A currency exchange rate denotes the value of one currency with respect to another. Most exchange rate quotations are with respect to the U.S. dollar. Under a fixed exchange rate system, such as in Malawi, the government determines the devaluation and revaluation of its currency. In a floating exchange rate system, such as in the United States, market forces determine currency depreciation or appreciation. Devaluation or depreciation means a decline in the value of the currency.
A country’s central bank will decide to devalue a unit of currency for several reasons — for example, a country may wish to increase the money supply and encourage lending — but the effect on debts is relatively consistent. Debts that are denominated in that currency are often easier to pay back as they are worth less. This is, of course, contingent on salaries rising along the level of inflation. A currency will therefore sometimes lose a significant portion of its value. This process, known as inflation, can occur for a number of different reasons. In some cases, investors will decide as a group to sell off the currency, creating a large amount of supply relative to demand and causing its value to drop. In other cases, the country’s central bank may decide to devalue the currency. This can lead to several effects.
Effect on National Debt
Currency devaluation will not only affect consumer debts, but it will affect how a country pays back its national debt. If a loan is denominated in the devalued currency, then the debt will be easier to pay off, as the country will have to spend less money paying back foreign investors. However, if the loan is denominated in another currency, it may be more difficult, as the debtor country’s money is not worth less.
Effect on Private Debt
Lenders often take a hit when a currency is devalued. This is because the money that the lender will receive when he is paid back for the loan is, in an inflationary atmosphere, worth less than it was when the loan was issued. However, inflation is good for borrowers, in that the borrowers will be better able to pay back the money they owe, as the money they pay back will be less value in real world terms.
Another effect of currency devaluation, if it is ongoing, is for lenders to raise interest rates steeply. This is because lenders will want to do their best to ensure that the money they receive when they are paid back the loan will be more valuable than the money was when they issued it. Often, the rise in inflation rates will create greater economic problems, only exacerbating the level of inflation and creating an inflationary spiral.
Possible Consequences of the Malawian Devaluation
Because Malawi is experiencing an austere economic climate and serious Forex shortage, unless there is a substantial cash injection into the economy, this devaluation will quite simply exacerbate the economic problems. Also because of Malawi’s poor monetary policy control measures, which are basically helpless against the black market and financial mercenaries, devaluation of the currency is likely to simply enrich the unscrupulous.
The poor in the villages will now be more affected than before, as prices are bound to keep skyrocketing without a possible relief in sight. Harsh times are inevitable.
Was the Devaluation a good idea?
This is rather hard to say. The crucial factor is whether or not the government will be able to source the Forex cushion that is required to support the devaluation and control its impact. In the absence of such a cash injection, the currency should have been left alone.
*The author is a lawyer by training and former legal counsel of late president Bingu wa Mutharika.Follow and Subscribe Nyasa TV :