Devaluation: Overview, advantages & disadvantages.

Over the past couple of years, countries have devalued their currencies. Just last year the Naira was devalued and in the past weeks there have been rumours of another possible devaluation. There are different reasons why countries decide to devalue. In this article, we will clarify what devaluation means and all you need to know about it.

What is Devaluation?

Devaluation occurs when the government of a country, officially revises the value of its currency downwards making it relatively cheaper to other currencies or a currency benchmark. This happens in countries with fixed^[1] or semi-fixed^[2] exchange rate systems. Devaluation is often confused with depreciation (a fall in value of a currency) which happens in countries with a floating^[3] exchange rate system.

For example, let us say the official exchange rate of Naira to USD is N10 to $1. For devaluation to occur, the government will have to communicate officially that the official exchange rate is now N30 to $1, making the Naira cheaper to Americans and the USD more expensive to Nigerians.

Why Devalue?

 Countries that maintain a fixed exchange rate system should have ample foreign currency in their reserves to be spent on imports and funding other economic activities. If a country does not have enough, they can devalue their currency – devaluing a currency makes exports more competitive and helps to reduce trade deficit.

Advantages of Devaluation

• It promotes Export. The local currency becomes cheaper relative to other currencies, making export cheaper to foreign buyers.
• It leads to a reduction in current account deficit. A country’s current account is in deficit when the value of goods and services it imports exceeds the value of goods and services it exports.
• It promotes economic growth. When the export sector experiences a boost, it can lead to creation of more jobs in the sector thereby increasing growth.

Disadvantages of Devaluation

• It makes import expensive and could result in inflation.
• It can dampen investor confidence resulting in a reduction of foreign investments - this is because investments in the devalued currency would have reduced in value.