What is Currency Depreciation?
It refers to the decrease in the value of the domestic currency (₹) in terms of one or more foreign currencies (like $). It makes domestic currency less valuable and more is required to buy a unit of currency. For example, if the price of $1 rises from ₹60 to ₹64, then it can be said that there is a depreciation of the Indian currency.
Causes of Currency Depreciation
The main reasons for the depreciation of currency are:
- The main factors contributing to currency depreciation are easy monetary policy and excessive inflation. In order to tackle inflation, central banks will raise interest rates because excessive inflation puts pressure on the country’s currency which might result in currency depreciation. Moreover, because of inflation, there is an increase in the cost of production, which increases the cost of exports and reduces the competitiveness of a country’s exports on the world market. Thus, it ultimately leads to a deficit and currency depreciation.
- It can also be caused by political instability. Due to uncertainty in the domestic country, investors fear investing in the domestic country. For example, Due to the war between Russia and Ukraine investors fear investing in the country because of instability in the economy.
- If the country imports large amounts of products, then there will be a trade imbalance which will lead to currency depreciation.
Effects of Currency Depreciation on Exports
Currency depreciation means a fall in the price of domestic currency (₹) in comparison to foreign currencies ($). For example, earlier people could get goods worth ₹60 from a unit of the dollar, but now they can get goods worth ₹64 from 1$. It means that more goods can be purchased from India in rupees with the same amount of dollars. Thus it leads to an increase in exports from India to the USA, as exports become cheaper.
What is Currency Appreciation?
It refers to an increase in the value of a domestic currency (₹) in terms of one or more foreign currencies (like $). It makes the domestic currency more valuable and less of it is required to buy a unit of currency. For example, if the price of $1 falls from ₹64 to ₹ 60, then it can be said that there is an appreciation of Indian currency.
Causes of Currency Appreciation
- The Main factors contributing to currency appreciation are interest rates and inflation. In the case of low inflation, there is an increase in interest rates, and higher rates attract more investors in the overseas market which will ultimately increase the value of the domestic currency.
- Another main reason is investor sentiment. If an investor feels that his/her money is safe in the economy; i.e., there is political stability in the country, then it will attract capital flows from overseas leading to an increase in the value of the domestic currency.
Effects of Currency Appreciation on Imports
Currency appreciation means a rise in the price of domestic currency (₹) in comparison to foreign currencies ($). Earlier, for example, an Indian resident needs ₹64 to buy a unit of dollar, but now he needs ₹60 to buy the same. It means that more goods can be purchased from the USA with the same amount of rupees in dollars. Thus it leads to an increase in imports from the USA to India as American goods become cheaper.
Difference between Currency Depreciation and Currency Appreciation
|
Basis |
Currency Depreciation |
Currency Appreciation |
|---|---|---|
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Meaning |
It refers to the decrease in the value of a domestic currency(₹) in terms of one or more foreign currencies (like $). | It refers to the increase in the value of a domestic currency (₹) in terms of one or more foreign currencies (like $). |
|
Rupee Requirement |
More rupees are needed to buy one US $. | Less rupees are needed to buy one US $. |
|
Causes |
Political Instability, Excessive Inflation, and Trade Deficit lead to Currency Depreciation. | Political Stability, Low Inflation, and Trade Surplus lead to Currency Appreciation. |
|
Effects on imports/exports |
It makes domestic goods cheaper in foreign markets as more goods can be purchased in rupees with the same amount of dollars. Thus it leads to a rise in exports. | It makes foreign goods cheaper in the domestic market as more goods can be purchased in dollars with the same amount of rupees. Thus it leads to a rise in imports. |
|
Example |
A change from 1$= ₹60 to 1$ = ₹64 represents a depreciation of the currency. | A change from 1$ = ₹64 to 1$ = ₹60 represents appreciation of the currency. |