Devaluation or not, that is the question

Just before the elections, and especially after the electoral success of Most, the story about the devaluation of the kuna re-emerged in public and in the economic program of Most as one of the possible reforms or monetary moves of the new government.

If we set aside the fact that the devaluation of the national currency is a monetary phenomenon and a matter of monetary policy, and that the newly elected political-fiscal authority should not interfere in monetary policy without serious reasons, the question arises whether devaluation would make sense and whether it would help the Croatian economy.

I believe that the kuna is a highly overvalued currency and that a certain devaluation of the kuna is necessary and probably unavoidable in the Croatian economic context, even if only in the form of a long-term decline in the purchasing power of the population if the HNB attempts to artificially maintain its current high exchange rate in the long term. However, before Croatian exporters start celebrating my approach, it should be noted that devaluation is a bad solution in itself. It is a pure monetary illusion because without serious structural reforms in Croatia, devaluation would only worsen existing problems. Moreover, any positive effect of devaluation, if structural reforms are not implemented, would remain marginal, if it even exists at all.

This is confirmed by the recent devaluation of the Russian ruble, which devalued by more than 60% against the US dollar and other world currencies mainly due to falling oil and gas prices during 2015. However, this did not help Russian exports because in the age of globalization and high technologies, to compete in the global market, one needs to have finished products and services that can then be sold cheaper when the national currency devalues and when they should become more competitive. But if such high-quality products and services do not exist or remain completely uncompetitive even after the depreciation of the national currency, then devaluation does not help exports, as is the case in Russia today.

Considering that quality modern products and services for the global market often require significant initial investment and that due to devaluation, the import prices of raw materials and other necessary products increase in order to complete the production cycle and launch the finished product on global markets, the initial effect of devaluation can be very negative, and the long-term effect depends more on the effectiveness of structural reforms than on devaluation.