Does a Currency That Is Undervalued Promote Growth?

Currency depreciation increases economic growth by encouraging production through the multiplier effect, according to the Keynesian paradigm. However, this is simply a required, not sufficient, condition for depreciation to be expansionary. Devaluation, for example, can decrease investment, which is a significant ingredient of aggregate demand, for the same reason. As a result, the net effect on production is dubious and empirically open. Devaluation, for instance, might shrink the combined supply loop by making imports of goods more expensive.

Many currency devaluation events have occurred since world currencies departed the gold standard and permitted to fluctuate openly against each other. These events have harmed not just the residents of the countries involved, and have also reverberated throughout the world. When the question that arises is why do nations devalue their currencies if the consequence may be so severe.

Boosting Export

On a global market, a nation’s goods must compete with those of every other country. Automobile manufacturers in the United States must compete with those in Europe and Japan. If the euro falls in the vault, the price of vehicles sold by European manufacturers in the United States in the dollar will be effectively lower than previously. A more valued currency, on the contrary, makes express more expensive to buy in overseas markets.

The same happens in the case of the trade relations between the UK and South Africa. The South African financial market is becoming one of the hubs of the industry which is mainly caused by the exchange rate of South African Rand, which created a friendly as well as profitable environment for foreign investments. As a result, we see the increased activity of the South African brokers and many other companies are trying to settle in the country, due to the advantages that can be brought to their companies or businesses because of the currency rate and monetary policy.

Exporters become more ruthless in the worldwide market. Imports are demoralized, but exports vice versa. However, there should be considerable care for two reasons. First, when global demand for a country’s exported commodities grows, the price will start to climb, in order to normalize the primary impact of the devaluation. The second is that, when other nations observe this impact in action, they will be enticed to deflate their own currencies in a race to the bottom, this may result in tit-for-tat currency warfare and uncontrolled inflation.

Shrinking trade deficits

As exports get cheaper and imports become more expensive, exports will rise and imports will fall. As exports rise and imports fall, the balance of payments improves, resulting in smaller trade imbalances. Deficits that endure year after year are not prevalent today, with the United States and many other countries experiencing chronic variances. Continuing deficits, on the other hand, are unsustainable in the long run, according to economic theory, and can lead to catastrophic levels of debt that can destroy an economy. Depreciation of the home currency can aid in the correction of the balance of payments and the reduction of these imbalances.

However, there is a prospective drawback to this logic. When foreign-denominated loans are priced in the local currency, depreciation raises the debt load. This is a major issue for a growing country like India or South Africa. These international loans become increasingly difficult to service eroding people’s faith in their local currency.

Reducing sovereign debt

If a government has a lot of state sovereign debt to pay on a regular basis, it may be encouraged to support a weak currency policy. If financial obligations are fixed a weaker currency reduces the cost of these payments over time. Consider that the federal government must pay $1 million in interest payments every month on its obligations. However, if that same $1 million in fictitious payments loses value, it will be simpler to pay the interest. If the native currency is depreciated to half its initial value, that one million payment will now only be worth $500,000.

This approach should be utilized with prudence. Because almost every country on the planet owes money in some way or another, a race to the bottom currency might break out. This strategy will also be a failure if the country has a considerable amount of foreign bonds since it would increase the cost of interest payments.

Summing It Up

Finally, to sum up, countries can employ currency devaluation to accomplish economic policy growth. A weaker currency in relation to the rest of the world can assist promote exports, decrease trade deficits, and lower interest payments on the country’s outstanding government loans. Devaluations, on the other hand, have certain negative consequences. They produce global market uncertainty, which can lead to asset market declines or recessions. Countries may be enticed to engage in a tit-for-tat currency war, depreciating their own currencies. This is a hazardous and vicious cycle that may cause far more harm than benefit.

Devaluing a currency, on the other hand, does not always provide the desired results. Brazil is a good example. The Brazilian reals have plummeted since 2011, but the sharp depreciation has been insufficient to compensate for other issues such as falling crude oil and commodities prices as well as growing corruption scandals. As a result, the economy of Brazil has grown at a slow pace.