Currency depreciation refers to the fall in value for a country’s currency when compared to other currencies in the forex market. When your country’s currency depreciates, it means that you will have to use more units of your currency to purchase a single unit of a different currency.
It, thus, becomes cheaper to purchase your currency, but expensive for you to access an alternative currency. A country’s value of currency often falls or drops as a result of various elements. The elements are as described below.
Causes of Currency Depreciation
1. A deficit in Balance of Payment (BoP)
Balance of payments (BoP) refers to the difference between a country’s exports and imports. The BoP results can either be positive or negative. A negative balance of payment implies a deficit in BoP, which means the exports figure is less than that of the imports.
High levels of importation results in the depreciation of the local currency, as the imports exceed
2. High rate of inflation
A country experiences inflation if the market prices of commodities keep rising or falling consistently over a particular period. High inflation is characterized by high market prices of commodities.
High market prices are difficult to stabilize. High inflation means that you require more of your local currency to purchase a foreign currency. This contributes to the weakening of the country’s currency, which is commonly referred to as currency depreciation.
3. Low interest rates
The level of interest rate has a great influence on a country’s exchange rate. The interest rate can either be low or high. In this case, low interest rate results in a depreciated currency. Low interest rates discourage lenders from providing finances to borrowers since there is little profit to gain from.
Since most investors rely on lenders such as banks and other lending bodies to provide them with finances to invest in, investments drop. With a drop in investment, the economic growth of a country plummets. A fall in economic growth results in a state of recession which is characterized by a weak or depreciated currency.
4. Political instability
The political situation of a country greatly impacts the direction of its currency. A country experiencing political instability discourages the economic growth of the country in that it does not provide a conducive environment for business to thrive.
Also, political instability shuns away external investors from investing in the country. Resultantly, political instability results in the weakening of a country’s currency.
5. Default in public debt
A country that has borrowed heavily externally or internally to finance its projects plus operations has a high likelihood of defaulting on the debt. As a result, investors with government bonds sell them out quickly in anticipation of the country’s inability of settling debt.
As investors pull out through the sale of treasury bonds, the currency takes a dive translating into a depreciated currency.
Effects of Currency Depreciation
The depreciation of a country’s currency has some effects, which can either be positive or negative. The effects of a weakening currency are as follows.
1. Exports become cheaper
A depreciating currency tends to favor exportation. With a low currency exchange rate, importers of your products find it cheaper to import your products. Hence, low currency exchange rates render your exports cheap.
2. Imports become expensive
If your currency is depreciating against other currencies, it implies that you will require more of your currencies to purchase a foreign currency. Hence, imports become expensive since you will have to add more of your currency to afford an equal amount of import that you afforded using less of your currency before the depreciation of the currency.
3. High unemployment rates
High levels of unemployment can be associated with high inflation. Since high inflation signifies low investments and a poorly performing economy, it implies that people do not have jobs to earn a living.
4. Poor economic growth
A depreciating currency is bad news to a country’s economic growth. Given that every aspect of currency depreciation has a negative influence on the currency, then the economy is not exempted from feeling the heat.
High inflation rates leading to high levels of unemployment is a bad characteristic of an economy. Also, the low interest rates discourage economic growth because lenders fear lending to investors who would have invested to increase economic growth. Political instability also means a poor economy.
Currency depreciation implies a drop in the value of a currency. The fall in currency’s value can be attributed to many factors as explained above. Currency depreciation negatively affects all aspects of life except for exports which increase with currency depreciation.