Devaluation of currency and the trade balance

Thirty years ago when I was an undergraduate student, my research project was on the effect of national currency devaluation and the balance of payment with Jordan as case study. I was one of the first students to study this issue. Three years later, the Jordanian government took a decision to devalue the Jordanian dinar by more than 52 per cent to address the sharp decline in foreign reserves due to irrational expenditure and imaginary growth of budget deficits.

The story started with the foreign exchange offices encouraging individuals to make their deposits into foreign currencies coupled with the biased international reports that overestimated the issue and encouraged more taxes and fees to finance deficit. The public deficit is still very high despite the fact that the government has fulfilled all requirements by the IMF.

Devaluation in modern monetary policy is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged.

“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 (relative to other major currency benchmarks) 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 US dollar. The opposite of devaluation is called revaluation.

Depreciation and devaluation are sometimes incorrectly used interchangeably, but they always refer to values in terms of other currencies if we looked at the reasons that may push in the direction of currency devaluation, we will find that they are related mostly to introducing reforms at the economy.

These reforms may bring economic welfare and stability; an aim sought by all countries of the world including the Gulf States.

Before taking a decision to reduce any currency there is a need to study the trade balance and the balance of payment for these countries, and to know the price flexibility of the imports and exports i.e. how far the demand for exports and imports will react to the change of prices resulting from the devaluation of currency.

If the price flexibility for some imported consumer goods is weak due to the fact that it is not manufactured locally or due to other consideration (such as the local products are of low quality or lack technical components), the price of such commodities will not affect the local consumption and may not lead to important decline in imports.

On the contrary, when the price flexibility for some exported goods are weak due to lacking the ability to compete beyond pricing or due to the tough international competition; the decrease in the prices of such commodities does not affect its consumption abroad. This does not lead to a remarkable increase in exports.

The devaluation of the national currency may be two-edged weapon as it may result in enhancing domestic production and national economy growth on one hand and may result as well in recession due to the soaring inflation from the price hike.

The experiences of countries such as Mexico and Argentine show that the devaluation of currency is always associated in most cases with growing inflation and production decline.

Based on the outcomes of many scientific studies made by our academic and non-academic institutions, we may say that there is a need to:

Introduce structural reforms in our economy to fill the big gap in trade balance, the balance of payment, diversify exports and to reduce reliance on oil revenues to avoid the effects of market fluctuations.

Develop a national strategy for the diversification of exports, imports by shifting from exporting raw materials to exporting value added goods.

Work very fast to reduce imports by encouraging local industries, promoting private sector and enhancing the establishment of SMEs.

Develop economic policies that provide the needed circumstances to attract foreign investments and capitals. (A number of researches and scientific studies have been used in brief only for the recommendations)