MCom I Semester Business Environment Devaluations Study Material Notes

MCom I Semester Business Environment Devaluations Study Material Notes : Meaning and Definition of Devaluations Need or Objectives and Causes of Devaluations Conditions for Success of Devaluations Adverse Effects or Disadvantages or Devauaitons of Indian rupee Causes Objectives and Need or Devaluations of Indian Repee Long Answer Questions Objectives Quesitons Short Answer Questions :

CTET Paper Level 2 Previous Year Science Model paper II in Hindi

Devaluation

MEANING AND DEFINITIONS OF DEVALUATION

Devaluation of a currency means lowering the value of currency in terms of foreign currencies. When the external value of a currency is lowered by the government itself as a deliberate policy measure, it is termed as a deliberate policy measure, it is termed as ‘devaluation’. Some of the definitions of the devaluation are as follows:

(1) According to Prof. Paul Einzig, “Devaluation is lowering the official prices”.

(2) According to Dr. Ganguli, To lower the external price of domestic currency is termed as ‘devaluation’.

It is clear from the above definitions that the term ‘devaluation’ refers to the deliberate steps taken by the government to reduce the value of national currency in terms of gold or other fereign currencies. In other words, devaluation means as international reduction in the external value of the national currency. Prices of domestic product, measured in terms of domestic currency need not change; but the exports of the devaluing country will be cheaper. The effect of devaluation will be to increase exports of devaluing country and to decrease the quantity of imports. By how much exchange devalution can expand exports or restricts imports of a country depends primarily on the foreign demand elasticities. The sum of the elasticities of demand for a country’s exports and of its demand for imports has to be greater than unity for a devaluation to have a positive effect on a country’s trade balance. If the sum of these elasticities is smaller than unity, it will have a negative effect.

NEED OR OBJECTIVES AND CAUSES OF DEVALUATION

Following are the needs or objectives and causes of devaluation:

(1) Export Promotion : After devaluation the price of export goods fall in foreign currency which means goods of own country become cheaper for foreign countries. This enables them to buy more than before.

(2) Reduction in Imports: Demand for imports goes down as a result of devaluation of currency. This happens as a result of imports becoming more expensive.

(3) Revenge : A successful devaluation by one country will usually have adverse effect on other countries. This is one of the chief reasons for competitive exchange depreciations. If one country devalues, other countries often feel that they must also devalue. If all the countries start depreciating their currencies in a competitive spirit, then no country may gain out of it.

(4) Receipts of foreign loans : As a result of devaluation of currency more foreign debts may be received from the foreign countries.

(5) Balance of trade : The exchange devaluation will increase the quantity of exports and decrease the quantity of imports. The country may thus achieve a favourable balance to pay off an earlier deficit.

(6) To remove the effects of Deflation : Deflation decreases the domestic demand for goods. Devaluation encourages export promotion and increases the demand of domestic products in foreign markets.

(7) Protection of domestic industries : To protect the domestic industries, the government makes efforts to control imports. For this purpose, the government resorts to devaluation.

Devaluations Study Material Notes

CONDITIONS FOR SUCCESS OF DEVALUATION

Devaluation is not always fruitful. For the success of devaluation, following conditions should be fulfilled :

(1) Production increasing capacity : The main objective of devaluation is to increase exports. It is possible only when industries are operating upto the full utilisation of their capacity. Devaluation is successful ifindustrial production is accelerated.

(2) Lack of control: Devaluation is successful if there is no control on the production, and distribution of goods and no control on prices, so that other countries should not restrain their imports.

(3) International cooperation : Devaluation is beneficial only when other countries are not adopting the policy of competitive exchange depreciation. If all the countries start devaluating their currencies, the country devaluating its currency may not gain out of it. The IMF has an objective to avoid such situations by using its ‘surveillance’ to resolve the policy of inter-dependence issues.

(4) Low cost : For a successful devaluation, it is necessary that due to devaluation of currency cost of production and prices of products should not increase. If with the increase in production, the costs and prices also increase, the exports will be adversely affected.

(5) Elastic demand : The main objectives of devaluation are export promotion and import restrictions. This depends on the elasticity of demand. To be devaluation successful, it is necessary that demand of exports and imports should be elastic.

ADVERSE EFFECTS OR DISADVANTAGES OF DEVALUATION

It was expected that the devaluation of rupee would be beneficial but it was not very fruitful. Following were the effects of devaluation :

(1) No improvement in balance of payments : It was argued that devaluation would substantially increase the exports and would reduce imports. But after devaluation the problem of deficit in balance of payments became more serious. The prices of raw materials become higher as a result of devaluation and devaluation resulted in import expenses going up on account of import of essential inputs within elastic demand.

(2) No increase in production : It was anticipated that devaluation would help to increase agricultural and industrial production. Many of industries were not operating upto the full utilisation capacity. Although the Governmnet adopted liberalised import policy, yet the devaluation was not very successful.

(3) Price Rising: As a result of devaluation imported goods become costlier. This results in shortage of imported goods in domestic markets. This increases the price of goods. All these result in increase in cost of living of persons which ultimately affected standard of living.

(4) Increase in import bills : There are many industries in India which are dependent upon import of technology, capital goods and raw materials and when these imports become costlier after devaluation, more payments has to be made for the import of essential goods.

(5) Obstacle in economic development : Devaluation has been proved to be an obstacle in economic development of the country. This policy could not achieve much in India because other things being just unfavourable like; the supply of export-oriented goods has not been satisfactory at all. The import substitutions were not upto the level. Decrease in world trade and production has also affected the impact of devaluation.

(6) Increase in loan burden : As a result of devaluation of rupee, more rupees are required to pay off the same outstanding foreign debts. The foreign debt expressed and repayable in foreign currencies increases in rupee terms. The annual interest on this debt also increases.

