Is currency devaluation always a bad thing?

We keep hearing that the INR is falling and losing its value compared to USD. This can make you wonder why the Indian govt. or the Reserve Bank of India (RBI) does not do anything to bring back the value. Turns out that devaluation is not always a bad thing. Sometimes even governments around the globe devalue their currency on purpose.

To understand this in-depth, let's understand what devaluation is, what effects it has and how countries devalue their currencies.

What is Devaluation?

Devaluation refers to the downward adjustment of a country's money relative to another currency.

For example, the Indian currency INR is pegged to the USD, which is currently hovering around Rs. 77.51 in 2022 was around Rs. 51 in 2012 compared to 1 USD, showcasing the drop in value of the INR over the last 10 years.

Why do countries devaluate their currency?

One reason countries devalue their currency is to combat trade deficits. For a country:

If Exports - Imports = +ve ==> Country is in trade surplus

If Exports - Imports  = -ve ==> Country is in trade deficit

Now when 1 USD = Rs. 51, let's assume India can export 100 units of a product. When devaluation occurs and 1 USD = Rs. 77, since the other country is paying in USD terms, their purchasing power increases since they can now buy Rs. 20 worth more goods with the same 1 USD, which in turn increases the amount of exports that India has, allowing Indian exporters to earn more INR.

The opposite impact occurs on Indian importers. Since the value of INR has decreased, they need to pay more INR to import the same 100 units of a product.

This is why simply devaluing currency does not work for every country. Example:- Nigeria. Nigeria tried devaluing its currency but the country's infrastructure, transportation, and industries were not set up at the time for this move, which did not lead to the positive outcome that Nigeria had hoped for.

One country that did this well was China. China devalued its Yuan in 2015 to boost its exports, which eventually led to a trade war with the US. But this also led to a boost in its exports as China was at the time ready to increase its exports.

Negative impacts of devaluation

Now that we understand the benefits of currency devaluation, let's look at the other side of the equation. Since import costs increase, it increases the price of imported goods for domestic consumers, which can boost demand for local industries helping the country move towards self-sufficiency. But that is not always the case. Take for example semiconductors. Taiwan alone controls 63% of the semiconductor industry because of its highly skilled labour and industry setup. So even if import costs of it increase in India, because of a lack of skilled labour, absence of the supply chain, and the industry setup, India will be forced to import these semiconductors.

Another negative impact is on inflation. As import costs increase, domestic prices increase which leads to higher inflation.

So how do countries devalue their currency?

It's all about supply and demand. If a country wants to increase the value of its currency, it can just reduce its supply in the market by buying back its currency in exchange for the foreign currencies they hold. When the supply will reduce, the value will automatically go up.

Similarly, when a country wants to devalue its currency, they print excess money and floods the market with its currency. The more the supply of the currency, the lower its value becomes.

Summary

In summary, the devaluation of currency can have both positive and negative outcomes. If coupled with the right infrastructure and setup and done at the right time, it can lead to a boost in the economy, but if done incorrectly can also lead to bad outcomes.