What drives some countries to want to lower the value of their currency?

On Wednesday (May 08, 2024), Bangladesh Bank introduced the crawling peg system, which mandated that commercial institutions exchange US dollars for and against Tk 117. 

A crawling peg is a currency exchange mechanism that limits the exchange rate of a specific currency to a minimum and maximum limit. As a result, it cannot increase or decrease significantly at once.

Bangladesh valued the dollar at 110 taka on Wednesday morning. In other words, the drifting peg system has caused the rupee to depreciate significantly against the dollar.

However, currency price declines may not always elicit concern. Additionally, some countries devalue their currencies for economic gain.

Additionally, numerous other factors can contribute to the depreciation of a nation's currency.

Through an examination of the information, research, and media outlets of numerous institutions specializing in currency management and the economy, three primary causes become apparent.

Enhancing Exports: A depreciated currency boosts a country's competitiveness in international markets. When a country's currency undergoes devaluation, the cost of its goods decreases for international purchasers. As a result, the increase in export quantities leads to economic growth and has the potential to reduce unemployment.

Reducing Trade Deficits: Countries seek to diminish trade deficits by intentionally weakening their currency. Reduced export costs and increased import costs contribute to trade account equilibrium. When imported goods become expensive, consumers can choose to purchase local alternatives, thereby providing further support to domestic industries.

Decreasing sovereign debt burdens: Currency devaluation can facilitate the repayment of a country's foreign debt. When the currency depreciates, the debt burden, measured in local currency, becomes comparatively less onerous.

Nevertheless, it is crucial to acknowledge that devaluation can result in unforeseen repercussions. For example:

Currency Wars: Competitive devaluation can result in a 'currency war' between nations, where one country mirrors another country's depreciation. This situation is more common when both currencies are under-regulated exchange-rate regimes.

Devaluation can have negative effects on productivity, as it leads to a decrease in production due to the high costs associated with importing capital equipment. Moreover, the purchasing power of citizens abroad diminishes.

To summarize, countries strategically depreciate their currency to obtain a competitive advantage in international trade and effectively handle economic difficulties. Nevertheless, officials must meticulously evaluate the benefits in comparison to possible disadvantages.

According to the IMF's World Economic Outlook 2015, a 10 percent decrease in the exchange rate has the potential to boost exports by around 1.5 percent of the gross domestic product (GDP)**. Consequently, it enhances the level of competition in the international market. It promotes the sale of goods to other countries while discouraging the purchase of goods from different countries.

Nevertheless, it is advisable to proceed with caution for two specific reasons. Initially, when there is a surge in international demand for a nation's products, the prices of those products will correspondingly escalate. Depreciation will lose its initial advantage. Furthermore, when other nations experience this impact, they can also attempt to depreciate their currencies.

Consequently, a 'currency wire' or 'currency war' could emerge, resulting in uncontrollable inflation throughout the entire economic system.

 

References:

** Dean Yang in WaPo, Brexit’s most severe impacts may extend to the developing world | Gerald R. Ford School of Public Policy. https://fordschool.umich.edu/news/2016/dean-yang-wapo-brexits-most-severe-impacts-will-extend-developing-world?theme=stpp