep the economy
going, economic policies must improve the aggregate demand. And the demand for
domestic products originates from outside the country, termed as exports.
Likewise, local residents demand for the imported goods and services. Therefore
the increase in exports increases the overall demand for domestic output, and
increase in imports decreases the demand. Hence exports are the determinants of
economic growth, while imports detract the growth of the economy.
International demand for a country's goods and services is an important for
boosting the economic growth. And to increase the demand of domestically
produced goods in the foreigner market. Attractive prices of these goods should
be set, making them more attractive.
Traditionally, there are three main approaches to devaluation or currency
depreciation: the elasticities approach, the absorption approach and the
monetary approach. According to the elasticities framework, devaluation improves
a country’s balance of trade when the Marshall-Lerner condition is satisfied,
when the sum of the import demand elasticities of the two trading partners
exceeds unity. In the absorption methodology, however, the elasticities do not
matter, and the trade balance improves only if the nation’s GDP increases faster
than domestic spending. In the monetary approach, by contrast, only money demand
and supply matter, and devaluation always improve the trade balance. According
to the monetary approach to the exchange rate, a devaluation or depreciation
decreases the real supply of money, resulting in an excess demand for money.
This leads to hoarding and an increase in the trade balance.
Devaluation is an official change in the value of a country's currency relative
to other currencies under the phenomenon of fixed exchange rate. Whereas in
floating exchange rate system, currency depreciation result as changes in market
forces.
Loosening of the monetary policy results in the increase of selling the domestic
currency for other currencies, this leads to domestic currency devaluation. And
domestic producers and exporter are the main beneficiaries of this action.
There are two implications of devaluation.
First, devaluation makes the exports of the country cheaper for foreigners.
Second, it makes imported goods expensive for domestic consumers, which
discourages the imports.
Depending on consumer and producer responsiveness to price changes (known as
supply and demand elasticities), an effective devaluation should reduce a
nation's imports and raise world demand for its exports. Improvement in a
country's balance of trade will cause an increase in the new inflow of foreign
currency; this, in turn, may help strengthen a country's overall balance of
payments account. The total effect of a currency devaluation depends on the
actual elasticities of the supply and demand for trading goods. The more elastic
the demand for imports and exports, the greater the effect of the devaluation
will be on the country's trade deficits and, therefore, on its balance of
payments; the less elastic the demand, the greater the necessity devaluation
will be to eliminate a given imbalance.
Devaluation often is criticized as an inflationary monetary policy because it
raises the domestic price of imports. The underlying cause of inflation is not
devaluation, however, but rather an excess money creation. Nonetheless,
devaluation is an unpopular policy, especially in small countries that are
extremely dependent on imports as a source of food and other necessities.
When the prices of imports are increased it results in the increase of the
demand for domestic products, devaluation results in inflation. If this is the
situation, the government should have to increase the interest rates to control
inflation.
Devaluation may discourage the investment in the country's economy and may
affect the foreign investment in the country.
Devaluation might negatively affect the export industry of the country.
Countries in the neighbor may devalue their own currencies to reduce the effects
of their trading partner's devaluation.
Currency depreciation affects the social welfare as well, which depends upon
real GDP and the rate of unemployment. If there is unemployment along with a
high trade deficit, then currency depreciation unambiguously raises welfare,
even though the price level rises and inflationary pressures escalate. This is
because in this case outputs as well as employment go up, while the trade
deficit disappears.
On the other hand, if the nation has been already at full employment,
devaluation simply raises the price level, lowers aggregate spending, improves
the trade balance, but has no impact on overall welfare. However, the weakest
sections of society, the retirees, the minimum-wage earners, the older workers,
etc., suffer, because their nominal incomes remain fixed while prices go up.
Pakistan's reference: Pakistan is also a developing economy. Some of the items
of its exports are oil seed, cotton, rice, wool, fish fresh, chilled frozen,
tobacco etc. Main export items are rice and Cotton. Pakistan also faces severe
competition in the world market like other developing countries. The volume of
exportable goods like cotton and rice also depend upon climate in the country,
which determine good or bad harvest. It is agonizing to accept that even after a
good harvest due to favorable climate Pakistani goods can fetch better prices
only if the harvest in competing nations has been bad due to unfavorable
climate. Pakistan has made consistent efforts to increase and diversify its
exports, but no cogent results have so far been achieved. Very recently Pakistan
has been paying acute attention in the sector of Information Technology. Every
endeavor is being made to enrich the younger generation of the country towards
this sector so as to boost software exports and promote email commerce. India
our main rival is far ahead of Pakistan in this field. Since the government now
gives due recognition to the matter, it is hoped that we will pick up momentum
very soon.
The main items of imports in Pakistan are petroleum and petroleum products,
vegetable oil and fats, tea, wheat, milk and cream, etc. The import bill of the
country, despite best efforts could not be brought down. Import of petroleum and
petroleum products is very vital for the survival of the economy. A substantial
portion of our foreign exchange is also utilized for the import of tea. Moreover
the prices of petroleum and its products prevailing in the international market
have direct impact on Pakistan's trade balance and its balance of payment.
Increase in prices of petroleum and petroleum products also results in a
corresponding increase in numerous items attached to it changing overall price
structure in the country.