Currency Depreciation

Currency Depreciation

“Currency Depreciation” is the fall in the exchange value of a country’s currency in comparison to other currency in a floating rate system and is determined based on trade imports and exports for that country. Increase in demand for foreign products results in more imports, which in turn results in investing in foreign currency thereby resulting in domestic currency depreciation. Value of a particular currency is determined based on the economic situation and it further impacts other economic decisions and/or value of its products and output. It directly impacts financial marketsFinancial MarketsThe term "financial market" refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more of that country’s securities.

Currency Depreciation

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Currency Depreciation (wallstreetmojo.com)

Currency Depreciation Example

Given below are the examples of currency depreciation.

Currency Depreciation – Example #1

Country A which has currency ABC trades with Country P having currency PQR. In the present scenario, in exchange for 1 unit of ABC, you are paid 2 PQR. Due to certain industrial setbacks and other political events in country A, the exchange rate for its currency got affected. Now, in exchange for 1 unit of ABC, you are paid 1.8 PQR. Can you relate this with depreciation of currency? Which currency got depreciated and by how much?

Solution:

In the above example,

Initially, 1 unit of ABC = 2 units of PQR or ABC / PQR = 2

In the next scenario, after a change in the currency exchange rate

1 unit of ABC = 1.8 units of PQR or ABC / PQR = 1.8

which means for every ABC, you are paid only 1.8 PQR now vs 2 PQR earlier. Hence ABC has depreciated, and PQR has strengthened.

Depreciation % = (2 – 1.8)/2 = 10%

Currency Depreciation – Example #2

Brexit is the most recent scenario which has impacted currency depreciation of GBP (Great Britain Pound or Sterling) with USD. With Britain’s decision to exit itself from European Union (EU), there was a huge impact on GBP. Till recently, Britain has been a part of the European Union, and hence EUR is prevalent in the UK. However, with Brexit, UK will have its official currency as GBP (and not EUR).

Within a 1-year span, it can be noticed that GBP has depreciated from 1.32 USD to 1.27 GBP, with intermediate ups and downs included.

currency depreciation example 2

Source: www.xe.com

Currently, GBP/USD trades at 1.27 (as on Jun 30, 2019).

When compared with its value in 2008, one can see how sharply it fell in these years:

currency depreciation example 2.1

Source: Bloomberg & BBC

Thus, GBP suffers a loss in value due to adverse political conditions prevalent in the country. Due to this, not only does the currency value get affected but also the economy of the country due to more expensive imports, currency relationships with other countries following EUR (which would have been par when UK was following EUR as well), contingent futuristic planning, etc.

Effects of Currency Depreciation

Disadvantages of Currency Depreciation

Limitations of Currency Depreciation

Currency depreciation and its impacts greatly depend upon the situation and current condition of the country’s economy. In case of a recession, depreciation can prove to bring growth to the economy by impacting industrial output due to competitiveness. The opposite impact may be in case of rapid development, if there is depreciation, the economy may experience a slowdown due to increased inflation. 

Important Points to Note
  • Depreciation in currency refers to an increase in imports. This is directly proportional to domestic balance outflow.
  • It denotes the situation of increasing inflation in that home country.
  • It denotes higher interest rates prevalent during that period in the home country. This directly impacts the financial markets.

Conclusion

Currency appreciationCurrency AppreciationCurrency appreciation is a rise in the value of a national currency over the importance of international currencies due to an increase in the demand for domestic currency in a global market, a rise in inflation and interest rates, and flexibility of fiscal policy or government borrowing.read more which is the opposite situation of currency depreciation gives exactly the opposite scenario to the above. As currency depreciation has both advantages and disadvantages, for an economy both appreciation and depreciation are required to maintain the right balance, however, based on different situations.

It may be clearly understood that during the prevalence of either situation markets are hit at once, and so are investments made into respective securities. In such cases, right hedges are required and accurate market view helps meaningful returns to investors.

This has been a guide to what is Currency Depreciation and its definition. Here we discuss the effects & causes of currency depreciation along with examples, disadvantages & limitations. You can learn more about macroeconomics from the following articles –

Reader Interactions

Comments

  1. Richard says

    Nice content seen

    • Dheeraj Vaidya says

      Thanks for your kind words!

Leave a Reply

Your email address will not be published. Required fields are marked *