A currency depreciation is when its value decreases comparing with another currency.
The value of the currency is measured by its exchange rate against another currency. Its value will fall, which will be reflected in falling price of that currency, or falling exchange rate, when supply of the currency exceeds demand.
With lower value, now, one unit of the currency will buy less units of another currency. For example, if USD$1 falls from RMB7 to RMB6.5, the value of the USD$ has depreciated. One USD$ will now be able to buy less RMB, or less products in China.
The opposite to depreciation is appreciation.
Depreciation of the currency – Winners & Losers
When a domestic currency depreciates, the exchange rate of that currency falls. It is easier to sell domestic goods and services to customers in other countries, because domestic products become cheaper for overseas buyers.
Winners of depreciation? Exporters
The businesses that gain from depreciation are:
- Exporters of ready products. Businesses which export overseas will benefit from increased sales. Exported products are now relatively cheaper overseas, hence this may increase demand. This will include many manufactured goods such as food, clothes or cars. Some businesses may choose to increase prices, increase employment, or even relocate from overseas to benefit from lower exchange rate. Also, domestic tourism will experience a rise in demand from overseas tourists because of the lower prices of services in terms of the foreign currency.
- Businesses selling domestically, but with foreign competitors. As depreciation makes imports more expensive, it will make domestic manufacturers more competitive in their own market. Consumers will be prepared to switch from imported goods and foreign holidays because of the cost disadvantages they have over domestic products. Businesses that sell in the domestic market will experience less price competition from importers as prices of imported goods and services are likely to rise on the domestic market.
Losers or depreciation? Importers
The businesses that lose from depreciation are:
- Importers of raw materials and components. Imports will be more expensive making cost of imported raw materials to increase. Businesses relying on imported raw materials to produce will not benefit from higher costs. This decreases their price competitiveness.
- Importers of ready products. Importers of ready goods and services will not be able to bring the products into the country more cheaply in terms of domestic currency. Wholesalers and retailers that purchase foreign products will see the prices of these imports rising, so they might trade more with domestic suppliers of similar, but cheaper products.
Effects of depreciation of currency on the country
Essential items generally do not get affected by fluctuations in exchange rate. More exports may lead to increase in Trade Balance in the Balance of Payments. Less imports may result in unemployment in the affected sectors.