(7) Temporary control on smuggling : Devaluation is the short-term remedy for smuggling. There is great demand for foreign goods in the country due to which smuggling and black marketing became profitable.

DEVALUATION OF INDIAN RUPEE

The rupee was linked to the British Pound-sterling till 1949. On 18th September, 1949 British Chancellor of the Exchequer announced the devaluation of the Pound-sterling in terms of dollar by 30.5%. India fell in line with England and devalued the Rupee to the same extent to which the pound sterling had been devalued. As a result of devaluation of rupee, the rupee became equivalent to 0.186621 gram of fine gold or 21 U.S cents ($1 = 24.75).

India devalued the Rupee again by 36.5 percent on June 6,1966. The devaluation of rupee further reduced the par value to 0.118494 gram gold or 13.33 U.S. cents ($ 1 = 7.50).

There was round change in the economic philosophy in India after 1990. There was excess of imports in India and balance of payments situation deteriorated. Indian Rupee was devalued by 9.7 percent on 1st July 1991 and by 12.3 percent on 4th July 1991 in terms of Pound-sterling German Mark, Japanese Yen and France Franc. Thus, the total devaluation of Indian Rupee was 22 percent in 1991.

CAUSES, OBJECTIVES AND NEED OF DEVALUATION OF INDIAN RUPEE

Causes, objectives and need of devaluation of Indian Rupee are as follows:

(1) Foreign Assistance : Whenever exchange parity of rupee became unrealistic IMF, World Bank and other developed countries tried to bring down the value of currency. When India borrowed from IMF, there was tremendous pressure on India to devalue rupee, which has to resorted to bring parity

(2) To Remove imbalance of payments : Despite untiring efforts of the government exports failed to pick up. Inspite of severe import restrictions imports were on the increase. Since devaluation could correct balance of payments situations, it was necessary to devalue the rupee.

(3) Restraint on unwanted Activities : Before devaluation large scale smuggling and diversion of precious foreign exchange to unauthorised channels were causing a drain on the country. Illegal and anti-social practices were depriving the government of foreign exchange worth several crores of rupees annually. Devaluation was expected to reduce that lure for quick profits out of smuggling

(4) Increase in Government Income: It was expected that devaluation would increse the income of the government. The exports of elastic demand goods will increase. It was visualised that the devaluation of rupee would help to promote foreign tourism in the country. The flow of foreign tourists into the country would help to increase foreign exchange earnings.

(5) Stipulation to foreign capital: Foreigners will get more rupee value for the same amount of foreign currency after devaluation. This will work as extra incentive for increasing the remittances from foreign currency to India. The foreign exchange crisis of 1991 could be overcome more easily because NRIs started deposing more amounts in their bank accounts in India. Multinational Corporations (MNCs) also get motivated to invest in India.

(6) Increase in exports : Devaluation would tempt Indian investors into investing their surplus funds in the expansion and growth of export industries. Doing so would increase production of export goods and encourage exports.

(7) Reduction in Imports: It was felt that devaluation would help in the expeditious implementation of the import substitution programme of the Government. Foreign machinery would now become more expensive on account of devaluation. This would help in the effective implementation of the import substitution programme of the Government.

In brief, it can be said that it is futile to expect substantial increase in exports due to the devaluation in the immediate future. The imported goods became more expensive consequent upon devaluation. Many of the imports are essential inputs with inelastic demand. The burden of foreign debt has gone up. With the increase in the prices of imported raw materials, machinery etc. the cost of production of manufactured goods has also increased. This will result in sympathetic rise in general price level. This would have adverse repurcussion on all sections of the society.

Devaluations Study Material Notes

EXERCISE QUESTIONS

Long Answer Questions

1 What is the meaning of devaluation ? Discuss the reasons which justify devaluation of currency in the country.

2. “Devaluation of money in India has failed.” Explain.

3. Explain the meaning of devaluation of money. What could be the possible effects of it on a developing economy like India ?

4. What do you understand by devaluation ? Discuss its objectives and effects.

Short Answer Questions

1 What do you understand by devaluation ?

2. Write the main objectives of devaluation.

3. Define the devalution.

4. What is need of devaluation ?

5. Write the effects of devaluation.

Objective Questions

(I) Select the Correct Alternatives :

1 The main cause of devaluation of Rupee is:

(a) Export promotion

(b) Increase in price

(c) Short-term remedy

(d) none of these

2. Negative effect of devaluation is:

(a) Increase in Government revenue

(b) Foreign assistance

(c) Not increase in production

(d) All of above

3. At the first time Indian Rupee was devalued in :

(a) 1966

(b) 1949

(c) 1991

(d) 1988

4. Condition of success of devaluation is:

(a) international cooperation

(b) balance of trade

(c) dumping

(d) all of above

5. Reduction in the external value of national currency in relation of foreign currency is termed as :

(a) dumping

(b) devaluation

(c) export promotion

(d) none of these

[Ans.: 1. (a), 2. (c), 3. (b), 4. (a), 5. b.)

(II) Write True or False :

1 Devaluation lowers the value of national currency in terms of external currencies.

2. Devaluation increases exports as well as imports.

3. It is expected that foreign aid would be liberably available due to devaluation.

4. ‘Devaluation’ refers to the deliberate step taken by the government to reduce the value of national currency in terms of foreign currencies.

[Ans. : 1. True, 2. False, 3. True, 4. True.]

(III) Fill in the Blanks :

1 The main objective of devaluation is ……………. promotion.

2. The aim of devaluation is to increase exports and ……..

3. Deflation eliminates internal………… of goods.

4. Devaluation is obstacle in. ………. of a country.

[Ans. : 1. export, 2. imports, 3. demand, 4. economic development.]

Devaluations Study Material Notes