Difference between Devaluation and Depreciation of Currency
Before we go ahead with the topic, it will be necessary to understand the exchange rate system that prevails among different currencies.they are of two types namely ;
- A fixed exchange rate
- A floating exchange rate or fluctuating exchange rate
Depreciation and devaluation are sometimes incorrectly used interchangeably, but they always refer to values in terms of other currencies. Inflation, on the other hand, refers to the value of the currency in goods and services (related to its Purchasing). Altering the face value of a currency without reducing its exchange rate is a re denomination, not a devaluation or revaluation.Devaluation is most often used in a situation where a currency has a defined value relative to the baseline. Historically, early currencies were typically coins struck from gold or silver by an issuing authority which certified the weight and purity of the precious metal. A government in need of money and short on precious metals might abruptly lowerthe weight or purity of the coins without any announcement, or else decree that the new coins have equal value to the old, thus devaluing the currency.Generally, a steady process of inflation is not considered a devaluation, although if a currency has a high level of inflation, its value will naturally fall against gold or foreign currencies. Especially where a country deliberately prints money (often a cause of Hyperinflation) to cover a persistent budget deficit without borrowing, this may be considered a devaluation.
Depreciation of Currency: Let us start with the meaning of the term depreciation of the currency. Depreciation of currency happens in those currencies which are linked to floating exchange rate and it is likely to change / vary on day to day basis (in actual practice popular currency rates change almost every few minutes / seconds). A floating exchange rate means that the global investment market determines the value of a country's currency. These countries allow supply and demand to determine the value of their currency relative to the currencies of other countries. Depreciation occurs when the forces of supply and demand cause the value of their currency to drop. To check the high volatility, as a prudent measure, almost all central banks of the respective countries try to influence the exchange rates through various means so as to curb such volatility, yet in the end it is the free market that determines the exchange rate of all the currencies linked to floating exchange rate. These days all major economies use a floating exchange rate. Thus, Appreciation / Depreciation (only marginal change) of all such currencies regularly occurs number of time during the period market remains open.. It is only in rare cases, that currency depreciates or appreciates by a wide margin. Such changes happen if something major happens on economic / political front of such country or in the global markets. If a country’s currency has depreciated it will mean that this country's money has less purchasing power in other countries because of the depreciation.
A floating exchange rate or fluctuating exchange rate: is a type of exchange-rate regime in which a currency's value is allowed to fluctuate in response to foreign-exchange market mechanisms. A currency that uses a floating exchange rate is popularly known as a floating currency.By the beginning of the 21st century, most of the developed countries and large economics have shifted to floating exchange rate system.
"Devaluation" means official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency. In contrast, depreciation is used to describe a decrease in a currency's value due to Market forces, not government or central bank policy actions. Under the second system central banks maintain the rates up or down by buying or selling foreign currency, usually but not always USD. The opposite of devaluation is called Revaluation.
Depreciation of the currency is a slow process and value of the currency automatically gets adjusted by the market forces. Thus, once the currency of a country has depreciated, the investors from other countries will see an opportunity and are likely to shift from other economies. This will help in boosting the economy which may in the long run even push back the value of the currency.
On the other hand in case of devaluation, there is less trust in the economy and once currency is devalued, Government finds it very difficult to revalue the same by government dictate as there will be fear that such revaluation can backfire and put the economy in risk mode.
Rajesh Goyal & wiki
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