What is currency depreciation?
To depreciate means to diminish the price or value. Depreciation of currency is when there is a fall in the value of a currency in a floating exchange rate.
When there is a fall in the value of a currency in a floating exchange rate, this is not due to a government’s decision but due to supply and demand-side factors.
What happens when a currency depreciates?
Suppose if the Chinese Yaun depreciates (the exchange rate falls), the relative price of domestic Chinese goods and services falls while the relative price of foreign goods and services increases. The change in relative prices will increase Chinese exports and decrease its imports.
Why countries devalue their currencies?
The reason a country may devalue its currency is to combat a trade imbalance. Devaluation reduces the cost of a country’s exports, rendering them more competitive in the global market, which, in turn, increases the cost of imports.
Currency depreciation involves taking measures to strategically lower the purchasing power of a nation’s own currency.
Prospects of currency depreciation
Currency devaluation offers four things:
- reduces the cost of the country’s exports
- increases global market competitiveness by lowering the prices of goods and services
- cuts back on imports because it becomes more expensive to import while currency depreciates
- reduce the cost of interest payments on its outstanding government debts.
Associated challenges
The drawbacks of currency depreciation are;
- it increases the debt burden of foreign-dominated loans when priced in home currency
- uncertainty in the global markets/ spur recessions
- global currency wars.
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