Currency Depreciation vs Devaluation

Notes

Depreciation is a fall in the value of a currency in a floating or market-determined exchange rate system, caused by market forces (demand and supply).
Devaluation is a deliberate downward adjustment of the official exchange rate by the government or central bank under a fixed or pegged system.
The opposites are appreciation (market-driven rise) and revaluation (a deliberate rise).

Basis	Depreciation	Devaluation
Regime	Floating or managed float	Fixed or pegged
Cause	Market forces	Government or central bank decision
Nature	Gradual	Sudden and official
Control	Market-determined	Policy decision

India's devaluations

1949: with the pound sterling (about 30%); 1966: the rupee was cut from ₹4.76 to ₹7.50 per dollar (about 57%) under Indira Gandhi, after wars, drought and pressure on the balance of payments; July 1991: a two-step devaluation of about 18-19% as part of the reforms.

Effects

Exports become cheaper and imports dearer; it can narrow the trade deficit and promote import substitution; it raises imported inflation; the rupee value of external debt rises; and it can trigger capital flight and retaliation.
Marshall-Lerner condition: devaluation improves the trade balance only if the sum of the price elasticities of demand for exports and imports exceeds 1.
J-curve effect: the trade balance first worsens and then improves, because trade volumes adjust slowly.
Competitive devaluation (a currency war): countries weaken their currencies to gain exports; it can trigger retaliation.

Related: the 1997 Asian financial crisis (the Thai baht float) and China's August 2015 devaluation of the yuan fix.

Key Points

Depreciation: market-driven fall; devaluation: official, deliberate cut under a fixed rate.
India devalued in 1949, 1966 and 1991.
Marshall-Lerner condition: sum of elasticities greater than 1.
J-curve: the trade balance worsens before it improves.
Weak currency raises import costs and external debt burden.

MCQs

Q1. Devaluation differs from depreciation because devaluation is: (a) Market-driven (b) A deliberate official decision under a fixed exchange rate (c) Always temporary (d) An appreciation Ans: (b).

Q2. The Marshall-Lerner condition says devaluation improves the trade balance if: (a) The sum of export and import demand elasticities is greater than 1 (b) Exports exceed imports (c) Inflation is low (d) Interest rates are high Ans: (a).