Devaluation in Developing Countries

The purpose of this paper is to study the effects of a devaluation on the economic variables of major concern in a non-oil producing developing country. The question of whether a devaluation can be expected to produce effects similar to those experienced in industrial countries is of considerable practical interest. For example, the International Monetary Fund has frequently been criticized for recommending devaluation in developing countries faced with non-transitory current account deficits. Opponents of devaluation point to the rudimentary economic structure of these countries and take the empirical fact that terms of trade are usually exogenous to these countries (with few exceptions) as an indication of the impotence of devaluation to redress the current account. The only clear-cut effect of devaluation would then be a rise in domestic prices. In this paper, I argue that even when the terms of trade remain unaffected, devaluation can have strong effect on the domestic relative price structure and thus on the sectorial allocations of resources, on development of the economy, and on the current account.