How does a currency depreciate?

Currency depreciation is loss of value of one currency against others in exchange rate system. There are several factors which lead to devaluation of a currency. The foremost among them is trade deficit.

When consumers demand foreign products you have to pay for that in foreign currency and since the international trade is done in US dollars your dollar reserves deplete paving the way for your local currency’s devaluation. The higher the foreign reserves are in the central bank, the value of the country’s currency will be more appreciated. Inflation in a country makes its currency to devalue. Political events and monetary policy also play key role in determining the value of a currency.

Last year between January and August, Turkish currency Lira sank drastically. A number of factors led to the devaluation including the United States doubling tariffs on steel and aluminum at the time when its economy was already struggling. The Turkish government also did not allow the central bank to raise interest rate.

Gradual depreciation of a currency is considered healthy for exports of a country, while sudden devaluation spreads fear among foreign investors.

Almost all of the factors that depreciate a currency are involved in Pakistan’s economy, which is experiencing a rough patch, but the biggest reason behind it is demand by the International Monetary Fund (for providing a fresh loan) to devalue Pakistani rupee to reduce the ballooning trade deficit. PKR has dipped to a historical low against dollar. One dollar was equal to 119 rupee in June 2018 and it has climbed to 157 rupee now.

Unfortunately, devaluation of currency in Pakistan could not uplift exports as foreigners find it cheap to buy Pakistani products but Pakistani industrialists have to pay more money to get foreign products. It has reduced local economic activities and shrunk economy.