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All you wanted to know about currency devaluation

K VENKATASUBRAMANIAN | Updated on January 24, 2018

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There’s no light at the end of the tunnel yet on Greece’s debt problem. With the referendum over, the issue is back to square one — How will Greece repay its mountain of debt? One opinion is that Greece must exit the Euro, adopt its earlier currency — drachma and ‘devalue’ itself out of trouble.

What is it?

Devaluation refers to the act of a country voluntarily reducing the value of its currency vis-à-vis a basket of other international currencies. Therefore, if the rupee were to devalue, it would get cheaper against the dollar, pound sterling or the euro. If Greece returns to the drachma, the currency would have to be devalued by as much as 40-45 per cent against the Euro.

Why is it important?

When a country devalues its currency, it makes local products and services considerably cheaper and, thus, more competitive in international markets. If Greece adopts the drachma and devalues, this may be helpful as its economy thrives on tourism. With a cheaper drachma, the country may get an influx of foreign tourists, generating more revenues for the economy.

One report from a London-based firm indicates that if the drachma were to be devalued by 30 per cent, the nation’s economy would receive a 20 per cent boost from such an influx. If the tourist influx is sustained or if exports become cheaper, Greece may over time earn enough foreign exchange or capital inflows to service its debt, get back to steady economic growth, improve its tax collections and put through pension reforms. The flip side is that currency devaluation effectively reduces the purchasing power of domestic citizens, which may diminish their standard of living. But even if devaluation turns out to be a good idea for Greece, the impact on the European lenders and the IMF may be quite serious, as nearly €290 billion are at stake. If Greece devalues, banks in Germany and several other stronger European countries with exposure to it would be faced with serious erosion in the book value of the loans. Currency volatility would be the other major fallout.

If Greece were to adopt its own currency, analysts indicate that in the short term, there could be depreciation the value of the euro, which has already fallen from 1.4 levels to the dollar to about 1.1 in the last one year. It may strengthen later as a weak country exiting the euro would eventually help the currency.

Why should I care?

If you’ve always yearned to travel to Greece, devaluation would be great news as it would make your trip considerably cheaper.

But if you’re an IT employee, a Greek devaluation would be reason to worry.

While Greece isn’t a big trading partner or export destination for India, what you should worry about is the fallout on the euro. There are several Indian companies with major operations in Europe — auto majors, IT companies for instance. If Greece devalues, and the euro weakens against the dollar and also the rupee, realisations could be hurt.

For two quarters in a row last fiscal, companies such as TCS, HCL and Infosys reported weak earnings from a sliding euro. Short- term weakness in the euro could hit the margins and thus the pay cheques of IT employees, if their firm has large European clients.

The bottomline

Devaluation may look like a nice quick-fix solution to anyone’s debt troubles, but in the long term, it can cost a country dear.

(A weekly column that puts the fun into learning)

Published on July 13, 2015

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