Devaluation is most often used in a situation where a currency has a defined value relative to the baseline. A 10% fall in the value of a nations currency can boost exports by an average 1. Devaluation controversies in the developing countries. Devaluation is usually undertaken as a means of correcting a deficit in the balance of payments. About 20 percent of the small states use the most rigid arrangement, dollarization, in which another countrys currency serves as legal tender, and exchange rate changes are impossible. Devaluation of the american dollar entailed devaluation of the currencies of many capitalist countries, but at the same time the currencies of the major capitalist countriesthe main trade competitors of the usawere revaluated. Cooper argues that the devaluation induced rise in the domestic currency. Both terms refer to the relative exchange rates between domestic and foreign currencies. A devaluation means that the value of the currency falls. Currency devaluation in improving trade balance economics. Power and water projects typically generate revenues in local currency, while their financing costs and fuel costs for thermal power projects are denominated in u. Causes and impacts of inflation on developing countries. Gregorio, edwards, and valdes, 2000, while edwards 1989 has investigated the role of capital account restrictions for twentyfour developing countries in the period prior to devaluation.
Currency devaluation in developing countries sciencedirect. As a result, very few studies shed any light on the relationship between stability of the model and the likelihood of contractionary devaluation. The devaluation must represent an acceleration of at least 10 percentage points. Historically, early currencies were typically coins struck from gold or silver by an issuing authority which certified the weight and purity of the precious metal. Contractionary effects of devaluation are also far more important for developing countries, particularly the balance sheet effects that arise from currency mismatch. Effects of currency depreciation on trade balances of developing economies.
Exchange rate misalignment in developing countries. Contractionary devaluation, substitution in production and consumption, and the role. Unesco eolss sample chapters global perspectives in health vol. Effects of currency devaluations on the economic growth in. Section 2 will describe the growth performance and devaluation strategy of ethiopia. Currency devaluation and its impact on the economy. To understand currency devaluation in developing countries. Currency devaluation in improving trade balance economics essay. A study by ratha, 2010 of india confirmed the keynesian positive view of devaluations and the multiplier effect on the. To examine the genesis and trends of currency devaluation in nigeria. Exchange rate misalignment in developing countries english abstract. However, since 1998 a lot more african countries have been put through a series of corrective devaluations at the instance of every surge in inflation. This article analyzes the theory of equilibrium real exchange rates and defines misalignment as a deviation of the real exchange rate rer from its equilibrium level.
Devaluation can restore competitiveness without reducing aggregate demand. International trade and exchange rate international trade volume data indicates developing countries play a bigger role in holding back trade growth, while developed countries show quite robust import growth. A devaluation in the exchange rate lowers the value of the domestic currency in relation to all other countries, most significantly with its major trading partners. Currency devaluation often is confused with currency depreciation. Sep 28, 2015 a 10% fall in the value of a nations currency can boost exports by an average 1. A definite answer is difficult itself and inevitably bias, unless supported by strong evidences and good explanations. By fo cusing on the bretton woods era, we can examine the fundamental empirical features of large nominal devaluations in a historical environment with gen eralized fixed exchange rates. Cooper, 1971, international finance section, princeton university edition, in english. A devaluation means there is a fall in the value of a currency. Threequarters of small developing countries maintain fixed exchange rate regimes.
Currency devaluation in developing countries 1971 edition. To seek and determine as far as possible methods by which the risk associated with exchange rate fluctuations can be minimized. From a longerterm perspective, however, global trade volume has not deviated much from its longterm trend. This paper discusses the effects of devaluation on output growth in less developed countries ldcs. A government in need of money and short on precious metals might decrease the weight or purity of the coins without. It includes most of the currency devaluations during the period 19591966. An analysis of recent trends, asian development bank economic staff paper no. This gives rise to the need of developing economic models which can be used to. The effect of structural adjustment programmes on the delivery of veterinary services in africa 3 officially recognized as part of the animal health delivery system. Contractionary currency crashes in developing countries 151 country, one would not want to say that a new currency crisis occurs every month. Cooper argues that the devaluationinduced rise in the domestic currency value of. Effects of exchange rate fluctuations on economic growth. Currency devaluation and economic growth the case of.
As a result, very few studies shed any light on the. Exchange rate policies in developing countries odi. Currency devaluation article about currency devaluation by. Even if we pursue the hypothesis that tenacity of the imf to devaluation. Countries often use currency devaluation for economic policies. The issue has played an important role in the economic and political agendas of developing. Nonetheless, the imf stabilization programs in developing countries still require the devaluation of the currency since the 1950s. Inflation thus can be seen as a cause of the devaluation of a domestic currency on global money markets 3. Cooper argues that the devaluation induced rise in the domestic currency value of exports is unlikely to offset the corresponding rise in the cost of imports and on balance aggregate demand, and thus output, generally will fall, i. This has been the case not only for the very poor countries which are heavily dependent on commodity exports and official aid flows for their foreign exchange.
Structural adjustment in most developing countries has been built on the twin application of economic liberalization and currency devaluation. Imf currency study shows power of devaluation business. When the local currency is cheaper than the foreign currency, exports will be encouraged and imports discouraged. Foreign exchange risk mitigation for power and water. Currency devaluation and economic growth the case of ethiopia. According to cooper 1971, currency devaluation is one of the most traumatic economic policy measures that a government may undertake and as a result, most governments are reluctant to devalue their currencies. The existence of a public debt burden, however, creates a potential policy tradeoff between these two measures. Note that such a setup implies, ceteris paribus, that while a devaluation visavis other developing countries has a negative impact on the terms of trade, that visavis. Truman, staff director of the boards division of international finance, prepared this article. In the shortterm, a devaluation tends to cause inflation, higher growth and increased demand for exports. Jul 23, 2019 currency devaluation in developing countries by richard n.
