What Causes Depreciation Of Currency Rates?

Currency rates depreciate when the economy is weak or due to external pressure from market speculators and the government.

Financial dictionaries describe currency depreciation as a process when a currency loses its value against another currency or basket of currencies. In such cases, more units of a local currency are needed to purchase the foreign currency i.e. if one British pound was able to purchase two U.S. dollars on a few years ago and now you receive 1.6 U.S. dollars for one British pound, then the pound has depreciated. Depreciation is a process driven by market forces and all fluctuations of currency rates reflect the present market conditions, forming the market value of a particular currency pair.

Various fundamental factors determine the currency rates and its appreciation or depreciation. Both appreciation and depreciation depend on the current state of the overall economy including indicators like trade balance (the difference between the value of export and import), inflation, political stability, etc. External factors like currency speculations on the Forex market can also contribute to depreciation of a particular currency. Such being the case, a government can intervene into the Forex market to support its national currency and suppress the process of depreciation.

The currency depreciation can effect positively the overall economic development, though. It boosts competitiveness through lower export costs and secures more income from exported goods in a similar way devaluation does. On the contrary, depreciation makes imports more expensive and discourages purchases of imported goods stimulating demand for domestically manufactured goods. The governments worldwide influence appreciation and depreciation utilising the powerful tool of the base interest rates, which are usually set by the country’s central bank and this tool is often used to intentionally depreciate the currency rates to encourage exports.

The forced depreciation of the currency rate, although used on a regular base by the central banks, can be a dangerous step when the country has accumulated large debts in foreign currency. In broad terms, currency depreciation lowers the value of companies assets and income, denominated in their home currency, and this situation can lead to a wave of bankruptcies because the companies will not be able to service their debts denominated in foreign currencies.

Market speculations can contribute to a process of spiralling depreciation after smaller Forex market players decide to follow the example of the leading Forex dealers, the so-called market makers, and after they lost confidence in a particular currency start to sell it in bulk amounts. Then only a quick reaction of the country’s central bank can restore the confidence of investors and stop the currency rates of the nation’s currency from continuous decline.