Disadvantages of Devalutaion in Forex
Devaluation in one country might lead to devaluation by other competing countries. This will counteract the effect of devaluation to a considerable extent. The effect of devaluation will be weakened, also, if the countries which are the important sources of the supply of raw materials for the export industries of the devaluing country refuse to follow suit.
The burden of their debts will increase after devaluation because most of the debts are expressed in terms of foreign currencies. On the other hand, the value of their credits with foreign countries will decrease as most of these are in terms of domestic currencies.
This will increase the price of imported raw materials and hence of export goods. The workers might demand higher wages to offset the higher cost of imported foodstuffs and other goods. The wage price spiral might go beyond merely counteracting the effect of devaluation and thus have adverse effects. Sometimes, devaluation leads to a rise in domestic prices in anticipation and the effect of devaluation is rendered nil.
Devaluation requires time to be effective. Consumers take time in reacting to price changes. It needs some time for the consumers to be aware of the cheaper products. Reaction to price changes might require certain changes in the consumption pattern which cannot be affected overnight without much inconvenience.
The use of foreign cheaper producer's goods might require certain techno logical adjustments which might not be profitable in the short run because the loss from the scrapping of existing equipment exceeds the gain from the use of new cheaper goods. Similarly, on the supply side, the supply is more elastic in the long run than in the short run.
In the short run, assuming that there exists no excess capacity, the supply can be increased only by overworking the existing plants which will raise the supply price rapidly and thus dampen the effect of devaluation. In the long run, the production can be increased either by increasing the number of plants of the existing size or by enlarging the scale of the existing plants or by a combination of the two.
This might lower the long run supply price by bringing in the economies of production and thus strengthen the effect of devaluation. Thus, it is just possible that devaluation might worsen the balance of payments in the short run while improve it in the long run when the supply of and the demand for imports and exports have adjusted to changed relative prices.
It, therefore, is not very useful for countries possessing scanty monetary reserves and needing immediate redress of disequilibrium in the balance of payment.
Devaluation is a suitable remedy if the disequilibrium in the balance of payments is due to a disparity in the movement of domestic and foreign price levels. It is not very effective and useful if the deficit is due to certain structural maladjustments; it might even prove harmful and accentuate the problem by increasing the value of imports, creating inflationary trends, and deteriorating the terms of trade.