What Is Currency Devaluation And Revaluation?

What Is Currency Devaluation And Revaluation?

Currency devaluation and revaluation are two of the primary tools used by a country’s central government to manage the exchange rate between its own currency and those of other countries. The process of altering the value of one’s own currency is often referred to as foreign exchange management and is done to ensure a country’s economic health and to keep its citizens and their purchasing power protected.

There are several forces that can lead to a nation’s currency being devalued or revalued and both of these terms have distinct meanings. Before considering the causes and consequences of devaluation or revaluation, it is important to understand the difference between the two concepts and what each does to the value of a country’s currency.

What Is Currency Devaluation?

Currency devaluation, also known as currency depreciation, is the intentional lowering of a currency’s value relative to other currencies. This decrease in the relative value of the currency is used to stimulate exports and growth while making imports more expensive in comparison.

It is typically employed by a government to create an export advantage, to reduce current account deficits, and to combat a loss in purchasing power through inflation which could otherwise harm its citizens. This can also be achieved without actually devaluing a currency but, instead, by lowering interest rates to reduce capital inflow and increase outflow.

What Is Currency Revaluation?

Currency revaluation, on the other hand, is simply the opposite of devaluation and is the sudden or gradual increase in the value of one’s currency relative to other currencies.

It makes imported goods and services more expensive compared to those produced domestically, essentially reducing demand and inflation. Revaluation can also be carried out to reduce the current account deficits and correct any purchasing imbalance in the economy.

What Are the Reasons for Currency Devaluation?

Currency devaluation is usually used to control inflation and balance a country’s current account deficit or surplus. Here, we look at the four primary reasons for a nation’s currency to be devalued.

1. Adjusting Balance of Payments: By reducing the value of its currency, a nation can make imported goods costlier and its exports more competitive, which in turn can help adjust a nation’s balance of payments.

2. Restricting Inflation: Currency devaluation makes imported goods more expensive, resulting in a decrease in the demand for foreign goods, thereby reducing domestic inflation.

3. Increasing Exports: By devaluing its currency, a country can make its exports more competitive in international markets. This acts as an incentive to export more products, thereby making the country more competitive.

4. Restoring Financial Stability: A currency devaluation can act as a corrective measure to restore financial stability when faced with increasing balance of payments deficits.

What Are the Reasons for Currency Revaluation?

Just like currency devaluation, revaluation is also mainly used to regulate inflation and current account deficits. Here, the primary reasons a nation’s currency will undergo revaluation are:

1. Reducing Inflation: Currency revaluation makes imports more expensive, thereby reducing the demand for foreign goods and services and ultimately reducing inflation.

2. Reducing Trade Deficits: By making its currency more expensive, a country can reduce its current account deficit and overall balance of payments.

3. Reducing Speculative Activities: Currency revaluation is used by governments to discourage speculative activities in the foreign exchange market.

4. Increasing Reserves: By increasing the foreign exchange reserves, a country can increase its purchasing power and change the actual value of its currency.

What Are the Consequences of Currency Devaluation?

Currency devaluation is one of the most commonly used methods of adjusting a nation’s balance of payments and inflationary pressures. But, along with boosting exports, currency devaluation can have significant economic repercussions as well.

1. Exchange Rate Instability: By devaluing its currency, a country can create an unstable environment for investors and ultimately contribute to market fluctuation.

2. Decreased Purchasing Power: The consequence of a decrease in the relative value of a currency is a decrease in the purchasing power of its citizens, making basic goods and services more expensive.

3. Negative Impacts on Financial Stocks: A devalued currency often leads to a decrease in the stock value of financial institutions as foreign investments are also devalued in the process.

4. Loss of Investor Confidence: Decreasing the value of its currency often leads to a decrease in confidence of domestic and foreign investors as the currency becomes less attractive for investment.

What Are the Consequences of Currency Revaluation?

In the same way that devaluation has negative economic implications, so does currency revaluation. Here are some of the key repercussions of currency revaluation:

1. Increased Inflation: It is possible for a country to cause inflation to increase when revaluing its currency as imports become more expensive and the demand goes up.

2. Debt Default: If a nation’s debt levels are too high when its currency is revalued, then it runs the risk of defaulting on its loans.

3. Decreased Exchange Rate Stability: Although revaluation is an effective way to increase a country’s currency, it can also lead to an unstable exchange rate as investors and traders become more reluctant to invest.

4. Reduced Business Profits: Revaluation can lead to decreased profits for businesses who depend on imports as those goods become more expensive due to the increased currency value.

Currency devaluation and revaluation are two of the most important tools used by countries to manage their currencies’ exchange rate with those of other countries. Both of these terms have distinct meanings and offer distinct benefits and risks.

It is important to understand the causes and effects of both types of currency management in order to make informed decisions when it comes to influencing and evaluating the state of the country’s economy and its relative currency value.