Question

b) Explain at least two possible
i. Positive economic effects of devaluing the pula.
ii. Negative economic effects of devaluing the pula.
[12 marks]

Answer 1

A devaluation means there is a fall in the value of a currency.  Devaluation is an official lowering of the value of a country's currency within a fixed exchange-rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to a foreign reference currency or currency basket.

For instance, let us suppose 5 pula= 1 dollar. Then after devaluation, the exchange rate will rise to maybe 7 pula= 1 dollar.

(i)  Positive economic effects of devaluing the pula:

1. Exports become cheaper and more competitive to foreign buyers. Therefore, this provides a boost for domestic demand and could lead to job creation in the export sector.

2. A higher level of exports should lead to an improvement in the current account deficit. This is important if the country has a large current account deficit due to a lack of competitiveness.

3. Higher exports and aggregate demand (AD) can lead to higher rates of economic growth.

(ii) Negative economic effects of devaluing the pula:

1. The imports become costlier. Sometimes important raw materials for domestic factories are imported, this will increase the cost of production. As a cconsequence, the domestic price of goods may rise.

2. Devaluation is likely to cause inflation because imports will be more expensive. Aggregate Demand (AD) increases – causing demand-pull inflation. Firms/exporters have less incentive to cut costs because they can rely on the devaluation to improve competitiveness. The concern is in the long-term devaluation may lead to lower productivity because of the decline in incentives.

3. A large and rapid devaluation may scare off international investors. It makes investors less willing to hold government debt because the devaluation is effectively reducing the real value of their holdings. In some cases, rapid devaluation can trigger capital flight.