Devaluation and depreciation are two different economic and financial terms that are wrongly used interchangeably. A clear-cut understanding of the difference between both terms would provide a better guide on their usage.
Devaluation occurs when a country makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate regime; while depreciation refers to a situation when there is a fall in the value of a currency in a floating exchange rate. Currency depreciation can occur due to factors such as economic fundamentals, interest rate differentials, political instability, or risk aversion among investors.
A fixed (or pegged) rate is a rate the government (central bank) sets and maintains as the official exchange rate e.g. the value of the Pound Sterling fixed against the Euro at £1 = €1.1 In a semi-fixed exchange rate, the rate is allowed to fluctuate between a specified range before an institution, usually a central bank, will intervene. For example, the Pound Sterling could fluctuate between a target exchange rate of £1 = €1.05 – €1.15.
A Floating Exchange Rate: This is when the government does not intervene in the foreign exchange market but allows market forces to determine the level of a currency.
While devaluation is the deliberate downward adjustment of the value of a country’s currency by the government through the Central Bank, depreciation on the other hand is similar but arising from the effect of the demand and supply forces.