Devaluation Definition

Dictionary of Financial Terms

A currency devalues when its value declines in relation to one or more other currencies. Let's say that on Monday $1 bought five rubles and that today, after the devaluation, it buys 10 rubles (not actual figures). Under this scenario, the ruble has devalued by 50%.

Why do countries let their currency fall in value? Well, some do it on purpose, usually to try to boost their exports and decrease their imports.

How does that work? Let's imagine I'm a Russian vodka exporter and I charge 100 rubles per bottle. On Monday, one bottle cost foreigners $20 (100 divided by five). Today, at the new exchange rate, one bottle costs $10 (100 divided by 10). In theory, Russia sells a lot more vodka and other goods because they are cheaper in dollar terms -- and exports go up.

At the same time, foreign goods become more expensive to locals with rubles, so imports go down.

However, sometimes devaluations are forced on a country when it can no longer defend its exchange rate. Russia, before its devaluation, was spending dollars and buying rubles to try to keep the ruble at the rate it wanted. But, the market kept selling rubles, and the government was in danger of running out of dollars. Therefore, it gave up and let the ruble-selling continue unabated, and, of course, its exchange rate to the dollar decreased.

Devaluations can have a lot of negative affects. Inflation can go up. Foreign debts become more difficult to service, and they reduce confidence among the people in their currency.

Definitions of Financial Terms