Table of Contents

Particulars Topics Page No 2

Chapter 1: Meaning of currency devaluation Objectives of currency devaluation Reasons for currency devaluation Benefits/Importance of currency devaluation Drawbacks of currency devaluation Dangers of currency devaluation Causes of failure of currency devaluation Suggested conditions for currency devaluation Impact of currency devaluation on economy Possible impact of currency devaluation on Bangladesh economy Currency devaluation related activities to be done by Bangladesh Summary

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Meaning of currency devaluation

Currency devaluation means the reduction of purchasing power of domestic currency in comparison to foreign currency. For adjustment in the balance of payment of a country, government reduces the exchange rate of domestic currency rate against foreign currency rate. It may be applicable in case of special drawing right enjoyed with international agencies like The World Bank (WB) or The International Monetary Fund (IMF). After currency devaluation, more of the devalued currency is required in order to purchase the same amount of other currencies. A fictional example: If last year, one U.S. dollar purchased 10 Mexican pesos, & this year, one U.S. dollar can only purchase five Mexican pesos, the U.S. dollar has undergone a currency devaluation. In a word, devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged.

Objectives of currency devaluation

1) Promoting export : Currency devaluation leads to better export opportunity. The developing countries may encourage export through currency devaluation. Without adequate foreign exchange, no economy can flourish to expected level. 2) Discouraging unnecessary imports : Currency devaluation puts a bar on unnecessary imports. Through this process, imports of unnecessary consumption items are obstructed successfully. 3) Checking unfair trade practices : Currency devaluation has significant effect on putting an impediment on unfair trade practices. It becomes extremely difficult to play a monopoly when currency devaluation comes into effect. 4) Prohibiting black-marketing of foreign currency : If the value of currency is not revised accordingly, black-marketing of foreign currency will be increased. This may collapse the entire economy.
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5) Adjustment of inter country foreign exchange rates: Through currency devaluation, intercountry foreign exchange rates are adjusted. These adjustments builds harmonious relationships between trading countries. 6) Removal of balance of trade deficit : Though currency devaluation, exports are encouraged and imports are discouraged. This process assists to maintain a balance between trade deficits, specially for developing countries. 7) Increasing domestic employment: Currency devaluation enables more opportunity for employment as it encourages exports and discourages imports. Some of the unemployed gets opportunity to get involved in export related jobs and some gets occupied in productions that meet domestic demand. 8) Encouraging foreign capital investment : When foreigners find convenient economic facility, they invest a huge amount of money. Currency devaluation creates this suitable environment. 9) Withdrawal of trade control : Currency devaluation has huge impact on withdrawal of the trade control mechanism. 10) Countering foreign dumping policy : Currency devaluation helps countering foreign dumping policy in many ways. It is an essential element for any stable economy. 11) Under & over invoicing : Issues like under and over invoicing can be given a solid solution through the process of currency devaluation. Under and over invoicing issues affects a number of important aspects of an economy.

Reasons for currency devaluation

1) Overvaluation of domestic currency : Currency devaluation usually comes about when some determination is made that the domestic currency is overvalued relative to other currencies. It may be used as a policy tool to relieve an unfavorable balance of trade or to stimulate fledging export industries. Such policies assume that devaluation will make the countrys exports more attractive abroad & it will make imports from other countries less attractive at home.

2) Domestic economic policies : The value of an item is often tied to its quantity. A diamond, for example, is rare because so few are in circulation. The same is true with currency: when many dollars circulate throughout the economy, the currency depreciates. An increase in the money supply occurs when the US prints more money or the Federal Reserve lowers interest rates. When interest rates are lowered, more people take out loans and the issued money increases the amount of money in circulation. If too much money is in circulation, the economy runs the risk of hyperinflation. Harvard economist and professor Greg Mankiw explains Zimbabwe was a country that experienced a rapid increase in prices due to inflation, but curtailed its rapid monetary expansion by tying its currency to the U.S. dollar. 3) Selling currency : Investors, financial institutions and central banks often purchase foreign currency. Foreign governments hold large reserves of foreign currency as a safeguard and as an investment. For instance, the "Wall Street Journal" reports that China owns 2.4 trillion U.S. dollars as means of steadying the country's local currency, the yuan. When countries or investors grow wary of a currency's stability, they often sell their reserves into the open market. Concern arises when a country is deep in debt, is experiencing economic hardship or endures a terrorist attack or natural disaster. Releasing a glut of any currency on the market causes depreciation.

