Impact of Currency Depreciation

A major factor that causes the depreciation of currencies of some Latin American countries to depreciate against the U.S. dollar

Depreciation of currency refers to the fall in the currency exchange rate between foreign and domestic currency. Such a decline in domestic currency causes significant changes in the balance of trade in terms of imports and exports. In the past, the value of the currency of some of the Latin American nations has fallen over a specific period relative to the U.S dollar. This has been attributed to several factors: economic conditions in those countries, market, and other monetary policies adopted in those affected countries. Undeniably, major political, social, and economic events can trigger further fall in the domestic currency against major world currencies.

To begin with, Latin American countries share common grounds with other emerging markets, therefore, have been attracted to gradual dollar-denominated lending (Meric & Meric, 2001). High demand for foreign currencies by the borrowers and investors exposes the investors to shell out their domestic earnings to meet higher dollar-denominated obligations in their lending contracts. Accordingly, this is the major contributing factor regarding the depreciation of domestic currencies in some of the Latin American countries. By so doing, these countries increase their current account deficit; implying more imports compared to exports. What is more, such deficits in the current account require a surplus on the capital account to be offset (Walsh, 2000). However, the problem of this type of financing is that it compounded the country’s economic problem if the country certainly does not attract foreign capital flows. Consequently, investors lose trust with such countries thereby withdrawing their savings away from domestic circulation. Taken together, decreases in currency exchange rates witnessed in most Latin American countries negatively affected trade-offs between imports and exports, ultimately causing their currencies to depreciate against the major world currency such as the US dollar (Bengui, Bengui, Nguyen, & World Bank, 2011). To alleviate this trend in depreciation, affected Latin American countries need to reverse the imbalance trade deficit in their current accounts by cutting down their relative prices to increase demand for locally produced goods at both domestic and international levels. This has the effect of increasing exports at the expense of reduced imports. To achieve this aim, depreciating exchange rates in a free-market mechanism or through government intervention measures becomes a prerequisite tool in preventing further depreciation of Latin American currencies against the U.S dollar.

The type of pressure that more imports and high inflation rates placed on the Russian currency

As McConnell and Brue (2005) posit, low capital mobility situations regarding international capital inflows tend to be unresponsive to changes in the interest rates putting upward pressure on Russian domestic income and interest rates. Equally, the impact could emanate from increasing government spending or reducing taxes. From this perspective, introducing expansionary fiscal policy will generate interest at the domestic levels that are lower than the rate required to achieve a balance of payment at its full equilibrium. Accordingly, there would be capital outflows represented by increased imports owing to a rise in domestic income (Beaugrand & International Monetary Fund, 2003). Such imbalances in trade-offs between exports and imports in Russia implies that the BOP reflects a deficit causing the domestic currency to depreciate.

To offset the pressure on the Russian currency to depreciate, the government needed to reduce its foreign reserves necessary to meet the BOP deficit (Al & University of Glasgow, 2011). When this happens, there would be increased money supply in the economy, therefore, shooting interest rates upwards; this is the effect of reducing income levels to reach consistent conditions of BOP equilibrium. To illustrate this, increases in relative prices of goods and services cause high inflation in the domestic market. The high rate of inflation in the country influences increasing imports to higher rates thus further devaluating the Russian domestic currency. Furthermore, more imports occur when the domestic currency depreciates while the price levels of major trading partners remain unchanged forcing the further devaluation of the currency. Conclusively, increases in interest rates discourage investors from borrowing therefore inducing people to save more.

References

Al, Y. Q., & University of Glasgow. (2011). The relevancy of the US dollar peg to the economies of the Gulf Cooperation Council countries (GCC). University of Glasgow.

Beaugrand, P., & International Monetary Fund. (2003). Overshooting and dollarization in the Democratic Republic of the Congo. Washington, D.C: International Monetary Fund.

Bengui, J., Bengui, J., Nguyen, H., & World Bank. (2011). Consumption Baskets and Currency Choice in International Borrowing. Washington, DC: The World Bank.

McConnell, C. R., & Brue, S. L. (2005). Macroeconomics: Principles, problems, and policies. Boston: McGraw-Hill/Irwin.

Meric, I., & Meric, G. (2001). Global financial markets at the turn of the century. Amsterdam: Pergamon.

Walsh, J. I. (2000). European monetary integration and domestic politics: Britain, France, and Italy. Boulder, CO: Lynne Rienner Publishers.