Impact of Devalauation in Forex

On the import side, the demand for foreign currency is not likely to fall to any considerable extent after devaluation.

The supply price of goods and services in terms of foreign currency remains unchanged after devaluation. The amount imported cannot be curtailed much without adversely affecting the development process as most of the imports of the developing economies consist of capital goods, essential raw materials, technical know-how etc., which are very essential for development programmes. On the exports side, the price of exports in terms of foreign currency falls after devaluation.

The value of exports will depend on the elasticity of foreign demand. Total value of exports will increase if the elasticity of foreign demand is more than unity, remains constant if it is; and would fall if it is less than it. It is generally believed that the foreign demand for the exports of an underdeveloped country is comparatively inelastic as most of the exports of the primary producing countries consist of foodstuffs, minerals, agricultural raw materials etc., the demand for which is comparatively inelastic.

But when there are many sources of supply, the demand from one individual source is generally, elastic even if the demand from all sources taken together is inelastic; any individual country can encroach on the market of other underdeveloped countries by lowering its rate of exchange.

Thus the demand for most of the exports of an underdeveloped country is elastic enough. It is comparatively inelastic only for those commodities which are the monopoly of a particular country and for which there are no competing sources. Even when the demand for exports is elastic, the value of exports will increase only if the supply can be increased.

It is here that most of the underdeveloped countries fail to realize the benefit of increased demand for exports. The supply of exports from underdeveloped countries is comparatively inelastic because of a lack of excess capacity, non-availability of complementary factors and other bottlenecks. The value of exports, therefore, is not likely to increase; on the other hand, it might fall if the domestic prices of exports do not rise to counteract the fall in foreign prices caused by devaluation.

In terms of domestic currency, the prices of imports will rise after devaluation. Because the demand for imports is almost inelastic, the value of imports is likely to rise almost in proportion to the depreciation of domestic currency. On the export side, the prices of exports in terms of domestic currency remain constant.

The elasticities approach assumes the existence of perfect competition. This assumption had some relevance before the thirties when the exchange and trade controls were unimportant and the commodity markets were substantially competitive.

Decades ago, the trade and exchange controls have increased tremendously. The recent emergence of planning in most of the countries has given a further blow to free trade. Imports and exports are determined by the government keeping in view the needs of the plan rather than being determined by the comparative prices. The imports consist of two kinds of goods, viz., consumption goods and investment goods.

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Impact of Devalauation in Forex

Foreign demand is likely to increase after devaluation as the goods of the devaluing country become cheaper in terms of foreign currency after the devaluation. Value of exports, however, is not likely to increase significantly because of the limited capacity to export.

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