4) International trade : Countries intentionally depreciate the value of their currency for reasons of international trade. When a nation's currency is weak its exports grow more enticing. For example, euros were sold en masse during the Grecian debt crisis, which in turn caused a weakening or devaluation of the euro. However, currency depreciation is not always bad: The Wall Street Journal explains a 10 percent euro devaluation could provide a 17 percent increase in the euro zone's gross domestic product. Export-heavy countries are typically able to sell more goods when they are cheaper for other nations to purchase. Several countries, such as the
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United States, accuse China of keeping the yuan artificially devalued in order to sell more exports at the economic expense of countries with strong currencies.

5) Existence of rate controls & other government exchange rate policies :-

Technically, the biggest cause of currency devaluation is the existence of rate controls & other government exchange rate policies. If these didnt exist, there would still be currency depreciation, but there would never be organized efforts (even if reluctantly) to allow currency values to fall. However, in the interests of stability, nearly all nations practice some form of rate intervention from time to time, whether by occasional targeted transactions on the open market or by a strict regime of price controls. The currencies most vulnerable to devaluation, hence, are those belonging to nations with uncertain economic prospects & with active rate control/support policies.

6) Currency Crisis :Developing countries in particular are periodically faced with a currency crisis in which they may need to consider currency devaluation. This can occur when chronic trade deficits, government budget deficits, or other internal weaknesses causes slackened demand for a nations currency. This was the case during the Asian financial crisis of the late 1990s. 7) Ease of implementation :One attraction of currency devaluation is its ease of implementation. In the estimation of some government officials, a devaluation is easier for an economy to swallow than harsh structural changes, like voluntary cutbacks in demand for impoted goods, that are otherwise necessary to ameliorate current account deficits & promote growth of output.

Benefits/Importance of currency devaluation

1) Foreign Currency :As exports increase and imports fall so Dollar/Euro/British Pound outflows may fall and inflows rise. This assists the accumulation of foreign exchange reserves for the government. This strengthens the whole economy and increases its viability temporarily. 2) Decrease in Imports and Increase in Exports :Devaluation leads to high import prices. Hence imports are reduced. Devaluation increases exports because due to devaluation the prices of exports fall. 3) Industrial Growth and Economic Development :High exports as a result of devaluation leads to industrial growth. Export earnings enable the producers to use improved means of production. More and more resources are explored and put into production process. Incomes, profits, and wages may rise and make the society better off and improve its living standards. It is evident that countries that are good exporters are also prosperous and rich nations. In fact exports are a key to success and development. So if devaluation gives boost to exports; it can also open doors of long term prosperity, growth, and development.

Drawbacks of currency devaluation

1) It is likely to cause inflation because :a) Imports would become more expensive b) Aggregate demand increases causing demand-pull inflation

c) Firms / exporters have less incentive to cut costs because they can rely on the devaluation to improve competitiveness.

2) It reduces the purchasing power of citizens abroad.

3) A large and rapid devaluation may scare off international investors. It makes investors less willing to hold government debt because it is effectively reducing the value of their holdings.

Dangers of currency devaluation

1) A risky undertaking: Other factors may diminish currency devaluation effects, making a planned devaluation a risky undertaking. Even if the domestic conditions are ideal for it, one countrys devaluation may trigger a cycle of competitive devaluations by other countries & thereby undermining the initial countrys strategy. 2) Aggravating inflation: By increasing price of imports & stimulating greater demand for domestic products, devaluation can aggravate inflation. If this happens, government may have to raise interest rates to control inflation, but at the cost of slower economic growth. 3) Dampening investor confidence: To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the economy may be jeopardized. Thus, devaluation may dampen investor confidence in the countrys economy & hurt the countrys ability to secure foreign investment. 4) A round of successive devaluations: One possible consequence is a round of successive devaluations. For instance, trading partners may become concerned that devaluation might negatively affect their own export industries. Neighboring countries might devalue their own currencies to offset the effects of their trading partners devaluation. Such policies tend to exacerbate economic difficulties by creating instability in broader financial markets. 5) Raising the cost of imports: Accompanying the currency devaluation, the bank has to raise a key lending rate by some percentage to guard against a surge in inflation which
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can be a threat to the economy. By requiring more currency to buy a dollar, a weaker currency could raise the cost of imports. 6) Economic crisis: The devaluation may also hurt the many companies that have heavy debts denominated by foreign money. It can make the economy slower, with falling growth & people may become worried. Exports may go down sharply & the nation may face budget deficit. The stock market may dip, the trade deficit may rise & bad property loans may bring crisis to financial institutions.

