On the one hand…
Most people believe that devaluation of your currency will increase exports, reduce imports and fix the balance of payments deficit. Ask any economist to explain and he/she will tell you the following.
In theory devaluation will increase exports and reduce imports.
Theory is based on certain assumptions or conditions. In this case the basic assumption on which this theory is based, is that the demand for exports and imports is price elastic. This means that if the price of a product is reduced it will automatically increase the demand for that product. Hence the increase in exports. Likewise, if the price of a product increases it will automatically result in the demand for the product to reduce. Hence the fall in imports.
In reality the above is rarely true although sometimes it may be true to a small extent. Some examples can help to illustrate this.
With a few exceptions it is generally true that no one country is the sole supplier of a product to the rest of the world. So if we are exporting leather to Italy, for instance, and so are various other countries, making our leather cheaper will only increase the quantity we sell to Italy under certain circumstances. One of these circumstances is that demand for leather in Italy is much greater than the quantity we export to Italy, so our price reduction (by devaluation) makes our leather cheaper than the leather Italy imports from other countries, and that the quality of our leather is at least equal to that being exported by other countries.
The same would be true of textiles, cement and other products we may be exporting.
Devaluation of currency is in most cases undesirable and will have a negative impact on the national economy. Nevertheless, keeping a currency from being devalued artificially is not a sustainable solution
In a lot of cases other factors may also influence our exports. For instance, to build a reliable supply chain most buyers and suppliers develop long standing relationships which often endure small fluctuations in price. Import quotas, import tariffs (in buyer countries) and international trade agreements may also hinder our ability to increase exports.
Similarly, in the case of imports various circumstances will determine if demand reduces as a result of a small increase in price. For instance, if we import oil (petroleum) for our domestic needs we will probably not reduce the quantity we import because it now costs us 5pc more. If we import a certain quantity of edible oil for our consumption, we are not likely to change our eating habits overnight simply because cooking oil is now costing 5pc more than before. Likewise imports of industrial raw materials will not decline or else domestic industrial output will suffer.
So if devaluation will not significantly increase exports and reduce imports, what else will it do? If we are a country largely dependent on imported consumer products and industrial raw materials, it will definitely increase the prices of all those products. Thus devaluation will result in inflation. Most economists would agree with this statement.
Inflation (of imported products) will increase the cost of fuel, transport, freight cost, electricity (which is generated from oil), gas (which we have now started importing), packaging materials (plastic and paper) and food (involving imported edible oil). So inflation, caused by devaluation, will not only increase the cost of living but also the cost of production. This increase in the cost of production will not only affect industries producing products for domestic consumption but also industries which are exporting. When the cost of production goes up manufacturers of exportable products will feel it necessary to increase their prices. Hence, even if devaluation does make exports cheaper it is most likely to be temporary.
Even in theory devaluation does not only impact exports and imports. Devaluation will decrease the current value (in foreign exchange) of existing foreign investment in the country. When foreign investors see their investments in our country being devalued they are likely to be discouraged from making further investments. Devaluation will also increase the cost of debt servicing in a country heavily indebted in foreign currencies (not just temporarily but permanently or for at least as long as the country remains indebted).
Devaluation of currency is in most cases undesirable and will have a negative impact on the national economy. Nevertheless, keeping a currency from being devalued artificially is not a sustainable solution (for a currency under pressure) either. The real and only solution is to adopt prudent fiscal and monetary policies so that the trade deficit is removed or remains within manageable limits and reduce dependence on foreign currency loans (particularly to finance deficits and revenue expenditure).
