What Are The Effects Of Exchange Rate Adjustment?

             When the currency of the country is devalued, the prices of the internationally traded goods of the devaluing currency fall in the outside world. The buyers in the foreign countries attracted by the low prices increase their purchases. The exports of the devaluing country are therefore stimulated. We suppose the exchange rate between Pakistan and England is rupees 30=.1 pound. If the exchange value of Pakistani rupee is reduced and the exchange rate is established at rupees 60=1 pound, which is 100 percent devaluation then in that case Pakistan will be cheaper market to buy for England. The English importers of goods can get rupees 60 worth of Pakistan goods in exchange for the same amount of their currency.

             The devaluing country can be benefit from the depreciation of currency in different ways. First is there is no retaliation on the part of foreign countries to devalue the currency. There is no appreciable rise in the domestic cost of production particularly in those industries which produce commodities for exports. If the traded goods mostly comprise luxuries which have elastic foreign demand the exports will not be stimulated much by devaluation. In the case devaluing country relies heavily on imports of goods and services for its development and the price elasticity of foreign demand for its goods is inelastic then the gain received from devaluation will be offset by its import disadvantages.

The effects of exchange rate adjustment are now explained in more detail:When the currency of a country is devalued, the prices of internationally traded goods of the devaluing currency fall in the outside world. The buyers in the foreign countries attracted by the low prices increase their purchases. The exports of the devaluing country are, therefore, stimulated.

We suppose the exchange rate between Pakistan and England is Rs. 20=1 pound. If the exchange value of Pakistani rupee is reduced and the exchange rate is established at Rs. 40= 1 pound, a devaluation of 100%. Then in that case Pakistan will be a cheaper market to buy for England.

Here it should be remembered that the devaluing country can benefit from the depreciation of its currency only when:There is no retaliation on the part of foreign countries to devalue the currency.There is no appreciable rise in the domestic cost of production particularly in those industries which produce commodities for exports.

If the traded goods mostly comprise of luxuries which has elastic foreign demand, the export will not be stimulated much by devaluation.In case the devaluing country relies heavily on imports of goods and services for its development and the price elasticity of foreign demand for its goods is elastic, then the gain received from depreciation will be offset by its import disadvantages.