In India’s post-independence history, the government has purposefully devalued the rupee three times in 1966 and 1991. Devaluation of currency occurs when the government formally lowers the value of its currency. The currency’s value determines the impact of currency appreciation and depreciation on trade deficits. In an ideal world, a country would be able to manufacture all it requires locally and export without importing any raw materials, goods, or services. But it is not a real scenario, as then there would be no trade deficit in that country.

Inflation and Deflation of Currency

Inflation

• As a result, prices for goods and services increase when the value of a currency falls.
• By definition, inflation is the process by which the value of a currency declines and, consequently, the overall price level for goods and services increases.
• Depending on the perspective and rate of change, inflation can be viewed as either good or bad.
• Real estate owners and other individuals with physical assets may appreciate some inflation as it increases their property’s value.

Deflation

• Deflationism is the idea that prices for goods and services have fallen significantly.
• Prices can also decline as a result of technological advancements and increased productivity. Deflation generally occurs when the availability of money and credit is reduced.
• The appeal of various investment possibilities changes depending on whether the economy, price level, and money supply are deflating or increasing.

Effect of Appreciation and Depreciation

Appreciation

Local currency appreciation means local items become more affordable and readily available when compared to foreign items. Local buyers find that imported goods are more affordable, which leads to an increase in imports. Appreciation might result in a decrease in competitiveness in the global market since local or native products are worth more in foreign currencies. As a consequence, exports are dropping. As imports increase and exports decline, the trade gap widens.

Depreciation

The huge impact of a falling Rupee is on importers, for those are hit particularly hard when their rupee cost per dollar rises in lockstep. In terms of the macroeconomy, high import costs cascade into local prices, which then rise. The rupee’s depreciation could lead to a further increase in domestic petrol prices, which would push up the cost of other essentials as transportation expenses rise.

Those seeking international education may also be harmed by a weakening rupee, as their prices may rise as a result. It is also unfavourable for individuals who intend to travel overseas. Due to the rupee’s significant depreciation versus the dollar, international travellers will need to rework their budget.

Example

Let us assume that India is the exporting nation and America is the importing nation. India sells apples to the United States. Assume that India’s rupee was devalued from Rs. 50 to Rs. 100 per dollar. In India, an apple costs Rs.50 before and after the rupee depreciation. Now consider what will occur. Before the rupee depreciation, Americans would only be able to buy one apple for one dollar. Following the depreciation of the rupee, Americans will now be able to buy 2 apples for the price of one. Consider the situation from the standpoint of the United States. Previously, people could only get 1 apple for 1 dollar. They now have 2 apples due to the collapse in the Indian rupee. As a result, importing from India has become significantly less expensive for America, and they will take full advantage of this situation.

Measures To Control Depreciation

Management should evaluate the depreciation mechanism at the end of each financial year. The depreciation method should be modified if the pattern of future economic gains from the asset changes dramatically.

A modification of an accounting estimate constitutes a change in the method of depreciation, according to the Disclosure of Accounting Policies. Consequently, the footnotes should contain quantitative information and full disclosure. The reason for the change, as well as the financial repercussions, must be made public.

As a result, the depreciation method might be changed retrospectively or not at all. There will be no changes for earlier entries if there is no retrospective effect, and depreciation will only be charged using the new method in the future.

Conclusion

These elements work together to depreciate or appreciate a currency’s value. However, if a country has a flexible exchange rate policy, such as India, its impact is more noticeable. The government artificially sets the exchange rate in a fixed exchange rate system, such as in China or pre-reform India. These factors do not affect the exchange rate but pressure government budgets. 

Fixed exchange rate regimes do not allow for currency appreciation or depreciation; instead, the government devalues or evaluates the currency. In a fixed exchange rate regime, the government had to have forex reserves in order to keep the currency’s fixed rate. Governments with flexible exchange rates, on the other hand, hold forex reserves as a buffer against exchange rate shocks.