One month before the end of 2022, we have to admit that it wasn’t the best year economically for most countries around the world due to the Russia-Ukraine war. On a local level, Egypt’s government had to allow the EGP to float in order to attract foreign direct and indirect investments. In such economic hardship many emerging countries could turn to currency devaluation to attract FDI and to encourage its exports.
Currency devaluation is the intentional reduction of the currency value against other currencies. This action is taken by the monetary authority of a country and is executed through a series of polices. For example, in 2015, the People’s Bank of China (PBOC) devalued its currency by changing the market mechanism for fixing the yuan against the dollar. This made the yuan weaker and Chinese exports cheaper.
Currency devaluation may help countries to adjust their trade balance as it will encourage exports and will put off the demand of imports. Also, a devaluation could be an opportunity for foreign investors and countries to invest and gain from the fact that the currency is undervalued.
While theoretically currency devaluation will stimulate an increase on exports. In reality, there are some limitations that may stand in the way of this. One limitation is pre-arranged transactions. Pre-arranged deals are long term deals between exporters and importers. A lot of countries and big corporations use pre-arranged deals to reduce costs and to avoid the risk of price changes. Pre-arranged deals reduce the effect of devaluation on exports on the short run.
In the long run, currency devaluation may lead to higher inflation level. Inflation will increase because of the higher prices of imported goods which will lead to demand-pull inflation. Also, manufacturers eventually will increase prices to gain from the gap between the price of exports and imports.
This was not written by Thndr and this is not investment advice, you should do your own research before making investment decisions.