Causes of failure of currency devaluation

1) Violation of conditions of successful currency devaluation : When the fundamental conditions of successful currency devaluation are gets ignored, tampered or wrongly performed, currency devaluation comes to a failure. This problem arises due to misunderstanding, ignorance and malpractice. 2) Full employment (cannot create supply of exportable goods) : When full employment exists, it fails to originate supply of exportable goods . This is a reason for failure of currency devaluation 3) Stable economic condition : When stable economic condition exists, currency devaluation cannot be made with ease. This poses a problem to the authority to select an alternative stable domestic economy or balance of international trade. 4) Elasticity of demand & supply : Elasticity of demand and supply is also responsible for failure of currency devaluation. It becomes hard to stabilize demand and supply because of elasticity of demand and supply. 5) Inflexibility of real wages (domestic), no increase of export value, no equilibrium in BOP: Inflexibility of domestic wages, lack of increase of export value and absence of equilibrium in BOP is responsible for failure of currency devaluation. 6) Stability of monetary standards : Amount of stability of monetary standards is a crucial and significant factor to be considered in case of success or falure of currency

devaluation.

7) Transfer of goods internally : If the goods are transferred internally it may cause some serious concerns. This is another factor that directly affects probability of success or failure of currency devaluation. 8) Credit receiving country does not get benefits of currency devaluation : It is to be noted that the countries that are receiving credits are notable to receive benefits of currency devaluation. 9) Minimization of trade restrictions : Trade restrictions are needed to be minimized to ensure better results arising out of currency devaluation. This will allow the authorities to enjoy more flexibility in taking decisions. 10) Frequent currency devaluations : Frequent currency devaluation may affect the chance of success of currency devaluation. When the currency is to be devaluated , this is a very crucial decision to take.

Suggested conditions for currency devaluation

There is no necessary connection between devaluation of a currency and domestic inflation. There are distinct benefits to devaluation and that is why governments in the past have allowed it to happen, or even engineered it to happen. 1) Devaluation results in a general reduction in export prices, and that will result in increased export volumes, all other things being equal. So devaluation can promote domestic output, employment and external earnings. 2) Devaluation is often arranged through reduced interest rates. Thereby, the currency becomes less attractive in the international currency market and balances will be reduced. However, lower interest rates are generally expansionary for an economy in decline, and should benefit enterprise, innovation and exploration. However, certain problems do exist. 1) If the devaluation is caused by international loss of confidence in the country or its government, then there is almost nothing the central bank or the government treasury department can do to restore it. No matter how interest rates are altered,
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or government policy statements are rnade, the international exchange market will avoid that currency, potential customers/importers will find alternative sources of good and services, and domestic output will not recover. This is typical of political weakness, empire-adventurism, unwise military activity and so on. 2) The second problem arises from the effect on import prices. Devaluation will cause those prices to rise and the consequences will depend on domestic reliance on imported goods, services and food. If there is very great reliance, then the population at large will suffer from raised prices.

Impact of currency devaluation on economy

1) Role of exchange rate policies :Ever since conscious efforts to increase growth rates in developing countries began in the early 1950s, a major source of controversy has been the role of exchange role policy in affecting the rate of economic growth. Numerous issues are related to this central question. Many developing countries exchange rates were maintained by use of fairly severe quantitative restrictions which restricted purchases from foreigners well below desired levels. This in turn led to relatively weak incentives for exports, & a marked divergence in domestic prices even inclusive of tariff charges. Some export pessimists believed that this did not matter because they regarded import substitution as the only feasible means of rapid growth. Others saw the bias against exports as a major impediment to rapid development. In addition to these issues, stabilisation programmes which included currency devaluation & efforts to curtail the government deficit & the growth of the money supply were highly controversial. Critics alleged that devaluation resulted in more rapid inflation & recession, with little or no improvements in the balance of payments.

