Changes in a Country's Currency

 

 

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euters on 4^th May 2020 reported that Iran’s parliament had passed a bill to slash 4 zeros from its currency Iranian Rial (Rial) and the currency will now be changed to Toman, which will be equal to 10,000 Rial.

This process is called Re-denomination of a currency.

There are following changes which are made with reference to a currency:

1.   Re-denomination

2.   Depreciation and Appreciation

3.   Devaluation

4.   Demonetization

1. Re-denomination

Meaning: Re-denomination is the process done by a country to adjust the value of its currency or to adopt a new currency at a fixed exchange rate with respect to the old currency.

Iran’s case: Iran is doing both, adjusting the value of its currency as well as changing the currency. It is adopting Toman as its new currency and the value of 1 Toman will be, as written above, equal to 10,000 Rials.

This effectively means, for example, that the 100,000 Rial banknote, the highest value banknote in Iran will just be equal to 10 Toman.

The bill for adjusting and changing the currency was approved by Iranian cabinet in August 2019. It has been passed in the Parliament of Iran, known as the Islamic Constituent Assembly on 4^th May 2020. Now it awaits the approval of the 12 member Guardian Council before the new currency comes into effect. The Central Bank of Iran will then phase out the existing currency and bring in the new currency in circulation over a period of next two years. Till that time, both the new and the old currencies will run concurrently.

The plan for re-denomination in Iran had started in 2008, with issue of traveller cheques of 500,000 Rials and 1000,000 Rials, with 50 and 100 mentioned on the cheques, respectively. But with recent sanctions on Iran to sell oil and gas by the US led to inflation and depreciation of Rial, thus making redenomination even more necessary.

Causes of Re-denomination

Re-denomination of currency is done due to the following reasons:

a)  Inflation or Hyperinflation: When prices of goods and services increase over time, the economy is said to be going through inflation. It is measured in percentage. It is measured as the rate at which price of selected goods increase over time. For example, 1 Kg rice is Rs. 100 and the next year it increases to Rs. 105, inflation is 5%. Inflation is a regular and normal thing to happen in an economy. However, when this rate is very high, the value of currency reduces as more amount spent gets you only little quantity of goods or services.

In case of Iran, as per IMF, inflation is at 34% for the year 2019-20.

In case of hyperinflation, the price rise is rapid and uncontrolled. It is said to happen when prices rise at the rate of more than 50% per month over a period of time.

In Zimbabwe new Zimbabwean Dollar (ZWR) was introduced at 1 ZWR = 1 Trillion ZWL (Old Zimbabwean Dollar). This was done to fight hyperinflation because the hundred trillion Dollar banknote had the value equal to mere USD 5 and was barely enough to buy two loaves of bread.

b)  Currency Union: When a few countries decide to collectively agree to use one single currency as their legal tender, it is called currency union. Introduction of Euro as the currency of European Union (EU) in 1999 is an example of currency union. In this case the existing currencies of participating countries of EU were adjusted in terms of Euro, for example in 1999, for Belgium, 1 Euro = 40 Belgian franc approximately.

2. Depreciation and Appreciation

This is what we all can relate to the most because we all see forex rate fluctuations in news daily.

Meaning: Depreciation is the fall in the value of a currency in a floating exchange rate system. As opposed to this, the rise in value is called appreciation.

The appreciation and depreciation of a currency are not regulated by the government but depend on market forces of supply and demand and certain other factors.

For example, if today 1 USD = Rs. 70 and tomorrow 1 USD = Rs. 75 then the Indian Rupee is said to be depreciated. Depreciation of currency makes exports cheaper but also makes the currency weaker in international market and the imports get costly as the importer will have to pay more Indian Rupees to get 1 USD to import goods.

On the other hand, if 1 USD = Rs. 70 and tomorrow 1 USD = Rs. 65 then the Indian Rupee is said to be appreciated.

This makes the currency stronger in the international market and makes imports cheaper because less amount is to be paid to get 1 USD to importer but now exports get less forex.

Causes: The market forces depend on factors such as stability of the country’s economy. If the country’s economy is weak, the currency will depreciate because foreign investors would not like to invest in the country and this will lead to less forex inflow.

3. Devaluation

Meaning: Devaluation is the official lowering of currency by the government in terms of another currency in a fixed exchange rate system.

Fixed exchange rate: When a country’s currency is linked to move in tandem with another currency, it is said to follow fixed exchange rate. The proportion is adjusted by the government periodically.

It should be noted that though the effect of devaluation on exports and imports is the same as of depreciation but in devaluation, the exchange rate is reduced by the government, being in Fixed Exchange Rate whereas in depreciation happens in a currency following Floating Exchange Rate and depends on market forces.

4. Demonetization

People in India are well versed with this term now as it took place in our country in November 2016.

Meaning: Demonetization is the process of cancelling the status of legal tender for a currency banknote or coin in a country.

It should be noted that demonetization is a part of redenomination but that may not always be the case.

For example, in the 2016 demonetization in India, new currency wasn’t introduced, just the new banknotes were introduced.

Other than re-denomination, the other objective of demonetization is to bring the unaccounted money to books. This is achieved by replacing the old currency notes/ coins with new ones, which is done through banks.

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