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Rupee devaluation to reduce sovereign debt burdens

Rupee devaluation to reduce sovereign debt burdens

ISLAMABAD: The Finance Ministry has high hopes that recent currency devaluation will reduce the sovereign debt burdens on the national economy. On Tuesday, the buying and selling rate of one dollar was Rs 118.80.

“A government may be incentivized to encourage a weak currency policy if it has issued sovereign debt to service on a regular basis. If debt payments are fixed, a weaker currency makes these payments effectively less expensive over time,” official sources at the Finance Ministry told Customs Today on Tuesday.

“Take for example a government who has to pay $1 million each month in interest payments on its outstanding debts,” the sources said, adding that if that same $1 million of notional payments become less valuable, it would be easier to cover that interest. In our example, if the domestic currency is devalued to half of its initial value, the $1 million debt payment will only be worth $500,000 now.

“Again, this tactic should be used with caution” the source said adding that as most countries around the globe had some debt outstanding in one form or another, a race to the bottom currency war could be initiated. This tactic will also fail if the country in question holds a large amount of foreign bonds since it will make those interest payments relatively more costly.

Persistent deficits are not uncommon today and many other nations running persistent imbalances year after year” the source added saying that economic theory, however, stated that ongoing deficits were unsustainable in the long run and could lead to dangerous levels of debt which could cripple an economy. Devaluing the home currency can help correct balance of payments and reduce these deficits.

There is a potential downside to this rationale; however, devaluation also increases the debt burden of foreign-denominated loans when priced in the home currency. This is a big problem for a developing country which hold lots of dollar- and euro-denominated debt. These foreign debts become more difficult to service, reducing confidence among the people in their domestic currency.