2) Stimulation of merchandise exports :Stimulation of merchandise exports discourages merchandise imports & thus improves terms of trade, increases revenue collection & savings in repatriation of profits & royalties by existing foreign investors, bringing illegal foreign exchange leakages into
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official channels & putting an end to gold smuggling. Inflow of foreign capital can be improved by devaluation only if prices do not rise. It is supposed to provide an escape from vexatious import controls that prevent utilisation of full industrial capacity, stifle export drives. 3) Trade & payments :Currency devaluation promotes export & discourages import. There is inflow of short term capital to domestic economy. 4) Trade terms :Currency devaluation changes export-import prices & affects trade terms. This impact is generally affects many aspects of economy and determines the course of future prospets or risks. 5) Wages & prices :Currency devaluation results in price hike, demand for more pay & wages. Inflation increases, purchasing power decreases. People feels obligation to minimize their consumption.

6) Domestic income & allocation of resources :Currency devaluation has a negative impact on income effect. However, it has a positive impact on resource allocation. Both this effect has significant effects on the economy. It is more severe when we are considering the impact on the economy of a developing country. 7) Capital inflow :Currency devaluation causes reduction of resources value in comparison to foreign currencies. It results in inflow of huge foreign capital to domestic economy. However, it can result in reduction of inflow of long term capital to domestic economy.

Possible impact of currency devaluation on Bangladesh economy

1) Little export boost :The markets for traditional Bangladeshi exports are inelastic. So devaluation may provide very little boost, if any, to Bangladeshi exports, because there is a small quantum of value
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added exports & major requirements are based on export of raw materials. Further, the quality of export is not competitive in foreign markets. If an export boom in agro-based industries does come about, there will be a rise in food prices & this will cause a rise in wages unaccompanied by any productivity gains. Most of the bigger enterprises will face increasing difficulties in loan repayments & the cost of new industrial investments will shoot up sharply.

2) Increased industrial costs & reduced capacity utilisation intensity :In Bangladesh, industries are heavily dependent on imported raw materials for industrial goods & capital goods & components, & their access to many advanced economies is blocked by quotas & tariffs. Any rise in the prices of such inputs through currency devaluation would increase industrial costs & reduce capacity utilisation intensity. Therefore, it should be avoided as a resort to deficit financing. Devaluation with its implications will cause a contraction in economic activity & consequently slide in income tax receipts will raise the burden of Bangladeshs foreign debt overnight. It cannot stop smuggling as long as black-market transactions in foreign exchange continue.

3) Devaluation of effort & ability :Devaluing Bangladeshi currency means devaluing Bangladeshi labour & talent in the international market that send foreign exchange through home remittance. Devaluation will make Bangladesh lose heavily both as seller & buyer. It would not be a good substitute of the remedial changes in economic policies & developmental planning. 4) Adverse effects on balance of payments :In the short run, currency devaluation would worsen Bangladeshs balance of payments position & raise the burden of Bangladeshs foreign debt & debt service liability & foreign loan repayments would break the back of the budget, which would in turn increase the trade gap. It will upset all the cost-price relationships in the economy, lead to galloping inflation, & will stall many ongoing projects due to rising costs.

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Besides, central exercise as well as sales tax recepits & custom duties will go down due to lower volume & high prices of imported inputs resulting in cutbacks in industrial production.

