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.
