THE IMPACT OF THE DEVALUATION OF CURENCY

8/7/2019 THE IMPACT OF THE DEVALUATION OF CURENCY

1/25

CURRENCY DEVALUATION AND

ITS EFFECTS

MADE BY


2/25

What is Devaluation??

Devaluation is a reduction in the value ofacurrency withrespectto those goods, services or other monetaryunitswith whichthatcurrencycan be exchanged.

Simply put : It is when a nation's government fixes the

relative price oftheir currency below its presentlevelandprohibits currency exchange atany other rate.

Ex : 45 Rs = $1

Devalued to : 50 Rs= $1

Therefore, more ofthe devalued currency is required inorder to purchase the same amount of other currencies


3/25

Equilibrium Exchange Rate

The exchange rate at which everyone who

wants to sellthe currencycan find a buyer and

everyone who wants to buythe currencycan

find a seller


4/25

Why do countries devalue currency?

When foreign currency reserves run low

and/or the export sector can no longer sell its

goods abroad, the government becomes hard

pressed to devalue its currency.


5/25

Benefits

Currency devaluation can help to achieve a moredesirable balance oftrade. For nationsexperiencing atrade deficit (when importsexceed exports), acurrency devaluation willreduce the price oftheir products abroad andincrease the price of foreign products in domesticmarkets. Increased demand for products in othercountries due to lower prices can also mean more

jobs and lower unemployment rates athome.


6/25

Drawbacks

Currency devaluation also has negativeconsequences. Individuals holding a recentlydevalued currencyhave lost international buyingpower. Their abilityto purchase goods or servicesfrom other countries has diminished.Additionally, ifa governmentartificially devaluesits currency, it may be forced to purchase its owncurrency with foreign reserves, depleting its own

assets and abilityto pay public debt. Thisoccurred in Russiaafter its 1998 currencycrisis.


7/25

Beggar-Thy-Neighbor

An improvement in acountry's trade balancemeans a decrease in the trade balancesomewhere else in the world, since the sum ofall

world trade balances must equal zero. An improvement in one country's trade balance

must be gained atthe expense of its tradingpartners' trade balances.


8/25

THE ECONOMIC IMPLICATIONS OF

DEVALUATION

Exports

Imports

Improvement of BOT Account,

Increased inflow of Foreign Capital (Provided thedomestic prices do not rise),

Defaults in repayment of internationalloans. ( in theterms of real money ),


9/25

Contd.

Decrease in the Credit worthiness ofthe

Nation,

Inflation In the Short Run,

Increase in Wages,


10/25

How it Improves the BOT Account

Devaluation

Of Currency

Domestic produce

cheaper for foreign

consumers

Foreign produceexpensive for domestic

consumers

Decrease In Imports(M)


11/25

Contd

BOT = X M

X = exports , M = Imports

From the above figure it is implied :

X increases , M decreasesHence the BOT ofthe nation improves.


12/25

DEFAULT PAYMENT

To explain the point of default paymentletusconsider ahypothetical example.

letus assume that Rs 100 = $ 1.

Rupee follows fixed exchange rate.

The present value of Rupee is above the eq.exchange rate.


13/25

Contd.

Rupee Devalued

Rs 100 = $ 1 Rs 100 = $ 0.75

IMF holds IGBs(Indian Government Bonds)

worth Rs 100 B @ 10 % .

Paid in USDs = $1 Billion


14/25

Before Devaluation

IMF Receives @ 10%

Rs 100 B + Rs 10 B (Interest) = Rs 110 B

That $1.1 Billion

Note : The bonds are Monetized in terms of

Rupees not Dollars.


15/25

Post Devaluation

IMF Receives @ 10 %

Rs 100 B + Rs 10 B (interest) = Rs 110 B

After devaluation Rs 110 B = $ 825 M

@ Rs100 = $0.75

Therefore a default of $175 M whichalso leads to

decline in the credit worthiness of India.


16/25

SHORT RUN INFLATION

DEVALUATION OF

CURRENCY

INTEREST RATE FALLS MONEY SUPPLY

INCREASES

RISE IN DEMAND NO INCREASE

IN SUPPLY

PRICES RISE

(INFLATION)


17/25

1994 MEXICAN CRISIS

The rootcause was the presidents policydecisions in office.

A pre-election disposition to stimulate the

economyled to post-election instability.

Concerns aboutthe leveland quality ofcreditextended by banks during the preceding low

interest period. Investors became wary of investing oftheir

money.


18/25

CONTD.

The govt.s finances and cashavailability were

hampered by:

2 decades of increasing spending.

Hyperinflation from 1985 to 1993.

Debtloads and low oil prices.

Abilityto absorb shocks was dented by its

commitments to finance past spending.


19/25

CONTD..

Investors sold bonds rapidly

Led to depletion ofalreadylow central bank

reserves

Govt. increases Fixed Rate Band by 15 % (up

to 4 Pesos per Dollar)


20/25

Contd.

Peso is floated as the govt. unable to hold

even the new line

Peso crashed :

4 Pesos = 1 $ to,

7.2 Pesos = 1 $ (within a week)

The economyatthe brink ofcollapse


21/25

US help

The US steps in withaid :

US purchased Pesos in the open market

Provides currency swaps and loan guarantee worth $20 B

IMF promises of 18 month stand bycreditagreement ofaround$17.7 B

Bank of international settlements offers $10 B line ofcredit

Bank of Canada give Short Term Swaps with USDs wortharound $1 B


22/25

CHINESE REVALUATION DRAMA

The Chinese Yuan was pegged from1994 untilmid 2005 at 8.28 Yuan to the U.S D.

In 2005 china shifted to a policy oflooselypegging the Yuan.

Economists believe thatchinas policiesamount market-distorting currencymanipulation.


23/25

CONTD.

According to a study by Peterson institute ofinternational economics :

Yuan mustappreciate 40% againstus dollar tocorrect global imbalances.

President Obama in 2008 stated chinascurrenttrade surplus is directly related to itsmanipulation of its currency value.


24/25

CONTD.

In a way itcan be said thatthe Chinese govt. issubsidizing exports and imposing tariffs onimports.

This is how china is dumping its products in othercountries markets and there bytaking advantageof devaluing its currency.

However the debate still rages on whether thepractices ofchinaare within the ethics ofinternationaltrade.


25/25

Conclusion

A weaker currency means that exports from theaffected country will be cheaper relative to prices inother countries, and that imports will be more costly.

For large internationalcorporations, devaluations oftentranslate into lost revenue and decreased profitabilityin the affected country.

For companies with substantial export-orientedoperations in countries whose currencies have beendevalued, the business may be able to enjoy some costadvantages in its labour and materials, enhancing itscompetitive position abroad.

THE IMPACT OF THE DEVALUATION OF CURENCY

Documents

Transcript of THE IMPACT OF THE DEVALUATION OF CURENCY