Currency devaluation related activities to be done by Bangladesh

1) Currency should not be devalued frequently: If the currency devaluation process is done frequently, it adversely affects the economy of a country and it imposes a lot of financial burden over the general people. 2) Export should be increased : The criterion where the most priority should be given is in increase of export. Export sector should be encouraged to raise the volume of export items. 3) Exportable goods should be increased : Number of exportable items should be increased in a manner so that the financial value of the entire exportable goods multiply. 4) Quality of goods used at home should be enhanced: Quality of domestic goods should be enhanced. It will allow to spend less on imports goods. It will also provide an opportunity of employment increase. 5) Unnecessary imports should be discouraged: Unnecessary luxurious, consumption and other items should not be imported. It creates an imbalance of foreign trade and makes it inevitable to adopt frequent currency devaluation approaches. 6) Allocation of foreign currency should be tightened: Allocation of the foreign currency should be constricted . It will allow the economy to flourish in a positive way. 7) Unnecessary tours to foreign countries should be controlled : Unnecessary tours to foreign countries create an imbalance of the foreign exchanges. So unnecessary tours to foreign countries should be discouraged. 8) Production of industrial goods should be encouraged: Production of industrial goods should be promoted. It will allow the economy to enjoy wider spaces of development. 9) Production of technology should be encouraged: Use and innovation of technology is a must for the rapid development of any economy. Proper and adequate technology should be used in every sector if a country.

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10) Foreign exchange agreements with other countries should be signed: More agreements will create more opportunities. So, after determining all the possible benefits and costs, favorable agreements should be made with other countries. 11) Government officials foreign tours should be tightly controlled: A huge number of Government officials are sent to abroad every year. This practice should be checked on order to minimize the imbalance of foreign exchanges. 12) Tourism should be encouraged : Tourism will allow an economy to receive a lot of ffresh foreign exchanges. This is an important emerging sector where priority should be given. 13) Employment of guest workers/executives should be controlled by training domestic people: Domestic manpower should developed in a way so that the country needs less guest/executives to bear. The economy will be highly benefitted if this practice can be done effectively.

Summary

In the short span of time:

If the local company appreciates, it is plasible that exports would decrease as they are less

competetive. Thus, if a firm manufactures above all for export, an apprreciation of the local currency has a negative impact on the company sales.However, if the company imports a large part of its raw materials, it will see the price of its import decrease. The appreciation of the local currency leads to a decrease in the takig receipts and the expenses receipts. It is necessary to determine if the impact is greater on the taking than on the expense. If the local currency depreciates, local sales would increase as the manufactured products

would become more competetive. All other things being equal, the price in foreign currency decrease. However, if the company imports a large part of its products, it will see its prices increase. The depreciation of the local currency leads to an increase in the taking and

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expenses. Again, it is necessary to determine if the impact is greater on the expenses than the takings. The first effect of devaluation is by consequence to increase the exports and decrease the imports of countries which decide to devalue.conversely, a revaluation will lead to a decrease of exports and an increase in imports in the country.this policy is perfectly apt to absorb a deficit or a surplus in the balance of paymments. In the mid and long term, it cannot remain there and neglect certain secondary effects from the devaluation.

In the mid and long span of time : Even if a country which devaluation its currency is importing less, this does not signify that it is no longer important. In these countries, the cost of the imported products, notably those for raw materials, increases. Companies react to this increase in costs by increasing their prices. This unpredictable effect is all the more important when the country in question is small and that it is not possible for companies to substitute national products for the imported products. It is reinforced when there is a system of automatic indexing of the salaries in the country, in relation to the general level of prices.

A devaluation policy led by a government with a view to reabsorbing a deficit in the balance of payment s therefore risks being accompanied by a general phenomenon of a price increase except it, for example the govt. applies strict control policy on prices, which in this case will prevent you from conserving your beneficiary margin.

Abroad, at the same time, the price of important component decreases. This reduction in production costs enables them to put pressure on their own prices in order to safeguard their section of the market which are momentarily threantened by the import of competing finished products becoming cheaper in foreign currency.

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Converesely, within a revaluation, enterpreneurs purchase national products at a higher prices. Therefore, they see their prices increase while the countey which is revaluaing record a drop in production costs for its firms, and consequently can maintain stable prices.This stability of national prices ends up offsetting the advantages that have been withdraw in the short term from the revaluation.

A policy of revaluation led by a government with a view to reabsorbing a surplus in the balance of payments therefore risks seeing it becomes useful following a general phenomenon of a general stabilization in national prices in comparison to the increase in foreign prices.

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