Confused, what is devaluation and depreciation of the domestic currency in International foreign exchange market class 12.
This topic is concerned with the Foreign Exchange Rate chapter of Macroeconomics class 12.
Let’s discuss it.
What is Devaluation of Domestic Currency in simple words
Devaluation of Domestic currency refers to the deliberate approach of the government to lower the value of its currency with respect to foreign currency in the international market.
let’s suppose in the year 2001 the foreign exchange rate was
in late 1990, the foreign exchange rate was
1 USD = 17.32 INR
during the year, India was in a huge economic crisis due to foreign debt.
In 1991, the Reserve Bank of India deliberately reduced the value of INR with respect to the dollar by 11% keeping internal value unchanged.
Due to the devaluation of the rupee. In 1992 the exchange rate was
1 USD = 25.92 INR.
Why Devaluation of the Domestic currency is done by the government.
devaluation of the domestic currency is done to overcome the economic crises.
Exports become cheaper and imports get costlier. It results in the inflow of foreign exchange and thus increases the National Income.
What is depreciation of Domestic currency
Depreciation also results in the fall of the value of a domestic currency with respect to foreign currency.
But, it happens due to market forces of demand and supply in the international foreign exchange market.
It happens when a country adopts the floating exchange rate or managed a floating exchange rate system.
In these exchange rate systems, the value of the domestic currency in the international market depends upon the demand and supply.
More is the demand of foreign exchange in a given country, lesser would be the value of its own domestic currency.
Let’s understand it with an example:-
the current exchange rate is
1 USD = 40 INR
suddenly there is an increased demand for the import of goods in India.
It results in the increased demand of USD in the foreign exchange market by Indians.
Due to the higher demand and supply remains the same.
The foreign exchange rate of USD against INR rises.
let’s suppose it become
1 USD = 45 INR
This phenomenon is called the depreciation of the domestic currency. It happened due to the market forces.
The government did not intervene in it.