This was one of the few major papers from that period to deal explicitly with the macroeconomics of developing countries. The relation between currency devaluation and trade balance is a controversial topic in economics and variety opinions have arisen in the literature research. Conversely, high imports countries should keep their currency strong. This paper examines the shortterm and longterm effects of a nominal devaluation on the real exchange rate. An upward movement in a countrys real effective rate can arise from an appreciation of its nominal exchange rate, the depreciation of other countries currencies, or a box 1. The insights from this exercise could inform policymakers and economists in developing countries on potential implications of exchange rate devaluation and. Macroeconomic and distributional impacts of exchange rate. Devaluation and the real exchange rate english world bank. Pang encyclopedia of life support systems eolss enterotoxigenic e.
Since currency devaluation may create inflationary pressures even as it may provide some positive effects on a countrys trade balance, the critical issue is what effects will dominate. I then discuss the choices policymakers face with regard to exchange rate regimes and exchange rate levels. Revisiting a policy of currency devaluation in african countries. Currency devaluation is one of the most dramaticeven traumatic measures of economic policy.
American economies in the 1990s after devaluation has led to gained attention to the negative effect of devaluation in developing countries pointing out to the adverse balance sheet effects. Even if we pursue the hypothesis that tenacity of the imf to devaluation is derived from some. Jan 22, 2016 a devaluation occurs in a fixed exchange rate. Devaluation often occurs in developing countries, especially those of latin america. Currency devaluation in developing countries yale economic. Foreign exchange risk mitigation for power and water projects. The impact of currency devaluation on commodity production.
Pdf effects of currency depreciation on trade balances. Furthermore, except for one, none of the studies has examined devaluation s effects under different tax system. With a decision to devalue the currency, the central bank can cut interest. The effect of depreciation of the exchange rate on the. Developing countries will often use an export oriented economic strategy to increase growth. The cross sectional data was tested via multiple regression analysis. Devaluations of a domestic currency will make exports look more attractive on foreign markets. Devaluation is a less damaging way to restore competitiveness than internal devaluation. Internal devaluation relies on deflationary policies to reduce prices by reducing aggregate demand. A depreciation occurs in a floating exchange rate system. Despite ambiguous results from empirical studies devaluation of currency has been used as a growth strategy by many developing countries. He finds that countries typically intensified their control programs in the year before devaluation, and concludes that at most one can argue that these heightened impediments to trade managed to.
These countries devalued their currencies within the same period under. This paper evaluates the current state of the literature concerning the effects of exchange rate movements on trade balance. Currency devaluation an overview sciencedirect topics. Currency devaluation in developing countries richard n. Ethiopias exchange rate devaluation of october 2017 was accompanied by an increase in interest rate which the central bank suggested will tackle the in. The role of currency devaluation in developing countries, a. To investigate the role of currency devaluation in developing economies.
Dollarizing an economy commonly entails dollarizing bank deposits and loans, transacting in dollars and tagging prices of goods and services in dollar. Some analyst are of the view that weakening the value of currency could actually be good for the economy since a weaker currency will boost exports, which in turn will lift employment and all this will set in motion economic growth and keep the economy going. The aim of this paper is to prove that devaluation can be contractionary and that its occurrence can be the result of a selffulfilling prophecy. Currency devaluation in developing countries by richard n. It is shown that in the absence of supporting policies that limit increases in prices and factor costs, devaluation will exert only a transitory. Currency devaluations and implications of the correspondence. Richard coopers currency devaluation in developing countries. Domestic residents will find imports and foreign travel more expensive. It almost always generates cries of outrage and calls for the responsible officials to resign. The effect of exchange rate movements on trade balance. Many countries, specially developing ones, use currency devaluation as a strategy to achieve short and long run growth. Revisiting a policy of currency devaluation in african. Devaluation is the decision to reduce the value of a currency in a fixed exchange rate.
The importance, how to, effect causes relationship, comparison, history, role, solutions are discussed. Start with the choice of what currency to peg to and at what rate. Pegging to the wrong anchor in a world of great volatility in the crossrates among the three major currencies can be devastating, as the countries ofsoutheast asia discovered recently. Fiscal effects of devaluation in a developing country with a. National currency devaluations of the lek all have been used by albania to.
The weight of our attention has over the last decade or two shifted increasingly away from rich countries and toward. Effects of currency depreciation on trade balances of. Apr 17, 2012 assuming that a developing country has to denominate its debts in the currencies of the principal creditor countries, how is the countrys economic performance affected when currency devaluation occurs. Economic effect of a devaluation of the currency economics help. On december 20, 1994, the government of mexico announced the devaluation of its currency, surprising. The general nature of macroeconomic problems of developing countries that require corrective policy actions is often associated with. This chapter provides an overview of the currency devaluation in developing countries. Making textual analysis of the available data from south asian countries, the study makes predictions on the devaluation of currency, its causes and the consequences.
Cooper currency devaluation is one of the most dramaticeven traumatic measures of economic policy that a government may undertake. Those devaluations during 6ils period that are ex cluded involve countries in unusual circumstances, such as laos and vietnam, venezuela was also excluded because it is a country with a large trade srplus. Get free research paper on the role of currency devaluation in developing countries, a case study of nigeria our project topics and materials are suitable for students in nigeria with case studies in pdf, doc. Lowering of the home currencies as compared to foreign currencies can improve exports, shrink trade deficits, and reduce a countrys debt burden. Devaluation and the real exchange rate english abstract. Currency devaluation is one of the most dramaticeven traumatic measures of economic policy that a government may undertake. Currency boards also face serious implementation problems of their own. Jul 28, 2019 a devaluation means there is a fall in the value of a currency.