Currency devaluation is a deliberate downward adjustment of a country’s currency relative to another currency, commonly used by governments with fixed or semi-fixed exchange rates to address trade imbalances. While devaluation can stimulate export growth by making goods more affordable on the global market, it often introduces instability in exchange rates as investors respond to the devaluation and its consequences (Majaski, 2023). Currency devaluation can decrease a currency's purchasing power, leading to a higher cost for imports. As imports become more expensive, domestic demand for foreign goods may decline, ideally reducing the trade deficit and balancing payments (Investopedia, 2023). However, this scenario can also induce inflation, especially if the cost of essential imports rises sharply, which in turn impacts exchange rate stability (Carbaugh, 2023).
Furthermore, devaluation can lead to capital outflows as investors may lose confidence in the devaluing currency, opting instead for more stable currencies or assets. This increased selling pressure can cause sharp fluctuations in exchange rates, exacerbating instability (WallStreetMojo, n.d.). Political factors and external shocks, such as changes in oil prices or geopolitical tensions, often heighten uncertainty and intensify the impact of devaluation on exchange rate stability, as seen in Thailand during the 1997 financial crisis. When foreign reserves are exhausted to defend a currency’s value, a devaluation is often inevitable, and while it may improve competitiveness, it typically results in exchange rate volatility until confidence is restored (Carbaugh, 2023).
China’s use of devaluation, such as in the 1990s and again in recent years, illustrates how a country can benefit from a trade advantage but face external criticism and potential instability. In 2019, for example, China faced accusations of manipulating its currency to gain a competitive edge, a factor that contributed to trade tensions with the United States (Majaski, 2023). While devaluation can boost exports and potentially attract foreign investment by making assets cheaper, this approach has risks, particularly if domestic industries become less efficient due to reduced competition (Investopedia, 2023).
In conclusion, while devaluation can be effective in addressing trade deficits and boosting export competitiveness, its side effects—including inflation, capital outflows, and market volatility—can create prolonged instability in exchange rates. A stable outcome often depends on credible policy measures that restore confidence and on managing inflationary pressures.
References
Carbaugh, R. J. (2023). International Economics (18th ed.). Cengage Learning.
Majaski, C. (2023). Devaluation: What It Is and How It Works. Retrieved from Investopedia.
WallStreetMojo. (n.d.). Currency devaluation. Retrieved from https://www.wallstreetmojo.com
How devaluations affect exchange rate stability
