Kenya is set to overtake Ethiopia as East Africa’s largest
economy in 2025, according to new projections from the International Monetary
Fund (IMF).
The shift comes in the wake of a sharp devaluation of the
Ethiopian birr in July 2024, part of a broader effort to stabilize the economy
and advance long-delayed debt restructuring talks.
The IMF forecasts Kenya’s gross domestic product (GDP) will
climb to $132 billion in 2025, surpassing Ethiopia’s projected $117 billion.
Ethiopia’s decision to liberalize its exchange rate system
and allow the birr to depreciate significantly, by more than 55%, helped unlock
a $3.4 billion IMF loan package and an additional $16.6 billion in financial
support from the World Bank.
Ethiopia’s drop was attributed to the devaluation of its
national currency, the birr, while Kenyan shillings, contrastingly, increased
in value.
So, countries may devalue their currency for several
reasons, primarily to boost exports, reduce trade deficits, and manage national
debt.
A devalued currency makes a country’s goods and services
cheaper on the global market, increasing demand for exports and potentially
stimulating economic growth through more foreign currency earnings.
It can also make imports more expensive, potentially
reducing the trade deficit and improving the balance of trade.
Additionally, a devalued currency can make it cheaper to
repay foreign debt in the local currency, easing loan restructuring for
struggling economies.
Countries with high levels of debt denominated in foreign
currencies may resort to devaluation as a strategy to reduce the real value of
their debt.
When a currency is devalued, the amount owed in the local
currency increases, but the actual value in terms of foreign currency
decreases, allowing some borrowing headroom.
This can ease the burden of debt repayment for the government,
particularly if the country is facing fiscal challenges. However, this approach
can be risky, as it might lead to loss of investor confidence and increased
cost of borrowing in the future.
WHAT IS CURRENCY DEVALUATION?
Devaluation is the deliberate reduction of a country’s
currency value relative to another currency or standard. It is typically
employed by countries with fixed or semi-fixed exchange rate regimes as a monetary
policy tool.
Devaluation lowers the cost of a nation’s exports,
potentially shrinking trade deficits.
STRATEGY BEHIND
DEVALUATION
By making its currency cheaper, a country increases the
global competitiveness of its exports. Simultaneously, imports become more
expensive, discouraging foreign purchases.
This approach is often used to address trade imbalances and
improve the balance of payments.
While a strong currency may signal economic health, a weaker
currency can drive exports, spur economic growth, reduce trade deficits, and
boost local production as imported goods become costlier.
WHY COUNTRIES DEVALUE
THEIR CURRENCIES
1. To Boost Exports
In a global market, a weaker currency makes a country’s
goods more competitively priced. For example, if the euro weakens against the
dollar, European cars become cheaper in the U.S., potentially increasing
demand.
However, rising global demand may push prices up again, and
other countries may respond by devaluing their own currencies, triggering
“currency wars.”
2. To shrink trade deficits
Cheaper exports and expensive imports improve a country’s
trade balance.
Persistent trade deficits, common among many modern
economies, are unsustainable in the long run and can lead to dangerous debt
levels.
Devaluation can help correct these imbalances, although it
raises the local currency cost of servicing foreign-denominated debt—a major
concern for developing countries with large external obligations.
3. To reduce sovereign debt burdens
Governments with significant sovereign debt may benefit from
a weaker currency. If debt payments are fixed, a devalued currency effectively
reduces their real value.
However, this approach must be handled cautiously, as it can
trigger inflation and hurt countries holding significant foreign-denominated
bonds.
A devaluation will lead to a rise in the domestic costs of
servicing external debt denominated in foreign currency.
Where the liabilities are those of businessmen who do not
benefit much from the devaluation, it may lead to bankruptcy and an attendant
decline in business activity, even when businesses are otherwise sound.
POTENTIAL
CONSEQUENCES OF DEVALUATION
While devaluation can offer economic advantages, it also
carries risks:
It can reduce the efficiency of domestic industries
protected from foreign competition.
It often leads to inflation due to increased import costs
and higher aggregate demand.
It may reduce incentives for manufacturers to innovate or
control production costs.
DEVALUATION AND
INTERNATIONAL TRADE
Devaluation shifts the international trade balance in favour
of the devaluing country by altering the relative costs of goods.
Historically, successful export-oriented economies have
maintained competitive exchange rates.
GLOBAL CASE STUDIES
OF EFFECTIVE DEVALUATION
South Korea (1970s)
Successive devaluations supported by tight fiscal and
monetary policies enabled export-led growth.
These policies were effective due
to high global demand and heavy investment in the export sector.
Brazil (1999)
The Real was devalued by 64 percent without sparking major
inflation, thanks to strict policy controls.
Economic growth rebounded, foreign
direct investment rose by 37 percent between 1998 and 2000, and industry became
the leading growth sector.
Egypt (2016–2017)
The Egyptian pound depreciated by 200 percent amid a shift
to a floating exchange rate.
While inflation surged to 30 percent, the
devaluation helped close the gap between official and parallel exchange rates
and restored foreign exchange reserves.
The policy was supported by a VAT
introduction, energy subsidy cuts, interest rate hikes, and liquidity controls.
