What it means
Depreciation occurs under floating exchange rates, where the price of a currency is set by trading. It differs from devaluation, which is a deliberate downward reset of an officially fixed rate announced by a government or central bank.
Currencies usually weaken for identifiable reasons. Interest rates that are low relative to other countries, persistent trade deficits, high domestic inflation eroding purchasing power and political instability all push in the same direction, as does a general flight of investors towards safer markets.
For businesses the effect divides sharply. Exporters and companies earning foreign revenue gain, because each unit of foreign currency converts into more local currency, while importers, foreign-currency borrowers and companies buying overseas software or services face immediate cost increases.
The wider economic effect is imported inflation. When a country buys energy, food or components from abroad, a weaker currency raises the price of those inputs across the whole economy, which is why central banks often raise interest rates when their currency falls quickly.
The arithmetic is again reciprocal and catches people out. A 20% depreciation does not raise the local cost of imports by 20%: it raises it by 25%, because 1 divided by 0.80 is 1.25.
Managed carefully, a gradual depreciation can help an economy rebalance towards exports. A rapid, disorderly one is a different matter, since it undermines confidence, raises the cost of foreign debt and can tip into a full currency crisis.
In practice
Real-world examples.
Example
A furniture maker exporting 60% of its output sees its currency fall 12% against the dollar. It holds its dollar prices steady, gains market share against higher-priced rivals, and reports its strongest gross margin in six years.
Example
A domestic airline is hit twice by the same move. Jet fuel is priced in dollars and most aircraft leases are dollar-denominated, so a 15% depreciation raises two of its three largest cost lines while ticket prices stay in local currency.
Example
A grocery chain in an economy with a steadily weakening currency shifts its buying towards local producers. Imported lines fall from 45% of the range to 28% over two years, reducing the cost impact of further currency moves.
Think of it
“Currency depreciation is your currency getting weaker-buying less foreign currency.
Formula
Calculation
Depreciation % = (old value - new value) / old value x 100, where value is the amount of foreign currency one local unit buys
A country's currency starts the year worth $0.25 per unit and ends it worth $0.20 per unit.
Depreciation = ($0.25 - $0.20) / $0.25 = 0.20, or 20%
Take an exporter selling a product for $50 in the United States. At the old rate that was $50 / $0.25 = 200 local units of revenue per item. At the new rate it is $50 / $0.20 = 250 local units, an increase of 50 units, or 25%.
Now take an importer buying $2,000,000 of components a year. The old cost was $2,000,000 / $0.25 = 8,000,000 local units. The new cost is $2,000,000 / $0.20 = 10,000,000 local units, an increase of 2,000,000 units, again 25%.
Both figures move by 25% rather than 20%, which is the reciprocal effect: 1 / 0.80 = 1.25.Case study
Seen in the real world.
Bramlyn Components is a fictional car parts manufacturer used purely as an illustrative example. Its currency depreciated 18% against the euro over a year, and the sales director initially treated this as excellent news, since 65% of output went to European assembly plants.
The finance team's analysis told a more complicated story. Around 40% of the cost of goods sold was imported speciality steel and electronic parts priced in euros and dollars, so the gain on the revenue side was substantially offset on the cost side, and the true margin improvement was closer to three percentage points than the fourteen the sales director had assumed.
In this illustrative case Bramlyn made two moves. It renegotiated steel supply to a local mill for the lower-grade components, cutting imported input costs from 40% to 26% of cost of goods sold, and it began selling forward six months of euro receipts so that a reversal in the exchange rate would not remove the benefit before contracts could be repriced. Margin improved by around five percentage points over the following year and, more importantly, became predictable enough to quote on.
Watch out
Common mistakes.
- Using depreciation and devaluation interchangeably. Depreciation is a market movement under a floating rate, while devaluation is a policy decision to reset a fixed rate downwards.
- Assuming exporters automatically benefit. If imported inputs make up a large share of costs, most of the revenue gain is cancelled out before it reaches the bottom line.
- Applying the headline percentage directly to import costs. A 20% fall in the currency raises the local cost of foreign goods by 25%, because exchange rates work in reciprocals.
Questions
People also ask.
Is a weaker currency good or bad for an economy?
Both: it supports exporters and tourism while raising the price of imports and any foreign-currency debt, so the net effect depends on the structure of the economy.
What is the difference between depreciation here and depreciation in accounting?
They share a word and nothing else, since accounting depreciation spreads the cost of an asset over its useful life and has no connection to exchange rates.
How should a small importer respond to a falling currency?
By fixing prices with suppliers where possible, buying forward cover for known future payments, and testing how much of a further fall the business can absorb before prices must rise.
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