Currency depreciation is a fall in the value of a currency in terms of its exchange rate versus other currencies. Currency depreciation can occur due to factors such as economic fundamentals (e.g. GDP decline/negative), interest rate differentials, political instability, rise in inflationary risk, risk aversion among investors, negative perceptions, speculative activity (by banks and others), export decline, current account deficit, low forex reserves, a deficit fiscal position and major outflow of “political” or “hot” money.
Countries with weak economic fundamentals, such as chronic current account (and fiscal) deficits and high rates of inflation, generally have depreciating currencies. Currency depreciation, if orderly and gradual, improves a nation’s export competitiveness and may improve its trade deficit over time. But abrupt and sizable currency depreciation may scare foreign investors who fear the currency may fall further. This may lead many to pull portfolio investments out of the country. These actions will put further downward pressure on the currency. Some economists and Government sources suggest that depreciation is good, it improves export competitiveness. But this is a short-term phenomenon. The “J” curve will result in situation returning to its pre-depreciation state.
In many situations, easy monetary policy and high inflation are two of the leading causes of currency depreciation. When interest rates are low, hundreds of billions of dollars chase the highest yield. Expected interest rate differentials can trigger a bout of currency depreciation. Central banks can increase interest rates to combat inflation, especially if it is of the demand-pull kind.
Additionally, inflation can lead to higher input costs for exports, which then makes a nation's exports less competitive in the global markets. This will widen the trade deficit and cause the currency to depreciate. While economic fundamentals for the most part determine the value of a currency, political rhetoric can cause a currency to fall as well.
Between 2015 and 2016, the U.S. and China were repeatedly in a battle of words with regards to each other’s currency value. In August 2015, the People’s Bank of China (PBOC) devalued the country’s currency, the yuan, by roughly 2% against the U.S. dollar. Chinese officials said the move was required to prevent a further slide in exports.
In 2019, the Trump administration labeled China a currency manipulator, saying Chinese officials were purposely devaluing its currency, leading to unfair advantages on trade. In 2018, U.S.-China political rhetoric turned toward protectionism that resulted in a long-term trade dispute between the world’s two largest economies.
Sudden bouts of currency depreciation, especially in emerging markets, inevitably increase the fear of "contagion," whereby many of these currencies get afflicted by similar investor concerns. Among the most notable was the Asian crisis of 1997 that triggered the collapse of the Thai baht and caused a sharp devaluation in most Southeast Asian currencies.
Today, an example of that would be the Turkish lira. The currency has lost more than 40% of its value against the USD since early 2021. A combination of factors led to the depreciation. First, investors grew fearful that Turkish companies wouldn't be able to pay back loans denominated in dollars and euros as the lira continued to fall in value. Secondly, President Trump approved the doubling of steel and aluminum tariffs imposed on Turkey.
Then Turkey’s president, Recep Tayyip Erdogan, did not allow Turkey's central bank to raise interest rates. And the country didn't have enough U.S. dollars to defend its currency. Turkey's central bank lifted interest rates in September 2018 from 17.75% to 24% to stabilize its currency and curb inflation. But Erdogan believes high interest rates are against the teachings of Islam!
For Malaysia, it is the decline against the Singapore dollar that “drops” our face.
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