How is devaluation of the currency supposed to cure an economy’s balance of payments current account deficit? Is it likely to succeed? Give reasons to support your answer.

Answer

• When the demand for export is price elastic such that a fall in their prices lead to greater increase in quantity demanded abroad and hence lading to increase in foreign exchange
• When the demand for imports is price elastic such that when the currency is devalued, the prices of imports increase discouraging importation
• When the supply of exports is highly price elastic such that when demand for them increase, the supply should follow immediately to avoid shortages
• There should be no restrictions put on country’s export.
• When other countries do no devalue their currencies
• When the devaluating country is not facing inflation
• There must enough to export and leave enough for domestic market
• When the currency in which exports are priced remains stable

Benefits of currency devaluations include

• It stimulates demand for export and increase foreign exchange earnings.
• It discourages import because it makes them expensive protecting infant domestic industries
• It reduces imported inflation
• It is a way or retaliation by one country against the other whose devaluation might have affected its economy.
• It corrects balance of payment deficits because it reduces the volume of imports and increases the volume of exports thereby increasing export earnings.
• It promotes self-reliance since it decreases demand for foreign commodities and encourages consumption of local goods.
• It reduces export unemployment since it makes exports cheaper, increase their demand which increases on investment.
• It enables a country to access financial assistance from IMF and World Bank because devaluation is one of the conditions.
• It motivates farmers since devaluation increase agricultural produce
• It restricts capital outflow as importation is discouraged.

Limitation of devaluation

• It causes retaliation by other countries that would have been affected by devaluation of one country.
• It limits the market for country’s exports especially when other countries also devalue their currencies.
• It may worsen imported inflation especially when the demand for imports is price inelastic.
• It causes smuggling as nationals will try to earn high value foreign currencies which increase per capita outflow.
• Balance of payments problem worsens in case of inelastic demand for imports by devaluating country.
• It increases the value of foreign debts because foreign currency becomes expensive.
• It leads to corruption in the civil service as they hoard foreign currencies so that they get higher profits in future when devaluation occurs.
• Cheaper substitutes commodities are developed especially in developed countries causing failure of devaluation process.
• LDCs tend to have insufficient import substitutes making importation inevitable

The policy of devaluation fails when the devaluing country is not a major produce/supplier of export commodities in questions.