Revaluation

Revaluation — an increase in the rate of foreign exchange. A country buys foreign currency at a cheap price and imports the foreign goods. At the same time, the competitiveness of exported goods on the world market is declining, while imports are increasing.

What is Revaluation 

Revaluation is a method to regulate the national currency. It is necessary to distinguish between revaluation and deflation. Both processes are characterized by the strengthening of the national currency. However, the revaluation means its growth in the external market, and deflation is a growth in the domestic market. The purchasing power of money increases and prices fall. Enterprises are working at full capacity, but demand is falling. Producers are forced to cut prices to sell off the surplus, and then reduce output. This leads to job cut and rising unemployment.

Revaluation is a way to protect the interest of exporters. Revaluation is also used to fight inflation and curb the growth of surplus on the balance of payments. Before the gold standard, revaluation required an increase in the amount of the precious metal to which the country's currency was pegged. Under the Jamaica agreement regulating the current monetary system and a floating exchange rate, the Central Bank's currency intervention and a change in the key rate became the main instrument.

Consequences of Revaluation 

The short-term effect of revaluation is typically positive. The government can acquire foreign assets, purchasing power grows, and foreign goods become available. Buyers of nationally produced goods remain in the domestic market.

However, there is also a negative side. Domestic producers can’t compete with cheap foreign goods and companies have to close. The unemployment and social tension grow as the country becomes dependent on foreign producers. Tourist flow decreases as the voyages in this country are expensive for them due to the losses in exchange. So, the revaluation can easily turn to devaluation. 

That's why artificial revaluation is a rare emergency measure. A sharp strengthening of the national currency can be more dangerous than devaluation.

Positive and negative sides of revaluation:

Revaluation in History

Several cases in history proved the negative influence of revaluation. In 2015 the Central Bank of Switzerland canceled the upper limit of the exchange rate. Then, the rise of the Swiss currency followed, and the franc became very expensive.

At first glance, this is a positive decision, but as a result, the Swiss National Bank lost several billion dollars. Such a significant rise in the exchange rate was a serious shock to the entire export industry. The stock market fell as a result, and the income from tourism decreased.     

Another example is a revaluation of the yen in 1998. In general, the yen has been constantly growing since the 60s, and this growth was quite natural. The Bank of Japan regularly took measures to stop this growth. In 1998 after the world financial crisis, the yen had sharply grown against the American dollar in three days. For an export-oriented country such as Japan, such an appreciation of the yen was a serious shock.

How to Forecast Revaluation

Big Mac Index is one of the well-known methods to predict revaluation. This indicator is based on the guess that a fair exchange rate equals the value of a commodity bundle in different countries (ratio of exchange rates). Big Mac Index is a non-official way to define the purchasing power parity.

The experts took a big mac as an example because this dish includes enough categories of food (meat, bread, vegetables, cheese), and McDonald's is present in the majority of countries. The value of a big mac in each country depends on the volume of production, rental prices, raw materials, labor, and other factors. This method allows you to see the discrepancy between the value of currencies in countries with a similar level of income, especially in a crisis, when an expensive currency is unprofitable. A weak currency gives an advantage in terms of costs and product prices.

Nevertheless, this theory has disadvantages. McDonald's is a private company, and it can define the price of production based on numeral factors. Also, other factors influence the price of big mac: income level of the population and its purchasing power, level of tax deductions in a particular country, product promotion company, competition, and price offers of other companies. That’s why it is better to apply the complex methods and compare the price for the raw materials, semises and other goods which are priced by the market and not by a private company.