DEVALUATION OF CURRENCY : DEVALUATION OF CURRENCY IN SEPCIAL REFERENCE WITH INR VS $
Presented by: Jiwant Kumar
Anand Salomon DevaluationRevaluationDepreciationAppreciation : DevaluationRevaluationDepreciationAppreciation Chronology of India’s exchange rate policies : Chronology of India’s exchange rate policies 1947 (When India became member of IMF): Rupee tied to pound.
18 September, 1949: Pound devalued; India maintained par with pound
6 June, 1966: Rupee is devalued, Rs 4.76 = $1, after devaluation, Rs 7.50 = $1 (57.5%)
18 November, 1967: UK devalued pound, India did not devalue
August 1971: Rupee pegged to gold/dollar, international financial crisis
18 December, 1971: Dollar is devalued
20 December, 1971: Rupee is pegged to pound sterling again
1971-1979: The Rupee is overvalued due to India’s policy of import substitution Continue : Continue 23 June, 1972: UK floats pound, India maintains fixed exchange rate with pound
1975: India links rupee with basket of currencies of major trading partners. Although the basket is periodically altered, the link is maintained until the 1991 devaluation.
July 1991: Rupee devalued by 18-19 %
March 1992: Dual exchange rate, LERMS, Liberalized Exchange Rate Management System
March 1993: Unified exchange rate: $1 = Rs 31.37
1993/1994: Rupee is made freely convertible for trading, but not for investment purposes. Needs for Devaluation : Needs for Devaluation overvaluation of the currency associated with import substitution for industrialization as opposed to export promotion policies
The risk of losing competitiveness
To relieve an unfavorable balance of trade
Correcting the price distortions
To increasing competitiveness in the foreign markets
To raise national income per capita
Achieve higher standards of living for their population
Close the development gap
Government policies of high tariffs on imports,
Restrictions on commodity as well as capital flows
A cycle of competitive devaluations CLASSES OF DEVALUATIONS : CLASSES OF DEVALUATIONS Planned devaluation.
Market-driven devaluation The Effects of Devaluation : The Effects of Devaluation Positive Effects
Improve trade balance
Alleviate balance of payments difficulties
Accordingly expand output and employment The Effects of Devaluation : The Effects of Devaluation Govt. taxes improves consumption increase. Export Increases Production increase Expansion of industries An import reduces Positive balance of payments Improve trade balance Rise in
gov. exp Per capita income increases Reduce the
smuggling Profit improves Employment improves Local output increases Increment in foreign investment Higher standards of living Economic stabilization ROI Price fall National output : National output Demand side channels Supply side channels Import Cost Channel Real Balance Channel Income Distribution Channel External Debt Channel Speculative Demand Channel Trade Liberalization Channel Tax Channel Imported Input Cost Channel Wage Indexation Channel Cost of Working Capital Channel Result of devaluation : Result of devaluation Devaluation is likely to be contractionary in the very short run (within the same year devaluation occurs), expansionary in the medium run (the year following devaluation) and neutral in the long run, i.e. negative and positive effects offset each other over time.
The results appear to be valid for both manufacturing exporters and agricultural and primary exporters.
Fiscal expansion (increasing the relative size of government expenditures) has a significant positive effect on output growth for all countries regardless of their export composition.
Similarly, unexpected monetary expansion also positively affects output growth.
The effect of terms of trade changes on output is generally negative for agricultural and primary exporters, but fluctuating for manufacturing exporters.
Manufacturing product exporters have a higher output growth trend than agricultural and primary exporters Approach to measuring effects of devaluation on output : Approach to measuring effects of devaluation on output The control group approach which aims at separating the effect of devaluation from other factors on output;
The before and after approach studies changes in country performance at the time of devaluation on output;
The macro-simulation approach employs simulation models to analyze the impact of exchange rate changes on output; and
The econometric approach applies econometric methods to time series to investigate the effect of devaluations on output. The 1966 Devaluation : The 1966 Devaluation Current account deficit of over Rs 290 crore due to SECOND Five year plan (capital goods import)
Inflation had caused Indian prices to become much higher than world prices
Budget deficit due to Defence spending in 1965/1966 was 24.06% of total expenditure
Money supply increase
Depleting foreign reserves
The first was India’s war with Pakistan in late 1965
The US and other countries friendly towards Pakistan, withdrew foreign aid to India
The drought of 1965/1966 The 1991 Devaluation : The 1991 Devaluation To avert a financial crisis
The trade deficit in 1990 was US $9.44 billion
The current account deficit was US $9.7 billion
The Gulf War led to much higher imports due to the rise in oil prices
Cost pull Inflation
Political and economical instability
Higher inflation rate
Depleting foreign exchange reserve
Gold is pledged to IMF by preceding govt Difference between two crisis : Difference between two crisis In July 1966 India was forced by economic necessity to devalue the rupee and attempt to liberalise the economy to attract foreign aid for come up from economic crisis.
While the devaluation of 1991 was economically necessary to avert a financial crisis, the radical changes in India’s economic policies were, to some extent, undertaken voluntarily by the government of P. V. Narasimha Rao. Result for INDIA : Result for INDIA India has been able to improve capital reserve by positive BOP in capital A/c. while still maintaining deficit in current account.
It has failed to take advantage of its devaluated currency by increasing exports to world market and hence increasing the percentage share in world trade significantly.
The sectors like IT, Automobile has been the biggest gainers with a spate of new players entering Indian players to take advantage of cheaper outsourcing since early 90’s.
Some how it has been able to improve economic prosperity in home as well credit worthiness in world. Slide 16: Thank You