Currency Devaluation: Civil Services Mentor Magazine - March - 2016

Currency Devaluation

Competitive devaluation or what is also called as currency war, is an economic situation in world, where countries compete to reduce the rate of their currency and make it more suitable for their domestic industries. Currency rate is indirectly related to exports from the country. As currency falls exporters benefit from getting more money for similar product and also imports to the country becomes much more expensive. This situation is favorable to domestic industries, they get the boost from domestic demand as well as from the international market. However this comes with price currency devaluation decreases the citizens purchasing power parity. This situation generally arises when country is facing difficulties in economic front. If other countries also start doing the same thing then it can severally harm the international trade and economy. Currency devaluation has been used after great depression in 1930’s. This might help domestic market and unemployment scenario for some time but when other countries also take similar measures it negatively affects the overall trade and economy of the world. After the economic crisis of 2007, countries are still trying normalise their economies. Quantitative easing in US continued for long time which pumped lot of money into the economy, which in turn devalued the US dollar. China is also facing decrease in growth rate in order to arrest this problem China has devalued their currency multiple times in recent months. Chinese move is also more critical as yuan is ready to enter into the basket of currencies used by IMF. This policy can also trigger retaliatory action by other countries which in turn can lead to a general decline in international trade, harming all countries.

Devaluation is not being a general phenomenon in the history of the world; there were very few instances when countries have highly devalued their currency. Countries have generally allowed market forces to work, or have participated in systems of managed exchanges rates. First such currency war broke out in 1930’s, as countries were trying to minimize the effects of great depression and countries currency devaluation actually increased the problem. As countries abandoned the Gold Standard during the Great Depression, they used currency devaluations to stimulate their economies. The period is considered to have been an adverse situation for all concerned, as unpredictable changes in exchange rates reduced overall international trade.

After the economic crisis of 2007, every country tried to stablise their economy through various means. US started the quantitative easing program under which they pump in huge amount of money into the economy. This process did help the US in stabilizing the US economy. However it negatively affected the other major economies, who are the competitors of US. Now European Central Bank has launched a €60bn per month quantitative easing programme in January 2015 by the European Central Bank. Lowering the currency rate was not part of initial program but it did lower the currency.

Chinese economy is majorly export dependent economy and it is facing some severe challenges in export front. Export growth was negative for almost a year for China. In August 2015, China devalued the yuan by just under 3%, due to a weakening export figures of -8.3% in the previous month. This drop in export is due to devaluation of currency by the competitors of China like Japan and Germany. This reduced the competitive advantage which China used to possess. It sparked a new round of devaluation among Asian currencies, including the Vietnam dong and the Kazakhstan tenge.

Chinese yuan devaluation will also negatively affect few major sectors in India. Indian competes with China in steel, textiles, chemicals etc. All these sectors will face a challenge in coming months. Majorly these few sectors will be affected by chinese yuan devaluation;

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