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Devaluation is a deliberate decision by a government or central bank to reduce the value of its own currency in relation to the currencies of other countries.
Governments often opt for devaluation when there is a large current account deficit, which may occur when a country is importing far more than it is exporting.
When a nation devalues its currency, the goods it imports and the overseas debts it must repay become more expensive. But its exports become less expensive for overseas buyers. These competitive prices often stimulate higher sales and help to reduce the deficit.
devaluationan administered reduction in the EXCHANGE RATE of a currency against other currencies under a FIXED EXCHANGE RATE SYSTEM; for example, the lowering of the UK pound (£) against the US dollar ($) from one fixed or ‘pegged’ level to a lower level, say from £1 = $3 to £1 = $2. Devaluations are resorted to by governments to assist in the removal of a BALANCE OF PAYMENTS deficit. The effect of a devaluation is to make imports (in the local currency) more expensive, thereby reducing import demand, and exports cheaper (in the local currency), thereby acting as a stimulus to export demand. Whether or not a devaluation ‘works’ in achieving balance of payments equilibrium, however, depends on a number of factors, including the sensitivity of import and export demand to price changes (see ELASTICITY OF DEMAND); the availability of resources to expand export volumes and replace imports; and, critically over the longer term, the control of inflation to ensure that domestic price rises are kept in line with or below other countries' inflation rates.
Devaluations can affect the business climate in a number of ways, but in particular provide firms with an opportunity to expand sales and boost profitability. A devaluation increases import prices, which makes imports less competitive against domestic products and encourages domestic buyers to switch to locally-produced substitutes. Likewise, a fall in export prices is likely to cause overseas customers to increase their demand for the country's exported products in preference to locally produced items and to the exports of other overseas producers. If the pound, as in our example above, is devalued by one-third, then this would allow UK exporters to reduce their prices by a similar amount, thus increasing their price competitiveness in the US market Alternatively, they may choose not to reduce their prices by the full amount of the devaluation in order to increase unit profit margins and provide additional funds for advertising and sales promotion, etc. Contrast with REVALUATION, definition 2.