Devaluation

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What is 'Devaluation'?

Devaluation is a deliberate downward adjustment to the value of a country's currency relative to another currency, group of currencies or standard. It is a monetary policy tool used by countries that have a fixed exchange rate or semi-fixed exchange rate. It is often confused with depreciation and is the opposite of revaluation.

BREAKING DOWN 'Devaluation'

The decision to devalue a currency is made by the government issuing the currency and, unlike depreciation, it is not the result of non-governmental activities. One reason a country may devalue its currency is to combat a trade imbalance. Devaluation reduces the cost of a country's exports rendering them more competitive in the global market. This, in turn, increases the cost of imports so that domestic consumers are less likely to purchase them, further strengthening domestic businesses.

The Downside to Devaluation

While devaluing a currency may be an attractive option, it can have negative consequences. By increasing the price of imports, for example, domestic industries are protected, but they may become less efficient without the pressure of competition. Higher exports relative to imports can also increase aggregate demand, which can lead to higher gross domestic product and inflation. Inflation can occur because imports are more expensive, aggregate demand causes demand-pull inflation, and manufacturers may have less incentive to cut costs because exports are cheaper, increasing the cost of products and services over time.

Examples of Devaluation

The devaluation of currencies is a result of specific government action. For example, Egypt has faced constant pressure from U.S. dollar black market trading, which began following a foreign currency shortage that hurt domestic business and discouraged investments within the economy. To mitigate black market activity, the central bank devalued the Egyptian pound in March 2016 by 14% compared to the U.S. dollar. The devaluation of the pound was a requirement by the International Monetary Fund before it would allow  Egypt to receive a loan of $12 billion over three years. The Egyptian stock market responded favorably when the currency was devalued. However, the black market responded by depreciating the exchange rate of USD to the Egyptian pound forcing the central bank to take further action. 

Using another example, China was accused of practicing a quiet devaluation of its currency in 2016 ahead of the results of the presidential elections in November of the same year. Both candidates, Hillary Clinton and Donald Trump, had spoken negatively of China. Some accused China of secretly devaluing its currency so that it could revalue the currency after the November election and appear to be cooperating with the United States