In the majority of economics textbooks a depreciation of the exchange is beneficial to an economy especially those like developing countries which depend a lot on export revenue.
A fall in the value of the exchange rate will make exports cheaper and so acts as an implicit subsidy to firms that sell abroad. Exposure to world markets also helps companies in the developing world learn and improve.Finished imported products that are still purchased will be more expensive and some of these will count in the country’s consumer price index. Costs of production will be pushed up because the cost of imported raw materials will rise. Domestic firms may also feel less competitive pressure to keep costs and prices low.
A rise in the value of exchange rate will make exports more expensive in terms of foreign currencies, and imports cheaper in terms of the domestic currency. Such a change is likely to result in a fall in demand for domestic products. A higher exchange rate may also reduce inflationary pressure by shifting the aggregate supply curve to the right because of lower costs of imported raw materials. The price of imported finished products would also fall and there would be increased competitive pressure on domestic firms to restrict price rises in order to try to maintain their sales at home and abroad.
It has been traditional for developing countries to try and engineer a weaker currency to make their exports more competitive especially as this revenue is one way in which their economies can start to grow. China and other South East Asian economies adopted this strategy as they went through industrialising their economy. Empirical studies suggest that an undervalued currency boosts growth more in developing rather than developed economies.
Why then is it that some African countries still want to maintain a strong currency? Primary sector exports and overseas aid raises the demand for local currencies making them appreciate. Governments are concerned about a weaker currency as
- Some are dependent on capital imports to finance infrastructure projects
- It forces them to spend more income to pay back foreign debts.
- Pushes up the cost of imported goods, including food, medicine and fuel – mainly impacts the city population who are more likely to complain to politicians.
- Some companies in developing countries import a lot of their machinery and raw materials – additional cost to their production.
- A weaker currency does make exports cheaper but this can be nullified by more expensive imports.
However all of this has been overshadowed by COVID-19. The pandemic is increasingly a concern for developing countries which rely heavily on imports to meet their needs of medical supplies essential to combat the virus.