Difference between Devaluation and Depreciation

Devaluation and Depreciation are two examples of a situation when the value of domestic currency falls in terms of foreign currencies. Even though both include a reduction in the value of domestic currency, the way in which it happens is different.

What is Devaluation?

Devaluation means deliberately reducing the value of a currency in terms of another currency using the fixed exchange rate system. For example, if 1 USD = 80 INR, the US Dollar is 80 times stronger than Indian Rupee. However, if the Indian treasury devalues its currency using the fixed exchange rate system to 82 INR, the US Dollar can buy more INR and the Indian consumer will have to spend more Indian Rupees to purchase goods with US denomination ($).

A country devalues its currency because of various reasons. One of them is to boost its exports. By devaluing the domestic currency, a country tries to make imports more expensive and exports more attractive.

What is Depreciation?

Depreciation means a decrease in the value of a currency due to forces of demand and supply in the market using the flexible exchange rate system. The value of a domestic currency will fall when its supply in the market increases and demand falls. There are various factors that cause the depreciation of a currency. For example, if the Indian export of Rice fall due to some environmental issue (like rain) affecting the rice crops, the Indian Rupee will depreciate in value. It is because, when India exports, it obtains US Dollars and supplies the USD to obtain Indian Rupees, which ultimately creates a demand for Indian Rupees. Now, when exports reduce, the demand for Indian Rupee will fall, resulting in its value to depreciate, and making it expensive for foreign buyers in terms of their currency.